Fixed income at a crossroads: Emerging-market debt gains appeal

THE global bond market has rarely been as pivotal – or as bifurcated – as it is today. Government bond markets are navigating a wave of issuance not seen in many years.

Countries around the world are competing more openly for investor demand, a dynamic that we believe has meaningful implications for pricing and market functioning. Coupled with divergent growth and inflation paths, shifting trade patterns and evolving fiscal pressures, the current backdrop underscores just how broad the fixed-income opportunity set has become.

At the same time, while corporate bond spreads suggest stability, this picture of calm may obscure pockets of unease beneath the surface. Concerns about rising default risks, shaped by slowing global growth and geopolitical tensions, continue to prompt the question of whether investors are being adequately compensated for the risks they are taking.

Simultaneously, the artificial intelligence (AI) investment boom continues to create almost insatiable demand for fresh capital, putting upward pressure on the supply of credit.

Amid this landscape, long-term structural forces, interest-rate cycles and the renewed appeal of emerging-market (EM) debt are creating a multilayered environment for investors. These factors are reshaping valuations and widening the opportunity set across government bonds, credit and emerging markets.

Implications of policy changes and duration

Duration remains one of the most consequential decisions in fixed income. With central banks around the world now in an interest-rate-cutting cycle, duration positioning has taken on renewed significance in our view. Lower policy rates are mechanically supportive of bond valuations, but the path ahead is not binary.

One possibility is that central banks will cut modestly, resulting in a relatively short-lived bull market. Another is that policy will prove insufficiently stimulative, requiring longer-term interest rates to move lower than markets currently anticipate. This latter scenario would be significantly more supportive for duration.

Given the current balance of risks, duration may present an interesting opportunity. Government bonds are well positioned within portfolios at this point in the rate-cutting cycle, though the cycle may later evolve into a shallow adjustment or require a deeper policy response.

Calm spreads, shifting risk dynamics

Corporate spreads remain contained, painting a picture of stability. However, the durability of this calm warrants scrutiny.

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Slower global growth and the ongoing impact of trade disruptions continue to influence issuer fundamentals and investor confidence. The key question is whether current spread levels accurately reflect the evolving credit risks.

As yields fall, market dynamics may become differentiated. Technical conditions – previously dominated by yield-hungry buyers – could give way to a more discerning investor base that is increasingly sensitive to credit spreads, particularly as issuance rises to finance the increased computing power and energy demands associated with AI.

Government issuance also remains elevated, intensifying competition for capital. Countries seeking to place supply with a finite pool of buyers reinforce the need for active credit selection, thoughtful sector allocation and the close monitoring of balance-sheet resilience.

Resurgence of emerging-market debt

The case for EM debt is supported by several reinforcing pillars. Fundamentally, emerging economies continue to grow faster than their developed-market (DM) counterparts. Inflation has eased meaningfully across many markets and is now firmly under control, enabling policymakers to ease after a prolonged period of tightening. This has restored monetary flexibility and improved the environment for local-currency bonds.

Valuations remain compelling. Investors continue to receive more compensation for taking on EM credit risk than for equivalent DM credit, even when the underlying credit quality is the same. A BBB-rated EM credit typically offers a higher yield than a BBB-rated DM equivalent, anchoring the relative value case for the asset class.

From a technical perspective, although new issuance remains healthy, the overall stock of outstanding EM bonds has been declining on a net basis. This should support pricing, and contributes to favourable supply-demand dynamics.

Diversification further strengthens the argument. Investors can express views across more than 80 countries and a wide range of corporate sectors, capturing opportunities across different economic cycles and policy regimes.

The balance between monetary and fiscal policy is also playing a growing role.

Long-dated borrowing now often requires higher term premiums, reflecting investor focus on debt sustainability. Broader themes – including evolving global trade patterns and the prospect of deglobalisation – continue to shape the landscape. Within this environment, local EM debt offers high real yields, improving inflation trends and attractive foreign-exchange valuations.

Defined by divergence and opportunity

As structural forces intersect with shifting policy cycles and evolving global growth conditions, fixed-income markets are undergoing a meaningful transition. Corporate and government bond dynamics are being driven by long-term pressures, while EM debt continues to reassert its relevance as a source of diversified returns.

While uncertainty remains regarding the depth and duration of global rate cuts and the resilience of economic growth, the breadth of opportunity across fixed income may continue to expand. From duration positioning to selectively allocated EM exposures, today’s environment offers multiple levers for investors seeking resilience, income and long-term total return potential.

The writer is fixed income investment director, M&G Investments