Wall Street’s Favorite Emerging-Market Bet Falters as War Rages

Once a top pick among emerging-market investors, local-currency debt is quickly becoming a pain trade.

After months being boosted by a weaker dollar, slowing inflation and interest-rate cuts, the bonds have delivered a loss of more than 4.5% since the Iran war started. That’s almost double the declines of its dollar peers. Just six out of 22 main EM currencies are up against the dollar this year, compared with 17 before the conflict broke out.

“EM local-currency bonds have, unsurprisingly, become the primary casualty of the current risk-off environment,” said Thierry Larose, a portfolio manager at Vontobel Asset ...