Investor appetite for emerging market (EM) local-currency bonds is rising sharply, with a surge in call-option demand signalling growing confidence in EM currencies and capital inflows.
The trend, highlighted in a new BIS report, reflects optimism fueled by a softer US dollar, widening growth gaps between EM and developed economies, and proactive monetary tightening in countries such as Brazil and India. Their currencies have outperformed the dollar this year, helping attract record inflows into local-currency bond funds.
Analysts say that a one-standard-deviation decline in the dollar historically corresponds to a 0.29 percentage point rise in EM bond inflows. The demand for call options — typically used to bet on rising asset values — now serves as a leading indicator of investor sentiment and anticipated stability.
BIS data also show that EM central bank rate hikes have been drawing capital back into local markets, with a 100-basis-point tightening linked to inflows equivalent to 0.2% of quarterly GDP. However, risks remain: US tariff threats and global volatility could quickly reverse gains.
The IMF has warned that while current inflows are strong, they remain below historical peaks, suggesting continued sensitivity to shifts in U.S. policy.
Call-option demand on EM bonds underscores a structural shift toward local-currency exposure as investors hedge against a declining dollar. Yet, sustained inflows will depend on global stability, and whether EMs can maintain growth outperformance without triggering fresh volatility.
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