Government bond yields reached year-to-date highs last Thursday as the escalating U.S.-Iran conflict, Houthi attacks on Saudi oil tankers, and Brent crude briefly rising above $100/barrel fuelled a sharp repricing of global rates.
Markets demanded a higher inflation risk premium amid concerns that sustained energy prices could slow the disinflation process. Although softer U.S. CPI and PPI data support the case for the Federal Reserve to keep rates unchanged at this week's meeting, uncertainty surrounding the Middle East remains a key upside risk to inflation.
Brent crude retreated sharply on Monday after reports that the U.S. had halted strikes on Iran. Nevertheless, the geopolitical outlook remains highly uncertain, with inflation risks continuing to skew to the upside as commodity prices, tariff uncertainty, and inflation expectations move higher.
Yield curves have generally become steeper, with the largest moves occurring at the long end.
Interest rate volatility remains closely linked to energy prices, although the sensitivity is lower than during the peak of the conflict earlier this year. Meanwhile, credit spreads have largely decoupled from oil price movements.
However, should geopolitical tensions persist and implied volatility rise materially, spreads could become more responsive to further energy price shocks.
Emerging markets
Emerging market (EM) corporate bonds remained relatively more resilient than sovereign USD and local-currency debt last week as higher U.S. Treasury yields weighed on total returns. The corporate segment continued to outperform both last week and year-to-date.
EM high yield (HY) corporates also compare favourably with developed markets, with average net leverage of 2.6 times EBITDA, around half that of U.S. HY issuers, although credit dispersion is significant.
EM corporate fundamentals are expected to improve further, a counterargument against the tight valuations. Consensus forecasts point to 15% revenue growth and 31% EBITDA growth in 2026, led by industrials, metals & mining and oil & gas, while Asia is expected to deliver the strongest earnings growth, driven by technology manufacturing.
Moody's one-notch upgrades of several Argentine corporates and local governments last week boosted investor sentiment. Besides, President Milei’s RIGI framework, “Régimen de Incentivo para-Grandes Inversiones”, provides qualifying energy and industrial projects with 30 years of regulatory stability, tax incentives and protection for foreign currency dividend payments.
EM debt funds recorded a sixth consecutive week of inflows, reflecting continued investor demand. We continue to favour EM bonds combining attractive carry, conservative leverage, and manageable duration, and ideally a demonstrated commitment to deleveraging.
EM debt funds recorded a sixth consecutive week of inflows, reflecting sustained investor demand. The best investment mix strikes a right balance between attractive carry, conservative leverage, a proven track record of deleveraging, and manageable duration.
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