Emerging-market rates are broadly fairly valued; easing trades in high-yield markets offer greater value

Overview

Goldman Sachs updated its local-currency emerging-market rates fair-value framework, assessing 2-year, 5-year, and 10-year rates across 18 emerging markets. The report finds that post-pandemic spreads between emerging-market and developed-market rates have narrowed to relatively low levels over the past two decades. Improved inflation and fiscal fundamentals support this convergence, although elevated U.S. rates remain a significant upside risk.

Core views

Overall, emerging-market rate pricing is broadly consistent with macro factors, but dispersion across markets is substantial. Inflation risk premia in high-yield Latin American and CEEMEA markets are overestimated, with most rates appearing high, supporting receiving at the front end or curve belly; inflation risk is underestimated in some low-yield Asian markets, where rates may be low. The long end is driven mainly by fiscal trajectories: long-term rates retain room to decline in markets with improving fiscal conditions, while curves should steepen in markets with deteriorating fiscal conditions.

Analysis framework

The report builds a panel fair-value model using directly observable rates at each tenor, replacing the Nelson-Siegel process of first decomposing curves into level, slope, and curvature and then fitting macro variables. The model combines short-term cyclical gap variables with long-term structural expectation variables to explain the impact of inflation, growth, fiscal conditions, and U.S. rates spillovers on rates across tenors.

Methodology notes

• Rates fair-value modelPanel regression model

  A cross-market, cross-tenor macro pricing framework with directly observed rates as dependent variables

  Directly models local-currency rates across 18 emerging markets, using inflation, growth, fiscal, and U.S. rates variables to estimate fair value and deviations from it.

• Yield curve modelNelson-Siegel

  Decomposition of the yield curve into level, slope, and curvature

  Used as a historical benchmark framework; the new model is broadly robustly consistent in explanatory power while providing more intuitive attribution of macro drivers.

• Macro cycle indicatorHP filter

  Output-gap estimation

  Measures the output gap through cyclical deviations of real GDP from trend, used to identify the impact of growth risk on rates.

• Event shock analysisLocal projections

  Estimation of rate performance under growth shocks

  Uses 2-year interest rate swaps, scaled to a negative one-standard-deviation output-gap shock, to assess relative performance between high-yield and low-yield markets.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• BRL local-currency interest rate swaps

  Receive rates at the front end or belly

  Strengths

  The market-priced inflation premium is significantly above the model estimate, leaving rates high relative to fair value.

  Weaknesses

  High front-end rates reflect fiscal constraints, and room for lower rates depends on fiscal sustainability.

  Comparison

  Compared with low-yield Asian markets, it is better positioned to capture rate performance during a growth downturn.

  Risks

  Election-related volatility, renewed inflation increases, and fiscal deterioration.

• HUF local-currency interest rate swaps

  Receive front-end and belly rates

  Strengths

  Under a 2% long-term inflation-target assumption, front-end and belly rates are high relative to fair value.

  Weaknesses

  The trade depends on confirmation of an adjustment in the monetary policy framework.

  Comparison

  Like BRL, it is among the report's preferred high-yield receiving markets.

  Risks

  The MNB does not announce a lower inflation target, and inflation expectations prove difficult to anchor.

• THB local-currency interest rate swaps

  Pay rates to fund receiving positions in high-yield markets

  Strengths

  Can serve as the funding leg of a relative-value trade.

  Weaknesses

  Front-end rates have responded insufficiently to higher short-term inflation expectations following energy shocks, leaving valuations low.

  Comparison

  Provides a relative-value hedge against elevated BRL and HUF rates.

  Risks

  Further crystallization of inflation risk drives rates higher.

• MXN local-currency interest rate swaps

  Exercise caution toward the front end and belly

  Strengths

  Relatively liquid, and the model identifies its high sensitivity to U.S. rates.

  Weaknesses

  The front end and belly are low relative to fair value.

  Comparison

  More vulnerable than most emerging markets to changes in U.S. rates.

  Risks

  Further increases in U.S. rates and stronger cross-border rates transmission.

• PLN local-currency rate curve

  2-year–10-year curve steepener

  Strengths

  Can express a rise in term premia arising from fiscal deterioration.

  Weaknesses

  The front end is supported by more moderate inflation risk; the trade depends on long-end risk repricing.

  Comparison

  Opposite to flattening trades in fiscally improving markets such as ZAR and INR.

  Risks

  Faster-than-expected fiscal consolidation or a significant deterioration in growth.

• ZAR local-currency rate curve

  Receive the front end and favor curve flattening

  Strengths

  More moderate inflation assumptions and improving fiscal performance support lower rates.

  Weaknesses

  Value realization requires inflation expectations to converge toward the new target.

  Comparison

  Long-end fundamentals are more supportive than in markets with weakening fiscal conditions.

  Risks

  Declining credibility of the inflation target or an interruption in fiscal improvement.

Key data

• Number of markets covered18The model covers local-currency rates markets in 18 emerging markets.
• Short-term inflation-gap sensitivityApproximately 70 basis pointsFor every 1 percentage point that short-term inflation expectations exceed long-term levels, emerging-market front-end rates rise by about 70 basis points on average.
• Fiscal-deficit sensitivityApproximately 20 basis pointsFor every 1 percentage point increase in the expected fiscal deficit, 5Y5Y rates increase by approximately 20 basis points.
• BRL inflation-premium deviationApproximately 300 basis pointsThe inflation premium priced by the market is about 300 basis points above the model-implied level, supporting a medium-term rates-receiving view.
• HUF long-term inflation assumption2%The model assumes Hungary's long-term inflation target and expectations converge to 2%, rather than the consensus 2.7%.
• ZAR long-term inflation assumption3%The model assumes South Africa's long-term inflation expectations converge to the 3% target, rather than the consensus 3.5%.

Impact & implications

Strategically, the report favors receiving rates at the front end or belly in BRL and HUF, funded by paying in low-yield Asian markets such as THB. The COP long end remains attractive, although the post-election rebound has already partly absorbed the undervaluation; the ZAR front end is high, and continued fiscal improvement could drive the long end lower. For fiscal divergence, it recommends steepeners in ILS, RON, and PLN, and flatteners in ZAR, INR, and potentially improving COP. Caution is warranted on the MXN and CLP front end because of substantial U.S. rates spillovers.

Risks

• Energy shocks cause inflation expectations to continue rising, weakening the support for rates from easing local inflation.
• U.S. rates rise further and transmit to emerging markets through cross-market beta, especially MXN and Latin American markets.
• Growth risk is not yet fully reflected; if growth deteriorates materially, market performance will depend on relative changes in inflation and policy space.
• Fiscal trajectory divergence widens, and fiscally deteriorating markets such as Brazil and Poland may face additional long-end risk premia.
• BRL election uncertainty and unfulfilled inflation-target adjustments in HUF and ZAR could all impede valuation normalization.
• The model has lower explanatory power for some Asian markets, including CNY, MYR, and IDR, reducing confidence in related fair-value assessments.

What to watch

• Energy prices and their transmission into short- and long-term inflation expectations.
• Changes in U.S. SOFR and U.S. Treasury yields, particularly spillovers to MXN and Latin American rates.
• BRL election developments and fiscal policy signals.
• Whether the MNB lowers its inflation target and whether Hungarian long-term inflation expectations converge toward 2%.
• The anchoring of expectations following the SARB's shift to a 3% inflation target and South Africa's fiscal performance.
• Fiscal-consolidation progress in India, South Africa, and Colombia, as well as fiscal-deficit trends in Poland and Brazil.
• Whether emerging-market growth weakens enough to create disinflationary output gaps.