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Emerging Market Debt Off to a Strong Start

With the market continuing to look favourably on risk assets, emerging market debt (EMD) could offer a combination of positive performance and local currency, which despite the continued strength of USD, has performed well this year.

18. Februar 2025 5 min read

Jason Simpson

Senior Fixed Income ETF Strategist

The market continues to look favourably on risk assets, with most equity markets performing well so far in 2025. In fixed income, high yield and convertible bonds have also posted positive returns and, perhaps more surprisingly given the resilience of the US dollar, so has emerging market (EM) debt.

The Bloomberg EM Local Currency Liquid Government Index has returned 2.34% as of 12 February, versus just 0.34% for the Bloomberg Global Aggregate Index. Robust returns from Brazil and Columbia (10.3% and 10.8%, respectively) have supported performance, largely as a result of rebounds in their currencies. Currency performance accounted for the majority of overall index returns — 141 basis points (bps) — against 90 bps for bond price returns and 55 bps from coupons.¹

The only country in the Bloomberg EM Local Currency Liquid Index to post negative overall performance was India at -0.82%. India was added to Bloomberg EM Local Currency indices as at January 2025, so it only accounts for 1% of the index currently, and so offered little drag. For the J.P. Morgan indices, weights are higher given inclusion began in June 2024.

The USD is currently 14.3% overvalued against the currencies that make up the Bloomberg EM Local Currency Liquid Government Index.² There appears no imminent catalyst for a broad decline against other currencies, either, with firm US growth and still-resilient inflation restraining the Federal Reserve’s ability to lower rates. The US dollar does not appear to have been adversely impacted by increased uncertainty around the imposition of tariffs, which has clouded the outlook for local currency exposure.

Focus on Hard Currency

Investors who see a material risk that the USD will stay stronger for longer, hard currency exposures may offer the prospect of more stable returns. The J.P. Morgan EMBI Global Diversified Index has returned 1.58% YTD. Most of this return has come from spread tightening in the high yield space³ with issuers such as Lebanon, Venezuela, and Ukraine all posting double-digit returns. However, the spread of the high yield component of the J.P. Morgan EMBI Global Diversified Index is now at its tightest since early 2020, which may act as a headwind to further gains.

An alternative strategy could be to focus on higher quality EM paper that benefits from a yield pick-up to US Treasuries but should be less exposed if the market loses its appetite for risk.

Saudi Arabia is a fast-growing low-deficit country. The IMF is projecting growth of over 4% over the next four years as it diversifies its economy, and a deficit-to-GDP ratio of just over 35% in 2029⁴. It has recently been upgraded to Aa3 by Moody’s and offers a yield-to-maturity of close to 5.5%, around 100 bps above US Treasuries.

The J.P. Morgan Saudi Arabia Aggregate Index is a combination of both hard currency (78%) and local currency (22%) issuance. Importantly, given the Saudi Arabian Riyal (SAR) is pegged to the USD, the index has very similar characteristics to a regular hard currency index. Local currency is included for three reasons:

Diversification. Only local bonds issued since January 2023 are included in the index. Notably, the annualised volatility of the index has dropped from 9.14% over the past five years to 6.24% over the 12 months to 31 January.⁵ The Saudi Arabia Aggregate Index is relatively well correlated to broader hard currency bonds (81%) but much less to local currency (54%) or US Treasuries 64%).⁶ As Figure 1 shows, its higher credit rating makes it less sensitive to swings in the broader hard currency market, with a beta of 77%.
Yield enhancement. Yields at the front end of the curve are higher for local currency issues than for USD-denominated ones. Local currency bonds out to 10 years in maturity provide a yield pick-up of 18 bps versus the equivalent segment of the hard currency index.
Index inclusion. Foreign ownership of Saudi Arabia local currency bonds is relatively low given accessibility issues. But, as demonstrated by the strong inflows into both Chinese and Indian bond markets ahead of their inclusion in broader EM indices, demand could rise if J.P. Morgan or Bloomberg decide that the local currency market is suitably liquid and developed to include in their indices.

Figure 1: Saudi Arabian Bonds Less Sensitive to Market Moves Than the Broader Hard Currency Index

Investing in EM Debt With SPDR ETFs

EMDL SE

SPDR® Bloomberg Emerging Markets Local Bond UCITS ETF (Dist)

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Footnotes

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