Valuation Metrics in Emerging Debt: 3Q26

GMO argues that emerging-market local-currency debt is substantially more attractive than hard-currency debt, warranting the maximum strategic tilt toward local debt.

• Hard-currency credit spreads have fallen to 71 bps of excess spread, placing them in GMO’s least attractive quintile; this valuation level has historically been followed by a mean two-year annualized credit return of -2.0% above the risk-free rate.
• USD duration is rated neutral, although GMO’s deviation-from-fair-value measure shows a modest improvement in its attractiveness, with rates slightly below fair value.
• Emerging-market foreign exchange is attractive: GMO’s expected spot-return indicator is +1.5%, in the upper end of the third attractiveness quartile, where subsequent GBI-EMGD-weighted spot returns averaged +5.1%, versus +6.8% in the fourth quartile.
• Local emerging-market rates are very attractive, with a +1.4% valuation gap versus U.S. interest rates; the most attractive quartile has historically produced a mean subsequent EM/U.S. return differential of +4.1%.
• GMO therefore positions 50%/50% blended currency portfolios at the maximum local-currency allocation, 70% local debt versus 30% hard-currency debt.

Takeaway: GMO’s valuation framework favors local-currency emerging debt and argues for a 70% allocation in blended portfolios, while viewing hard-currency credit as expensive and USD duration as broadly neutral.