The headwinds that plagued emerging market debt (EMD) for most of 2021 and 2022 have broadly become tailwinds— thanks primarily to swift central bank action that has allowed emerging markets to reach peak inflation and begin leveling off rates faster than their developed market counterparts. With risks to the asset class well exposed and fully priced in, today's EMD offers investors the potential for high income with limited downside and favorable diversification.

Global central bank policy rate hikes
Count, 2007–present

Line graph

Source: Bank for International Settlements, Bloomberg, Principal Asset Management. Data as of March 31, 2023.

Emerging market debt (EMD) faced many stubborn challenges in 2022. The post-COVID surge in global inflation, and developed market (DM) central banks’ subsequent scramble to “catch-up”, sent global fixed income assets into a tailspin and strengthened the USD. Furthermore, China’s zero-COVID policy, and its property sector’s serial defaults, hampered economic activity. However, these challenges have largely abated today, and EMD is now reemerging as an attractive option for investors.

  • Central banks in most EMs—who began hiking rates in 2021, well before their DM counterparts—are now considering rate cuts from very high levels, potentially providing attractive yields and enhanced returns on local currency bonds. Additionally, in a steadier USD environment, EM currencies will likely begin to regain ground.
  • Today, most EM sovereign defaults have already happened and should remain confined to select frontier countries with low systemic importance.
  • EM’s growth premium versus DMs will likely be at a 10-year high in 2023 and may increase further in 2024.
  • EMD has already seen unprecedented outflows in 2022, leaving the asset class attractively valued and vastly under- owned—likely making EMD one of the most asymmetric trades in global fixed income.

With its risks well exposed and fully priced in, EMD offers investors the potential for high income with limited downside and favorable diversification.

Fixed income

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