Emerging market local-currency bonds are being tipped to beat their dollar-denominated peers despite offering lower yields than even US Treasuries.

The securities have had the best start to the year since 2022 against their dollar rivals, as global trade turmoil boosts expectations for interest-rate cuts in developing nations and cools inflation by pushing down oil prices. Dollar bonds meanwhile have underperformed as US President Donald Trump’s tariff threats weigh on the greenback.

“We have a strong preference for EM local debt” over emerging dollar bonds due to the weak dollar and the prospect that EM central banks will have more room to lower policy rates, said Jon Harrison, managing director for EM macro strategy at GlobalData TS Lombard in London.

“The slowing US economy, with a growing chance of recession, is bad for global growth, which is likely to further incentivize EM central banks to cut rates,” he said.

Emerging-market local-currency bonds have returned 3.2% this year, while their dollar-denominated peers have gained just 0.7%, according to Bloomberg indexes.

The outperformance of local-currency debt has led to an unusual situation where the historically riskier bonds are trading at lower yields than those denominated in the dollar — traditionally the world’s main haven asset. The average yield on the local-currency index has dropped to 4.03%, compared with 7.1% for the dollar-denominated gauge and 4.12% for US Treasuries.

One of the major drivers of local-currency bonds in recent weeks has been increasing expectations that central banks will ease monetary policy due to the turmoil set off by Trump’s announcement of “reciprocal tariffs” on April 2.

An index of one-year interest-rate swaps from 18 emerging economies has dropped by around 15 basis points in April alone, heading for the largest monthly decline since September, based on data compiled by Bloomberg. 

‘Heightened volatility’

“Among the larger markets, we prefer the local-currency side” as that gives us greater means to express our views on currencies, monetary policy, duration and yield curves, said Philip McNicholas, an Asia sovereign strategist at Robeco in Singapore. 

“The heightened volatility in Treasuries and US policy should be imbuing a higher term premium — as is playing out — and diminishing the allure of the dollar,” he said. The term premium is the compensation bond investors demand to bear the risk that interest rates will fluctuate over the life of the security.

Emerging local-currency bonds may get a further boost as the weak dollar bolsters the performance of its developing-nation counterparts. Bloomberg’s dollar spot index has fallen almost 4% in April, heading for a fourth monthly decline.

“The US dollar still looks very expensive following a decade long US dollar bull market,” said Mike Riddell, a fixed-income portfolio manager at Fidelity International in London. “An unwind of lofty USD valuations, coupled with heavy long USD positioning, would likely be the main multi-year tailwinds for emerging markets.”

Lower issuance

The worsening outlook for the dollar is making some bond issuers more cautious about sales of debt denominated in the US currency.

Issuance of dollar bonds in emerging markets excluding China, has fallen 36% so far in April compared with the same period a year ago, to just $5.1 billion, based on data compiled by Bloomberg.

Goldman Sachs Group Inc. is among those saying EM local-currency bonds should keep outpacing their peers.

“In the face of recession fears, we think that EM local rates would be poised to outperform other EM assets,” Goldman Sachs analysts including Andrew Tilton and Kamakshya Trivedi wrote in a research note published Thursday. 

What to watch

• Chinese banks will announce their loan prime rates on Monday, while Bank Indonesia will make a rate decision on Wednesday
• Malaysia, Singapore and South Africa will publish inflation data, with further signs of disinflation to support wage-cut bets
• South Korea will release first-quarter advance GDP, with investors looking for any impact on the economy of the global tariff uncertainty

This story was originally featured on Fortune.com