August 2025 EMD Review and Outlook: dovish Fed and weak dollar lift EM

Market review

Emerging market (EM) debt posted positive returns across the board in August. The asset class was supported by a benign risk environment, a more dovish US Federal Reserve (Fed) and a weaker US dollar. Higher-risk frontier sovereign bonds (1.8%) [1] led the rally, outperforming broader hard currency sovereigns (1.6%) [2], while corporate bonds (1.3%) [3] delivered slightly more modest returns. Meanwhile, local currency bonds (2.1%) [4] rebounded strongly, fully recovering July’s losses, as the US dollar resumed the weakening trend from the first half of the year.

Geopolitical developments were in focus this month, particularly the meeting in Alaska between US President Donald Trump and Russian President Vladimir Putin. Initial optimism around a potential ceasefire quickly faded, as the summit yielded only vague commitments and no concrete agreement. Sentiment deteriorated further after Russia rejected proposals for US and European-backed security guarantees, and signalled that Putin was not immediately prepared to engage in direct talks with Ukraine’s President Zelensky, contrary to Trump’s suggestions. Meanwhile, concerns about US growth resurfaced following disappointing payrolls data. However, sentiment improved after Fed Chair Powell’s dovish pivot at Jackson Hole, which increased expectations for a rate cut in September. The 10-year US Treasury yield declined by 15 basis points to 4.23%, generating positive Treasury returns for hard currency EM bonds and supporting overall risk appetite.

Selected country news

The US implemented a 25% “secondary tariff” on India in response to the country’s continued importing of Russian oil, raising the total tariff burden to 50%. Meanwhile, President Trump extended the tariff deadline with China by 90 days to 10 November, providing some relative calm for the time being. Recent data on manufacturing, retail, and investment in China came in below expectations, potentially indicating the end of pre-tariff frontloading. Towards the end of the month, a federal appeals court ruled that most of Trump’s global tariffs were unlawful, citing executive overreach. However, the levies remained in place while the case is subject to further review.

Politically, August was relatively quiet. Bolivia’s presidential election was the main event. Two pro-business candidates advanced to the October runoff, marking a likely end to nearly two decades of socialist governance. Rodrigo Paz, of the centrist Christian Democratic Party, led the first round with 32% of the vote, followed by former President Jorge Quiroga with 27%. The outcome should signal a shift towards more market-friendly policies.

The trend of sovereign rating upgrades continued in August, while there were no downgrades. Moody’s unexpectedly upgraded the Dominican Republic to Ba2, although the agency noted that further upgrades would depend on fiscal reform. Moody’s also raised Pakistan’s rating to Caa1, following upgrades from S&P and Fitch earlier this year. Elsewhere, S&P upgraded India to BBB, citing robust economic growth and policy stability. S&P also upgraded Kenya to B, supported by strong export earnings and diaspora remittances, which have strengthened the country’s foreign-exchange reserve position. Additionally, S&P revised Ecuador’s outlook to stable from negative, reflecting improved access to official financing. Lastly, S&P amended Kazakhstan’s outlook to positive from stable, driven by expectations of fiscal consolidation, broader tax revenues and rising oil production.

Outlook

We continue to see value in the high-yield and frontier markets. While spreads remain tight, they are supported by structural reforms and multilateral support, and certain credits on the fringes of rating buckets look attractive where we think risks are overpriced. In addition, we think a US slowdown could support a US Treasury rally, so we have reduced our underweight in investment-grade EM bonds.

In EM local bond markets, while many mainstream EM rate-cutting cycles are mature, central banks are likely to continue easing as growth slows, inflation remains near target and policy rates remain high relative to historical averages. We remain overweight in Latin America due to attractive real rates in the region and expect more rate cuts from frontier market central banks. Moreover, we have increased our overweight in EM currencies, with a particular focus on Central European and frontier market currencies.

For EM corporates, credit fundamentals remain supportive and net supply should fall as companies continue to pay down their bonded debt. As global economic growth slows, we are likely to see downward adjustments to operational performance; however, leverage levels remain low and interest coverage is healthy.

One of the biggest risks to the asset class includes the imposition of new tariffs, which could hurt EM exports and global growth. A US recession and a weaker Chinese economy could weigh on commodity prices, particularly oil. However, a further steepening of the US Treasury curve may raise financing costs for frontier issuers and limit access to the primary market. Geopolitical risks also remain heightened, with no end in sight for the Ukraine war and tensions in the Middle East having dampened but not disappeared.