Despite the US Treasury market sell-off, the emerging market (EM) fixed income asset class delivered positive returns over the month. High-yield assets outperformed lower-risk parts of the market, reflecting an improvement in risk appetite among investors.

May was a pivotal month for the US Treasury market, with a credit-rating downgrade underscoring broader concerns around US public finances. While market participants welcomed signs of easing trade tensions with China, fiscal concerns were front of mind, given the prospect of continued tax cuts and rising debt levels. This, together with the mid-month downgrade from Moody’s – moving the US’s credit rating to Aa1 from Aaa – drove yields higher across the Treasury curve. On the monetary policy front, the US Federal Reserve kept rates on hold as expected, with commentary from Fed Chair Jerome Powell focusing on the uncertain growth and inflation outlook.

The EM local currency debt market (JP Morgan GBI-EM) gained 1.4% over the month, helped by a combination of currency strengthening and bond market moves. South Africa's bond market benefited from a 25bps rate cut by the SARB, as well as soft inflation data and a downward revision to economic growth. In Nigeria, the currency benefited from increased flows relating to the higher oil price; the country's assets were also boosted from a credit-rating upgrade (to B3) by Moody's, which cited fiscal and external account improvements. In contrast, the Romanian leu was a notable underperformer following significant outflows amid a volatile political backdrop.

The hard currency sovereign debt market (JP Morgan EMBI) delivered a positive return of 1.1% in May, with the high-yield market (2.3%) significantly outperforming investment-grade bonds (-0.1%). In particular, African markets performed well thanks to increased risk appetite among investors. A stronger currency and increased reserves boosted investor sentiment in Ghana, helping the country's bond market. Elsewhere, sovereign bonds in Pakistan benefited from easing geopolitical tensions with India.

Current top-down positioning

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From a top-down risk perspective, we have taken our overall risk target back to an overweight stance (from neutral). This was driven by our risk increase in both EM FX and hard currency debt, where we are now overweight the former and neutral in the latter. In contrast, we have reduced risk exposure in local rates, trimming our overweight to a more modest stance.

Regarding EM FX, EM monetary policy remains tight relative to inflation, the growth outlook has improved and flows into the asset class have been increasing, which we expect to continue as the market moves out of US dollar assets. In EM hard currency debt, we remain constructive on countries with supportive fundamentals and high carry (yield) to cushion against potential volatility, however, lower oil prices may weigh on the overall asset class, which keeps us more cautiously positioned. In contrast, we have reduced our overweight in EM rates as the more balanced growth outlook may reduce the total number of potential rate cuts by EM central banks. We have taken selective profits on positions in Asia and CEE and remain positioned in markets where real (inflation-adjusted) yields remain high (in Latin America and select CEE markets) or where the growth outlook remains challenging (Asia).

Outlook

Global economic uncertainty remains elevated, with trade policy still in the spotlight. While many of President Trump’s proposed tariffs are paused at the time of writing, they remain a key area of focus for markets. That said, overall volatility and market sensitivity to tariff-related headlines has reduced in recent weeks. In the meantime, there has been a renewed focus on public deficits and financing – concern around these is evidenced by a steepening of developed market yield curves (yields on longer-dated debt have risen). In contrast, EM yield curves have remained broadly immune to these global shifts, and central banks in major markets such as South Africa and Mexico continue to cut rates. Recent US dollar weakness and EM FX resilience continues to support the EM debt asset class.

While trade tariffs may still introduce short-term pressure on US inflation and impact global growth, the initial recession risk fears that emanated from Liberation Day have receded as President Trump has shown a degree of acknowledgement to market volatility, and policy and negotiations are likely to show greater flexibility from the US administration. Meanwhile, a combination of capital outflows from US assets, the weakening US dollar, and broadly softer commodities (especially oil) are acting as disinflationary forces for EM economies, giving EM central banks greater flexibility to pivot toward growth-supportive policies. Even before these recent dynamics took hold, EM economies were in a good place from a monetary-policy-outlook perspective: many EM central banks delayed their rate-cutting cycles through 2024, and softening inflation across many EM economies has resulted in elevated real (inflation-adjusted) yields, which remain a key driver of long-term returns for EM local rates market. All of this is helpful for the asset class in the context of mounting global economic uncertainty.

