Global investors are unwinding their bets on local currency bonds, a trend that could potentially put pressure on central banks to raise interest rates. This development is particularly concerning for turbulent economies like Turkey and South Africa, as well as emerging giants like India and Mexico. The decision on whether these countries will raise their borrowing costs will largely hinge on the evolution of monetary policy in the United States, a factor that could significantly impact the global economic landscape.

But fears of a delay in the easing cycle are already disrupting the most popular certainties from the beginning of the year: buying local currency bonds seen as benefiting from a potential rate cut. Emerging market bonds are collapsing. The asset class recorded its most significant monthly decline since September, with a total loss of $62 billion, the biggest loss since 2021.

Countries relying on external financing are potentially vulnerable. India, Turkey, Indonesia, Mexico, Brazil, and South Africa are the most exposed among the major emerging economies.

Since April 10, the date of the release of U.S. inflation data, the dollar has appreciated against 31 of the 32 most traded emerging market currencies. This abrupt shift had interrupted the accommodating turn made by emerging economies in mid-2023 when global disinflation was expected to help the Fed begin easing its policy in early 2024. The potential consequences of this shift are significant, with the most vulnerable segments likely to be oil importers who may need to be more vigilant.

Concerns about the Middle East do not help; calls for international sanctions against Iran could threaten oil prices and maritime supply lines even without escalation. If inflation shows signs of resurgence, the vulnerable segments will largely be oil importers, who may need to be more vigilant.

The recent rebound in commodity indices and Treasury yields, at a time when regional growth is picking up, makes the prospect of a new series of rate hikes credible. This is particularly the case for export-oriented central banks facing current account deficits, higher inflation, and higher levels of external debt.

Negative real rates have begun to spread across emerging markets, with Europe, the Middle East, and Africa faring the worst. In this regard, Angola, Egypt, Nigeria, Turkey, and Zambia have borrowing costs below consumer price growth rates despite high nominal policy rates ranging from 12.5% to 50%.

Previous expectations of rate cuts have pushed bond yields to such low levels that the average yield of the Bloomberg Global EM Universal Index in local currency for governments stands at 4.61%, 38 basis points below the two-year Treasury yield. This makes these countries less attractive to investors, posing a problem for financing their debts.

The winners of this phase will be countries with high real rates, stable budget and external balances, and countries that can benefit from the cyclical rise in manufacturing and commodity prices. These factors are crucial for emerging market success, but unfortunately, they are not prevalent in EM.