Emerging market (EM) bonds are currently outperforming Treasuries, largely due to a resurgence in carry trades. This trend is fueled by surging crude oil prices, which are bolstering commodity-exporting EM currencies and reinforcing expectations of elevated interest rates. An index tracking the emerging market carry trade has jumped approximately 2.6% from its March low and about 1.2% since the Iran conflict began in late February. This strategy involves borrowing in low-yielding currencies like the Japanese Yen, Swiss Franc, and Chinese Yuan, then investing in higher-yielding EM currencies such as the Brazilian Real and South African Rand. Strong performance is noted across Latin America and Africa, with several issuers in these regions delivering over 9% year-to-date returns.
The strength in EM bonds is further supported by factors such as a stronger US dollar, high oil prices, and credit rating upgrades stemming from structural reforms in some countries. For instance, Argentina's hard currency bonds have outperformed, rallying after a credit rating upgrade. Venezuela has also seen high returns, reflecting optimism about its future given new leadership and debt restructuring efforts. While global aggregate bonds show a modest 1.15% year-to-date return, and US aggregate is at 0.62%, global emerging-market sovereign bonds boast a 3.38% return, with a yield-to-worst of 6.9% as of June 30, 2026.
Despite potential concerns about Federal Reserve hawkishness, foreign investors are increasingly drawn to Asian emerging market bonds. Combined inflows into Thailand, Indonesia, India, and Malaysia reached an over two-year high of $8.2 billion in June. This resilience is attributed to regional central banks maintaining elevated interest rates and the bonds showing less sensitivity to US Treasury movements, with the 30-day correlation between five-year US and similar-dated emerging Asia yields around 0.04, compared to higher correlations in EMEA and Latin America. Strategists anticipate that Asia's hawkish policy outlook will continue to bolster demand for local-currency debt, with net bullish sentiment towards Asia at 13% among investors.
The carry trade strategy significantly contributed to strong EM returns in 2025, with one Bloomberg measure showing a 17% gain, the largest since 2009. This momentum is expected to continue into 2026, as ebbing foreign exchange market volatility and a weak US dollar provide a conducive environment. Although oil prices temporarily reverted to pre-war levels after the US-Iran deal in mid-June, analysts still foresee Asian central banks maintaining a hawkish stance due to persistent underlying inflation. High-carry, non-US dollar currencies and emerging market debt are highlighted as attractive alternative income and diversification sources, reducing reliance on the AI-led narrative.
