Emerging markets outlook: Weathering the storm

Emerging market (EM) economies have held up better than expected despite the Middle East conflict, higher energy prices, and rising global bond yields. Domestic policy responses have partially shielded households and firms from higher costs, while strong demand for artificial intelligence (AI)-related technology products has supported global manufacturing and exports.

Unlike the initial energy shock following Russia’s 2022 invasion of Ukraine, EM manufacturing activity has largely shrugged off the spillovers from Iran. Output has maintained favorable momentum, while export orders stabilized after an initial dip. China’s drawdown of strategic petroleum reserves and less disruption to flows through the Strait of Hormuz than initially feared helped contain the price shock (Chart 1).

However, China’s role as a pressure valve may weaken. Oil imports picked up to 8.5 million barrels per day in August, which we believe may suggest the government will want to raise imports gradually toward 10 million barrels per day over the next six months to slow the drawdown of strategic reserves.^1,2 Even so, reserves should remain around 450 million barrels above the operational threshold if the conflict is unresolved by the end of 2027 (Chart 2).

Fiscal buffers face a harder test

With little sign of an end to the Middle East conflict, the next six months or more will likely remain characterized by sticky conflict risks. Oil prices in a range of $80–100, together with persistent supply constraints on gas and refined products, would increase the challenge for EM governments seeking to shield their economies.

Policymakers have relied on price caps, fuel subsidies, tax relief, and other measures to offset higher global energy prices. Firms have also absorbed higher costs in their margins, helping blunt the pass-through to output prices. But a growing fiscal drag and pressure from higher global bond yields make such intervention increasingly difficult to sustain. El Niño could add to food inflation, although the effects will vary substantially by region and country.³

Central banks can still chart their own course

The broad EM monetary-easing cycle has stalled since the war began, with policymakers largely pausing rate cuts or, in some cases, hiking to offset price and foreign exchange (FX) pressures. Yet currency pressure has moderated since June, and many EM currencies have held up well.

The rise in developed market (DM) bond yields has also not triggered a synchronized or disorderly EM selloff. At the 10-year point, EM yields have generally risen by a similar or slightly larger degree than US yields. Higher borrowing costs complicate government finances, but many EM debt trajectories can still be stabilized with modest primary deficits. IMF projections often show smaller shortfalls relative to debt-stabilizing levels than in many DMs.

Neither FX nor debt dynamics therefore need force EM central banks into broad-based tightening. Policy paths will diverge as delayed inflation pressures and regional food shocks emerge.

Emerging Asia

Central banks in EM Asia are among the most exposed to the combination of energy and food supply shocks, with the Reserve Bank of India and Bank Negara Malaysia likely to join the hiking cycle before year end.

Latin America

In Latin America, Brazil’s real rates remain especially high despite 125 basis points of easing since March, leaving room for further cautious cuts.⁴ Colombia began hiking before the war because of domestic price concerns, while Mexico is expected to remain on hold until at least mid-2027.^5,6

On net, the EM rate cycle is likely to tighten only modestly (Chart 3).

Brazil’s election sharpens the fiscal focus

Brazil’s October election puts its fiscal and monetary trajectories in the spotlight. Major polls show incumbent President Luiz Inácio Lula da Silva and right-wing opposition candidate Flávio Bolsonaro broadly tied at around 46% ahead of the first round. Prediction markets have moved in Bolsonaro’s favor, although the two-round system, Lula’s incumbency advantage and high rejection rates for both candidates make the contest difficult to call.

Our current assumption is that incumbency advantage leads to a narrow Lula victory. For instance, recently announced rises in welfare payments could be followed by further populist pledges to bolster electoral support in the coming weeks.⁷ But we only put his chances at 55%, and upcoming polls could see a further shift in Bolsonaro’s favor.

Regardless of the winner, difficult market conditions should encourage modest fiscal consolidation and facilitate further gradual monetary easing next year. However, yields and real rates are likely to moderate only slowly unless consolidation efforts exceed expectations (Chart 4).

China: Trade relief, technology friction

China continues to follow its own path. The renminbi has strengthened against the US dollar even as the nominal spread between Chinese and US 10-year yields reached a record -3.27 percentage points.⁸ China’s lackluster domestic economy partly explains the gap. Demand for technology products is providing an offset, but China remains, at best, a weak source of demand for other EMs.

Authorities will eventually provide additional stimulus, but China’s global influence may depend more on how long it can act as a pressure valve for the oil market and whether US-China tensions intensify. A meeting between Presidents Trump and Xi should place the bilateral trading relationship on firmer ground and reduce near-term uncertainty.

Technology increasingly presents the larger threat. China’s development of near-frontier large language models threatens US business models and raises cybersecurity concerns. Even if trade tensions ease, competition over AI could put the two countries on a new collision course.

Endnotes

¹ "Kpler Sees Oil Grinding Higher as Diesel Crunch Deepens." OilPrice.com, September 2026. ² "Oil pushes past $100 as wave of US-Iran attacks exposes dwindling safety net." Reuters, September 2026. ³ "Frontier markets: When the weather moves markets." Aberdeen Investments, August 2026. ⁴ "Brazil central bank delivers fifth straight rate cut, leaves next move open." Reuters, September 2026. ⁵ "Colombia central bank raises rates to 11.25%, government withdraws from board." Reuters, March 2026. ⁶ "Mexico's central bank likely to hold key interest rate this week: Reuters poll." August 2026. ⁷ "Brazil's Lula boosts welfare payments, eyes new debt-relief push ahead of election." Reuters, September 2026. ⁸ "US-China borrowing costs diverge to widest level ever." Financial Times, September 2026.

Important information

Past performance is not an indication of future results.
Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.
Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.

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