Emerging market (EM) debt returns were positive across the board in May, as risk sentiment was bolstered better news regarding tariffs. Against this backdrop, higher-risk frontier sovereign bonds (+3.6%) [1] outperformed compared to hard currency sovereign bonds (+1.1%) [2], while EM corporate bonds lagged relatively (+0.6%) [3]. Local currency bonds (+1.4%) [4] posted their fifth consecutive month of gains as the US dollar continued to weaken.

On the tariffs front, financial markets welcomed the announcement of a 90-day period of lower tariffs for US and China trade, with the US rate on China dropping from 145% to 30%. Later in the month, however, President Trump threatened to impose a 50% tariff on the EU starting 1 June, although he later agreed to extend negotiations until 9 July. Adding to the complexity, the US Court of International Trade ruled that the Trump administration lacked the legal authority to impose most of the announced tariffs, including those on Canada, China, and Mexico, as well as the 10% baseline tariff for all countries. The Trump administration appealed, and a federal appeals court temporarily upheld the tariffs.

Amid continuing tariff uncertainties, concerns about the US fiscal situation intensified, helping push the 10-year US Treasury yield up by 24 basis points (bps) to 4.4%. In other news, OPEC+ announced a second month of accelerated production increases in June, which drove oil prices lower. In addition, there was speculation of a potential US-Iran nuclear deal that could result in sanctions against Iran being eased, which would help the oil supply outlook. Despite this, Brent crude ended the month 1.2% higher at USD63.9 per barrel, buoyed by optimism surrounding US-China trade talks. All in all, risk assets generally performed well in May, which supported EM debt returns as well.

Selected country news

It was a busy month in terms of EM elections. In Romania, George Simion, leader of the far-right Alliance for the Union of Romanians party, exceeded expectations in the first round with 41% of the vote, sparking a selloff in Romanian assets. However, he was later defeated by Nicusor Dan, the centrist mayor of Bucharest, who secured 53% in the runoff. Meanwhile, in Poland, Rafal Trzaskowski of the ruling Civic Platform Party won the most votes in the first round but was ultimately beaten by Karol Nawrocki of the nationalist and EU-sceptic Law and Justice party, who won the second round with 51% of the vote. In Suriname, parliamentary elections saw the opposition NDP party win 18 out of 51 seats, narrowly beating the incumbent, but more market-friendly, VHP party. Lastly, in Venezuela, regional elections resulted in the ruling party gaining control of 23 out of 24 governorships and 83% of congressional seats.

The prospect of a peace deal between Russia and Ukraine continued to dwindle. Early in the month, Ukraine and European leaders demanded that Russia join an unconditional ceasefire or face a fresh wave of sanctions. In response, Russian President Vladimir Putin proposed holding direct talks with Ukraine for the first time in three years, but without saying anything about a ceasefire. The prospect of peace further diminished after Russia conducted its largest aerial assault against Ukraine since the war began, targeting 30 cities, including Kyiv, with drones and missiles. In response, Western allies authorised Ukraine to launch strikes deep inside Russia, with no range limits, in an apparent attempt to pressure the Kremlin. In other geopolitical news, Donald Trump announced that Pakistan and India reached a full and immediate ceasefire agreement after tensions escalated following a terrorist attack in the India-controlled part of Kashmir on 22 April.

Sovereign rating changes were positive across the board in May. Standard & Poor’s (S&P) upgraded Ghana from Selective Default (SD) to CCC+ due to its debt restructuring efforts. Fitch upgraded Argentina from CCC to CCC+, following the launch of a new IMF program and liberalisation of the foreign exchange market. Several countries demonstrated improvements in their fiscal and external accounts, including Guatemala, which was upgraded from BB to BB+ by S&P, and Nigeria, which was upgraded from Caa1 to B3. Similarly, S&P revised Uzbekistan’s outlook from Stable to Positive as stronger gold prices should help the country’s exports, fiscal revenues and foreign exchange reserves.

Outlook

We continue to see value in the high-yield and frontier space where spreads and yields look attractive, supported by structural reforms and continued multilateral support. However, we think the growing risk of a US recession could support a US Treasury rally, so we have reduced our underweight in investment-grade.

In EM local markets, although many rate-cutting cycles are mature, central banks will likely continue reducing rates as economies slow and inflation benefits from favourable base effects. We remain overweight in Latin America due to attractive real interest rates in the region. For EM corporates, credit fundamentals remain supportive and net supply should keep reducing 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 healthy.

The biggest risks to the EM asset class include an escalating trade war which would hurt EM exports and global growth. A US recession and a failure of the Chinese economy to rebound could weigh on commodity prices, particularly oil. Geopolitical risks also remain, including in the Asia Pacific region, the Middle East and Russia-Ukraine.