Despite rising Treasury yields due to inflation, credit spreads in emerging markets remain tight. This is because credit markets can stomach inflation if it's a byproduct of strong, resilient growth. Higher nominal GDP growth is ultimately beneficial for credit, leading to continued spread compression.
The market's focus hasn't truly shifted from geopolitics to macroeconomics. Instead, geopolitical tensions, like the U.S.-Iran conflict, are now a primary input for inflation data through their impact on energy prices. This directly influences expectations for central bank policy.
Emerging markets are currently insulated from rising US inflation because investors believe the Fed maintains a growth-biased, asymmetric reaction function. The significant risk isn't the inflation data itself, but a fundamental change in the Fed's dovish philosophy which would alter the real yield outlook.
The no-confidence vote against Romania's Prime Minister creates significant market uncertainty. The core long-term risk isn't the immediate political noise, but whether a new government will abandon the recent path of fiscal consolidation, thereby jeopardizing EU fund disbursements and potentially leading to credit rating downgrades.
Counter-intuitively, the Romanian Leu, a managed currency that typically doesn't move much, had the largest FX reaction to recent political risk. In contrast, high-carry currencies like the South African Rand were more insulated by the strong global backdrop, demonstrating that local politics don't impact all EM currencies equally.