A historic shift in global inflation is fueling a significant rally in emerging market bonds, as analysts predict developing nations will cut interest rates faster than the U.S. and Europe.
Investment managers, including Morgan Stanley Investment Management and Ninety One, are positioning for further gains in local-currency debt, extending a year of strong returns across assets from stocks to dollar bonds, according to Bloomberg.
Inflation Divergence Reaches Historic Levels
The surge follows a rare divergence in consumer price trends. Data from Bloomberg indexes shows inflation in emerging economies has now run slower than in developed nations for two consecutive quarters, a pattern not seen in over three decades, excluding the volatile pandemic period.
Local bond investors have gained 7% on average this year, outperforming U.S. Treasuries. Some markets have delivered particularly strong returns, with bonds in Hungary, Brazil and Egypt rising more than 20%.
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The rally stems from expectations of substantial interest rate cuts, with the latest inflation figures potentially paving the way for deeper and faster easing. Bloomberg data shows average annual inflation in emerging markets fell for a fifth consecutive quarter to 2.47% between July and September, the lowest level since early 2021. By contrast, inflation in developed economies rose to 3.32%.
Central Banks Begin Easing Cycle
Several countries have already begun lowering borrowing costs, with Mexico and Poland joining the list of central banks easing policy. Markets expect Thailand, South Korea, Turkey and India to follow with rate cuts before year-end.
However, most emerging market central banks remain cautious, keeping interest rates well above inflation. Brazil’s central bank held rates steady this week for the third straight month, leaving its inflation-adjusted rate near 10%. Turkey, India, South Africa and Colombia also maintain real rates above 3.5%.
Grant Webster, co-head of emerging market sovereign and FX at Ninety One, estimates that real policy rates across emerging markets are near their highest level in more than 20 years. He said these high yields are supporting currencies, with the Brazilian real and Hungarian forint both posting double-digit gains against the dollar this year.
In September, traders were polled by Acuiti regarding emerging market currencies perceived to offer the strongest return potential. The Indian rupee (INR) stood out, supported by India’s expanding economy and possible advantages stemming from U.S.–China trade dynamics. The Brazilian real (BRL) received similarly high marks, with expectations of a rebound after its 2024 decline.
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