Emerging-Market Debt Is Looking Better as Bond Market Changes

Mexico has so far managed to exempt most exports from U.S. tariffs. Here: Drivers along Reforma Avenue in Mexico City. (YURI CORTEZ/AFP via Getty Images)

Government finances are deteriorating in the U.S., United Kingdom, and France. They are improving in Mexico and Peru, and at least holding steady in most emerging and frontier markets, from Costa Rica to Pakistan.

Investors have noticed. The iShares J.P. Morgan USD Emerging Markets Bond exchange-traded fund has climbed by 8% this year, bringing spreads over U.S. Treasuries to their lowest in a decade. The analogous local currency bond ETF has jumped 13% as Donald Trump’s tariffs and tax cuts counterintuitively spurred flight from the dollar.

“EM is pretty much the same old EM,” says Samy Muaddi, portfolio manager for emerging market bonds at T. Rowe Price . “What’s new is structurally higher volatility in developed market debt.”

The highest U.S. import tariffs since the 1930s have left emerging market debt unscathed for two somewhat contradictory reasons. For one group of large borrowers—China, Brazil, India, South Africa—exports to the U.S. are 3% or less of gross domestic product. “That’s not of the magnitude that would move the needle much on sovereign creditworthiness,” says Cem Karacadag, head of global sovereign debt and currencies at Barings.

Countries with more exposure—Mexico, South Korea, Taiwan, Malaysia—can expect a Trump tariff-driven slowdown, notes Arthur Budaghyan, chief emerging markets strategist at BCA Research. But that, along with an expected fall in U.S. interest rates, will allow their central banks to loosen.

Declining rates are generally positive for fixed-income investment. “U.S. tariffs are deflationary for the rest of the world,” Budaghyan concludes. “That’s bearish for equities, bullish for bonds.”

Opinions divide on where the sweet spot is in a highly diversified asset class. Karacadag is focusing on dollar credits from BB-rated sovereigns, the top rung of high yield. Examples: Turkey, Guatemala, Paraguay, Serbia, Albania. “You’re getting a yield above 6%, and most EM BB is resilient enough for a cyclical U.S. slowdown,” he says.

BCA’s Budaghyan tilts toward local-currency credits, anticipating interest rate cuts and continued dollar weakness. “EM currencies will be flat to up, and even the Asian economies will be cutting,” he predicts.

His top pick is Mexico, where President Claudia Sheinbaum has so far managed to exempt most exports from U.S. tariffs and is nibbling away at the budget deficit left by predecessor Andres Manuel Lopez Obrador. “If there’s one asset of any kind to buy in EM, we recommend 10-year local-currency Mexican bonds,” he says.

Peter Kent, co-head of emerging market fixed income at asset manager Ninety One, sees “super interesting currencies” in Asian trade titans like Taiwan, Korea, and Malaysia. These currencies all climbed as the dollar dove following President Donald Trump’s April 2 Liberation Day. Kent expects more of the same as governments “sell excess dollars to cut their overexposure.”

T. Rowe’s Muaddi is inclined to caution, as bond values everywhere look rich. “We’re three years into a very strong rally in leveraged credit products globally,” he says. “One portfolio theme for us is a rotation out of frontier into investment-grade debt.”

A borrowing splurge by advanced economies since the pandemic erupted five years ago has eroded the certainty that they are safe and emerging markets risky. Trump’s economic gamesmanship since January undermines it further. “The breakout event this year is higher policy uncertainty in the U.S., while EM governance inches forward,” Barings’ Karacadag says.

Investors will remain uncertain for a while about where the global dust settles. Emerging market credit still offers opportunity.