Q3 2025 EMD outlook - Resilience in Uncertain Times

Q3 2025 EMD outlook - Resilience in Uncertain Times

A short Q3 2025 outlook

Q3 EM Outlook - YTD Review

EMD Resilience: Fluke or Feature?

• EMD proved resilient in a volatile environment with strong year-to-date returns, outperforming DM peers such as US HY (LHS).

• Tactically, the strong performance of EM Debt is symptomatic of an environment shaped by peak US exceptionalism and elevated, but declining policy uncertainty (RHS).

• Structurally, 3 DM-centric regime shifts support the relative performance of EMD: High, but not extreme policy uncertainty & geopolitical risks driven out of DM, developed worlds newfound fiscal largesse and a tightening EM-DM inflation gap.

Q3 EM Outlook - In a Nutshell

EMD & The Three Peaks

• MACRO: Three reasons to be constructiveI.Peak US exceptionalism, cont’d:

  • Growth gap between the US and EM has widened as outlined in our Q2 outlook (RHS) due to “unintended” consequences of Trump 2.0 (confidence shock, front loading and shifting fiscal balance of power. As the RoW has stimulated more than the US lately (both in monetary and fiscal terms), we think this theme has legs.

  • Peak policy uncertainty: Trade policy uncertainty and geopolitical risks are likely to trend lower as Trump’s focus shifts towards the less disruptive part of his agenda (tax policy, deregulation).

  • Peak growth pessimism: Growth expectations & sentiment bottoming out together with soft data. Hard data could weaken over the coming months, but markets should look through this, provided policy signals point towards easing.

  • MAIN RISK: This stagflationary feeling... The coming months might see US inflation temporarily spike due to tariffs and growth slow as frontloading effects reversing.

• MARKETS: Buy into weakness

  • More growth rebalancing away from US, monetary easing and peak policy uncertainty provides a fertile ground for EMD returns.

    • We keep a strategic preference for LC, while being neutral tactically after a strong run for EMFX year-to-date.

  • Policy-driven markets: As long as policy uncertainty declines, we remain in buy-the-dip mode.

  • Uncertainty reigns & structural shifts abound. Range of outcomes remain wide and vol high.

Q3 EMD Outlook - Macro Playbook

Peak Growth Pessimism

• US consensus growth expectations are bottoming out, US tax bill might be more expansionary than previously thought (LHS).

• US soft data softening no more & growth indicators have shown remarkable resilience (RHS), despite elevated policy uncertainty. Hard data (labour market & consumption) will weaken further, but markets should be able look through this, provided the policy backdrop continues to improve.

• That said, we could see some near-term “pay-back” from front-loading US imports.

Q3 EMD Outlook - Macro Playbook

Monetary Conditions Easing

• While DM inflation should level off above central bank targets, EM is by-and-large back at pre-pandemic levels (LHS)

• Cutting cycle to be continued in EM and DM.

• Monetary conditions easing (RHS) amid central bank cuts, improving credit impulse & weak USD.

• Unbalances easing cycle: More easing outside the US, supporting growth rebalancing away from the US.

Q3 EMD Outlook - Macro Playbook

Peak Policy Uncertainty - What it Means for EMD

• We believe tariff uncertainty peaked around April and the US effective tariff rates will be negotiated down below 20% → declining US recession risk.

• In our view, policy uncertainty & geopolitical risks and should mean revert towards high, but not extreme levels (light blue bar/ LHS).

• Better than feared: In such an environment, both local currency EM debt and frontier EM debt tend to perform (RHS).

• Policy uncertainty shock is more limited in EM as compared to DM, arguing for more real economic downside risks in DM.

Q3 EMD Outlook - Market Expectations

EM Risk: Buy the Dip

• Our contrarian GE Risk Index triggered a positive signal for EM risk in April (LHS) → solid EMD 12M return expectations (carry-driven).

• Tactical signals point to limited risk of spread widening overshadowing carry as main return driver in hard currency debt.

• Resilient global growth in the context fo peak US exceptionalism → further Dollar weakness & and EM FX strength on a 12M horizon.

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