Emerging Markets Debt: the Aftershocks of Liberation Day

In the latest episode, Edwin and Paul recap the first quarter of 2025 before turning their attention to tariffs and trade wars and what they could mean for emerging market fixed income investors.

Edwin Gutierrez Head of Emerging Market Sovereign Debt 
Paul Mohr Senior Director, US Institutional Business Development

"If economic policy in the US continues to cloud the outlook for the US equity market, investors are really going to have to look at alternative places to make returns."

In the latest Quarterly Perspectives podcast, Head of Emerging Market Sovereign Debt Edwin Gutierrez joins host Paul Mohr to review the first quarter of 2025 before turning their focus to the recent impact on US Treasury yields, local currency bond outperformance, and successful debt restructurings.

Tune-in to listen to our Quarterly Perspectives episodes on Apple Podcasts, Buzzsprout, and Spotify.

 

Paul Mohr: Hello everyone. My name is Paul Mohr, Senior Director with Aberdeen, and you're listening to the Emerging Markets Fixed Income Quarterly podcast. The show, it looks at the events of their most recent quarter and provides our outlook for the asset class. Today I'm joined by my colleague Edwin Gutierrez, Head of Emerging Markets Sovereign Debt with Aberdeen. Edwin, welcome to the podcast.

Edwin Gutierrez: Great to have you on. Thank you, Paul.

Paul: Well, before we jump into the the current news, let's take a look back at the first quarter. Can you take us through how the different sectors of the emerging market fixed income performed?

Edwin: Sure. I think what was remarkable about the first quarter returns was the lack of divergence between the different segments of the asset class. Give or take. All the different segments returned around 2.5%, and there was little divergence between sovereign and corporates, or between high yield versus investment grade. And this was in marked contrast to the past two years, where high yield and frontier markets significantly outperformed investment grade. The main cause of this change was the fact that we had a strong U.S. Treasury environment in the first quarter, where ten-year bonds peaked at 4.8% a week before, Trump took office, for this quarter, 4.2%. And that helped investment grade credit, both in sovereign and corporate space. And that helped them keep track with their high yield brethren. We also knew that, coming in, it was simply possible for high yield sovereigns to replicate the strong performance of the past two years. As an example of this, for instance, those credit, which were really rated below B-minus by the ratings agency. So, the most distressed of emerging market credits, they returned 50% last year. And the year before that was 40%. So mathematically, it is just impossible for them to keep up that pace of outperformance. And then, moreover, from a fundamental standpoint, the distressed credits that comprise this rating buckets, they're no longer that distressed. We had a number of countries where their bonds are trading around 25 to $0.30 three years ago, and those bonds finished the first quarter trade in the 80s, which means they aren't that distressed anymore. And this was a result of the fact that we completed successful debt restructurings last year. And most of the countries that defaulted in recent years, those being Ukraine, Ghana, Zambia and Sri Lanka. And then in addition, we had a number of countries which were teetering on the brink, such as Egypt, El Salvador and Pakistan, where the market had been pricing in defaults. These end up remaining currency due to a combination of multilateral and bilateral assistance and also fiscal consolidation undertaken by these countries themselves. But to what was most striking was the outperformance in the first quarter of local currency. So, after underperforming the last two years, and quite frankly, for most of the past one and a half decades, local currency bonds, nearly double return those hard currency bonds in the first quarter. And the reason for this was really affects which had suffered previously because of the strength of the US dollar. But in the first quarter, we saw the dollar underperform. And we'll speak of more about that in a bit. But also, low currency bonds themselves. They began to price and more rate cuts from both the fed as well as from emerging markets, central banks themselves, with investors increasingly concerned about global growth. And it's understandable that they are now pricing in more central bank easing from both developed market and emerging markets. Central banks. But let's dive into that. The local currency story a little bit more in the, the lack of strength in the US dollar. And that was one of the assumptions that I think most folks had, with a second Trump presidency, very similar to, the first time around, we we assumed a strong US dollar would be, would be, on the forefront of the policies of the administration.

Paul: Can you kind of talk us through how that, what's happened and, and really what you're seeing in the local markets and.

Edwin: Yeah. Yeah, absolutely. Very good question. But as I mentioned, this was really made possible by the weakness of the US dollar. The consensus is, as you mentioned, Paul, was that investors would see a strong dollar during Trump 2.0. And there was a few reasons for that. One was the belief that U.S growth would continue to outstrip that of the rest of the world. Two, we'd have a more hawkish fed than other central banks, and thus the interest rate differential would be in the US favor. Three the imposition of tariffs by the US would serve to reduce U.S. imports and thus improve the US trade balance, which would also tend to strengthen the dollar. And then for the deregulation efforts and corporate tax cuts by the Trump administration would also further encourage inflows into the US equity market. Now, most of that has been called into question during the past few weeks. And as you know, the market is now increasingly pricing in a high risk of recession in the US. And, that really accelerated or was exacerbated by the announcements from one week ago, from so-called Liberation Day. And and now, as a result, we now see the differential between the US expected differential between the US and the rest of the world, has declined. And on the other side of the coin, we now see, better expectations for European growth, admittedly from a low base, in Europe is is due to the so-called whatever it takes. Announcement in Germany, where Germany has promised to significantly increase both infrastructure spending and defense spending. And in conjunction with that, we also had the European rearmament plan, announced by the EU, to Mr. Van Dylan, which promises a pretty substantial increase in defense spending across the board for EU partners.

