EM local bonds gain favour as dollar debt lags

Emerging-market investors are for now sticking with local-currency sovereign debt as surging Treasury yields dim the appeal of dollar-denominated developing-nation bonds.

Behind the strategy are attractive valuations and the potential to profit from carry trades, where investors borrow in low-yielding currencies to invest in higher-yielding assets.

Read more: JioBlackRock CIO Rishi Kohli decodes Nifty’s inflection point after two years of weak returns


The preference is showing up in fund flows, positioning and relative performance. A Bloomberg gauge of domestic EM debt has beaten an index of dollar-denominated bonds by more than three percentage points since the end of June, set for the biggest quarterly outperformance since 2022.

Fund managers are leaning into that divergence too. A Bank of America Corp. survey of 38 global fixed-income fund managers overseeing $444 billion in combined assets showed that 84% of the respondents were overweight local EM debt relative to hard currency bonds, versus just 38% in August. The poll was conducted between Sept. 4 and 9.

The trade could still be tested after the Federal Reserve raised interest rates and signaled it may do so again. A renewed advance in the dollar could turn investors away from emerging-market assets such as local-currency debt.

Read more: Will Nifty extend gains to 4th session on Monday? US sanctions on Russia among factors to decide D-Street action

“Current valuations lead us to favor local-currency debt over hard currency debt at this stage of the cycle,” said Diliana Deltcheva, London-based head of emerging-market debt at Dutch investment firm Robeco. Local markets continue to offer a broader set of opportunities, while spread tightening for hard-currency bonds “appears increasingly limited,” she added.

So far in September, investors have pulled out more than $800 million from the $14 billion iShares JPMorgan USD Emerging Markets Bond ETF — the largest exchange-traded fund for the category. That’s set to be the biggest monthly outflow since March.

In comparison, the $5 billion VanEck JPMorgan EM Local Currency Bond ETF — the largest for this category, has lured about $41 million so far this month, adding to August’s inflow of $294 million.

With US Treasuries offering higher yields, investors have less incentive to take on the additional credit risk of EM dollar debt. And, the extra yield investors get for holding EM dollar bonds over Treasuries is near its lowest level in almost two decades, according to data compiled by Bloomberg. The spread stands at 1.69 percentage points, not far from the low of 1.53 in June.

“I prefer EM local currency bonds to EM dollar debt over the next few months, but would take a selective approach rather than seek broad index exposure,” said George Efstathopoulos, a portfolio manager at Fidelity International. “I favor Latin America, particularly Brazilian local currency bonds, with a focus on the front end of the curve,” supported by attractive carry and real yields, he added.

Robeco’s Deltcheva also said Latin America offers high real yields and remains in a strong position to attract capital.

The dollar remains a key fault line for the trade, with EM local-currency bonds increasingly moving in the opposite direction to the greenback. The 120-day correlation between a Bloomberg gauge of the securities and the Bloomberg Dollar Spot Index stands at around -0.51, the most negative in about a year. The dollar index climbed 1.1% last week, the most since early June.

That said, developing-nation currencies have provided investors with a cushion. Up 3.7% in 2026, the MSCI Emerging Markets Currency Index is on course for a second straight annual gain.

“Local-currency bonds possess considerable attractiveness given the combination of massive improvements in central bank credibility, the reduction in inflation expectations, the advancement of foreign direct investment and the amelioration of balance of payments figures,” said Jason Devito, a senior portfolio manager for emerging-market debt at Federated Hermes Inc. “This has become ever more apparent so far in 2026.”

Meanwhile, the yield on benchmark 10-year Treasuries climbed to the highest level in almost two decades ahead of the Fed’s rate hike last week, deepening a monthslong global bond selloff sparked by worries over sticky inflation, elevated government spending and massive corporate borrowing to fund the artificial intelligence buildout.

A further increase in US yields could deepen the pressure on EM dollar-denominated bonds, whose valuations are directly exposed to moves in Treasuries.

Higher US Treasury yields could create additional pressure on EM hard currency bonds if they materially increase refinancing costs, said Harry Richards, a fixed-income investment manager at Jupiter Asset Management. “Weaker sovereign and corporate issuers would be most exposed, particularly where debt-servicing capacity is already constrained.”