This is especially true when compared to equities, with the S&P 500 Index down 4% in 2025 so far, having earlier declined by as much as 18% in April.¹

What explains the comparative outperformance of EM debt in the face of the US-led global trade war, and to what extent might this be sustained?

Tariff shock and potential impacts

Local emerging market bonds

When it comes to local currency bonds, returns can be broadly categorized into local bond returns and local currency (FX) returns. Generally, country bond yields tend to move lower (i.e., bond prices go up) whenever local growth and inflation decline, with local interest rate cuts often becoming more likely.

As such, the President Trump tariff shock appears to tick both boxes – global growth (including in EM countries) is expected to weaken, and inflation in non-US countries is also expected to decline as Chinese goods formerly destined for the US are sold elsewhere at lower prices. The recent decline in global oil prices, attributed to concerns about global growth, is also disinflationary.

Local emerging market currency

Unlike the local bond market, the impact of sharply increased US tariffs on EM local currencies is less straightforward. Before Trump was re-elected, it’s probably fair to say that the prevailing expectation was that US policy changes would likely be dollar positive.

The thinking was that increased tariffs would narrow the US trade deficit, while Trump’s more pro-growth policies would also put upward pressure on US interest rates, thus supporting the US dollar.

However, contrary to such expectations, the whole tariff saga has had a markedly negative impact on the US dollar, which was down by nearly 5% vs. the Euro in April. Conversely, the impact for EM local currencies has been favorable (Chart 1).

The main reason for the dollar's weakness is that while higher US tariffs were widely anticipated under Trump, the extent of the hikes and the disorderly manner of their implementation took most by surprise. With input costs expected to soar, the inflationary impact will likely be greater, and the US growth outlook has weakened significantly, with a recession now seen as a real possibility.

Why recent dollar weakness could persist

Amid growing concerns about stagflation and generally increased US policy and economic uncertainty, US equities have especially borne the brunt of the tariff fallout. While this reflects increased domestic selling, we believe a major contributor will also have been selling on the part of foreign investors. Over many years, aided by the US exceptionalism narrative, foreign investors have accumulated substantial holdings of US assets, which has certainly bolstered the dollar.

Going forward, however, if general concerns about US policies persist, foreign investors may look to reduce further their (still substantial) US assets overweight and effective long US dollar positions.

The fact that both US equities and the US dollar remain historically overvalued on most measures may also be a consideration. Reducing foreign allocation to US assets, or even slowing their accumulation, would likely be negative for the dollar but positive for non-dollar assets, including EM local currency bonds.

Some caveats for the weak dollar case

Having briefly outlined why recent US dollar weakness could persist, it is essential to note some caveats. Firstly, predicting currencies with great conviction is always difficult, and betting big against the US dollar hasn’t worked out well for investors over the past decade.

In the near term, it’s worth remembering that, despite growing speculation to the contrary, we believe the US dollar’s pre-eminence as the global reserve currency is unlikely to be challenged.

Additionally, in the short term, there are multiple potential scenarios in which the US dollar could rebound strongly. For example, recent deals, including the newly announced temporary agreement with China, suggest that ‘reciprocal’ tariffs may eventually be removed from the table, with the baseline 10% and some sectoral tariffs remaining. While this would increase costs for US consumers, it may not be enough to trigger a disruptive recession, a fear that was surely behind some of the dollar’s weakness this year.

Outlook about much more than just the dollar

The broader picture, it should be remembered, is that EM LC bond returns will ultimately depend on much more than just what happens to the US dollar. To start with, an index yield of over 6%, the income contribution will be substantial.

Furthermore, as in the past, and underscoring the need for selectivity, returns will continue to vary significantly based on country-specific factors.

Indeed, even with respect to higher US tariffs, the country-level impact could vary considerably. For example, if some form of tariff reciprocity were retained, this could result in sizable US tariff differentials between countries, thereby creating both potential US trade diversion winners and losers.

¹ J.P. Morgan Emerging Markets Bond Index Monitor, May 2025.
² S&P 500, April 2025.

Important information

Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.

Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.

Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).

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