Investment-grade emerging market bond spreads over US Treasuries fell under 100 basis points in August 2025, a post-global financial crisis low. Emerging market local-currency bonds have returned 13.8% year-to-date to end-August 2025, while hard-currency EM bonds returned 8.7% over the same period, Schroders said in its September 2025 note. The asset manager said portfolios have largely kept bullish positioning and have wound down short-term currency hedges introduced in July. That leaves limited room for further spread compression and shifts the focus to rates and currency risks.

EM returns and the record spread

Investment-grade emerging market spreads narrowed to levels not seen since before the global financial crisis. Schroders reported the move in a September 2025 note. The firm said the difference between yields on investment-grade EM bonds and comparable US Treasuries slipped below 100 basis points in August 2025. That followed strong performance across EM debt sub-sectors through the first eight months of the year.

Local-currency EM government bonds, measured by the JP Morgan GBI-EM GD index, returned 13.8% year-to-date at end-August 2025, Schroders said. Hard-currency EM debt, tracked by the JP Morgan EMBI GD index, returned 8.7% over the same period. Schroders said every country in the local index contributed positively to returns through that point.

The near-term picture is one of tight spreads and rising prices. For investors, that mix reduces the potential gain from further spread tightening. It also raises sensitivity to other drivers of returns. The next moves in US yields and currency swings will matter more when spreads are this compressed.

Why spreads tightened

Schroders pointed to several factors supporting EM debt. Global growth expectations have recovered after a mid-year dip, the firm said. That recovery has helped demand for EM assets. Schroders also cited strong balance of payments and manageable external financing needs in several key emerging markets.

Those fundamentals, the note said, made many EM issuers look resilient.

Policy frameworks matter too. Schroders said policy in many EMs remained reasonably stable and predictable. That lowered investor risk premia. At the same time, the asset manager noted persistent risks such as US trade tariffs and uncertainty over China’s long-term growth. Despite those concerns, the firm said the overall environment favoured EM debt this year.

Fund flows and portfolio moves

Schroders flagged improving sentiment towards EM debt and positive fund flows. The firm included fund-flow charts and a sector scorecard in its note, showing where it sees relative opportunities across EM segments. That scorecard kept a constructive tilt toward local-currency rates and EM currencies, while still finding selective value in high-yield dollar-denominated debt.

Between July and August 2025 Schroders said it unwound some tactical currency hedges it had put on in July. The move reflects a shift back to longer-term constructive positioning. The firm said tactical hedges could still be used if dislocations in developed market government bonds require them. But at the time of the note its portfolios were less hedged than they had been.

Mastheads

For managers, tighter IG spreads change trade-offs. With less room for spread compression, performance depends more on currency moves and duration decisions. Schroders said duration exposure to US rates remained a tool to manage sensitivity, noting that interest rate duration refers to US rates performance in its scorecard.

Risks that could reverse gains

Schroders listed headwinds that could re-open spreads. Chief among them were renewed weakness in global growth, sharper-than-expected rises in developed-market real rates, and worsening demand for EM external financing. The firm also flagged the uncertainty posed by US trade tariffs and the longer-term trajectory of China’s economy.

When spreads are tight, those macro shocks can have an oversized effect. A rise in US Treasury yields would make EM carry less attractive.

And sudden currency weakness in an EM issuer would hit local-currency bond returns. Schroders said those dynamics meant careful hedging and active duration management remained useful tools for portfolios.

Tighter spreads alter the risk-reward math. Schroders said the post-crisis low in IG spreads reduces the scope for gains from further compression. That pushes investors to consider alternative return drivers. Currency appreciation in local markets, lower US yields, or selective credit moves in high-yield segments are now more important for performance.

Schroders also noted pockets of value remain. The firm continued to identify opportunities in EM high-yield dollar debt even as it stayed constructive on local rates and currencies. That suggests managers are shifting allocation from broad IG exposure toward selectivity within EM credit. The shift is driven by where the potential payoff still looks attractive after the large rally earlier in the year.

Active managers, Schroders said, are likely to keep a mix of tools at hand. Those include tactical currency hedges, duration positioning, and selective credit selection. When spreads compress, careful trade selection and risk controls matter more than ever.

The note described how portfolios were adjusted during the recent market moves. Schroders said the bullish stance held for much of the year remained broadly unchanged as of September 2025.

The manager trimmed short-term currency hedges in August. It did so gradually rather than in a single move.

That approach reflects a two-part view. One, the firm sees structural support for EM debt from improving growth expectations and solid external positions in many issuers. Two, it recognises the narrower buffer for spread tightening and the need to manage duration and currency risks. Combining those views leads to a cautious but constructive allocation.

At these spread levels, return drivers are mixed. The big rally through August 2025 left many EM assets priced for favourable conditions. Schroders said investors should weigh the limited scope for further spread compression against the potential upside from currency moves and selective credit picks. Active risk management and flexible hedging are the tools Schroders highlighted.

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Local-currency EM government bonds returned 13.8% year-to-date to end‑August 2025, underscoring that the rally leaves little room for further spread compression and shifts focus to US rates and currency.

This article was created with AI assistance.