As we progress into 2025, a global rate cutting cycle and resilient growth point toward solid EM bond returns. Looking beyond the tailwinds for next year, investors in frontier and emerging markets are facing a changing environment—in large part driven by policy and political developments in larger markets.
Key among the changes is that investors can no longer rely on structurally dovish-leaning developed-market central banks to support the emerging-market carry-trade. Newfound fiscal largesse, and the changing contours of globalization, with redrawn global supply chains and demographics, are likely to fuel inflation uncertainty in developed markets.
Not only will the risk of structurally higher inflation prompt central banks to be less dovish on average in the years to come, it will make them more reactive, so rate-cutting cycles should be shorter, but also more frequent.
At the same time geopolitical risks remain elevated, so we expect global risk appetite will become more volatile, which will create a more tactical market environment.
The frontier advantage
In an uncertain global policy environment, investors can benefit from the fact that frontier markets are generally uncorrelated, underinvested and underrated compared to larger bond segments. Frontier markets offer unique diversification and outstanding yields, effectively reducing fixed income portfolios’ sensitivity to these global risks without sacrificing return potential.
Firstly, frontier bonds carry a significantly shorter duration than larger EM fixed income indices and core bond markets. This means that potential losses will be more limited in case core yields rise further amid latent inflation worries. In 2022, when most bond segments suffered severe losses amid soaring inflation, frontier markets had limited losses and a faster recovery compared to mainstream bonds.
Secondly, frontier markets are driven more by idiosyncratic risk rather than global factors. For example, frontier debt exhibits lower correlation with global geopolitical risks than hard-currency EM debt or US high yield. At the same time, frontier debt does not sacrifice return potential: the yield-to-maturity is currently around 14%, offering a comfortable yield cushion.
Reformers reap rewards
We are particularly optimistic about emerging market countries showing decisive fiscal and monetary reform momentum. We have identified a group of BB-rated countries with improving fundamentals that we believe are on a path towards investment grade status, with several likely to come to fruition during 2025.
Further up the risk curve, Turkey stands out for its recent economic policy shifts and punitive forward-looking real rates, which support carry trade opportunities. Ecuador, buoyed by new government policies, and Argentina, which holds potential for a macroeconomic turnaround, are also on our radar.
Witold Bahrke is a senior macro & allocation strategist at impact-focused EM and FM debt investment fund manager, Global Evolution
