Emerging markets are demonstrating resilience amid the Federal Reserve’s recent interest rate hikes, defying historical trends that typically see these economies follow suit due to currency and debt vulnerabilities. Despite deteriorating U.S. debt dynamics and tighter monetary policy from the Fed, many emerging markets have maintained relatively stable financial conditions and are not under immediate pressure to raise rates.

Traditionally, emerging economies have felt compelled to tighten monetary policy alongside the Fed even when domestic economic conditions did not warrant it, to guard against currency depreciation and capital outflows. However, this year’s stronger-than-expected economic growth, improved fiscal positions, and already elevated interest rates and bond yields have provided greater flexibility for central banks in emerging markets. This could enable them to begin easing rates over the coming year or, at minimum, refrain from matching the Fed’s pace of tightening.

Emerging markets continue to face risks including geopolitical tensions, trade disputes, energy price volatility, and concerns over a potential bubble in artificial intelligence-related investments. Some countries remain vulnerable to shocks from persistently high energy costs or a disorderly correction in AI-related trades. Nevertheless, the threat of aggressive monetary tightening appears limited, as policy rates in many emerging economies are comparatively high. The weighted average yield on 10-year emerging market bonds was about 6.45 percent in late September, near a five-year peak, with inflation-adjusted yields close to 3 percent.

These elevated policy rates have helped restore central bank credibility in emerging economies, supporting exchange rates and providing a buffer of positive real interest rates. Strategists at Bank of America note that front-end interest rates in emerging markets have “materially overshot,” suggesting that implied policy rates for next year will remain restrictive in all major emerging economies except China. State Street strategists recently concluded that widespread tightening in emerging markets seems unlikely.

While emerging markets appear relatively calm and attractive, there are notable exceptions, such as Indonesia, which shows signs of economic vulnerability. In contrast, developed economies—including the United States, Japan, much of the eurozone, and the United Kingdom—are experiencing heightened investor concern over fiscal outlooks, pushing yields on government debt to multidecade highs.

Investor sentiment continues to favor emerging markets. A recent JPMorgan survey at the IMF and World Bank meetings in Bangkok indicated 33 percent of investors preferred emerging market equities over 26 percent for developed markets. Bank of America’s fund manager survey showed a net overweight position in emerging market stocks at 34 percent, only a slight decline from the previous month, reflecting generally sustained bullishness.

Some caution remains warranted given that emerging market debt carries higher risk relative to developed market securities such as U.S. Treasuries. However, realized volatility in emerging market bonds has been lower than that of Treasuries over recent years, according to exchange-traded fund benchmarks.

Emerging economies’ debt burdens are rising and narrowing the gap with highly indebted advanced economies. The International Monetary Fund projects that the average emerging market debt-to-GDP ratio will increase from 77.2 percent this year to 86.2 percent in five years, while advanced economies’ ratios are expected to rise from 108.2 percent to 114.8 percent. Although lower debt tolerance due to less economic resilience remains a concern, current trends suggest policymakers are managing their debt cautiously.

Fed rate hikes and volatility in U.S. markets will continue to impact emerging economies, especially those with significant dollar-denominated debt. Idiosyncratic challenges remain—for example, Indonesia’s current distress—but these cases do not broadly reflect emerging market conditions. Excluding Indonesia, emerging market equity indices appear increasingly appealing to investors.

The emerging market landscape is diverse, with central banks adopting varied policy approaches. Countries such as Brazil and Mexico are lowering rates amid stable core inflation and anchored expectations, while others like South Africa and South Korea are tightening policy to combat inflation or currency pressures. Many others are maintaining flexible stances to preserve options. Overall, the Federal Reserve no longer dictates emerging market monetary policy as directly as in previous cycles, a shift welcomed by investors, as reflected in strong participation at the recent Barclays Emerging Markets Conference in Bangkok.