Hopes for EM Debt Dashed as Dollar, Fed Cloud Outlook
(Bloomberg) -- What started as a promising year for emerging-market local debt is quickly souring as a strong dollar and a barrage of US tariffs have fund managers rethinking one of their main bets for developing assets.
In the wake of a hawkish Federal Reserve — after pausing interest rate cuts on Wednesday, Chair Jerome Powell said officials are not “in a hurry” to lower — investors are skeptical that a turning point is near. Chile, Sri Lanka and Hungary all held rates last week, citing resurgent inflation risks.
The impact of President Donald Trump’s trade war on the greenback and the global economy is complicating the outlook for emerging markets. Canada and Mexico vowed to hit back after Trump imposed 25% tariffs on imports of their goods, while China vowed “corresponding countermeasures” to his 10% levy on Chinese products.
Even before the tariff threats materialized this weekend, some money managers including Loomis Sayles were already slashing exposure to local-currency bonds from developing nations, which outperformed their dollar-denominated peers at the beginning of 2025. The firm is favoring hard-currency debt in the developing world.
“I’m finding it hard to be excited about EM local,” said Amer Bisat, a managing director and head of emerging markets fixed income at BlackRock Inc. “Without having a directional view on where rates and the US dollar are going to go, the reality is we’re hostages at this stage.”
The caution is evident in recent fund flows and activity from short sellers. Despite small inflows in the past week, investors have pulled nearly a billion from local currency bond funds so far this year, with the biggest outflows during the first week of Trump’s administration. Meanwhile, US short sellers are making the biggest bets in two years against local-currency sovereign bonds in emerging markets in a popular exchange-traded fund.
The yields in local-currency bonds in developing economies are finding hard competition with US Treasuries or hard-currency debt. The average yield for local-currency emerging sovereign bonds has been below that of US Treasuries for the past eight weeks, according to data compiled by Bloomberg.
“There is a concrete case favoring hard over local currency bonds on a risk-adjusted basis,” said Peter Yanulis, who co-manages Loomis Sayles’ EM debt blended total return strategy. “It’s too early to call the turning point.”
Rate Decisions
Much like investors, the uncertainty around US rates and tariff policy is also keeping central bankers on edge. While most developing currencies have gained since Trump took office, they will serve as the “relief valve” for any potential pressure, said Samy Muaddi, head of emerging markets fixed income at T. Rowe Price.
For Chilean officials, soured sentiment on Colombia after the country’s brief tariff spat with Trump added “a layer of uncertainty to the global landscape,” according to strategist Ivan Stambulsky at Barclays. That shrinks the room the central bank has to cut rates without risking a currency sell-off, he said, “and the board appears to have internalized this risk.”
In Colombia, the central bank unexpectedly paused rate cuts Friday due to concerns over the country’s fiscal deficit, inflation flare-ups and tariff threats from the US.
Trade Tensions
Fears that Trump’s economic measures might boost the dollar and fan inflation in the world’s largest economy, cutting the room the Fed has to lower rates, have muddied the waters for developing economies. The specter of higher tariffs is also concerning for export-dependent economies across emerging markets.
JPMorgan Chase and Co. remains underweight EM local bonds, saying rates haven’t built up risk premium like currencies have. But for those who can stomach the volatility, the cheap currency valuations in Latin America provide rooms for outperformance, said Claudia Calich, the head of EM debt at M&G Investment Management.
Vanguard’s co-head of emerging market and sovereign debt Dan Shaykevich has added exposure to currencies in Latin America, Central Europe, and Africa, while remaining cautious on Asian FX.
“When the EM tide finally turns, there is plenty of room for outperformance in a weak dollar environment,” said Loomis Sayles’ Yanulis. “The ball is in Trump’s court now.”
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