EM sovereign credit: Can the juggernaut roll on?

Guillaume Rigeade and Alessandra Alecci, managers of Carmignac Portfolio Global Bond and Carmignac Portfolio EM Debt, explore opportunities in hard-currency emerging market sovereign credit. After strong performance in 2025, spreads are close to multi-years lows. Can the rally continue?

Emerging market (EM) debt has travelled a long way since the turbulence following Covid and the aftershocks of Russia’s invasion. Today, the asset class stands as one of the most dynamic segments of global fixed income. Over the past decade, emerging sovereigns have strengthened their macro frameworks, diversified their investor bases, and built resilience against external shocks. As a result, EM hard-currency debt – or sovereign credit – now occupies a strategic position within global bond portfolios: an asset class combining attractive carry, improving credit quality, and a meaningful diversification from developed-market duration.

2025 has been another stellar year for EM sovereign credit. The asset class has delivered a 10.9% total return year-to-date¹, with spreads tightening by around 40 bps. Performance has been broad-based: high-yield sovereigns (+12.5%) have outpaced investment-grade names (+9.3%) thanks to strong carry and improving credit stories. Regionally, Africa (+14.4%) has led the advance, followed by Latin America (+12.6%), while Asia (+8.9%), Europe (+8.8%) and the Middle East (+9.4%) have also posted solid gains amid renewed inflows and a favourable rating-upgrade cycle.

Behind this rally lies a confluence of factors: global disinflation and signs of labour market weakness enabling the Federal Reserve’s (the “Fed”) return to easing, a weaker US dollar, well-anchored commodity prices, and renewed investor appetite for EM carry. Fundamentals, too, are part of the story – after a period of painful adjustment, many emerging economies are showing stronger growth, narrower current-account deficits, and more credible policy frameworks.

With allocations of 35.0% (123bps contribution to portfolio duration) and 65.3% (387bps) for Carmignac P. Global Bond and Carmignac P. EM Debt respectively², they benefited fully from this solid performance, with hard currency sovereign debt being the main contributor to performance since the beginning of the year.

After such a strong performance year to date, the question naturally arises: can the juggernaut roll on?

The global macro environment remains remarkably benign for EM. Growth is moderating but still resilient, inflation is trending lower, and the Fed’s easing cycle has removed a key headwind. The market currently prices in around 110 bps of rate cuts over the next twelve months³, signaling a dovish bias. Yet this may prove somewhat optimistic, as resilient US growth, fiscal support and inflation still near 3% could temper the pace of easing. Even so, the policy stance has clearly shifted, leaving the balance of risks supportive for EM debt.

A weaker dollar reinforces this tailwind. Historically, EM sovereigns outperform when the dollar depreciates, as it eases external financing conditions and reduces debt-service burdens. Meanwhile, commodity prices remain well supported: oil around USD 60/bbl is a comfortable level for both exporters and importers, and other structural drivers – from defence spending to the energy transition and artificial-intelligence-related demand for metals and semiconductors – continue to underpin EM commodity producers. Finally, China’s stabilisation after two years of adjustment should provide a modest but steady anchor for Asian and African exporters.

Emerging central banks should continue easing

If fundamentals explain the direction, technicals explain the velocity of this year’s rally. After two years of outflows, dedicated EM bond funds turned positive in mid-2025, with steady inflows since April and the three-month rolling average at its highest since 2022⁵. Primary issuance has been heavy but comfortably absorbed, aided by higher buffers and robust cash-flow profiles across issuers.

Another key driver is crossover demand. With developed-market credit spreads near cycle tights, US and European investment-grade investors have been increasing exposure to EM credit, particularly in the BBB segment. Their allocations remain well below previous peaks⁶, leaving scope for further re-engagement. Meanwhile, domestic investors in EM countries have also become a stabilising force, purchasing both local- and hard-currency sovereign bonds and helping to dampen volatility in times of global stress.

From a relative-value perspective, EM sovereigns do not appear expensive versus developed-market corporates. On a rating-adjusted basis, EM investment-grade debt still trades at a spread premium to US credit, and EM high-yield sovereigns offer comparable carry to US HY with significantly longer duration.

At current spread levels, total return(s) will increasingly come from carry rather than further tightening. Yet this is not a reason to retreat: EM remains one of the highest-yielding liquid bond universes, with all-in yields above 8% on average⁷. Carry provides both income and cushion – the first hedge if spreads widen. In a world of subdued volatility and modest global growth, this income component is a powerful performance driver. For long-term allocators, we believe that EM credit continues to offer one of the most attractive risk-reward profiles in global fixed income.

The main counter-argument to our constructive view lies in valuations. EM spreads are close to multi-decade tights, particularly for investment-grade issuers. This means that indiscriminate exposure is no longer rewarded.

