Emerging markets defy the global bond sell-off

Rising bond yields have weighed on markets globally, but emerging markets have been more resilient than expected, argues Pendal’s emerging markets team

Key points:

• Emerging market currencies supported by strong real rates
• Environment remains supportive for selected emerging market equities
• Learn more about Pendal Global Emerging Markets Opportunities Fund

EMERGING markets have held up better than expected during the 2026 bond sell-off because their fundamentals are stronger this cycle: high real interest rates, improved government budget management and a weaker US dollar have lifted emerging market currencies and returns — leaving them less exposed to the fiscal fears hitting developed markets.

Higher interest rates, better government budget management and a weaker US dollar have lifted currencies and returns in emerging markets in recent times.

That’s been particularly the case in higher-yielding countries such as Brazil, Mexico and South Africa.

But how will the current global bond sell-off affect emerging market investors? Where are the opportunities and risks?

As most investors know, emerging market equities are highly influenced by global financial and economic conditions, including moves in global bond and currency markets.

Weaker bond markets and higher yields in developed markets – especially the US – can be a drag on the emerging market world due to higher global funding costs.

Meanwhile a stronger US dollar can tighten domestic liquidity, weaken currencies and force central banks to maintain higher interest rates.

But the current global bond sell-off may be developing differently.

Long-term yields have risen sharply across developed markets, with US Treasury yields close to three-year highs.

Japanese and UK yields have reached levels not seen for decades, as a combination of higher energy prices and inflationary pressures meet structural pressures from ageing populations and voters’ choices.

Different emerging markets, different outlook

Importantly, the pressure has not been transmitted uniformly across emerging markets.

Long-term yields in emerging markets have risen less than in developed markets and have shown a degree of resilience that exceeds what historical sensitivity to higher US yields would typically imply.

This is largely the legacy of more orthodox fiscal and monetary policy in emerging markets. The median emerging market now has a better medium-term fiscal outlook than the median developed economy.

Currency markets provide further evidence of this divergence.

US dollar-funded emerging market carry trades have generated positive returns for seven consecutive quarters, their longest run since 2008.

Returns have been strong from classic emerging markets carry trades such as Brazil, Mexico and South Africa, while US dollar weakness has more recently spread into Asian currencies, and the MSCI emerging market currency index is at a record high level.

Consequently, we are not convinced that higher global interest rates will mean tighter financial conditions in emerging markets.

With higher developed market yields reflecting fiscal risk, rising capital demand and increased term premia, we see a growing likelihood of weaker developed market currencies and capital outflows from developed markets into emerging ones.

Dollar matters more than rates for emerging markets

We continue to believe the direction of the US dollar matters more than the direction of US bond yields for emerging markets.

The Pendal Global Emerging Markets Opportunities Fund maintains significant exposure to Brazil, Mexico and South Africa, where high real interest rates and attractive carry have supported currencies and financial markets.

We also have meaningful exposure to liquidity-sensitive sectors across emerging markets, including investment real estate, investment banks, brokers and exchanges, alongside positions in gold miners within the materials sector.

Since the US dollar’s recent peak in January 2025, the MSCI Emerging Markets Index has substantially outperformed the developed market MSCI World Index, the S&P 500 Index and the NASDAQ Composite Index.

In our view, investors may want to consider remaining bullish on emerging markets, with a focus on carry trade economies and liquidity plays.

Frequently asked questions

Why have emerging markets held up better during the 2026 bond-sell off?

Emerging markets have been more resilient than expected because their fundamentals are stronger this cycle. High real interest rates, better government budget management and a weaker US dollar have supported currencies and returns — leaving emerging markets less exposed to the debt and deficit fears driving developed-market yields higher.

How do rising bond yields affect emerging markets?

Rising bond yields usually raise borrowing costs and pull capital toward developed markets. But strong real rates, better budget management and a weaker US dollar have helped emerging markets stay resilient through the 2026 sell-off.

Why do emerging markets perform well when the US dollar weakens?  

A weaker US dollar is one of the biggest tailwinds for emerging markets. Local currencies rise, equities lift, and US dollar-denominated debt becomes cheaper to repay. It also lowers import costs, helping to keep inflation and interest rates lower.

What is the outlook for emerging markets in 2026 and beyond?

The outlook for emerging markets is supported by China’s manufacturing strength and a weaker US dollar over the next few years. The main note of caution is around stretched valuations in AI chip stocks in markets such as Korea and Taiwan.

About Pendal Global Emerging Markets Opportunities Fund

James Syme, Paul Wimborne, Ada Chan and Roshni Bolton are co-managers of Pendal’s Global Emerging Markets Opportunities Fund.

The fund aims to add value through a combination of country allocation and individual stock selection.

The country allocation process is based on analysis of a country’s economic growth, monetary policy, market liquidity, currency, governance/politics and equity market valuation.

The stock selection process focuses on buying quality growth stocks at attractive valuations.

Find out more about Pendal Global Emerging Markets Opportunities Fund here
 
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