Dollars and Sense podcast

Making dollars and talking sense….in emerging market debt

Polina Kurdyavko, Head of EM Debt, and Mike Reed, Head of Global Financial Institutions, discuss geopolitical risk in relation to recent events, what a weakened dollar means for emerging market currencies, and the opportunities and challenges for the asset class in the year ahead.

Mike Reed 00:05

Hello, and welcome back to the RBC BlueBay podcast. I am Mike Reed, Head of Global Financial Institutions. It's a new year, and to ring in the changes, we have a new name for the show. For the podcast formerly known as Unlocking Markets is now Dollars and Sense. I hope you like it. We will continue to bring our experts from across the firm who'll provide you with their opinions on markets, global policy, macroeconomics, while at the same time highlighting how they make sense of the news and where they will position their dollars this year.

Today, I'm joined by Polina Kurdyavko, Head of our Emerging Markets Fixed Income team. Polina has, as you know, been a regular guest on the show, and it's always incredibly interesting and helpful to hear her thoughts on markets, politics, and economic trends. It is great pleasure that I welcome her back.

Polina Kurdyavko 00:54

Mike, it's a pleasure to be here.

Mike Reed 00:56

Good to have you. I don't know where to start. 2026 has started with an enormous bang in terms of events of the markets with the US's raid on Venezuela, Trump's threats to Iran. In addition, we have seen his desire to acquire Greenland one way or another. The US appears to be taking a much more forceful approach in what Trump has termed the US's hemisphere. I've read some commentary around this raises risks in other regions, whether it be China with Taiwan, Russia with former Soviet republics. How real do you think these geopolitical risks are, and do you think they will derail emerging markets this year?

Polina Kurdyavko 01:35

I think it's fair to say that what Donald Trump has created is a new, no-rules-based approach, and ultimately, an approach where might is right. We don't have a framework that we operate on. If anything, just using his quote a few moments ago, "If you say no to what we want, we will remember," whatever that means. I think it's a very challenging environment to operate it from a longer-term vision perspective.

With that said, I do feel that if we look at the actions that other countries might take, and I know that obviously Russia and China are the ones in question, while short-term that a no-rule-based approach might be viewed as beneficial for other players like Russia and China, I think longer-term, it's also worth acknowledging that China, and actually to a much bigger extent Russia, is strategically losing some of its allies. Venezuela is a case in point for both of the countries, but we can also say that for Russia, countries like Iran, countries like Syria, countries like Armenia, are no longer strategic allies.

For us, it is too premature to draw conclusions from what the no rule based approach means for these countries longer-term, but I think it's fair to say that, ironically, it's easier to some degree to express that in the financial markets than to express it in the longer-term, real growth estimates. When we look at emerging market fixed income products, we actually think that the asset class has not increased its volatility on the back of those comments.

If anything, last year, we've experienced the lowest volatility in the asset class for over 15 years, with the volatility reducing from an average of 8% through the cycle to 3% across most of the young fixed income portfolios, being on par with developed markets. As long as this volatility gets anchored, we are likely to see flows in the asset class. The only point to me that would upset the apple cart is the increased volatility in the core rates, and that's the area that we focus on.

Mike Reed 04:09

I guess, does that mean EM assets are becoming the safe haven to go to these days? I don't know. You talked on volatility, and volatility reduced last year, but we saw political volatility and shifting global narratives, and that's not new to EM markets. In 2025, we had the global playbook rewritten, the various political tensions, whether it be across Ukraine, Iran, Israel, etc. Despite all of this, EM debt posted mid to high teens returns. That's double what you got in the US fixed income equivalents. What was behind that? Does the investment climate still remain favourable into 2026?

Polina Kurdyavko 04:59

If I think about the key drivers of returns in fixed income, to me, we always have to start with expectations for defaults. Last year, like we've expected, we had a zero default environment for sovereign debt, and we had a default environment in the corporate space, which was below historical average. In fact, it was low single-digits compared to mid-single digits in terms of historical average.

Now, therefore, for us, the question is, this year, could we see the same narrative? To us, the answer is yes on the sovereign side. We expect default for this year to be below 1%. In fact, 0.7 is our bottom-up estimate, to be exact. However, we do think on the corporate side, the defaults are likely to shift upwards, perhaps to a 5% range, mostly driven by four companies in two countries that are suffering from very high real rates in domestic markets.

