My first working day of the new year begins with an unusually empty calendar. Before appointments, roadshows, and market debates set the pace, there is room for a question that is crucial after an extraordinary year like 2025: What was cyclical – and what was substantive?

The key question is not whether the performance can be repeated, but why it came about in the first place. This focus on causes rather than results shapes my view of the asset class at the beginning of 2026.

Economic Growth is Supportive 

EMD had a phenomenal run in 2025. Corporate markets returned 8%, Sovereign added 14% and Local Currency up 18%. This leads investors to ask the question, can this continue? Fundamentals suggest yes. Economic growth is supportive where we expect a slight slowdown from 4.3% in 2025 to 4.0% in 2026. Although slightly lower, the EM-DM growth alpha remains healthy at 2.4% in 2026, similar to pre-pandemic trends. The key variable therefore comes from the US which will impact all fixed income markets. An easing Federal Reserve combined with a continued weakening of the US dollar would add an impetus for strong returns to continue.

Inflation Returned to Target Levels

EM local currency debt markets have structurally improved, with more countries adopting inflation targeting and fiscal rules, boosting domestic investor confidence. The local investor base now exceeds 100% of GDP in many EMs, reducing risk as domestic holders are less likely to sell during uncertainty. Inflation has returned to target levels in 2025, but rates remain high, with central banks only halfway through their cutting cycle, resulting in high real rates. We favor long duration in countries likely to cut rates and remain tactical where fiscal or political risks persist.

Few Defaults, Few New Issues: Tailwind for EM Bonds

We predict that EM Sovereign fundamentals will continue improving in 2026 following a strong 2025. EM countries reported lower deficits and zero defaults in 2025, continuing the trend of zero defaults in 2024. In 2026 we predict limited defaults with 0.4% of the index at risk. Strong fundamentals are being reflected in upgrades from credit rating agencies. EM Corporate fundamentals are more stable but present sector divergence providing the possibility for alpha generation. We expect mid-single digit EBITDA growth, stable leverage and a small increase in defaults due to idiosyncratic issues. While valuations may seem tight based on historical data, we find they are justified by these strong fundamental factors and technicals.

We predict corporate markets will have the 5^th consecutive year of negative net supply meanwhile sovereign issuance is expected to be driven by investment grade issuers while high yield issuance is expected to also be negative on a net basis. As such any inflows to the asset class should see spreads tighten. In Sovereign, we favor a barbell approach with selective short duration high carry and longer dated quality issuers. In Corporate, our active position taking is focused on BBB and BB issuers with a high current yield supporting total returns. 

The Central Scenario for 2026

We break down our market environment scenarios into three categories of recession, sub-trend or re-acceleration.

Our central scenario of sub-trend growth has the highest upside with returns between 9 and 12% for Sovereign and Local markets. However, our expectations of tail risk scenarios are increasing. 

Re-acceleration is the most negative scenario for EMD with increasing inflation leading to a stronger US dollar and central banks not being able to cut rates as expected impacting Local Currency Debt. Improving quality combined and a spread buffer leads to less negative returns in Sovereign markets.

A recessionary market environment would deliver positive returns in EMD. Sovereign would benefit from US policy rate cuts while spreads in the investment grade portion of the market would be expected to remain contained and act as a ballast for the market. In Local, high policy rates give EM central banks capacity to significantly cut rates offsetting US dollar strength.

When we probability weight our different scenarios, we see positive returns for both Sovereign and Local markets in 2026 around 6%.

Pierre-Yves Bareau is Managing Director, Head and CIO des Emerging-Market-Debt-Teams, J.P. Morgan Asset Management.