After a 15% Gain, Traders See Fed Cuts Powering EM Bond Rally

Money managers and market strategists are increasingly wagering that the Federal Reserve’s pivot back toward interest rate cuts will inject fresh momentum into the strongest emerging-market bond rally seen in years.

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So far this year, a benchmark tracking local-currency government debt from developing nations has delivered a 15% return in dollar terms. That puts it on pace for its best performance since at least 2017. The rally gained traction after former President Donald Trump’s trade war and the Fed’s rapid policy shifts raised doubts about the U.S. economy’s strength, prompting investors to diversify into other markets.

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With the Fed resuming rate cuts after a nine-month break, investors are finding even greater motivation to chase yields outside the U.S. Local currency bonds which benefit further if the dollar continues to weaken are now top picks for major firms like Jeffrey Gundlach’s DoubleLine Capital and JPMorgan Asset Management.

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Neuberger Berman is leaning into emerging-market currencies and debt, while Bank of America argues there’s “no alternative” this year that can match the appeal of EM carry trades, where investors borrow in low-rate economies and invest in higher-yielding assets.

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“There’s definitely clear demand for non-dollar opportunities,” said Patrick Campbell, portfolio manager at Morgan Stanley Investment Management. “We’re seeing renewed appetite for EM local strategies we haven’t observed since 2012.”

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These positioning shifts reflect the expectation that Fed easing will keep downward pressure on the dollar, enhancing returns from bonds tied to appreciating currencies. They may also energize carry trades that involve borrowing in the U.S. “The Fed’s actions support the outlook for a weaker dollar and lower global rates,” said Nathan Thooft, senior portfolio manager at Manulife Investment Management. “Both trends are favorable for emerging-market stocks and bonds.”

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The surge in EM assets was also fueled by Trump’s unpredictable tariff announcements, which earlier this year sent the dollar tumbling at its fastest pace since the early 1970s. At the same time, many developing nations maintained relatively higher interest rates, as their central banks hesitated to cut too aggressively due to inflation concerns.

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The result: emerging-market sovereign debt has outpaced nearly all other fixed-income categories. The 15% return is more than double that of U.S. high-yield corporate bonds and far above the 5.4% gain in the Bloomberg U.S. Treasury Index. Brazil, Mexico, Colombia, Hungary, and South Africa have led the charge, each delivering at least 23% gains this year.

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Of course, the rally’s size could limit room for further upside. A rebound in the dollar whether from scaled-back Fed rate-cut expectations or rising geopolitical risks — could dent sentiment. Earlier selloffs in Turkey and Argentina’s recent financial turmoil, which forced its central bank to draw down reserves, highlight how quickly politics can shake emerging markets.

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Still, analysts believe the Fed’s latest policy shift, coupled with signals of more cuts ahead, will overshadow those risks. If developing-country central banks follow the Fed’s lead, that could provide another lift to their bonds. Real yields in countries like South Africa and Colombia remain attractive enough to keep drawing in carry-trade flows.

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On average, emerging-market debt has returned between 6% and 8% in the aftermath of Fed rate cuts, according to Iain Stealey, international CIO of fixed income at JPMorgan Asset Management. His team’s JPMorgan Global Bond Opportunities fund continues to overweight EM positions.

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At DoubleLine, portfolio manager Valerie Ho said the firm has been building exposure to Brazil, South Africa, and Hungary markets likely to benefit from the Fed’s pivot and dollar weakness. “Given the current backdrop, we’re comfortable maintaining those positions,” she noted.

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The rally has also been pulling in steady investor cash. In the week ending September 17, EM debt funds attracted roughly $300 million, marking the 22nd consecutive week of inflows, according to EPFR data compiled by Bank of America. Year-to-date, net inflows have reached $45 billion.

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Not every manager is going all in, however. At PGIM Fixed Income, Cathy Hepworth has trimmed exposure to hard-currency debt after this year’s strong run. Even so, the head of EM debt still maintains a short-dollar bias and overweight stance in higher-yielding currencies. “The environment remains supportive for emerging markets,” Hepworth said. “The direction of travel is clear.”

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