In the current inflationary environment, a key differentiator for EM performance will be central bank behavior. Markets will favor "proactive" banks that hike early to anchor inflation expectations and engineer a soft landing, while the markets of "reactive" banks that fall behind the curve may underperform.
Recent increases in emerging market rates are accompanied by flattening or stable long-end yield curves. This suggests markets are pricing in central bank rate hikes to control inflation, rather than reacting to worsening fiscal concerns, which would typically cause the curve to steepen.
In recent years, private credit saw massive inflows at the expense of public EM debt. Now, with increased scrutiny on the private credit space, incremental investment dollars may be shifting back to EM hard currency products, providing a structural tailwind and supporting strong inflows despite market volatility.
The current US rates sell-off is characterized by rising real yields rather than just higher inflation expectations. This specific type of move is the most damaging for emerging markets because it tightens global financial conditions, making it difficult for EM rates to decouple from US pressure.
While emerging market sovereign credit spreads remain near historic lows, the all-in yield has risen sharply due to the repricing of US rates. This increases the real cost of borrowing and refinancing for riskier sovereigns, a danger that isn't immediately apparent from looking at spreads alone.