Under pressure from energy and rates risks, emerging-market trades still require selective carry and relative-value opportunities
AI summary card
Under pressure from energy and rates risks, emerging-market trades still require selective carry and relative-value opportunities
Goldman Sachs believes that renewed escalation in the Iran conflict has weighed on EM currencies, but less severely than in March, with oil prices remaining the key driver of relative performance; in carry, rates and equities, it favors markets with high carry-to-vol, dovish central banks and clearer fundamental support.
- EM currencies broadly depreciated against the dollar during July's oil-price rise, with energy importers underperforming and energy exporters BRL and COP relatively outperforming, although the overall volatility was smaller than during the early-March shock.
- BRL and COP remain the most prominent currencies in terms of carry and carry-to-vol, but BRL faces election noise and the risk of higher US long-end yields; the report prefers long COP.
- Among currencies offering approximately 3% dollar carry, the report favors MXN carry, followed by INR and ZAR, while remaining cautious on IDR because of domestic factors.
- EM local rates remain constrained by oil prices and the risk of tightening by core central banks; the report favors markets such as PLN, HUF and ILS, where rates have backed up and central banks are relatively dovish.
- MSCI EM has retraced 12% from its late-June high, but non-tech EM equities rose 2% in July; the report still expects a non-tech broadening trend supported by improving earnings and diversification appeal.
Report interpretation
Overview
This report covers emerging-market foreign exchange, local rates, equities and sovereign credit. The key backdrop is oil-price volatility caused by renewed escalation in the US-Iran conflict, together with repricing pressure on EM assets from expectations of Fed tightening and higher US long-end yields. The report finds that EM currencies reacted to the oil shock in July in the same direction as in early March, but more mildly, reflecting a friendlier risk backdrop, the fact that many energy-importer currencies had not fully recovered beforehand, and a smaller terms-of-trade shock.
Core views
The core views are: first, oil prices remain a key variable for EM relative performance, benefiting energy exporters BRL and COP, although their high beta also makes them vulnerable to higher US long-end yields; second, there is still room for EM FX carry, but longs and funding currencies must be selected carefully, with priority given to maximizing carry-to-vol; third, the easing space for EM local rates is constrained by energy-supply uncertainty and Fed risk, with opportunities concentrated in markets such as PLN, HUF and ILS, where rates have backed up and central banks are relatively dovish; fourth, crowded technology trades in EM equities continue to delever, but non-tech sectors remain resilient, and EM equities could continue broadening into non-tech areas if oil and rate volatility remain contained; fifth, issuance of EM sovereign dollar bonds remains strong, with total 2026 issuance forecast at approximately US$209bn for the full year, but rising net supply could push spreads modestly wider over the next 12 months.
Analysis framework
The report compares EM FX performance during the renewed escalation of the US-Iran conflict from July 6 to July 23 with the energy shock in early March, and uses a simple model incorporating oil prices, copper prices, the S&P 500 and US 10-year real yields to explain relative currency returns. It also uses carry and carry-to-vol to assess the attractiveness of FX trades, central-bank reaction functions, real policy rates, US-rate sensitivity and term premia to explain local-rate opportunities, and valuation, earnings surprises and position deleveraging to assess broadening in EM equities.
Methodology notes
Use the S&P 500, oil prices, copper prices and US 10-year real yields to explain weekly returns of EM currencies against the dollar.
The report estimates sensitivities using five years of weekly data through February 27, 2026, then compares model-predicted returns with actual returns from July 6 to July 23 to determine whether currencies such as KRW, COP, ZAR, CLP and MXN deviated from fundamental explanations.
Use the ratio of carry to volatility to measure the risk-adjusted attractiveness of carry trades.
The report considers BRL and COP leaders in carry and carry-to-vol, while noting their exposure to US long-end yields; MXN's carry-to-vol has risen, particularly relative to EUR, making it more favored among currencies offering approximately 3% dollar carry.
Compare the impact of changes in oil and copper prices on the terms of trade of energy importers and exporters.
The report notes that the deterioration in terms of trade in July was generally smaller than in March, while CLP and PEN were less affected because of copper-price resilience, helping explain the milder declines in some EM FX markets.
Use rolling OLS to estimate the sensitivity of EM 10-year zero-coupon yields to the US 10-year term premium and risk-neutral rates.
