Emerging-market debt hit hard as risk sentiment shifts

[Emerging market]
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Local-currency bonds in emerging markets have quickly turned from a favored trade into a source of losses as global risk sentiment deteriorates, Bloomberg News reported Sunday.

After benefiting earlier this year from a weaker dollar and easing inflation, the asset class has dropped more than 4.5% since the Iran conflict began, underperforming dollar-denominated EM debt. Currency weakness has compounded the decline, with far fewer emerging-market currencies now gaining against the dollar.

Rising oil and gas prices are a key driver, pushing inflation expectations higher and forcing central banks to reconsider rate cuts. In some cases, policymakers are signaling that rates may need to stay elevated or even rise, adding pressure to local debt markets.

Losses have been particularly steep in countries like South Africa and Hungary, where currencies have weakened sharply. Other markets, including Mexico and Indonesia, have yet to stabilize.

Investors are adjusting strategies in response. Some are reducing exposure to more volatile currencies and shifting toward regions seen as more resilient, particularly parts of Asia where central banks may be better positioned to manage inflation and currency pressures.

Others are favoring interest-rate trades over currency bets, seeking more defensive positioning as uncertainty rises.

Not all markets have struggled equally. In Colombia, where expectations for tighter policy were already priced in, local bonds have held up better than peers.

Overall, the shift highlights how quickly investor sentiment can reverse in emerging markets when global conditions change.

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