At Carmignac, we therefore favour selectivity and active risk management. We maintain significant exposure to EM hard-currency debt across our portfolios, but we are also adding protection through credit default swaps, the only realistic hedge against a potential widening of spreads. In Carmignac P. Global Bond, we currently hold around 15% CDS protection on iTraxx Xover, while in Carmignac P. EM Debt, we have raised CDS hedges to 18%. This disciplined approach allows us to preserve convexity and participate in upside scenarios while mitigating downside risks.

Our investment process focuses on sovereign creditworthiness and relative value. Because external debt eliminates local-currency risk, our analysis concentrates on a country’s ability and willingness to repay its hard-currency obligations – the true cornerstone of long-term performance.

This repayment capacity can vary significantly across issuers. Countries that defaulted in recent years, such as Ecuador (2020) or Zambia (2020), illustrate the dangers of weak external buffers and fragile institutional frameworks: both had high foreign-currency debt and low reserve coverage, leaving them exposed when access to international markets tightened. Conversely, economies with strong external positions and policy credibility – for example, the Philippines or Morocco – maintained market access and avoided restructuring despite periods of stress. These contrasts demonstrate why rigorous assessment of repayment ability remains central to our process.

Thus, we evaluate each sovereign through a multi-factor framework encompassing four dimensions:

1. Growth potential – faster-growing economies can service debt more easily.
2. Public-debt metrics – the size, composition and interest burden of government liabilities.
3. External vulnerabilities – reserve coverage of upcoming FX-debt service, balance-of-payments resilience and access to USD liquidity.
4. Institutional strength – policy credibility, central-bank independence and governance quality.

Each sovereign receives a fundamental score, which we systematically compare with market valuations. We map spreads against a synthetic “sovereign score” derived from fiscal and current-account balances, GDP per capita and human-development indicators. Cross-country regressions highlight outliers – issuers whose spreads diverge materially from fundamentals. This quantitative screening, complemented by qualitative judgment, guides our portfolio allocation across investment-grade, crossover and high-yield segments. The goal is twofold: to uncover mispriced opportunities and to manage the portfolio’s overall balance across macro, credit and liquidity dimensions.

In practice, this disciplined framework translates into selective exposure to countries combining robust fundamentals, improving credit trajectories and spreads that still compensate for risk. The following examples illustrate how we apply this approach in our portfolios.

The Ivory Coast is one of our current strongest convictions. With average growth of 6–7% in recent years, it ranks among the world’s fastest-growing economies. Expansion is increasingly diversified, supported by investment in infrastructure, manufacturing and services, and the country’s emergence as a regional financial hub within the WAEMU area. Recent offshore oil discoveries further strengthen medium-term prospects and external accounts. The fiscal position remains sound and well managed, with moderate debt and credible oversight under an IMF program. Yet euro-denominated bonds still yield above 8%, a level we see as inconsistent with these fundamentals. We believe this reflects excessive political concerns ahead of elections rather than genuine solvency risk. In our view, The Ivory Coast combines robust growth, improving fiscal resilience and prudent governance — an undervalued story offering attractive carry and potential for further spread compression.

Exceptionally High Growth (Real GDP Y/Y % Chg)

The two Funds hold the following EM debt positions in the Ivory Coast:

Romania’s outlook has brightened markedly since the spring elections. The decisive victory of reform-minded President Nicușor Dan has reaffirmed the country’s pro-EU and pro-NATO orientation, easing political risk and improving investor sentiment. Economic activity is gradually recovering as EU funds accelerate and disinflation allows for more accommodative policy. Fiscal consolidation remains the key challenge, but the new government has committed to restoring discipline and stabilising the deficit. Romania’s external position is underpinned by strong FDI inflows, energy self-sufficiency and growing gas exports, which should help narrow imbalances. In term of valuations, Romanian USD and EUR sovereigns still trade around 50–70 bps wide of BBB peers, despite improving fundamentals and supportive technicals. We see scope for further spread tightening as confidence in policy execution builds—making Romania one of the most compelling recovery stories in Central and Eastern Europe for 2025.

Romania sovereign spread versus BBB/BB. Romania now trading slightly below BB credit

The two Funds hold the following EM debt positions in Romania:

Fed easing, moderate global growth and subdued volatility continue to provide a benign backdrop for EM assets. Yet with spreads near historical lows and fundamental dispersion widening, country and credit selection will be decisive. EM debt remains a high-carry, diversified asset class supported by improving fundamentals and strong technicals, but its next phase will reward precision rather than beta utilising Carmignac’s flexible, research-driven approach – combining fundamental discipline, valuation awareness and active risk management. In this environment, we expect the juggernaut to continue rolling, albeit at a more measure pace.