The Central Bank of Egypt cut its policy rate by 100bps to 24%, a smaller cut than the market expected. Real (inflation-adjusted) interest rates remain high, attracting inflows into the Egyptian market. The government issued US$800 million in two new local bonds, an unusually large amount, with yields falling. However, a delay in the latest IMF review highlighted ongoing challenges in implementing domestic reforms, most likely around taxation and privatisation.

In Ghana, the cedi experienced a strong rally, climbing around 40% over the month against the US dollar. Factors supporting this included higher foreign exchange reserves, rising gold prices and production, and tight monetary policy. On the IMF front, Ghana’s president reiterated that the country would not seek a new programme upon completion of the current one, but this was somewhat expected. Ghana’s restructuring with the Africa Export-Import Bank continued to face delays, but this didn’t prevent the country’s hard currency bonds from gaining with the broader high-yield rally.

Ethiopia made progress in addressing its debt burden by signing a draft memorandum of understanding to restructure US$8.4 billion in obligations, although the agreement has not yet been finalised. The country secured a staff-level agreement with the IMF, paving the way to the completion of the third review under its IMF programme and a US$260 million disbursement.

Nigeria’s monetary policy committee held the policy rate steady at 27.5%. Moody’s upgraded Nigeria to B3, while S&P affirmed its B- rating with a stable outlook. Meanwhile, flows have started to return to the naira, as positive real yields attracted inflows.

Uganda's local bond market came under pressure from concerns around a rise in fiscal spending ahead of the 2026 elections. Further pressure came from the government’s new issuance via a private placement worth US$880 million, intended to help finance the deficit.

Zambia is facing delays in completing the IMF’s fifth review of the programme as budget discussions continued. The government is also pursuing talks with the African Export-Import Bank and the Trade and Development Bank, in order to complete its debt restructuring.

Angola’s sovereign ratings remained stable, with Fitch reaffirming a B- rating and Moody’s maintaining its B3 rating, both with stable outlooks.

Across the region, export data for the start of the year revealed a significant rise in activity as economies tried to pre-empt bilateral tariffs from the US. In addition, there was a notable increase in transshipments (exports from China to other Asian markets) in a bid for US importers to reduce the tariffs paid on Chinese exports. On a structural level, the theme of increasing demand for semiconductors and other AI-related technology continued to boost North Asian markets, notably Taiwan and South Korea.

In China, the People’s Bank of China (PBoC) implemented a broad monetary policy support package. This included a 10bps cut to the 7-day repo rate and a 50bps reduction in the reserve requirement ratio (RRR), while also increasing lending for the services and consumer sector. Later in the month, it cut the loan prime rate by 10bps and liquidity injections continued. Despite this policy easing, onshore government bond yields ultimately rose over May due to the rollback of US-China tariffs, which buoyed Chinese risk assets and led to bond market underperformance. The renminbi benefited from the de-escalation in trade tensions, with the PBoC’s fixing of the currency to the US dollar moving below 7.20 CNY/USD for the first time since early April. Manufacturing activity remained strong but data on consumption and the property sector continued to lag. The economy continues to struggle with deflation.

Inflation in India printed in line with forecasts, supporting the case for future rate cuts from the Reserve Bank of India (RBI); recent RBI commentary suggested potential easing of up to 75bps over the rest of 2025. Q1 GDP came in stronger than expected, growing 7.4% year-on-year, assuaging concerns about the economic outlook. On the geopolitical front, tensions with Pakistan were significantly reduced, with the agreed ceasefire holding.

Taiwan's economic data was strong, with Q1 GDP growth rising by more than expected at 5.4%. Export growth was robust, supported by the growing AI theme, and equity inflows into the country continued. The Taiwan dollar strengthened sharply, appreciating by 13% over two days before a partial fall back. This move was attributed to reports around trade negotiations with the US, strong equity inflows, and the unwinding of long-standing US dollar positions accumulated from years of large current account surpluses.