Now, what does that mean for emerging market fixed income? We think that for the sovereign asset class, that means that not only the higher yield will still be on offer as it is today, but we think the volatility regime is likely to remain low. Therefore, we do think that investors can generate high single digits to double-digit returns from the core emerging market fixed income allocations, of course, provided that we're anchoring the Fed rates at the current level.

Mike Reed 06:36

That's coming where I want to come onto this, because those are…you're anchoring around this within the core rates in the US. Historically, a lot of EM returns, whether it be equities or performance in the EM economies, is centered around US rates and the US dollar, to a certain extent. How do you think we're positioned going into 2026? We saw a 10% odd devaluation in the dollar last year, which was supportive definitely for EM equities, and I think for EM countries generally. How do you feel on that going into 2026?

Polina Kurdyavko 07:12

I think that when we look at local currency markets, there are two big trends that we need to observe. The first trend is when it comes to the breadth and the depth of the local markets, where we now look at EM fixed income continuum, which is the size of US treasury markets, which is over USD30 trillion. Within that, over 85% is denominated in local currency. That has been the fastest-growing segment of the market. Now, that has, first, ramification of reducing debt sustainability risks in emerging market countries. That's why we're observing lower default rate.

Also, with the growth comes complexity. As these markets mature, it doesn't mean that the volatility goes down in those markets. It just means that you have a lot more players in the market that drive that. Case in point would be Brazilian local corporate market, which has tripled over the last few years, reaching USD400 billion. When you see that fast pace of growth, there's undoubtedly going to be some wobbles along the way. However, for us, the biggest implication is growth in local market on the back of orthodox monetary policy means good news for hard currency credit investors and sustainability of debt in emerging markets.

The second point is, where are we in terms of valuations? Can we see local currency being attractive not only from a debt sustainability perspective, but from a total return perspective? The short answer is yes, because when we look at the real rate differentials in emerging markets, it's still at all-time high on the last 10 to 15-year time horizon. If you look at the dollar against trade weighted basket, it is still close to two standard deviations away from its mean over the last 50 years i.e. the dollar is still expensive.

As we've learned over the last couple of years, what Donald Trump wants, often, Donald Trump gets. We clearly have seen a policy direction for a weaker dollar coming from the US in addition to real rates, which are creating a buffer for local currency. In a nutshell, we do think that local currency markets can generate double-digit returns this year.

Mike Reed 09:33

That's great. I read your recent insight paper on Polina's perspective and you talked about the journey - I think you call it journey to maturity for emerging markets. I would thoroughly recommend that to our listeners to read that. It's very, very good. You can find it on our website, www.rbcbluebay.com. Definitely gives you some perspective on what's going on in local currency markets. I have to say, I was surprised about how much they have grown and how important they are. 

You talked a lot about volatility, and we, as a firm, we're active fund managers. We've seen the dramatic rise of passive index tracking funds over the last few years, and money has moved away from some active managers, not us, I might add…but emerging markets strike me as part of the market which should potentially offer rich pickings to managers who are able to do their bottom-up research, and top-down, obviously. If you look across the main EM bond indexes, as background, there's a huge diversity of economies. You've got bond yields in China, which are about 2%, and Brazil, they are in the low teens. Potentially, to me, as an outsider, it looks like this is somewhere you could be looking to generate alpha. Is this true? Would be great to see, are there lots of alpha-generating opportunities? Talk us through some of the stuff that you do. I know you were active in Venezuela recently, which is very much off-benchmark, and be interested to see your thoughts behind that, and what was the rationale?

Polina Kurdyavko 11:02

I would start by saying that there are plenty of opportunities in this asset class. I think it stems from the fact that even though the asset class has grown, the allocation to the asset class remains in low single-digits. That has not changed for the last two decades, if we think about that as a percentage of the global fixed income pie. That's what creates opportunities, i.e. dislocations from the alpha perspective. That's why if you look at the hard currency funds in the universe, unlike some of the equity universes, we're not seeing the index being in the top quartile performance. If anything, we're seeing very healthy alpha generation opportunities. In particular for us, the last five to six years has been especially fruitful, given that volatility and newsflow has been high to generate potential dislocations of performance that we could exploit.

Now, if we think about the opportunities today, if I look at hard currency, you mentioned Venezuela. This is the hot topic, if you will, for discussion. Again, I would say that this is another example where the narrative that we see in the newspapers is, if you will, more difficult to digest in the context of what's the longer-term future of Venezuela. However, the economic narrative and the bond narrative are much easier to express because there are very few times when you can double your money in fixed income.

