To Bond Investors, Some Emerging Markets Look Safer Than US

Pedestrians walk through the Shi Lin Night Market in Taipei.

(Bloomberg) -- Global bond investors are beginning to view select emerging markets as safer than many far richer nations, a momentous shift that’s setting the stage for the next phase of outperformance in the asset class.

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The trend is most evident in the sovereign and corporate securities from AA-rated countries like the United Arab Emirates, Qatar, Taiwan, South Korea and the Czech Republic. They have delivered stronger total returns this year than equally rated developed-world credits, in dollars as well as in local currencies. And for some of these nations, dollar borrowing costs are slipping toward those of the US, long considered the safest market of all.

What’s more, there are signs of a broader risk convergence, one that’s encompassing even economies with lower credit scores.

The outperformance stems to a large extent from the progress that swathes of the developing world have made in cutting debt, taming inflation and improving current-account balances. But it’s also down to unprecedented fiscal backsliding in the Group of Seven industrialized nations, where debt-to-output ratios are set to rise for years more, eroding their safe haven status.

“If I want fiscal conservatism and policy orthodoxy, I go to the emerging-market world currently, not developed markets,” said James Athey, a portfolio manager at Marlborough Investment Management.

Athey said he’s upped emerging-market debt allocations, buying in Mexican pesos, in addition to Chilean local bonds and South African dollar-denominated securities.

In terms of annual bond gains, 2025 is set to be the strongest year in emerging markets since before the pandemic.

In the sovereign dollar-debt market, investors now demand the smallest premium in seven years over Treasuries. For AA-rated issuers, that spread has shrunk to a record 31 basis points. And since late 2024, average local-currency debt yields have been below Treasury rates, with the discount widening to a record this August. China, Thailand, Malaysia and Lithuania are among countries that borrow at lower rates at home than the US can.

Macro Edge

To be clear, the emerging-market universe contains many fragile credits, mostly across Africa and Latin America, where debt distress and political instability are constant risks. Only a handful of sovereigns carry AA ratings — too few for investors to deploy meaningful capital. Investors also tend to treat developing countries as a group, selling indiscriminately when sentiment sours, and dumping strong credits along with the weak.

Much of this year’s outperformance is down to dollar weakness and lower US interest rates, helped by longer bond duration and lower new debt supply. That’s re-ignited the so-called “carry trade,” luring capital to high-yielding markets like Lebanon and Argentina. The carry trade involves borrowing where interest rates are lower and putting that borrowed capital to work in markets that yield more.

For all that, there’s a palpable shift underway: instead of merely seeking carry, many investors say they are committing to emerging markets because key macro fundamentals are flipping in their favor.

For instance, inflation across the developing world has fallen below advanced-economy levels — a rare reversal seen only once in the past 35 years — even as emerging-market central banks keep interest rates on average 2.1 percentage points higher than developed peers.

The advantage extends to external and fiscal fronts, too. While emerging economies, on average, run current-account surpluses, richer nations sit in deficit. Budget gaps are similar across both groups, but growth in developing nations is far stronger, with output expected to expand about 2.5 percentage points faster this year.

“It’s ironic that EMs, once seen as serial defaulters, are now the ones with primary surpluses and inflation under control, while developed markets are running persistent fiscal deficits,” said Marco Ruijer, a fund manager at William Blair.

Shrinking Premia

Nowhere is the change as stark as in the US, where President Donald Trump’s trade and taxation policies are forecast to significantly expand US deficits. Government debt now tops 100% of annual output, the US budget deficit equates to almost 6% of GDP, and annual debt-servicing costs surpassed $1 trillion for the first time ever.

“If someone didn’t tell you the country and they showed you the US metrics, you wouldn’t want to touch that with a 10-foot pole, it’s so horrible,” said Erik Weisman, a fund manager at $660 billion MFS Investment Management. “You could say something similar about the UK or France.”

Weisman runs a developed-market portfolio but is using his flexible mandate to buy high-grade emerging debt at the expense of G-10 peers.

Recent months have brought several examples of risk convergence with the US. In October, investors accepted a yield premium of 17 basis points over Treasuries for South Korea’s five-year dollar bonds, a record low. And no wonder: the country’s debt-to-GDP ratio is projected at 55% this year — half the G7 average — and it’s running a 6% current-account surplus.

Similarly, Abu Dhabi sold 10-year bonds at 18 basis points over Treasuries — the tightest spread ever for that maturity in emerging markets. And China priced its three-year dollar sale bang in line with Treasuries, erasing the premium investors had demanded last year.

That some emerging bonds now trade flat or inside similar-duration Treasuries is a sign there’s real demand for diversification, according to Nick Eisinger, head of emerging-market sovereign strategy at JPMorgan Asset Management.

“High-quality EM countries have been structurally improving for years, and the market is finally waking up to it,” Eisinger said.

What to Watch

• A slew of inflation prints will give investors clues on the pace of monetary easing by EM central banks; Pakistan, Indonesia, South Korea, Philippines, Taiwan, Peru, Colombia, Chile will publish their CPI figures in the course of the week

• Data on Monday may show Chile’s economic activity rose 1.8% year on year in October, implying a small monthly gain after 0.5% growth in September

• South Korea may say on Monday its export growth accelerated in November, lifted by surging demand for computer chips and a jump in auto shipments

• Investors will get to know whether Brazil’s economy grew or contracted in the third quarter after 16 consecutive quarters of growth, with elevated interest rates and steep US tariffs weighing on activity. Data due Thursday

• On Friday, the Reserve Bank of India may cut the repo rate by 25 basis points to 5.25% and adopt an accommodative stance

--With assistance from Carolina Wilson, Marcus Wong and Daedo Kim.

(Minor edits throughought.)

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