Whilst underlying geopolitical issues in the Middle East may not be fully resolved, energy supply risks have decreased following the memorandum of understanding signed between the US and Iran. Assuming the March-May spike in energy prices proves temporary, EM fundamentals should remain sound, featuring resilient growth, contained inflation, interest rates comfortably above inflation, and limited external financing needs, supported by ample foreign-currency reserves. Sovereign credit rating upgrades have outpaced downgrades for the past three years.
EM central banks have been prudent, maintaining a gap between policy rates and inflation. This approach has served policymakers well; barring a few cases, most central banks have not needed to tighten policy in response to the recent energy shock. Given the moderation in energy prices and the resilience of most EM currencies, we anticipate that inflation pressures should be manageable. In the near term, greater uncertainty may stem from changes to the US Fed’s policy approach under the new chair.
Renewed interest in diversification has supported EM assets; investor flows and primary markets have remained steady despite bouts of geopolitical volatility. Over the long term, structural forces continue to benefit EM debt, including stronger growth prospects relative to developed markets and a widening opportunity set 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.
