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        Weekly ETF Brief

        Returns triple boosts powers of local emerging market debt

        Emerging market local currency debt (EMD) has performed exceptionally well in 2025, with year-to-date returns of 13.7% in USD compared to 5.3% for US Treasurys. Three factors are driving the outperformance.

        5 min read
        Jason Simpson
        Senior Fixed Income ETF Strategist

        Triple boost for local emerging market debt

        Emerging market local currency debt (EMD) has had a very strong 2025. Year to date USD returns for the Bloomberg EM Local Currency Liquid Government Index are 13.7%, compared with 5.3% for US Treasurys.1 The stars have aligned, with the three key drivers of returns all making a strong positive contribution.2 The total return of an EM bond (or portfolio) is largely composed of coupon return + price return ± currency return:

        • Currency return — USD strength has been a constant thorn in the side of EMD performance. However, the near -10% decline in the trade-weighted DXY year-to-date delivered currency moves which were the biggest single driver of performance at 6.29%.
        • Coupon return — a high average coupon of just under 4% has resulted in returns of 3.61% year-to-date.
        • Price return — EM central banks have been cutting rates this year. The Federal Reserve (Fed)’s refusal to ease this year has limited how far rates have fallen. Fears that policy loosening could weaken domestic currencies and boost inflation makes many EM central banks cautious. But higher bond prices have delivered 3.3% returns.  

        EM nations can carry idiosyncratic risks but the geographical breadth of gains is impressive. Only Turkey has posted a negative return year-to-date and that is a marginal -0.28%. Five out of the 19 countries in the Bloomberg EM Local Currency Liquid Government index have posted gains over 20%.

        What next? The Fed drives the future

        Final quarter performance largely hinges on Fed policy. The market is pricing just under 70 basis points (bps) of cuts to year end — and about the same next year, in our view. There is material evidence that the US economy is slowing, and the August US PPI and CPI numbers have cleared the path for easing to start in September. State Street Investment Management expects 75bps of cuts in 2025 which would continue to undermine USD.

        The start of the Fed policy easing cycle should also liberate EM central banks to resume their rate cuts. The real, or inflation-adjusted, central bank rate for the Bloomberg EM Local Currency Liquid Government index is rising and higher than it was at the start of the year (Figure 1). This is not because central bank rates are being increased (there remains a bias to ease) but because CPI has fallen. Central bank rates that are well above inflation rates suggest there is scope for policy easing.

        A resumption of Fed easing should see USD depreciation continue and allow EM central banks to cut policy rates. This would support EM local currency debt in the next few quarters.

        The issue for many non-USD-based investors is that the weakness of the USD has undermined returns. This may persist. so hedging out the currency risk looks prudent. The EUR-hedged Bloomberg EM Local Currency Liquid Government index has returned 11.77% year-to-date, in EUR, against a meagre 0.32% for the unhedged USD-denominated index in EUR terms. Most of the performance upside has come from USD depreciation being captured.

        A harder EM solution?

        Investors who believe USD weakness has overshot and may correct might prefer hard currency EM exposure. But spreads are at historically tight levels, which raises risks of a material widening if the US economy slows. A focus on quality EM exposures, such as Saudi Arabia, can help limit these risks, since spreads of better-rated credits typically widen less in broader risk-off market events.

        The J.P. Morgan Saudi Arabia Aggregate Bond Index has a combination of hard currency and local currency. The Saudi Riyal is pegged to USD, presenting little currency risk. There is also the prospect that the local currency portion of this exposure will be included in the broader J.P. Morgan indices. This could help spreads compress further. For a more detailed analysis see: Safe havens reimagined.

        How to access local EM..

        ...and Saudi bonds

        More on Emerging Markets

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