EM spreads are holding up well as energy route disruption continues, but differentiation is occurring across sovereign credits as investors reassess future risk.
US President Donald Trump’s announcement of a pause on infrastructure strikes, conflicting accounts of diplomatic activity, and recent intimations that US marines may launch an operation to seize Iran’s primary export hub at Kharg Island have, above all, raised uncertainty. Routes to de-escalation undoubtedly exist, but financial markets have in recent sessions begun to contemplate a more prolonged period of disruption.
Spread performance
Emerging market debt (EMD) hard currency spreads have widened in aggregate since the start of the conflict, though the scale of widening remains contained. The JPM EMBI Global Diversified index spread was 279 bps at the close on Friday 27 March – a level last seen in November 2025 and around 25 bps wider than before the start of the conflict. Drivers of spread widening have included both high yield credits, whose relative performance typically reflect broader risk appetite, and more unusually numerous investment grade-rated sovereigns whose proximity to the conflict or reliance on exports via the Strait of Hormuz has led them to underperform.
Differentiated markets
Within Middle East sovereigns, the market has differentiated between credits according to their respective dependence on oil exports and imports and the underlying strength of their sovereign balance sheets.
Not all regional sovereigns are subject to the same factors. Qatar, for instance, has halted all liquefied natural gas production following Iranian strikes on its Ras Laffan facility and its complete dependence on the Strait of Hormuz as an export route. Other sovereigns may mitigate the impact of the Strait’s closure by diverting oil exports to the Red Sea (for example, via Saudi Arabia’s East/West Pipeline, which can carry around 70% of the country’s production) or transit points outside the Strait (via the Port of Fujairah, in UAE’s case). However, last week’s Iranian drone attack on Saudi Arabia’s Red Sea refinery and the risk of Houthi attacks on Red Sea shipping serve as reminders that disruption is possible here too.
Bahrain, where fiscal strength was low even before the crisis, and Egypt, an energy importer still highly dependent on foreign portfolio inflows, are among the most exposed issuers and have continued to underperform.
It is reasonable for Middle Eastern sovereign issuers, and even oil exporters, to attract somewhat larger risk premiums than previously, given the now elevated risks to both oil and non-oil economic activity. Any conflict outcome that does not deliver credible security guarantees to the region will also justify wider spread valuations than before. We also note the further risk that non-dedicated portfolio flows from credit investors – so supportive of EMD IG credit in the recent past – may diminish or reverse because of heightened volatility.
Outside the Middle East, several Asian credits have been under pressure, reflecting their oil import dependency. These include the Philippines and Sri Lanka and show the potential impact of the conflict on growth, inflation and fiscal stability.
The bottom line
While a prolonged period of regional disruption is not our base case, the risk of lasting damage to oil supply is material. Inflation spilling over into more restrictive global financial conditions could threaten 2025’s soft dollar theme and the positive risk sentiment that accompanied it. In time, constrained energy supply will inhibit growth and put pressure on government finances in emerging market economies.
However, the relatively resilient performance of high yield, non-MENA (Middle East and North Africa) sovereign credits so far this month illustrates that EMs are better insulated than they were from the distress observed after the Russian invasion of Ukraine in 2022. External and fiscal balance sheets are in far better health across emerging market economies relative to that period.
Debt market access over the past year or so has permitted EM issuers to build generous liquidity buffers, and global central banks are better able to ‘look through’ first round energy price shocks without the complication of post-Covid goods supply chain disruption and labour market imbalances.
We remain conservative in our allocation of risk, preferring credits with more subdued historical volatility profiles or those where fundamentals provide insulation from sustained higher energy costs.
