Emerging Market Bonds Surge as Weaker Dollar Revives Investor Appetite

A sharp decline in the U.S. dollar is breathing new life into emerging market (EM) local currency debt, an asset class long overlooked by global investors. According to EPFR data, EM local currency bond funds recorded eight consecutive weeks of inflows, hitting a record $3.8 billion in the week ending June 13. With over 10% returns this year—more than double the return on hard-currency bonds—investors are once again eyeing the debt markets of countries like Brazil, Mexico, India, and Indonesia for higher yields.

The U.S. dollar recently hit its lowest point in over three years, a key factor behind renewed interest in non-dollar investments. As confidence in the U.S. “exceptionalism trade” wanes and global interest rates decline, investors are increasingly seeking alternatives with better returns. JPMorgan’s local currency bond index shows yields at their lowest since 2022, signaling renewed foreign interest and liquidity in these markets.

Despite recent gains, fund managers emphasize that the shift is still modest compared to years of outflows. JPMorgan and Bank of America strategists note that the market is just beginning to recover from a 14-year drought, during which EM bonds were largely propped up by local investors. The asset class has doubled in size since then, reaching $13 trillion, yet foreign holdings remain historically low—leaving significant room for growth.

Analysts say the changing interest rate landscape is also working in favor of EM debt. Many emerging market central banks have already begun cutting rates, while uncertainty looms over U.S. Federal Reserve decisions. This divergence boosts the relative appeal of EM bonds. Economists describe it as a “Goldilocks moment” where lower inflation, high real yields, and currency stability make local bonds highly attractive.

Although the inflows remain a trickle rather than a flood, even modest allocations can have an outsized effect. Given the smaller size of EM markets, a slight reallocation from U.S. assets could translate into a significant impact. Experts predict continued gradual inflows and strong year-end returns, as global investors diversify away from an overconcentration in U.S. dollar assets.

Source: Reuters