The report believes EM long-end rates are more vulnerable to rising US term premia, while the spread between EM local rates and USTs is already tight, limiting the scope for broad long-end compression.
Asset mapping & comparison
Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).
- COPAn energy exporter, high-carry currency and one of the preferred EM FX longs
- Strengths
- Supported by high oil prices, post-election optimism and expectations of further tightening; actual performance exceeded model predictions.
- Weaknesses
- Its high beta makes it sensitive to higher US long-end yields and global risk volatility.
- Comparison
- Relative to BRL, the report prefers COP because Brazil faces election noise and is in an easing cycle.
- Risks
- A decline in oil prices, higher US yields, or a reversal in Colombian policy or fiscal expectations.
- BRLAn EM currency leading in carry and carry-to-vol
- Strengths
- High carry and support from higher energy prices; it remains one of the strongest carry candidates.
- Weaknesses
- Sensitive to US long-end yields and facing increased volatility ahead of the October election.
- Comparison
- It is a leading carry currency alongside COP, but the report currently favors COP.
- Risks
- Brazilian election noise, the BCB easing cycle and continued increases in US long-end yields.
- MXNA more favored carry long among currencies offering approximately 3% dollar carry
- Strengths
- Carry-to-vol has risen, particularly relative to EUR; it has exposure to the US growth cycle and is relatively resilient to oil-price volatility.
- Weaknesses
- Front-end rates are sensitive to US front-end pricing, while the spread relative to the US is relatively low.
- Comparison
- Among INR, IDR, MXN and ZAR, the report gives priority to MXN carry.
- Risks
- USMCA negotiations, Banxico turning dovish in a hawkish-Fed scenario, and sustained expectations of Fed tightening.
- INROne of the second-tier EM carry longs
- Strengths
- Carry-to-vol has risen and it is supported by RBI measures that have moderated depreciation pressure.
- Weaknesses
- Central-bank support also limits scope for spot appreciation.
- Comparison
- Ranked after MXN and ahead of IDR; it can be paired with a short THB position to partially neutralize energy risk.
- Risks
- A more severe energy-price shock, India's energy-import exposure and limited scope for spot appreciation.
- ZARAn EM currency with spot resilience but low carry-to-vol
- Strengths
- If the conflict eases and energy risks decline, the rand could have significant rebound potential because of its high volatility.
- Weaknesses
- Carry-to-vol is well below that of peer currencies, while the SARB's surprise decision to remain on hold reduces the certainty of central-bank support.
- Comparison
- The report ranks it behind MXN and INR, emphasizing that it is better suited to an energy-easing scenario than to a stable carry-long position.
- Risks
- SARB policy uncertainty, energy shocks, higher US rates and domestic South African risks.
- HUFConstructive medium term but more a spot trade than a carry trade in the short term
- Strengths
- It retains medium-term appreciation potential; the report forecasts 6-month EUR/HUF at 350.
- Weaknesses
- Carry and carry-to-vol have declined materially after the election, central-bank support is limited, and energy-supply and price risks remain.
- Comparison
- It can be paired with a short PLN position to neutralize HUF's energy exposure and trade valuation convergence.
- Risks
- Energy-supply shocks, insufficient central-bank support and declining carry attractiveness as yields continue converging with euro-area yields.
- PLN, HUF, ILS local ratesPreferred EM front-end rate opportunities
- Strengths
- Rates have backed up while the respective central banks lean dovish, suggesting that market pricing of tightening may be excessive.
- Weaknesses
- They remain constrained by oil, natural gas, winter-supply and core-central-bank rate risks.
- Comparison
- Relative to the MXN front end, the report prefers these markets, where central banks are dovish and rates have already backed up.
- Risks
- A renewed energy-inflation shock, sustained expectations of Fed tightening and central banks being forced to turn hawkish.
- MXN local ratesA front-end rates market on which the report remains cautious
- Strengths
- Front-end rates have repriced, while domestic inflation dynamics remain moderate.
- Weaknesses
- The spread relative to the US is relatively low, and rates are sensitive to US front-end yields.
- Comparison
- It offers a less clear front-end receiving opportunity than PLN, HUF and ILS.
- Risks
- Sustained expectations of Fed tightening, a stronger dollar and changes in Banxico's policy path.