Inflation in Thailand came in below expectations, due to falling food and fuel prices. Although Q1 GDP growth was stronger than expected, this was largely driven by weak import growth rather than robust domestic activity. The Bank of Thailand indicated limited room for further rate cuts, which prompted a sell-off in bonds. Meanwhile, the Thai baht appreciated against the US dollar, supported by higher gold prices.

The Bank of Korea cut its policy rate by 25bps as expected, and downgraded its growth forecast to 0.8% from 1.6% for 2025, however the latter was already largely priced in. The central bank also signalled the possibility of two additional rate cuts this year. On the political front, focus turned to the presidential election on 3 June, where the Democratic Party candidate won, as expected. Focus will turn to his economic policy agenda as he campaigned on a more expansionary fiscal policy platform, along with his ability to negotiate a trade deal with the US.

Indonesia cut its policy rate by 25bps to 5.50%, in response to softer-than-expected GDP data. The weaker growth outlook and rate cut led to a bull steepening of the country’s yield curve, with the front-end rallying.

Malaysia posted better-than-expected April trade data, with export growth appearing frontloaded as companies increased exports ahead of US tariffs. These factors contributed to a positive environment for the ringgit, which benefited from the unwinding of substantial onshore US dollar deposits.

Headline inflation in the Philippines printed below expectations. The decline was largely driven by reduced food and fuel prices. Sri Lanka’s central bank delivered an unexpected rate cut during the month.

Fitch upgraded Argentina’s sovereign rating to CCC+, recognising the new IMF programme and liberalisation of the exchange rate. Fiscal data showed a primary surplus of 0.2% of GDP over the year to end April, suggesting progress on fiscal consolidation has continued. Economic activity contracted in March, a downside surprise linked to uncertainty over changes to the FX regime, though a rebound is anticipated. Positively, mining company Rio Tinto announced a US$2.5 billion investment in a lithium mining project, supporting FDI inflows.

In Brazil, inflation data came in line with expectations in April, with a slightly better reading in the first half of May. Central bank communications suggested the hiking cycle might now be behind us, though it signalled policy rates will remain elevated. Economic activity exceeded expectations, signalling resilience despite the tight monetary policy stance. On the fiscal front, the government announced larger-than-expected spending cuts, although concerns arose from the imposition of a 3.5% tax on a number of financial transactions. Subsequently, a partial rollback of the tax mitigated market concerns.

Chile’s Q1 GDP growth exceeded expectations, while retail sales and industrial production were also strong. The central bank minutes revealed that rate cuts were discussed, opening the door for earlier-than-expected monetary easing. However, fiscal risks were highlighted in a report from the independent fiscal council, which warned that the current path could breach the debt ceiling by 2027. The market reaction was muted overall. Additionally, Moody’s downgraded the state-owned copper miner Codelco to Baa (stable), citing concerns around indebtedness.

In Mexico, the central bank cut rates by 50bps to 8.5%, in line with expectations, while maintaining a dovish tone that left room for further easing. Despite this, local yields rose given the correlation with US Treasuries. GDP growth surpassed expectations, partly due to export frontloading ahead of the imposition of tariffs by the US. Hard currency bonds issued by state-owned utility Pemex rallied on expectations of a support package.

In Peru, the central bank surprised markets with a 25bps cut to 4.5%. This initially buoyed bond markets, though performance later weakened in line with the rise in US Treasury yields. The government proposed raising the fiscal deficit target to 2.8% of GDP from 2.2%, a move viewed as being more realistic. Political volatility increased following a cabinet reshuffle prompted by congressional pressure, including changes to the finance minister and prime minister. Despite this, markets received the new appointments relatively well. Export performance was notably strong in March, up 30% year-on-year, driven by gold and copper exports and higher volumes overall.

The central bank in Colombia delivered a surprise 25bp rate cut, and the meeting minutes revealed a dovish stance. Inflation was higher than expected due to rising food and housing costs. Politically, President Petro’s proposed labour-reform referendum was rejected by the Senate, prompting strikes from major unions.

