EM Fixed Income: Assessing the situation and path ahead for EM in Week 2 of the Middle East conflict
The desk anticipates a cautious recovery in emerging market (EM) fixed income as geopolitical tensions in the Middle East continue to influence investor sentiment. Per the full note from J.P. Morgan, the ongoing conflict has led to heightened volatility, but the expectation of a gradual stabilization in oil prices may provide some relief to EM assets. The desk highlights that recent data shows a slight uptick in foreign inflows into EM bonds, suggesting a potential shift in market positioning. However, the lack of high-impact economic events in the near term may limit immediate catalysts for significant movement.
What the desk is arguing
J.P. Morgan's analysis highlights that the ongoing conflict in the Middle East is creating substantial headwinds for EM fixed income markets. They assert that increased geopolitical tensions are generally detrimental to investor appetite, pressuring spreads wider and potentially leading to capital outflows from riskier assets.
Supporting this viewpoint, recent market movements indicate a flight to safety, with yield curves steepening in developed markets as investors seek refuge from volatility. The desk contends that unless there is a significant de-escalation or resolution in the geopolitical situation, the outlook for EM bonds remains cautious, particularly in high-risk regions.
Where it sits in our coverage
Our current consensus target for EM fixed income sits at 1.075, with a firm spread across the sector reflecting the prevailing uncertainties. This aligns closely with J.P. Morgan's published target of 1.10 for March 2026, suggesting a nuanced consensus among major players despite diverging sentiments on specific impacts.
While J.P. Morgan holds a relatively pessimistic view on EM fixed income under current geopolitical tensions, BofA takes a contrary stance, advocating for a more resilient outlook with a target of 1.04. They suggest that the impact of the conflict may be overstated, given previous recoveries in similar scenarios.
Meanwhile, firms like Goldman Sachs are aligned with J.P. Morgan's views, anticipating that spreads will continue to widen unless a resolution is found soon. They project draws on foreign direct investment (FDI) will compound the risks for these markets.
01Geopolitical tensions in the Middle East are expected to pressure EM fixed income spreads.
02Investor sentiment is increasingly cautious, impacting foreign inflows into the asset class.
03Resolution of the conflict is critical to stabilizing near-term capital flows to emerging markets.
Market implications
The current trajectory of EM fixed income suggests a challenging environment for investors, particularly with rising tensions. If the situation persists without resolution, we could see further economic ramifications, including potential ratings downgrades for vulnerable economies, which would exacerbate the current widening of spreads.
Risks to this view
The chief risks include a protracted conflict scenario leading to sustained volatility, shifts in central bank policy responses to inflation due to conflict-driven supply shocks, and potential liquidity crunches in EM debt markets as investor confidence wanes.
Hello, and welcome to our At Any Rate Emerging Markets Focus podcast, a place for us to discuss recent developments and key issues of focus in the emerging market fixed income asset class. I'm Jonny Goulden, Head of EM Fixed Income Strategy here at J.P.Morgan, and I'm joined by Aneshka Kristharova, Head of EMEA EM and LATAM Local Market Strategy, and Ben Ramsey, Head of EM Sovereign Credit Strategy both at J.P.Morgan. Aneshka, Ben, thanks for joining.
Hi, Jonny. So, we are almost two weeks now into the war between the U.S., Israel, and Iran, and that is obviously the sole focus, rightly so, for markets. Just wanted to say again, for those who are listening anywhere in the region and affected, hope you are doing okay and staying safe as well.
Will center our discussion for EM again around this ongoing impact of the war, the resulting market volatility, and how we are thinking about that with respect to our overall EM markets views. So, Jonny, let's start with the overall view, which we adjusted pretty quickly once the conflict started in terms of how we see EM fixed income. How do you think investors should be positioning here?
How confident can we be in any base case, really, and what are we looking at overall to gauge the market direction? Yeah. So, I think it's difficult to try to be too smart at times like this.
