Fed Rate Cuts May Help Revive Bond Flows To Emerging, Developing Economies
For ETF investors, the key point is that a Fed easing cycle does not just change duration math in developed-market bond funds; it can also alter the funding environment for emerging-market sovereign borrowers. When external rates fall, the refinancing window for hard-currency debt can reopen, which matters most for issuers that depend on market access rather than deep domestic savings pools. That makes the rate backdrop an important lens for assessing the investable universe behind emerging-market bond ETFs.
Eurobonds sit at the intersection of credit risk and currency structure. Because they are issued in a foreign currency, usually dollars or euros, they can reduce funding constraints for borrowers but leave governments exposed to exchange-rate pressure and global funding conditions. For ETF holders, that means the index may capture a very different risk profile from local-currency emerging-market bond strategies, even when both sit under the same broad label.
The issuance cycle also affects portfolio composition. In periods of stress, weaker issuers may disappear from primary markets while stronger countries continue tapping investors or shift toward local-currency funding. That can change the quality mix inside benchmark-tracking funds over time, with new supply, refinancing needs and maturity schedules influencing sector and country weights. Investors should therefore look beyond yield and ask how the index is likely to evolve as borrowing conditions improve or tighten.
For long-term allocators, the practical takeaway is behavioural and structural: emerging-market bond exposure is not a static income sleeve. It is sensitive to global rates, refinancing access and reserve strength, so rebalancing discipline matters when flows recover after a policy shift. Understanding whether a fund holds sovereign hard-currency debt, local debt or a blend helps set expectations about volatility, diversification and how much of the risk is driven by credit versus currency.
Richard Drury
By Paula Arias, Research analyst, IMFโs Strategy, Policy, and Review Department Front Office, & Robin Koepke, Economist, IMFโs Strategy, Policy and Review Department
Capital flows to emerging market and developing economies went through several boom-bust cycles in recent decades, often partly driven by external developments such as monetary policy decisions in major advanced economies. During the recent global monetary tightening, inflows to many emerging market and developing countries proved relatively resilient, benefitting from robust policy frameworks and healthy international reserves. However, some of the most vulnerable countries were disproportionately affected by higher external borrowing costs, as illustrated by a sharp slowdown in Eurobond issuance.
Eurobonds are international debt instruments issued by countries in a currency different from their own, typically the US dollar or the euro. Eurobonds are primarily used by higher risk emerging market and developing countries because they avoid the limitations of their often less-developed domestic capital markets, allowing borrowers to access foreign capital and diversify their funding sources. But unlike local currency bonds, Eurobonds involve exchange rate risk for the borrower, and their interest rates are particularly sensitive to monetary policy settings for the currency of issuance.
The Chart of the Week highlights the sharp slowdown of Eurobond net issuance by emerging market and developing economies, which fell to an annual $40 billion in 2022-23, down 70 percent relative to the prior two years. During this period, 26 of 75 countries saw net Eurobond outflows, totaling $58 billion (including countries like Bolivia and Mongolia). These outflows resulted from maturing Eurobonds exceeding new issuance, rather than outright sales by global investors.
The reduction in Eurobond flows reflected a combination of Original Postii/S1042443116301317">tightening external financial conditions and pre-existing vulnerabilities in affected economies, such as fiscal and external sustainability challenges. Some countries with more robust fundamentals and policy frameworks were able to substitute foreign currency issuance with local currency debt, funded in part by domestic investors. Many countries responded by cutting investment to reduce imports, weighing on economic growth. Many countries also drew on their reserve buffers, which could reduce their ability to withstand future shocks.
Net Eurobond issuance has a strong negative association with advanced economy interest rates, approximated by the 10-year US Treasury yield. When bond yields in the United States and other advanced economies slumped during the pandemic, borrowers in emerging market and developing economies took advantage of cheap borrowing costs to issue debt.
During the subsequent tightening of monetary policy by the Federal Reserve and other major central banks, Eurobond inflows in many lower-rated emerging market and developing countries dried up as borrowing rates reached prohibitive levels. Eurobond issuance diminished even as the interest rate differential widened in favor of emerging market and developing economies, pointing to the importance of external interest rates for this type of capital flows.
This year, global interest rate conditions have started to become more favorable for borrowers, as central banks in several major advanced economies moved toward easing monetary policy. This supported a recovery in Eurobond issuance to $40 billion in the first quarter of 2024 as countries such as Benin and Cรดte dโIvoire returned to the market. The onset of a Fed easing cycle may support an additional rebound in Eurobond issuance and a broader revival of capital flows to emerging market and developing economies.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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