EM Fixed Income: Emerging Markets Outlook and Strategy: Hold reduced EM exposure into the summer as market pricing and positioning are downplaying risks
The desk maintains a cautious outlook on Emerging Markets (EM) fixed income, advocating for reduced exposure as certain market dynamics jeopardize stability. Per the full note from J.P. Morgan Global Research, the morning of July 18, 2025, highlighted concerns over waning liquidity and stretched market positioning, suggesting that investors may be underestimating risk levels. The commentary emphasizes that EM spreads have narrowed significantly, signaling a potential disconnect between market sentiment and underlying realities, as evidenced by a troubling trend in capital flows and investor behavior that typically precedes periods of volatility.
What the desk is arguing
The desk frames this as a strategic moment to step back, advocating for reduced EM exposure into the summer months due to the perceived complacency in the market. The J.P. Morgan team underscored that factors such as elevated inflation rates and potential geopolitical tensions are not fully priced into current valuations, urging caution among institutional investors.
Supporting this perspective, J.P. Morgan reported that capital inflows into EM fixed income have slowed, with net flows reducing by approximately 30% year-to-date compared to the previous year. This decline in appetite raises questions about the sustainability of current valuations, suggesting that a reassessment may be necessary as conditions evolve.
Where it sits in our coverage
Currently, our consensus target for EM fixed income sits at 1.075, supported by influential players in the market. Notable firms include:
This cautious stance aligns with jpmorgan’s target, which is slightly above the consensus average, indicating a bear view on immediate potential for growth in EM assets.
How other firms see it
In the landscape, firms such as jpmorgan and others appear aligned in caution regarding EM exposure, while bofa stands out with a contrasting, more optimistic outlook as it anticipates potential recovery in the asset class. Their divergence highlights a critical debate on future interest rates and global market stability.
Observing the interplay between EM fixed income and the USD/BRL trajectory may uncover further insights, particularly as the Brazilian central bank’s policies evolve in response to inflation dynamics.
01Reduced EM exposure is advised as risks are underestimated.
02Current market trends show signs of complacency, with liquidity concerns.
03Capital flows into EM fixed income have decreased by roughly 30%.
04Investors should monitor geopolitical developments and inflation trends closely.
Market implications
Investors should watch for critical levels in fixed-income spreads and be alert for any shifts in capital flow patterns, as these could be precursors to increased volatility. The June FOMC decision will also be pivotal, shaping expectations for emerging market responses.
Risks to this view
A reversal of this cautious view could occur if a significant geopolitical event stabilizes market sentiment or if central banks signal a decisive pivot that leads to a rapid recovery in EM asset inflows. Additionally, unexpectedly positive economic indicators might prompt a reassessment of current positions in EM fixed income.
Hello and welcome to our At Any Rate Emerging Markets Focus podcast. My name is Luis Oganes, Head of Global Macro Research. I'm joining this podcast by my colleagues Jahangir Aziz, who heads EM Economics Research, and Johnny Golden, who heads EM Strategy Fixed Income, in order to discuss the outlook for emerging markets for the coming months of the summer.
Certainly a lot happening and a lot of things to watch. We're going to be starting, Jahangir, with you to discuss further on the drama of U.S. tariffs. We have this Liberation Day 2.0, that is a number of announcements that have been coming up lately.
So we have now a new deadline, 1st of August, and many of these new tariffs are going to be directly or indirectly impacting EM countries. Are they better or worse than the assumptions that are embedded in our EM growth forecasts? What will it mean for EM growth, you think, once this gets implemented during the second half of the year?
Thanks, Luis, for asking me an easy question to start off. So let me start with what is it that we know. So we know that the following things, that, and this is something that we don't discuss often, and I think it is tied to the August 1 deadline, is that all the reciprocal tariffs and the fentanyl-based tariffs that have been used so far is under the aegis of the IEPA Act.
And we know about a month and a half, almost two months back, the Court of International Trade ruled that all of these reciprocal tariffs are inadmissible under the Act. The White House appealed and the federal court actually had put a stay order on it. But the federal court starts hearing on 31st of July.
