How are EM investors navigating 2025's policy minefield?

Emerging market debt investors will need to tread carefully in 2025 amid heightened policy uncertainty.

Local currency rate differentials offer limited appeal, while frontier markets look at risk in the medium-term amid higher future refinancing needs and the U.S. reconfiguring the bilateral and multilateral development architecture.

Hard currency in EM could well be a safer bet, particularly if dollar strengthening has peaked and leads to a recovery in issuer repayment capacity as currencies appreciate. Still, segments of large EM are exposed to tariff war broadsides.

Fitch sees the macro-credit EM outlook for 2025 as neutral on balance. Gross financing needs are moderate, and most central banks look set to continue easing policy. On the other hand, geopolitical risks and strains on public finances remain challenging.

Local Currency

U.S. Treasuries had a higher average yield than those on EM local currency sovereign bonds in December-January, highlighting the competition LC fixed income instruments face from their developed market peers.

This has led some fund managers to favor hard over local currency bonds in EM, as LC bond funds experienced nearly $1 billion in outflows in January.

JPMorgan is underweight on LC, noting that risk premiums have yet to build up, while short sellers have built up positions against LC EM sovereign debt via an ETF.

Some investors see value in local currency bonds - including in the corporate segment - in stable EMs such as South Africa, Mexico, and Brazil, pointing to attractive real interest rates.

Turkish companies that can manage currency volatility could be attractive, while Argentine corporates are viewed less favorably.

Low currency valuations in Latin America offer some LC upside, despite projected volatility.

There may also be LC opportunities in FMs, including in Kenya and Côte d’Ivoire, given cheap valuations and improving credit profiles.

FMs offer some insulation from trade tensions with the U.S. and other diversification benefits, though they are exposed to cuts in bilateral aid and concessional financing.

Frontier Markets

Lazard recently stated that credit metrics for FMs point to a structural weakening, especially in Africa.

There are heightened risks that these governments will have trouble paying their debts in the medium term.

While the 2025 refinancing profile is modest for FMs, these countries have larger repayments due over 2026-2028.

Still, the near-term risks to FM are very real, as a result of Trump-Musk policies to cut bilateral aid and which are also poised to hollow out IFI support for these countries.

Case in point: Ghana is scrambling to fill a $156 million hole left by the USAID pullback.

China

Nevertheless, imbalances in China’s economy look set not only to persist but to grow, with few prospects of resolving the over-investment-driven property bubble.

With Chinese export volumes rising at three times the rate of global trade, Xi’s trade policies are coming at the expense of manufacturing sectors elsewhere.

All told, Trump’s unpredictability, aversion to trade, and misguided tariffs won’t mix well with ongoing Chinese reliance on export dumping.

If the U.S. shuts the door on China, other countries won’t be able to absorb much Chinese overcapacity, clouding the near-term outlook for Beijing.