- EM non-tech equitiesThe area expected to benefit from broadening in EM equities
- Strengths
- Low starting valuations and prices, better-than-consensus early 2Q results and upward earnings revisions provide support.
- Weaknesses
- Non-tech resilience could weaken if oil and rate volatility increases.
- Comparison
- Relative to crowded technology and AI-infrastructure trades, non-tech sectors performed more steadily in July.
- Risks
- Spillover from global deleveraging, higher oil prices, Fed risk and unsustainable earnings surprises.
- EM sovereign dollar bondsStrong issuance but facing modest widening pressure on spreads
- Strengths
- First-half issuance was strong, with both IG and HY issuance at their second-highest levels in a decade; demand and issuance terms remain favorable.
- Weaknesses
- Full-year net supply could rise, putting pressure on spreads.
- Comparison
- IG GCC sovereign issuance is an important source of supply, while HY contributes approximately one-third.
- Risks
- Weaker risk appetite, net-supply pressure, higher US rates, geopolitical risks and increased fiscal spending.
Key data
- Oil shock observation window2026-07-06 to 2026-07-23The report uses this interval to measure EM FX performance before oil prices peaked following renewed escalation in the US-Iran conflict.
- MSCI EM drawdown12% retracement from the late-June highThis gave back approximately half of the strong first-half gains driven by technology and AI-infrastructure stocks.
- MSCI EM ex-tech July performance+2%Despite another rise in oil prices, non-tech EM equities reacted relatively mildly.
- Full-year EM sovereign dollar-bond issuance forecastApproximately US$209bnIG accounts for approximately US$138bn, or 66%; HY accounts for approximately US$72bn, or 34%.
- HUF medium-term FX forecast6-month EUR/HUF 350The report maintains a constructive medium-term view on HUF, but sees short-term challenges from energy and insufficient central-bank support.
- Leading carry currenciesBRL, COPBoth remain clear leaders in carry and carry-to-vol, but are also exposed to US long-end yield risk.
Impact & implications
The portfolio implication is that EM assets should not be treated as a simple directional, broad risk-on trade. Instead, allocations should be structured around energy exposure, US-rate sensitivity, central-bank reaction functions and carry-to-vol. In FX, investors can favor longs such as COP, MXN and INR, where relative advantages are clearer, and use THB, PLN, ILS, CLP or G10 currencies CHF, EUR, JPY and CAD as funding or risk-neutralizing instruments; in rates, investors should favor PLN, HUF and ILS front ends, which have repriced and whose central banks are relatively dovish, while treating the MXN front end cautiously; in equities, investors should continue monitoring whether technology deleveraging spills over, while focusing on non-tech EM earnings resilience and regional diversification demand.
Risks
- Oil prices remain elevated or rise again, continuing to weigh on energy-importer currencies and local rates.
- Expectations of Fed tightening re-emerge, pushing up the dollar and US front-end rates and pressuring EM FX and local rates.
- Higher US long-end yields and term premia limit compression in EM long-end rates and hurt high-beta carry currencies.
- The US-Iran conflict lacks a sustainable resolution, causing continued energy-supply uncertainty and market volatility.
- Brazilian election noise in October could increase volatility in BRL and Brazilian rates.
- USMCA negotiations and changes in Banxico's policy path could weaken the MXN carry view.
- If deleveraging of crowded technology and AI-infrastructure positions is not fully completed, it could continue weighing on MSCI EM.
- Higher net supply of EM sovereign dollar bonds could lead to modest spread widening over the next 12 months.
What to watch
- Whether oil prices can continue falling after July and whether the US-Iran conflict develops a sustainable path to resolution.
- Whether US front-end tightening pricing persists ahead of the September FOMC and whether the dollar strengthens in tandem.
- Whether US 10-year yields, term premia and EM long-end spreads continue rising or remain under pressure.
- The sensitivity of BRL and COP to US long-end yields and the flow of Brazilian election news.
- MXN carry-to-vol, progress in USMCA negotiations and Banxico's policy stance relative to the Fed.
- Whether EM central banks including SARB, NBP, MNB and BoI continue to lean dovish relative to tightening pricing.
- Whether deleveraging of EM technology positions continues to spread and whether 2Q earnings surprises can support non-tech sectors.
- The impact of IG GCC sovereign issuance and full-year net EM sovereign dollar-bond supply on spreads.