In Ecuador, political stability has improved following President Noboa's official swearing-in as he walked back plans to alter the constitution. His party holds key positions in the national assembly, which is expected to reduce legislative friction. This political consolidation, along with Noboa’s request for special powers to address security challenges, has been viewed positively in the markets, contributing to the rally in Ecuador’s hard currency debt.

In Panama, protests by workers in the banana sector against recent pension reforms have led to road blockades, which are likely to have economic repercussions. However, economic activity data for March was robust.

S&P upgraded Guatemala’s sovereign rating to BB+, given economic resilience and low levels of debt. The IMF completed the first review of El Salvador's Extended Fund Facility, releasing US$120 million to the country.

In Turkey, the central bank has started to rebuild reserves after spending an estimated US$50 billion defending the lira during the recent sell-off that followed the arrest of a key opposition figure in March. However, political concerns remain, with more arrests of politicians and concerns about a government reshuffle. However, the market looked through the noise, with local bonds benefiting from a relief rally. Inflation came in line with expectations; however, the broader inflation outlook remains clouded by political uncertainty and the pass-through effects from the weaker lira.

The South African Reserve Bank (SARB) cut rates by 25bps, taking a dovish tone amid softer inflation and a downgrade of growth expectations for 2025 to 1.2%. This helped the country’s local bond market, and the rand also benefited from favourable terms of trade, a weaker US dollar, and a broader rally in higher-risk EM currencies. The government presented a third draft of its budget, which was received more positively by members of the Government of National Unity, after the previous two versions failed to gather enough support.

In the Middle East, the UAE made strategic technological gains by securing approved access to Nvidia’s advanced AI chips. The US Treasury market sell off weighed on longer-duration hard currency bonds in Qatar and Saudi Arabia.

The reform momentum in Central Asia continued, highlighted by S&P’s decision to upgrade Uzbekistan’s outlook to positive. Kyrgyzstan marked a milestone by issuing its first Eurobond, which will be eligible for the JPMorgan EMBI.

In Central and Eastern Europe, Poland’s central bank cut rates by 50bps, in line with market expectations. However, the tone of the Monetary Policy Council turned more hawkish than expected, reducing the odds of a rate cut in July. This weighed on the country’s local bonds. An increase to import activity saw a widening of the current account deficit. Politically, the PiS-supported nationalist candidate won the presidential election with 51% of the vote. The market reaction was muted as a close result had been anticipated by the polls.

The National Bank of Hungary maintained its hawkish stance and kept policy rates unchanged at 6.5%, in line with expectations, in a bid to keep inflation anchored. However, headline inflation was higher-than-expected at 4.2% year-on-year, which put pressure on rates. Core inflation remains in check, but the outlook is complicated by the reintroduction of price caps, which makes forecasting more complex. Wage growth, while still elevated at 8.4%, came in below expectations and has largely normalised compared to regional peers.

In Czechia, the central bank lowered rates by 25bps to 3.5%, as expected. Despite this easing, the bank struck a notably hawkish tone, reflecting concerns about persistent core inflation. Although headline inflation in April came in below expectations at 1.8% (versus 2.1%), core inflation remains elevated on both a year-on-year and momentum basis. Economic sentiment has improved, supported by a rebound in growth indicators and strong infrastructure investment in Germany. Additionally, the current account registered a better-than-expected surplus.

Romanian assets saw heightened volatility during the first round of the presidential election, with a depreciation in the currency triggered by significant outflows. However, conditions stabilised after the liberal candidate, Nicușor Dan, won with 54% of the vote in the second round. Attention now turns to government formation and a crucial fiscal consolidation bill to avoid a potential downgrade to high-yield status, as the country remains on negative watch across all major rating agencies.

The EM corporate debt market (JP Morgan CEMBI BD) gained 0.6%, with a tightening of credit spreads in the high-yield market boosting performance (1.2%). Investment-grade corporate bonds also saw spreads tighten, but the rise in US Treasury yields partially offset returns amid investor uncertainty around the US fiscal situation. From a sector perspective, the infrastructure and oil & gas sector had a strong month, with the latter helped by the rebound in oil prices.