Despite worsening on-the-ground conditions in the Middle East, Emerging Markets have rallied. This is not due to a belief the conflict is solved, but that tail risks of a wider military escalation are contained. The market is pricing the absence of a worst-case scenario, with negotiations continuing through non-military leverage like blockades.
A significant shift is occurring where EM central banks, like in South Africa and Korea, are turning hawkish pre-emptively to combat inflation. This is happening even without the typical trigger of currency depreciation, indicating a proactive policy response to the inflation-growth mix rather than a reactive move to provide risk premia for a weakening currency.
Viewing the EM credit market in aggregate is misleading. While overall spreads are tighter year-to-date, this is driven almost entirely by Latin America's 50bps tightening. In contrast, regions closer to the conflict, like Europe, the Middle East, and Africa, have seen spreads widen, revealing a highly differentiated market reaction to recent shocks.
The investment case for Hungary is not fully priced in following the opposition's landslide election victory. The trade is considered in its "early stages" because the win introduces new fundamental drivers, such as a credible path to Euro adoption and a supermajority that simplifies unlocking EU funds, suggesting sustained upside beyond the initial relief rally.
Zambia's state-contingent debt instruments highlight a key risk for investors in restructured frontier market debt. The triggers for higher cash flows, based on complex assessments like a World Bank score, can be misunderstood by the market. This creates unexpected risks regarding who reports data and how it's interpreted, leading to a potential reassessment of the investment case.