From Fragility to Flow: EM Assets Rebound as Global Investors Rotate Away from the US
According to the IMF, emerging market (‘EM’) governments have increasingly turned to local-currency financing, with resident investors now providing a larger share of funding. This change has reduced dependence and exposure to the US Dollar. IMF staff estimate that higher domestic participation reduces sensitivity of EM yields to risk-off shocks. It also deepens the relationship between central bank–government bond policy makers, linking fiscal and financial stability more tightly.
These structural improvements have coincided with a pronounced market rally. In local currency terms, EM equities have delivered their strongest performance since 2009. The rally has extended into local currency government bonds, underscoring investor appetite for higher real yields and a revived search for diversification. Roughly half of the bond gains stem from currency appreciation as the US dollar has depreciated nearly 10 percent against major EM peers this year.
Bank of America’s monthly fund-manager survey shows the most bullish sentiment toward EM equities since early 2023, with a net 37 percent of managers overweight. Rising optimism about China’s economy, coupled with a bearish consensus on the dollar, has reinforced this view on EM risk assets amongst institutional investors . Investors view the combination of cheap valuations and monetary-policy flexibility as a favourable mix: a softer dollar lowers external debt costs and allows EM central banks to ease policy without destabilizing their currencies. On top of this, as we have highlighted before, EMs have a much less severe inflation problem than their developed counterparts, allowing for greater easing potential.
Market data highlights the scale of the rotation. The EM index has outperformed its developed market counterpart by over 11% in local currency terms, and in particular done c.15% better than the S&P500. Valuations remain compelling—EM equities trade near 14× forward earnings, versus 23× for the S&P 500—prompting JPMorgan and others to upgrade the asset class to “overweight.” A net 49 percent of respondents to the BofA survey believe EM equities are undervalued, the highest share in more than a year.
Bonds have echoed the optimism. Local-currency issuance across 17 large EMs has reached a record USD 286 billion this year as governments tap demand for higher-yielding paper. Real yields remain elevated because larger EM central banks—particularly in Brazil and South Africa—have cut rates cautiously, while others with weaker external balances, such as Türkiye, maintain double-digit rates to attract capital. Even in lower-rate Asian markets, disinflation has kept real yields positive, supporting domestic participation.
It's not all positive, to balance the above, the IMF cautions that despite these favourable dynamics, risks persist and high borrowing costs, relative to real rates, could expose fiscal vulnerabilities. Greater domestic ownership of sovereign debt may cushion external shocks but also concentrates risk within national banking systems. A sudden reversal in investor sentiment—potentially triggered by renewed US rate volatility or political shocks—could test the depth of local bond markets. That said, so far markets have gone one way, pricing in these risks as relatively well understood and not significant.
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