The EM Rally: Momentum or the Start of a New Cycle?
- Tikona Capital
- 12 minutes ago
- 4 min read
"Markets rarely repeat history — but they often rhyme with it." – Global Strategy Desk
Emerging Markets Take Centre Stage
2025 has been an unusually strong year for Emerging Markets. Local currency bonds, equities, and sovereign credit have all witnessed sharp inflows, supported by a combination of falling inflation, stabilizing currencies, and improving investor confidence.
But here's the question global capital keeps asking:
📌 Is this rally a temporary stretch… or the beginning of a structural allocation cycle toward EM?
This isn’t just momentum. It’s a macro regime shift.
1. U.S. Monetary Policy: Quantifying the Push
The U.S. Federal Reserve has already delivered three consecutive 25-basis-point (bp) cuts in 2025, taking the federal funds rate down to 3.50%–3.75% — the lowest in nearly three years.
Looking ahead, markets and forecasters price in roughly one additional 25-bp cut through 2026, likely delivered later in the year — bringing cumulative expected Fed easing to around −25 bps in 2026 beyond the 2025 cuts already enacted.
Other market pricing (e.g., rate futures) indicates the possibility of two smaller 25-bp cuts in 2026 — totaling 50 bps — though timing and probability remain uncertain.
What this means for EM:
Each 25-bp cut in U.S. rates diminishes the relative yield advantage of U.S. fixed income, making higher-yielding EM assets more attractive on a carry basis.
A cumulative easing of 25–50 bps acts as a modest but meaningful stimulus to global risk assets and can weaken the U.S. dollar — supportive of EM capital flows.
2. Dollar Dynamics and EM FX
A softer U.S. dollar has been a key backdrop for EM performance. The dollar index (DXY) has slid significantly through 2025 — marking its sharpest annual drop in nearly a decade — as markets price a less hawkish path for U.S. monetary policy and a cooling labor market.
Currency strength matters for EM assets in two ways:
Valuation uplift as EM currencies appreciate against a softer dollar, narrowing FX losses for foreign investors.
Reduced refinancing and hedging costs in local currencies as global capital allocators feel more comfortable deploying capital into EM credit and EM bonds.
3. Inflation Trends: EM Stabilisation
Inflation has broadly normalized across many EM regions after the macro volatility of the past few years. This allows EM central banks to either hold policy steady or modestly cut rates without triggering disorderly currency depreciation — a precondition for attracting foreign capital in local-currency instruments and emerging equities. (General consensus supported by multiple central bank communications in 2025.)
4. Growth Differentials: Temporary Premium for EM
Consensus forecasts suggest EM growth — excluding China — will stay relatively resilient in 2026, with real GDP growth expected near ~4.4% — slightly higher than in 2025.
In contrast, many developed markets are forecast to experience slower growth or stagnation, creating a temporary growth premium for EM that can spur allocation into equities and credit markets.
5. Yield and Bond Signals
Local-currency EM bond yields remain elevated relative to developed markets — offering carry — even as yields trend down modestly through 2025. The anticipated modest Fed easing in 2026 (25–50 bps) could push EM local yields lower and improve total returns.
However, as markets fully price in rate cuts, the tailwind fades, and pricing of future rate increases (often within 100 days after the last cut) can start to temper fixed-income performance, especially if inflation proves sticky in major economies.
6. Equity & Credit Implications
EM equities have outperformed through 2025 amid attractive valuations, improving earnings prospects, and supportive global liquidity. High-yield and EM corporate credit are also drawing interest due to improving fiscal profiles and manageable refinancing needs.
Nonetheless, economy-specific fundamentals — not broad index exposure — will matter most for capturing the next leg of inflows.
So What Does All This Really Mean?
The current EM rally is real and macro-aligned, supported by:
Measured U.S. rate cuts (~75 bps in 2025 with potential ~25–50 bps in 2026) and a softer dollar.
Inflation moderation and policy stability in many EM regions.
Relative growth resilience versus many developed markets.
But this phase is largely cyclical:
Expected U.S. rate cuts in 2026 are modest (25–50 bps) — less dramatic than earlier easing cycles.
A softer dollar is priced into markets already, so the scope for further weakness may be limited if inflation proves persistent.
Risks remain if developed markets re-accelerate in H2 2026, driving yields and the dollar higher again.
In investment terms:
Opportunity exists in EM assets — especially where fundamentals and policy credibility are strong.
Risk management is critical, especially for unhedged EM FX and carry-dependent positions.
This is not a blanket “buy everything” environment — selectivity and timing will define success.
Overall, the EM rally appears to be cyclical momentum amplified by macro alignment, with a window of opportunity that could compress if global conditions evolve faster than currently priced.
Where Tikona Capital Fits In
At Tikona Capital, we track macro cycles and capital flow regimes to understand when opportunity expands — and when risk returns. Our focus stays on disciplined allocation, not chasing late-cycle momentum.
We're here to guide you.
📧 Email: contact@tikonacapital.com
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