Persistent inflation worries and currency swings are pushing emerging-market investors to adjust bets in an $886 billion asset class that\u2019s been delivering outsize returns for more than a year.<\/p>\n
An index tracking inflation-linked EM local-currency government debt has handed investors an 11.3% return in 2026 through Thursday, following its best year in over a decade. That compares with a 1.5% gain for a broader index of local debt and a 0.1% loss for the benchmark Bloomberg Global Aggregate Bond Index.<\/p>\n
The gains, boosted by currency appreciation across the developing world, are giving investors another reason to look beyond conventional local bonds as they navigate renewed price pressures, higher energy costs and increasingly divergent central-bank paths. After strong returns in Brazil and Mexico \u2014 the two largest markets \u2014 traders are turning to so-called linkers in places such as Chile, Poland and Argentina for the next opportunities.<\/p>\n
\u201cInflation-linked bonds are increasingly interesting in the current environment, particularly given the uncertainty surrounding inflation and the path of central bank policy globally,\u201d said Benjamin Souza, BlackRock\u2019s head of strategy for Latin America. \u201cHowever, investors need to be selective, because not all inflation-linked bonds offer the same risk-reward profile.\u201d<\/p>\n
Whereas ordinary bonds pay a fixed return, the principal and interest payments on inflation-linked debt rise in step with consumer prices. The most recent data releases from developing economies show prices accelerated more than expected in Argentina, India, South Africa and Romania, while remaining sticky in Brazil and Colombia.\u00a0<\/p>\n
On Thursday, the Turkish central bank recognized its \u201cpartial failure\u201d to meet CPI targets, having to revise its year-end inflation projection to 28%, up from a previous 26%. The situation is further complicating the outlook for policymakers and investors who had spent much of the past year positioning for lower interest rates.<\/p>\n
Thierry Larose, a portfolio manager at Vontobel, is favoring inflation-linked debt in Argentina. In Brazil, he\u2019s switched away from linkers, betting that implied inflation expectations are turning a little excessive.<\/p>\n
Still, rising water temperatures in the Eastern Pacific, a phenomena known as El Ni\u00f1o, could disrupt weather patterns and push food costs back up.<\/p>\n
\u201cLinkers had a great run so far this year but are now generally less attractive,\u201d Larose said. \u201cHowever, we will be prompt to reassess our views and stance if and when El Ni\u00f1o is to affect food and electricity prices more than currently anticipated.\u201d<\/p>\n
The majority of these notes come out of Latin America, where risks associated with potentially stronger-than-expected temperatures are putting additional pressure on inflation. Brazil and Mexico account for more than half of all index-eligible, EM inflation-linked debt, a pile that\u2019s surged to above $800 billion, according to Bloomberg Intelligence.<\/p>\n
Options are more limited elsewhere in the emerging world. Inflation-linked bonds are out of major EM bond indices, making local players the dominant holding force. Pension funds are a natural buyer for the asset class, as they have long-term investment horizons, according to a JPMorgan Chase & Co. report published last year. The bank recently recommended long-term investors add Poland and South Africa, citing attractive valuations and liquidity.<\/p>\n
\u201cLinkers are a bit expensive in most countries at the moment, perhaps with the exception of Poland,\u201d said Kieran Curtis, head of EM local currency debt at Aberdeen. \u201cThe reason for the cheapness is probably that the government has issued a bit too much when there isn\u2019t the same natural buyer base you have in Brazil, where pension funds are big buyers.\u201d<\/p>\n
With central banks across the globe readjusting monetary paths for the impacts of the Middle East war, some nominal yields are starting to look appealing again, prompting some rotation from inflation-linked notes in markets like Brazil and Mexico, according to Jeff Grills, head of US cross markets and emerging-market debt at Aegon Asset Management.<\/p>\n
\u201cChile and Colombia look more balanced and we would favor inflation linked over fixed,\u201d Grills said. \u201cInvestors have favored inflation linked bonds in Brazil, but now that long rates are mid-double digits, we would prefer fixed coupon.\u201d<\/p>\n
Even as the trade becomes more nuanced, it\u2019s unlikely to lose its shine, as inflation-linked debt is also a window to play into the outperformance of Latin American currencies relative to their Asian counterparts. The Colombian peso, the Brazilian real and the Mexican peso are the three best performing currencies in emerging markets this year \u2014 gains that have helped boost returns for the index.\u00a0<\/p>\n