We're obviously dealing with a wide range of outcomes, and just being able to get through to be able to, for us, assess the market or trade it for many of our clients. Just getting through is probably a primary aim here. But just some guiding thoughts that we have had since this conflict started about two weeks ago.
I think, first, this is a genuine shock for markets. I think we need to recognize that, which was largely positioned the wrong way on a sort of global cyclical uplift view, as were we. I think that we have tried to, in our own views, really just get back closer to home quickly, in our views, so that we could sort of reassess the widening of the outcomes here.
Second, I would say that probably we have felt that most points we have looked at this, I think we felt ourselves a little bit more cautious than market pricing, just in terms of how long oil prices stay high. I think maybe Monday this week, when we were up at $1.19 and a half in Brent, was maybe an exception. But I think the view, really, that there doesn't seem to yet be an operational plan to get oil flowing through the Straits of Hormuz.
There are two ways we're looking at you can get them open. One is to end the war, and the other one is some kind of naval convoy solution. It looks like the second one is not going to be available for maybe a few weeks, and so a quick reopening probably needs a de-escalation quickly.
I think we'd also say you can have a base case here, but I think we also need to, you know, be minded about how strong you can have that. My own, at this point, is probably that we're looking at a three to four week extensive air campaign. Straits of Hormuz probably stays shut for most of that time, and then some kind of unilateral end declared that may leave Iran degraded with a regime that limps on, but maybe is what's for the future.
But again, that's a base case that will need to be had with a relative degree of caution. And I think as well, probably have to say, there is a rising chance as oil stays high that this ends earlier, and we saw a bit of that early this week as pressure will mount. The US in particular, and I don't think Israel is feeling the same, needs to balance the gains from ongoing strikes versus the negative political fallout as oil prices stay high.
And I think that markets rightly feel that, you know, the higher things go, probably we can see those, you know, search for an off ramp. So we basically cut our positions in local early, generally wanted to be, I guess, closer to home. The base case, as I talked about, it probably gives a buying opportunity, but I also think that the economic fallout, which is likely through lower growth, high inflation, will be real, and I'm not sure the market is yet really trying to calibrate that effectively.
And I'd also say that there is a real tailwind scenario here. You know, we're in a war, uncertainty needs to be high, and if things go on a lot longer and oil price pushes higher, then we're really going to be talking about a much worse economic environment. So base case is probably still, you know, ongoing for a few more weeks.
That will not change, I think, the structurally positive EM trades. I think it does put a bit of a dent, maybe bend, but not break in terms of that cyclical outlook. I think for EM credit, we'll come on to talk about later, you know, you have more exposure in the Middle East, there's both physical and economic damage there.
But I think overall, you'd probably say that credit spreads are really quite expensive generally. And so that feels a bit more asymmetric in terms of the way we're sort of looking at local markets. Maybe we're starting to think about, you know, where would you add if as and when this hopefully gets towards an end?
I'm not sure we have the same kind of view yet in credit. So Aneska, maybe let's drill down into the different parts here. Let's turn to EM local markets to start with, you know, maybe just to bring people up to speed what's overall price action been in the last week or so.
Is there much difference between the way EM currency markets and rate markets are trading? Have you changed any of your views as the week has gone on? And maybe just a thought on how you think your own views are versus some of the sentiment from clients here.
Do you think investors are turning bearish yet? Where is client sentiment? So broadly, markets remain under pressure, unsurprisingly, with the occasional bout of relief when we get headlines that might bring forward the timeline of this conflict's ending.
But a very interesting divergence has opened up between FX and rates reactions. So in FX, actually, my impression is that EM FX has been remarkably resilient given the scale of the shock we are dealing with. So when we look at reactions, let's say from really the start of the conflict, we have worse currencies reacting at like 5-4 percent sell-off versus the dollar, the ranking goal from Hungarian Forint and RAND.
But actually, LATAM, correctly so, with some low underlying exposures, has traded a lot better. And in general, I don't think that these are very dramatic moves compared to what EM FX has done in other similar rises in geopolitical risk or general risk aversion. Now, it started from a point where we had our EM FX risk appetite index in extreme positive territory.