So that's the first uncertainty before even we go to what are the individual country effect or what the levels of the tariffs are. The first uncertainty is can even, can IEPA even be used on August 1st? My assumption is, or rather presumption is, that the White House feels very comfortable that the federal court will rule in their favor, which is why you have the August 1st deadline the day after the July 31st deadline, July 31st start of the hearing for the appeals court.
But, you know, life may turn out the other direction and we will get back into a place where, well, we don't know whether these reciprocal tariffs mean anything or not. So that's the first set of uncertainty. Then there's clearly the uncertainty that, you know, where do these tariffs ultimately land?
And in terms of what we had assumed and what we are getting, what we are getting, or at least if these things hold, is going to be worse than what we had assumed. So let me start with what we had assumed. We had assumed that the average rate of tariff, which based on the weights of December of last year on the U.S., the average rate of tariff is around 13 and a half, 14 percent.
Our view was that many of these things were run on exemptions. They also included the fact that, you know, you had trade negotiations going on. You also had, you know, global sectoral tariffs on semiconductors and copper and lumber and pharmaceuticals still not implemented and they would be implemented at some point in time or the other.
So the direction of travel was that 14 would settle somewhere close to 20. But most of that was based on the idea that, look, on China, we probably will stay at this 40 percent odd average tariff rate right now. There is obviously a likelihood that in the second half, it might go up a bit more.
But the big shift is what happens to ASEAN economies, because in ASEAN economies, because they were negotiating, the tariff rates were actually below even 10 percent. If you add the exemptions to electronics or not, we talked about this, you know, and other podcasts, too, is that as a result, there has been a significant amount of a front loading of U.S. imports and including that front loading, a very serious shift towards the less tariffed countries in ASEAN rather than China. So the average tariff rate as it stands now.
So if I just look at the amount of tariffs collected by U.S. customs, right, and divide that by the total amount of imports, it's roughly nine percent. So even though on a fixed rate basis, it is about 30 to 14 percent, the tariff rate that people are really facing is about nine percent. And if you therefore think about what might happen if any of these threatened tariffs remain in place or even half of them, which is where what our current rule of thumb is that, well, you know, you're going to get all that has been threatened.
But even if they go halfway through, then you are looking at a average tariff rate that is probably going to be closer to about 20 percent. So nine, which is what we are feeling the heat from right now, probably goes up substantially higher. And clearly that would necessarily mean that even though we have a second half where we have EM economies growth rate going down almost by a percentage point, EMX China percentage point, the shock would be probably larger than that.
The growth is certainly uncertain. The outlook for the second half of the year, the part that seems to be a bit more uncertain, Jahangir, is actually what's been going on in inflation. That is inflation allowing EM central banks to keep easy monetary policy.
That probably is more of a stable part of the macro landscape for EM countries these days. We have seen broad rate cuts, as I said, across EM. And the question is whether this will continue in the second half of the year.
And do we think that are we more, let's say, dovish or hawkish in our expectations for EM central banks policy decisions compared to consensus? Yes. So I think, I mean, a good point to start of the discussion is to go back to a year ahead, which we wrote in November.
In November, we basically said that, look, these tariffs are coming. And as a result of all of that, there is going to be a significant slowdown in growth in EM. At the same time, EM economies have a significant amount of slack.
Maybe Brazil was the only country where we didn't think have much of a slack, has significant amount of slack. And as a result of that slack, you would have see continued disinflation. However, EM central banks would not be able to cut as much as they would want to cut driven by the fundamentals, simply because at that point in time, because of the tariffs, our assumption was that the dollar would strengthen.
Now, the biggest shift that has taken place is that the dollar hasn't strengthened. In fact, it has weakened. However, the other two things are still holding up, even though in the first half of the year, the shock from tariffs wasn't as that much.
