A weaker U.S. dollar is drawing new attention to a long-overlooked investment—emerging market local currency debt. After more than ten years of slow interest, this asset class is finally attracting investors again.
In the week ending June 13, emerging market local currency bond funds recorded their highest-ever inflows: $3.8 billion. It marked the eighth straight week of net investment, according to data from EPFR.
Though the money flowing in is still relatively small, analysts say this could be a key turning point. Investors are now looking beyond the U.S. for stronger returns, especially as global interest rates decline and the dollar weakens.
“This could be a potential turning point,” said Jonny Goulden, head of emerging market fixed income strategy at JPMorgan.
Yields on the JPMorgan GBI-EM local currency bond index have fallen to their lowest since 2022. That signals growing investor interest. Since the beginning of the year, these bonds have returned more than 10%. In contrast, emerging market hard currency bonds returned only about 4% over the same period.
Bond spreads, or the difference in yields between emerging market bonds and more stable ones, have also narrowed. Local currency bond spreads are now the lowest since 2022.
Several factors are driving this renewed interest:
The U.S. dollar dropped to its lowest level in more than three years.
U.S. and European interest rates are expected to fall.
Investors are searching globally for higher yields.
“The dollar is going to be much, much weaker,” said Luca Paolini, chief strategist at Pictet Asset Management. “So there is a search for yield. Emerging market bonds could benefit a lot.”
Since the 2010s, global investors had pulled back from these markets. During that time, the size of local currency debt in emerging markets grew from $6 trillion to $13 trillion, but most of the buyers were local.
Now, that trend may be reversing.
“After years of a strong dollar and U.S. outperformance, allocations to emerging markets were absolutely rock bottom,” said David Hauner, head of global EM fixed income strategy at Bank of America.
He added that the current movement is small but steady. He expects local currency bonds to deliver double-digit returns by year-end in dollar terms.
Many emerging market central banks have started cutting interest rates. Meanwhile, the U.S. Federal Reserve has not made its direction clear. That difference is encouraging investors to move into emerging market bonds.
“It’s a rare moment of goldilocks for local assets,” said Phoenix Kalen, global head of EM research at Societe Generale.
He pointed to countries such as Brazil, Turkey, the Philippines, Hungary, South Africa, Colombia, and the Czech Republic as offering particularly good value.
“So far this year to date, local currency has performed very well,” said Carlos de Sousa, a portfolio manager at Vontobel. “That’s a really direct, automatic effect from the drop in the dollar.”
Despite the excitement, experts say we’re still in the early stages. There’s been no major reversal of the years of outflows. But even small inflows could make a big impact because the emerging market debt market is much smaller.
“If you take out 1% from the U.S., that is basically the equivalent of 20% in emerging markets,” said Hauner. “So the impact of this flow could be quite meaningful.”
The long-ignored market is now in the spotlight again. With the dollar weakening and interest rates falling globally, emerging market local bonds may finally be getting their moment.
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