December was a challenging month for Emerging Market Debt (EMD), but over 2024 the asset class delivered positive returns in most cases. Hard currency sovereign bonds fell 1.4% this month but ended the year up 6.5% [1]. Frontier sovereign bonds outperformed in both periods, declining 1.0% in December and gaining 11.4% in 2024 [2]. Similarly, corporate bonds dipped 0.5% in December and closed the year up 7.6% [3]. In contrast, local currency bonds were the weakest, down 1.9% in December and fell 2.4% overall in 2024 [4].

On 18 December, the Federal Reserve (Fed) cut interest rates by 25 basis points (bps) to 4.25-4.50% in line with expectations, but otherwise struck a more hawkish tone. The Fed’s latest median ‘dot plot’ now projects only two interest rate cuts in 2025. With market participants also dialling back rate cut expectations, the 10-year US Treasury yield rose by 40bps over the month to 4.57%. This resulted in negative Treasury returns for hard currency bonds. The global move higher in yields also negatively affected local currency bonds. Additionally, the US dollar strengthened by a sizeable 2.60% over the month, which further weighed on local currency bonds.

In terms of performance, the JP Morgan EMBI Global Diversified Index fell 1.4% as the negative treasury return (-1.9%) outweighed the positive spread return (0.5%), as spreads tightened by 11bps to 325bps. Most of the spread tightening came from the High Yield (HY) side, while higher-rated Investment Grade (IG) countries underperformed. Several distressed and low-rated credits were among the top performers, including Venezuela, Ukraine, and Lebanon, the latter rallying a staggering 39.5%. This followed the collapse of the Assad regime, which was seen as reducing the regional influence of Iran and therefore Hezbollah in Lebanon. Argentina was also among the top performers on the back of lower-than-expected inflation. At the other end of the table, Sri Lanka, and Panama were among the worst performers. Panama was adversely affected by US president-elect Donald Trump threatening to retake control of the Panama Canal.

In local currency sovereign bonds, the JP Morgan GBI-EM Global Diversified Index (unhedged in US dollar terms) declined 1.9% this month. The yield on the index rose by 10bps to 6.39%, generating a negative bond return (-0.3%), which was also accompanied by a negative currency return (-1.6%). Asia was the top performing region, driven by China. It generated a strong local currency return, as 10-year yields slipped below 2% for the first time ever, reflecting its weaker growth. On the other hand, South Africa was among the worst performers as hopes for stimulus in China, its largest trade partner, fell short. As a result, the South African rand, which is often seen as a broader proxy for risk appetite in emerging markets, fell 4.5% over the month.

Lastly, the JP Morgan CEMBI Broad Diversified (EM Corporate Index) dropped 0.5% as the negative Treasury return (-1.0%) outweighed the positive spread return (0.5%), with spreads tightening by 9bps to 241bps. In keeping with hard currency sovereign bonds,  HY corporates outperformed (-0.1%) compared to Investment Grade corporates (-0.9%). Regionally, Europe was the top performer, while Asia and Latin America lagged.

Selected country developments

In December, Ghana’s opposition leader John Mahama won the presidential election, as voters punished the ruling party for failing to address economic issues. Romania held parliamentary elections, with the pro-EU parties eventually managing to form a coalition government despite their ideological differences. Elsewhere in politics, South Korea's President Yoon Suk Yeol shocked the world with the sudden imposition of martial law. He claimed the action was necessary to safeguard the country from ‘anti-state forces’ and North Korean sympathisers. Yeol rescinded the decree just six hours later in the face of a fierce backlash and was later impeached by the National Assembly. Amid the political turmoil, the South Korean won fell 5.1%, making it one of the worst performing currencies in the month.

Sri Lanka completed its debt exchange in December, becoming the fourth country to exit default in 2024 following Zambia, Ukraine and Ghana. Fitch upgraded Sri Lanka’s credit rating to CCC+. On completion of the restructuring, Moody’s also upgraded its rating to Caa1 with a stable outlook. All in all, 2024 marked the first calendar year with no sovereign bond defaults since 2019. Meanwhile, the number of outstanding defaults fell to five, namely those of Ethiopia, Lebanon, Venezuela, Russia and Belarus.

The IMF continues to play a pivotal role in supporting many emerging economies. El Salvador reached a staff-level agreement for a $1.4 billion (bn) program, focusing on fiscal consolidation aimed at improving the primary balance by 3.5% of GDP over three years. Additionally, the IMF reached a staff-level agreement on the first review of Ecuador’s Extended Fund Facility, providing access to $500 million upon board approval, as well as the fourth review of Egypt’s Extended Fund Facility arrangement, which would provide access to $1.2bn.

Outlook

December was a weaker month for EMD amid higher US Treasury yields and a stronger US dollar. We continue to see value in the HY and frontier space, where spreads and yields look more attractive, supported by increased market access, continuing multilateral support, and progress on debt restructurings. In EM local markets, we remain overweight Latin America due to attractive real rates in the region; less elevated economic growth and contained domestic wage pressures also provide room for central banks to cut rates. We have also been selectively adding duration in Asia in anticipation of rate cuts in the second half of the year.

For EM corporates, credit fundamentals remain supportive and net supply is expected to stay negative as companies continue to pay down bond debt. As global economic growth slows, we are likely to see downward adjustments to operational performance; however, leverage levels remain low and interest coverage healthy.

The biggest risk to the EMD asset class is potential curtailment of US rate-cutting due to the inflationary impact of Trump’s policies, including fiscal loosening, increased tariffs, and much tighter immigration. Geopolitical risks also seem considerably higher this year, with America’s adversaries, such as North Korea and China, potentially gearing up to test the new Trump administration’s resolve in the Asia Pacific region. Additionally, ongoing conflicts in the Middle East and Russia-Ukraine continue to contribute to global instability.