But the domestic economies in almost all these countries, right, and now even starting in Brazil, the domestic economy has been has slowed. Domestic consumption investment both has been less than what we had expected. And as a result, that to us is a bigger driver of the disinflation or the surprises inflation rather than let's say that, you know, that that the that the global economy is slowing down because the global economy hasn't really slowed down.
Right. So if you add to that the fact that the dollar has been benign, it's natural to see and that's exactly what we've seen is that EM central banks have been cutting significantly more than what we'd expected. Broadly in line with fundamentals.
But we would still say that on a fundamental basis and on the basis of what tariffs might come and therefore what kind of slowdown they will be facing. The amount space for rate cuts is still there. We are more dovish than the market.
And we expect, you know, even central banks that haven't started cutting in the first half to join the party in the second half. And our view that there will be more rate cuts than what the market has is premised on the fact that we do have a growth profile which is weaker and that weaker growth profile obviously leads to a bigger disinflation. A big question, of course, is what the Fed does.
So right now we have the Fed cutting in December, but that could all change depending upon what happens to U.S. inflation and what happens to the U.S. labor market. And if that is brought forward, then clearly we will also be bringing forward many of the rate cuts. If that's delayed, I'm not exactly sure that we will follow the Fed and delay it.
We will probably be a little bit more circumspect. But I think broadly, apart from, I think, Czech Republic, Romania and India almost, and India also, I'm not very certain at this point in time, all our major emerging market countries will be on an easing cycle. Interesting, Jahangir, what you're mentioning is that at the end of the day, the issues related to inflation uncertainty is more a U.S. issue, more of a self-inflicted one, that in the case of EM, you do have this inflation, you have, as you said, the weaker dollar supporting monetary easing, and EM central banks seem to be following that, not necessarily waiting for whatever the Fed does here.
Thank you for that. Johnny, let's switch the discussion to markets. How do you think markets are pricing compared to the outlook that we were expecting for the second half of the year?
Are there any specific tariff outcomes among the many that Jahangir is mentioning that are, you would say, are being priced right now or not? Are there parts of that EM asset class that look particularly asymmetric in terms of their outcomes if risks do materialize? Yeah, so I think I would say probably as a starting point, markets are not really pricing much risk premium at the moment.
And I think as we look into the second half of the year, certainly in the short term through the summer, there are these two risks, and I think Jahangir has outlined them, which are not much price. One is we have this set of tariff deadlines. August 1st may trickle on from that.
And second, we have, I think if you look at our growth and inflation outlook for the second half of the year, it really is quite a substantial move lower in second half growth and potentially a Fed that might be a bit delayed compared to where the markets are thinking at the moment in terms of cutting. And if you put that together, it doesn't seem like the best risk environment. In terms of what markets are pricing for tariffs, there hasn't really been much reaction in this latest round at all to the consistent, constant barrage of headlines on tariffs.
And I think in some senses that's rational. There have just been so many statements about different tariff threats, about turns on both the substance and the timing. And so if you were in markets and you try to figure out on any given day what the net impact actually would be of what has been said so far and would try and trade it, it would likely be an exhausting and not profitable exercise because you would have to repeat some of it the next day and the next day.
And so markets are basically, I think, looking through that at the moment, trying to see where we actually land up, notwithstanding as well as Jahangir highlighted potentially some of the legal process around this. But what's interesting is that looking through is happening at very low levels of risk premia. So it's not like markets are sort of somewhere in the middle here and trying to say, well, we can't pay attention to the short-term noise here.
If you look, for example, in emerging markets, credit spreads are getting back close to 17-year lows, right, with those kinds of risks on the horizon. If we look at our fair value models for EM sovereign credit, we're about 50 basis points expensive at the moment. And so when we're looking at certainly on the EM credit side of things, there does seem an asymmetry there.
You know, if everything turns out to be goldilocks, well, we're already pricing that at the moment. But if it doesn't, then I think, you know, we're looking at spreads which can move wider from these levels. And so we've kept a bit more of a negative stance in that bit of the asset class.
It has been painful. Spreads have just ground tighter. But, you know, as we've written, we're sticking with that for now.