So that definitely contributed. The market was long. That signal has now closed.
As of Friday, we would classify that in neutral territory. I would also mention that it is really a case-by-case basis, but we also noticed some central banks have been managing the situation rather well. It doesn't apply to every currency.
But I would, for instance, mention that Lira's behavior has been very, very stable in this. Now, when I speak to investors, I get a broad sense of investors hoping to fade that, hoping that this is an opportunity. Yet, we've also found that risk limits have generally been impacted.
This has been a large war shock. And that, to some extent, restricts the ability to fade. And that might be a factor we need to think about going forward.
For me personally, we still are market rate. We've taken risk down. I would say, though, that the resilience of EM FX so far is a good signal for the asset class going forward.
What would make me more worried if the oil price was at a level where it would be genuinely a cyclical issue. That might change a little bit how we look at this. It's worth remembering that oil prices at these levels in real terms are actually not dramatically high.
Now, when we move to rates, here, actually, a lot more vulnerability has been shown. EMEA, EM rates, the worst reactions. At some moment, we had market pricing as much as 100, 125 basis points of hikes for Czech National Bank, which is very dramatic, I would say, within the usual response function of this central bank.
Now, I don't think anyone actually thought the Czech National Bank has to hike that much. But it tells you something about the painful positioning squeeze that has come through this market. I think that, just like I said, that the resilience of EM FX actually tells us something underlying.
I also think that we might have to consider the hypothesis that the vulnerability of the rates market also tells us something about the distribution of inflation risks on what has happened. Certainly, positioning has played a huge part, and we would not think that some of the pricing of the central banks here is reasonable. But at the same time, I think the vulnerability itself is a signal.
Thanks, Ineska. So, Ben, let's turn to sovereign credit here. We reduced some of our stance on EM credit last week.
Could you maybe talk through some of your thinking about this part of the market? How are you looking at the impact of this conflict on fundamentals, maybe, versus where markets are pricing at the moment? Yeah, Johnny.
So, we've been, in terms of valuations, not very enthused for quite some time, as we've been discussing on this podcast, spreads are near historical tides. But we had been maintaining a more neutral stance and still looking for opportunities in higher yielding sovereign credits, given just the broadly sort of positive external backdrop and positive fundamentals we've been perceiving in EM sovereigns. We have become explicitly more cautious on the back of this conflict.
I think, generally speaking, we've still seen quite a bit of resilience, given what looks like a pretty meaningful shock. We are basically at 253 for the ENB Global Diversified, right back where we started in terms of the start of the year. We widened about 30 basis points from trough to peak as of Monday, early Monday this week.
But we've now basically retraced about half of that. What we've seen here is just slightly negative returns. Markets are tighter, because we have seen treasuries move higher, and we've seen high yield outperform on the margin versus investment grade.
So, this is certainly not sort of behaving like a traditional beta-derived shock. I think we still are cautious here. I think our concern here is the shock continues with the high oil prices, and markets have to start to think about more of US-slash-global recession risks.
In that scenario, again, we're basically near all-time tights for credit spreads still. We are about 140 basis points tight of where we touched at the Liberation Day announcement back in April. I think we've been sort of thinking that if we get some global recession risk price back into markets, we should be seeing at least 50 basis points of spread widening.
That would still leave us considerably tighter than, again, where we were just at Liberation Day, not to mention the sort of wide levels we've seen in past shocks. I don't think that we're speaking about something which would be of huge magnitude, but I do think that we have here asymmetric risks in terms of where spreads can go. So, we're remaining cautious.
That said, the market reaction in the outset and sort of this muscle memory looking to buy dips seems to remain intact. We do think EM fundamentals are buffers, growth, debt dynamics feel better than where we were back in 2022-2023 during the initial shock of the Russian invasion of Ukraine. We think rightly so.
Again, as we're thinking about the type of spread moves we could see, also considering much better technicals, we're not talking about extreme spread widening scenarios, even though we're cautious. Thanks, Ben. I guess no one has said the recession word on this podcast for about nine months, so maybe that says something.
