UBS Equities-Global Strategy _EM credit 2026 Outlook_ Mevorach-118864953

ab14 November 2025Global ResearchGlobal StrategyEM credit 2026 Outlook2025 was a strong year for EM credit; will 2026 follow suit?EM credit had a good year with an index level total return of 11.9% driven by an almost evenly split ~100bps rally in spreads and UST. Notably, both EM IG and EM HY produced excess returns over US corporates - making EM HY an outperformer for a third consecutive year (Figure 2A third consecutive year of HY outperformance over US corporates; what wil 2026 bring? EM HY managed to outperform US HY for a third consecutive year with exces returns of 195bps/586bps/64bps in 2023/2024/YTD - marking a reversal to Covid and Rusia/Ukraine related underperformance in previous years. Meanwhile, EM IG also outperformed US IG but after two years of underperformance. This picture is consistent with the idea that EM HY valuations have became stretched versus the US (as oposed to EM IG) and the fact that EMBI portfolios are generaly OW the HY space and UW IG. Together with rising suply, the bar for EM HY to outperform is high now. ). Meanwhile, EM country-level return attribution in 2025 was dispersed, unlike 2024 (Figure 3Unlike 2024, the country-level total return atribution in 2025 has ben dispersed Thre countries acounted for 89% of the index return in 2024. The story in 2025 (YTD) is much diferent. The top-3 performing countries acount for only 16% of the return of the index. In the HY space, Egypt and Ecuador stand out as alpha generators for two years in a row. ). This outcome defied our spreads widening call (see Mid-year Oulook) as a more predictable US trade policy and expectations for AI productivity gains buoyed markets. What will next year bring? For 2026, we expect EMBI GD spreads to end at 300bps (vs 270bps currently), with possible front-loading correction in 1H26 as US HY default rates tick higher on cyclical US weakness (real GDP sub-1% saar in 4Q25 to 1Q26), and as EM supply becomes a headwind (more below). Our spreads framework implies low-single digit returns of ~4% for 2026 with UBS call for10y UST at 4.00% in end-2026.Key trades/allocations: (more details from page 3)(1) Long Romania, short Poland on diverging rating paths; (2) Long Argentina 2035; (3) OW Mexico, UW Indonesia; (4) OW Nigeria vs Egypt as a left-hand side hedge; (5) OW Turkey vs Bahrain. Five key themes:#1 Waning EM credit pull factors pose a higher bar, don't expect the USD to helpFirst, on (an EMBI weighted) average, the primary deficits breakeven that keeps gov debt/GDP stable is drifting weaker to 1.3%/GDP in 2026 from 1.6%/GDP in 2025 vs 2015-2019 avg. of 2% (Figure 7Underlying conditions for stabilizing EM debt/GDP ratios We use the latest macro forecasts from the IMF (WEO from Oct) to calculate the primary balance level that is required to stabilize debt/GDP ratios on an EMBI index (weighted) level. This is the blue line in the LHS chart. The so-caled breakeven primary balance should rise to -1.3%/GDP in 2026E from -1.6%/GDP in 2025