What’s been going on with emerging market bond yields?
The spread between yields on emerging market (EM) government debt and US Treasuries has fallen to multi-year lows, amid concerns over America’s traditional safe-haven status1. This comes as US President Donald Trump’s repeated attacks on Federal Reserve chair Jerome Powell to cut interest rates have caused investors to question the Fed’s independence, as they grow weary of whether future chairs will be able to resist such political pressures and fight inflation by raising rates. At the same time, EMs, like China, India, Brazil, Mexico, and the Middle East have been improving their regulatory stability, by focusing on central bank independence and inflation targeting. While also encouraging domestic investor participation in local debt markets to deepen liquidity. This has lowered perceived regulatory risks in these markets just as America’s has increased. A perception that President Trump’s tariffs have amplified, as investors fear his policies will spur US inflation, and hence lower real returns on bonds, which has incited investor interest in EMs, that may be less affected and offer better real yields.
US government fiscal position concerns have also been brought under the spotlight by President Trump’s “One, Big, Beautiful Bill,” that will raise the federal deficit by $US3.3 trillion over the next decade. EMs’ debt positions have, by comparison, been broadly flat, causing markets to ascribe the same to lower default risk to these markets while they ascribe higher risk to the US – tightening the risk premium assigned to EMs. This has then caused investors to demand higher yield compensation for holding US Treasuries, and lower compensation for holding EM government debt.
What about the impact of the USD?
EM governments typically issue both USD-denominated and local currency denominated bonds. On USD-denominated debt, interest payments are made in USD, meaning the greenback’s sharp fall in 2025 has reduced the local-currency cost of interest payments, lowering default risk. For local currency denominated debt, a weaker USD makes EM bonds more attractive for foreign investors, as coupons and sale proceeds can be converted into higher USD amounts.
EM-pressive returns?
Investor interest in EM bonds, which has pushed down yields, has endured despite rising yields on US Treasuries, prompted by investors pushing out their expectations for Fed rate cuts in 2025. This usually would have drawn capital away from riskier EMs and back to the US, highlighting investors now questioning the risk premium traditionally assigned to EM bonds, and being attracted by the higher yields on EM debt.
It remains to be seen whether the broadening of investor portfolios into EM debt will continue, but regardless questions about America’s fiscal position and EM’s traditional risk premium will remain front of mind for investors.
References
- Financial Times, “Emerging market borrowing premium over US falls to nearly lowest since 2007,” 23 July 2025