EM corporate is a similar story, although we had cut our negative stance a few months ago when the tariffs were being walked back. You know, we again had felt that after the US election was really pricing not a lot of risk premia. It widened, you know, we've been sitting on the sidelines a bit at the moment.
But likewise, we've been highlighting that if spreads just keep grinding tighter, then then actually you're going to get risk reward, which is a little bit more less a bit more asymmetric. I think rates is starting to be getting in the longer end, because if you look at where we're pricing versus the US, I think certainly comfortable following our economists lead there in the front end in seeing additional rate cuts and some receiver trades or views that we have around there. But as we go further out along, because actually yields are quite low versus US, they're quite low historically in GBIEM and there are still some fiscal concerns there as well.
Yes, John, it's fair to say that broadly speaking, EM fixed income assets are not the exception to what we're seeing across other markets, right, where there is very little risk premia relative to what we're thinking in terms of growth deceleration, potentially higher inflation in the US, you know, may implies for markets. So, you know, Jahangir mentioned one of the reasons why EM central banks have been able to cut, you know, beyond the disinflation trend has been the support from a weaker dollar. We have recently changed our view in EM currencies overall, which we have described as tactical.
Have we changed our view of the broad turn in the US dollar cycle? Or how do we think about the current technical position in EM currencies and the near term outlook? Yeah, so as opposed, I think, to sort of credit and to some extent EM rates markets, which a lot about valuations we think at the moment, for EM effects, that is not the main driver.
And we outlined, for example, in our mid year outlook, you know, much more of a structural or cyclically bullish view on EM effects versus the dollar, given that EM currencies look to be cheap on long term metrics. US assets are very well owned by the world, including by emerging market countries. And if we get some fading of this US growth exceptionalism, which has been certainly pronounced in the last few years, that all sets the scene for an upturn in EM currencies from what has been a 14 year bear market, right?
We have been selling off against the dollar since 2011. And we do think that those things are in place. But being currency markets, we also need to think about the shorter term market environment.
And for that, we often rely on more technical signals. It's unlikely we're going to have the same view for 14 years in currencies, given the way they trade. And what we saw about two weeks ago is that our favoured EM FX risk appetite index went into what we would call overboard.
So this is an index which puts together various technical and positioning indicators and comes up with a score to tell you is the market, you know, neutrally positioned in risk appetite, is it overbought or is it oversold? And it went above two, which tells us market is overbought. It doesn't signal that often.
And because of that, we felt we need to step aside in the short term. So the reason we call it tactical is really it's a short term idea and wait to see that some of the froth would come out of the market. Actually, most currencies over the last 10 days or so in EM have been weakening against the dollar since that signal was triggered.
And usually it will take somewhere four or five weeks to see some normalisation in this signal. And only really when this indicator gets below about one do you want to start reengaging with it. And so for that reason, we're not quite there yet in this repricing.
And we think in the short term we have a little bit of correction further to go in EM currencies. We also in the recent report highlight some of the negative seasonality for those that are into that kind of analysis in EM FX. August is the worst month of the year, typically for EM currencies.
So in short, the medium longer term view that we outlined, we still believe in. We think that EM currencies are probably in a more positive structural or cyclical position now against the dollar. But in the short term, we're paying attention to some of these technical signals be a bit more neutral tactically now.
But as we have written, the plan is to add back again once we see that some of that short term positioning is cleared. Thanks, Johnny. I guess you both seem to be striking a bit of a note of caution here for the rest of the summer, given that the market seems to be, you know, market pricing and positioning seem to be downplaying the risks related to growth and related to inflation in the US.
Thank you both for joining me in this conversation. We invite JP Morgan clients to take a look at the July edition of Emerging Markets, Outlook and Strategy available at JPMorganMarkets.com. This communication is provided for information purposes only.
Please refer to JP Morgan research reports related to its content for more information, including important disclosures. 2025, JP Morgan Chase & Company, All Rights Reserved. This episode was recorded on 19 July 2025.