Most of the times, it comes from bonds trading at a deep discount. We entered this year with Venezuelan bonds trading below $0.20 on the dollar. That's an asset which, again, even if we look at historical recovery patterns, should deliver between $0.40 to $0.50 on the dollar once the restructuring is finalised. That's what we found attractive as an asymmetry. On top of that, of course, given that we did have events happening at the end of last year with the US gathering troops, if you will, or at least military, if you will, increasing its military activity, I should say, around the borders of Venezuela, we felt that that gives you a better time horizon.

That's why we've increased our exposure to Venezuela at the end of last year and have taken partial profits on that exposure on the back of the 30-plus percent outperformance year to date. For us, this continues to be an interesting source of alpha. It's actually interesting to note that most geopolitical events can be positioned for through some of the distress credits, Lebanon being another example, which rallied over 80% last year and close to 30% year to date.

On the local side, we think opportunity is equally rich, not only because of the divergence in the local yields and currencies performance, as you mentioned, Mike. We have a huge disparate bucket from very low-yielding countries to countries with double-digit policy rates. Also, it's worth noting that GBI index actually is very misleading when it comes to representation of the universe. It only includes a handful of countries, or in fact, maybe a dozen countries. It's not the same as the size of the total universe. For us, the best approach to explore opportunities in local currency is an unconstrained approach where we actually look at best ideas across the universe and use the benchmark as a guide, if you will, rather than being restricted by the benchmark composition.

Mike Reed 14:53

It is a very diverse universe. Seeing that there are opportunities out there, I find very, very interesting and a good way to approach it. Obviously, every time I speak to a portfolio manager, they're always very constructive on their asset classes. What are the potential pitfalls for emerging markets in 2026? What could derail things?

Polina Kurdyavko 15:20

If I think about the pitfalls for the asset class, I would perhaps describe it in three different buckets. I guess, firstly, is the pitfall for the fixed income asset class. I think, here, you have, as I mentioned earlier, the core focus on the core rates because ultimately, this is an asset class which has a safe haven, if you will, i.e. fixed income products are used, if you will, as a low volatility product in the investment portfolios. If we see increased volatility in US treasury, we feel that that would pose risk for the performance of the fixed income products more generally. Emerging markets is not an exception.

The second pillar in terms of risks for emerging markets stems from credit spreads. Again, this is a generic statement around fixed income. Global credit spreads are close to all-time tights. Even though in EM, fixed income spreads still give you a bigger buffer than developed markets, the trend has been similar. We have seen tightening in spreads. The less spread buffer you have, the more asymmetric your risk-reward is. We need to be very mindful of the default forecast materialising, as you expect, in order to justify these global spreads where fixed income products, both on the corporate credit and sovereign credit, are trading.

The third point would be the risk related to the political cycle. This is a big election year for emerging markets. We have two countries, in Latin America in particular, which are likely to see volatility related to elections in Colombia and in Brazil. We think that, again, in both cases, incumbents have been not market friendly, so there is a potential for upside. Equally, if we stay a status quo, we can see the market being disappointed.

Interestingly, that even in low-volatility countries like Hungary, we have elections in early April. Again, we have potential for an opposition or, rather, a market-friendly candidate winning the elections, which the market is currently pricing as 50/50. Should they succeed, we would expect double-digit returns from the local currency segment, in particular, on the rate side in Hungary. The idiosyncratic risks are centered around election cycles this year, and that's the risk that we are monitoring very closely.

Mike Reed 17:54

So many different stories within emerging markets. I don't know how you get your mind around it all, to be honest, but it's fantastic, and you and your team obviously do. Thanks for joining us today, Polina. It's been great catching up. We really look forward to seeing how things evolve. Hopefully, you can come back on the show later in the year and give us an update.

Polina Kurdyavko 18:14

It will be my pleasure. Thank you very much, Mike.

Mike Reed 18:16

Many thanks for listening to the show. If you've enjoyed it, please like and subscribe on your podcast platform of choice. We will be back next month when we will be joined by portfolio manager Neil Mehta from our investment grade team. With high grade bonds making up such a large percentage of many investors' portfolios, it will be good to hear Neil's views on the macro trends that will likely impact returns this year.

If you wish to listen to any of the previous editions of the podcast, they are available on our website, www.rbcbluebay.com, or can be found on Apple, Spotify, or Google. Thank you once again for joining us today. Good luck and goodbye.