Market Review

Emerging markets (“EM”) debt indices demonstrated resilience to the ongoing geopolitical uncertainty in May. Yields on hard currency sovereign and corporate credit declined modestly by 0.10% and 0.05%, respectively, versus similar-maturity U.S. Treasuries. Within sovereigns, high-yield rated issuers outperformed investment-grade issuers, though within corporates performance was similar between rating categories. In local currency bond markets, interest rates eased moderately, while EM currencies finished the month roughly flat against the U.S. dollar.

Economic, Political & Market Developments

• Colombia held the first round of its much-anticipated presidential election on May 31. The surprising result was that of far-right candidate Abelardo de la Espriella, who received 43.7% of the vote, an improvement of approximately 12% compared to his latest polling average. Iván Cepeda, the leftist candidate running under the mantle of current President Gustavo Petro, received 40.9% of the vote, similar to his polling expectations. Espriella’s share came at the expense of other conservative and centrist candidates, highlighting a degree of political polarization. The two leading candidates will compete in a second round runoff on June 21. Based on estimates of how voters backing other candidates will shift, along with his momentum from the first round, Espriella is the perceived favorite. Markets reacted favorably to these developments, as there are greater concerns about Colombia’s fiscal and monetary policy trajectory under a Cepeda presidency.

• Turkish politics came back into focus due to a controversial court ruling that voided the 2023 party congress of Turkey’s main opposition party, CHP, thus invalidating the election of CHP chairman, Özgür Özel. Özel had emerged as a political threat to President Recep Tayyip Erdoğan, and the court’s ruling was viewed as politically motivated, given that other courts had previously rejected similar complaints. CHP has been managing an internal leadership struggle, dating to 2025 when popular leader Ekrem İmamoğlu was charged with corruption by the government and taken into detention. The latest events were seen as an effort to further undermine the opposition.

• Bonds in Senegal came under pressure after President Bassirou Diomaye Faye chose to fire his Prime Minister, Ousmane Sonko and reshuffle the government. The former political allies were unable to reconcile their policy differences, some of which center around the economy. Senegal has been searching for a solution to manage the fallout of its “hidden debt” crisis, whereby the previous government contracted debt that had not been appropriately recorded. There is some concern that Sonko, who has since rejoined Parliament and is the political leader of the majority party, could block Faye’s policy decisions, making reform implementation more difficult.

Central Bank Policy Highlights

• The U.S. Federal Reserve is weighing the risks around inflation, which remains mildly above target, and an employment situation that it views as broadly balanced. In their April meeting, Fed officials voted to stay on hold at a 3.5-3.75% policy rate. Resilient economic data and higher energy prices have caused markets to price in a hike over the next year, versus the easing that was priced prior to the Iran conflict. Investors will also be looking for an indication of how newly confirmed Fed Chair Kevin Warsh will view policy settings.

• EM central banks displayed varying reactions to the conditions created by the fallout of the Middle East conflict. Most notably, Indonesian authorities delivered a larger than expected 50 basis point rate hike, as authorities look to get ahead of greater domestic and external economic uncertainty that has caused the currency to depreciate. In South Africa, policymakers implemented an anticipated 25 basis point hike, which they view as precautionary to manage possible second-order effects of higher energy prices. Mexico’s central bank proceeded with a further rate cut, while signaling its recent easing cycle may now be complete.

Source: Bloomberg, Country Sources

Market Outlook

Heading into the U.S./Israel conflict with Iran, EM fundamentals were on a solid footing. Growth was steady, inflation was moderate, real rates were firmly positive, and external accounts were in balance, underpinned by elevated foreign reserves. The primary economic effect of the conflict has been higher energy prices, which is putting upward pressure on inflation and may keep growth subdued relative to prior expectations. However, assuming that tanker transit through the Strait of Hormuz can gradually normalize, the economic effects should be manageable.

Prior to the energy price shock, EM central banks were easing monetary policy, though they remained prudent by maintaining a gap between policy rates and inflation. This approach has served policymakers well, and it may allow central banks to be relatively patient regarding the path of future policy. Combining the view that energy prices will moderate from recent peaks with an expectation that EM currencies should broadly resume appreciation versus the U.S. dollar, we anticipate the inflationary impulse to be limited in most countries.

Renewed interest in diversification has been favorable for EM assets; investor flows and primary markets have demonstrated resilience to the current geopolitical volatility. Over the long term, structural forces continue to benefit EM debt, including stronger growth prospects relative to developed markets and a widening set of investment opportunities across nearly 90 countries, spanning sovereign, corporate, and local market bonds. In our view, EM debt offers value as a strategic allocation, with attractive yields that can generate income over time.

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