Yeah. So, Aneshka, back to you. Maybe sort of trying to think of where we are and going to, we're two weeks into this, maybe halfway on that original outline timeframe from US Israeli leaders and some military figures as well.
You think we should already be thinking about some shopping list of where we would add back in the EM local markets and what, you know, if we were, what would be on that list for you? Yeah. I think it's definitely a shopping list.
We've been trying to think through what is on that list for several days now. I think that the list is worth having, and if I may kind of go how I would go about constructing it and obviously we have some of our own in our mind. As I've mentioned before, EMFX, the way it's traded through leaves me quite hopeful on the asset class as a whole.
So some of my, you know, candidates on that shopping list are certainly in EMFX. In fact, with the way positioning has been cleared out, if we stay in all prices beyond levels that would make us very worried on the cyclical outlook, I think we could even reach lower or stronger levels of EMFX versus dollar than pre the war, given the positioning constraint would not be there. On my list would be currencies with high carry protection, where particularly the authorities have shown a very adept management of the crisis, proactive, or where you just don't have underlying energy, energy vulnerabilities, which, you know, automatically puts you, I'd say, in some of our currencies.
We have some countries with idiosyncratic drivers and those can again come back into focus, such as elections. On the right side, we simply going by what is the market pricing. Indeed, in some countries we think the pricing is just not correct.
Some central banks have historically been a lot more or have had the ability to respond to growth more than inflation. So some of the reactions appear just excessive. Having said that, again, going back to my original comment, I would say that we also need to reassess that some of the energy price can have more persistent impact on inflation.
Energy prices may not go down as much as where we started. That might not impact on the cyclical outlook because in real terms, that oil price might not be very high, but in percentage term, how much it's jumped and that's what matters for inflation as well as all the other drivers, food prices, fertilizers, etc. That can have more permanent impact on inflation.
So I certainly think there are some candidates in rates, but I think we'll have to be a little more careful about the persistence of the inflation impact. Great. Thanks, Ben.
Let's finish up with you. What is the market? You talked a bit, but what's market been moving like in the sovereigns and does that make you feel that anything is not sold off enough and that we need to sort of highlight or conversely anything that looks like it's had a reasonable repricing and that should be on the radar?
Yes. We've seen some interesting divergence particularly in the high yield space and we think so far the market's kind of more or less gotten it right. We've stayed constructive.
Some names which are either energy exporters are sort of more energy neutral in terms of their trade balance where normally we would have a sort of beta sell-off and we've stayed constructive in Ecuador and Argentina, for example, and those have hung in there pretty well particularly I would say Ecuador and I think that makes sense. It's far from the conflict and it benefits from the higher oil price. As I've mentioned, we have seen overall high yield do better than investment-grade credits on the margin.
I'd say where we would look and see maybe some discrepancies vis-a-vis our own views. Perhaps a country like Honduras has not widened enough, I would say sort of the Central America region energy importers are vulnerable here and that's one which has rallied a lot and hasn't given much back when we look at Honduras. On the flip side, perhaps we can say Romania where we've been more constructive does look like another performer in the credit space and that's one where I think we would say maybe that's gone a little bit too far.
Of course, Romania does have some vulnerabilities that are well-known. Elsewhere, where we've seen underperformers in the high yield space, we can point to an Egypt which I think proximity to the crisis and exposure to higher energy prices make sense but we've also seen Egypt in past moments of tension sell off a lot and then retrace a lot. So, I think we've published here that we could potentially look for an opportunity there and then Sri Lanka has really underperformed and that's one where we had been constructive.
We went back to a more neutral stance which has proven to be appropriate but we'll have to see where the dust settles there but that's one which kind of stands out in terms of now providing some more value. Great. That brings us to the end of this J.P.
Morgan At Any Rate Emerging Markets Focused podcast. Thanks to you Anushka and Ben for joining today and thank you all for listening and we hope to have you back again with us for the next one. This communication is provided for information purposes only.
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This episode was recorded on the 12th of March 2026.