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Witold Bahrke
Senior Macro and Allocation Strategist
MACRO: Upside risk to global GDP growth as investment cycle broadens
I. Global business cycle rumbles on, but regional growth composition is becoming less EM-friendly than during most of 2025. One Big Beatuiful Bill Act (OBBBA), AI capex, shut-down pay-back, low energy prices & fading trade policy uncertainty to fuel growth from early next year, mostly in the US in H1 with Euro Area and China taking over in H2. EM-DM growth gap to tighten as we head into 2026, rewidening in the 2nd half.
II.Trend inflation leveling off above most central bank’s target as growth remains relatively strong and spare capacity limited.
III.Fiscal stimulus taking over the baton from monetary stimulus as monetary conditions move past “peak easy”. The central bank easing cycle is past its peak both in DM and EM, Fed to cut less than priced by markets.
•Key risks: Bonds going haywire amid fiscal spending spree igniting a melt-up/boom-bust. On the positive side, an AI driven productivity boom combined with low energy rpices on the back of a Ukraine peace deal could create a goldilocks environment and USD weakness.
MARKETS: Good but not as good as 2025.
•Review: Low expectations meant positive surprise potential, paving the way for strong EMD returns in 2025, leaving DM peers like US HY behind.
•Not so fast: Tactically, an overwhelmingly bullish consensus, stretched valuation, Fed pausing, and US-growth outperforming implies spread widening risk and a USD appreciation. We prefer Hard Currency EMD over a 3M horizon.
•Strategic horizon: A comfortable carry cushion, strong fundamentals and renewed EM growth outperformance in H2 should lead to high single digit returns across EMD for the year as a whole. We expect Frontier and GBI to outperform on a 12M horizon.
Where are we in the business cycle? 2025 marked the end of a mid-cycle slowdown rather the beginning of the end.
Upside risk to global GDP growth in 2026 as US labour market is past the worst (LHS), the capex cycle broadens and fiscal policy turns more stimulative than last year (RHS).
However, growth expectations are adjusting quickly, suggesting much more limited surprise potential than in 2025.
EM faces upside risk from the investment cycle as capex broadens out (LHS): Notwithstanding tariffs, companies output prices increase faster than input prices, supporting corporate profits. A strong profit cycles normally lays the groundwork for accelerating investment growth (main swing factor in the business cycle) - also in EM.
As if the tariff shock didn’t happen: EM exports have held in well in light of rising tariffs as rerouting cushioned the blow. We expect further upside in 2026 (RHS).
Global inflation is leveling off above most central banks target (LHS). EM-DM inflation is at multi decade lows.
Monetary tailwinds fading: Fewer central banks are cutting policy rates, in EM as well as in DM (RHS). Monetary conditions are set to become less market friendly in 2026 (RHS).
Something has to give: Either growth & earnings will disappoint or (our main scenario) the macro backdrop remains solid and Fed will cut less than expected → we see potential for hawkish Fed repricing acting as a headwind to risk appetite.
Market cycle: Near-term wobbles after a strong run in 2025: The business cycle looks robust, but tactical indicators (RHS) suggest caution. Together with stretched valuations and fading monetary tailwinds, this flashed some set-back risk for credit and EMFX risk in Q1 (LHS).
Near-term EMFX weakness - appreciation later. EM-DM growth differential to move in DM's favour in H1 as US accelerates and vice-versa in H2 due to new stimulus in China and a slowing US economy → preferring EM hard currency debt in the short-term, local currency should resume outperforming later in the year, in our view.
Regime shifts: Higher inflation, rising geopolitical risk & fiscal largesse are DM-centric, impacting DM vol more than EM vol (LHS).
→ Improving relative risk/reward in EM debt, particularly via EMFX. EM Local Currency Debt to move north-west in the RHS diagram.
Asset allocation take-away I: DM-centric nature of structural regime shifts improve the relative risk/reward of EMD vs. DM bonds.
Top-down regime shifts (higher trend inflation, rising geopolitical risks, higher fiscal deficits) resulted in shorter market cycles (LHS).
On the other hand, the DM-centric nature of the drivers behind shorter risk-on/risk-off phases means EMD’s diversification appeal has improved relative to DM debt as intra-EMD correlations and betas relative to DM duration has decreased (RHS).
Asset allocation take-away II: Shorter market cycles call for a more prominent role to active asset allocation between EMD and DM debt as well as within EMD.
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