Paul: So, as a result, expectations of a more hawkish fed versus the rest of the world is definitely gone to the wayside.

Edwin: Indeed, is the example of this in the market now is priced in roughly five cuts, rate cuts from the fed and only 3 or 4 from, the ECB. And then, well, tariffs or is seen as being disruptive for America's trade partners. They're also seen as pretty damaging to the US supply chain and growth overall for not just for for the rest of the world, but also for the US. So, we've seen increasingly this questioning of US exceptionalism, which for so many years drew so much money into the US equity market, then we still end up being the case as tax cuts and deregulation come into play. But that is seen as very much more of a second half of the year phenomenon. And then the here and now investors are much more concerned about the implications of tariffs and how this could be pushing the US economy to recession as a result. And your has weakened, really across the board as well as against EU currencies. And we've seen emerge markets themselves the strongest returns of bets on the central European currencies. That is again for its Polish Lottie, Czech Luna and also the Romania live as they are linked to the euro and therefore, they've done well with the rally in euros for the case of, the proverbial tide lifting all ships. But we've also seen, strong performance from some of the Latin currencies, such as the Brazilian real Colombian peso, Leon peso, and Mexican peso. There. And this there was perception heading into the announcements of the tariffs that Latin America would be less of a focus of U.S. tariff policy. And that was indeed borne out. So, I think, you know, that is help to, buttress, some of these major Latin American currencies.

Paul: Well, you mentioned the, the "T" word tariffs. So, we'll we'll dive into that. We're recording this on Monday morning here in the states, the global equity markets are selling off for the third consecutive day on the back of the the tariff announcement last week. Talk to us about a little bit about the bond market reaction, particularly in emerging market countries.

Edwin: Well across the board really both developed markets and emerging markets. Bond markets are rallying. And this is understandable as investors are increasingly concerned about the outlook for global growth. And they are starting to price in more dovish central banks and not just, emerging markets, but also, from developed markets, as well. We've also seen inflation has been falling in most emerging market countries. So, this isn't an impediment for emerging markets, central banks to cut in the face of what are clearly stronger global economic headwinds. Central Europe and Latin America have led the charge here, just like they did, in currency markets, for Central Europe. The Western Europe means its biggest export market. And as a result of the tariffs, which the US has been hit by, with the announcement last week and their expectations, there'll be softer growth in the near term for Western Europe. While there will be a positive impacts on fiscal spending from Germany and its EU partners with respect to defense, that's going to take time. And so meanwhile, the impact on growth from US tariffs is here and now. And as a result, that is what's really is propelling the rally in Central European markets. And we see the central Europeans policymakers, central bankers there will look to cushion the blow on their economies by cutting rates. And these are, by and large, small open economies where exports are high percentage of GDP. In case of Hungary, it's 90%. So, they're very sensitive, very exposed to global headwinds in the case Latin America, the rate cycles there, we've seen as well to mature as the Latin market. Central banks were really the first central banks globally do start cutting, but given how the global economic backdrop has taken a turn for the worse, unsurprisingly, investors are now expecting more rate cuts from the likes of Chile, Colombia, Mexico and for Peru. As a result of the impact or the the likely impact on global growth from the Liberation Day announcement? Well, the situation certainly fluid. So, I'm not going to I'm not going to ask you to predict the future. But I do want to look ahead a little bit, to the year and look to some of the areas where we're emerging markets fixed income investors can look to for diversification.

Paul: You mentioned, you know, Eastern Europe, Latin America already, perhaps frontier markets. An area for, for investors to explore. It's a very good question, but, I mean, I'll begin with a caveat that in the event the US does to tip into recession, this is growth has been bad for all credit markets and not just the emerging markets.

Edwin: It's bad for us high yield, European high yield, etc. So, there's very few safe havens to be found. In the event of a US, recession. And we wouldn't expect this to be any different. But ultimately there will be opportunities that arise, as selling tends to be indiscriminate as we get outflows, particularly from ETF funds, which tend to just sell across the board. And there will definitely be value opportunities that are being created. And we've been looking at the space places like frontier markets where there should be some opportunities. We already see some really interesting opportunities arising as a result of this pretty powerful sell off that has taken place over the past week. But, you know, in the near term, I think local currency markets this is probably proven to be the, the, the most, safe of safe havens. As I mentioned earlier, we do think that emerging markets under banks will continue to cut rates. And this, you know, this segment, the asset class will also in turn, be supported by rate cuts from the fed and ECB, which we do see forthcoming. The inflation also may benefit to we'll should benefit from lower energy prices from oil and gas prices. Have you seen we've had a pretty large correction over the past week there. So that's also going to be a positive for EM, inflation at headline rates and could also provide, some comfort for even central bankers to cut rates. Well, you know, the near-term trajectory of the US dollar remains in question, I think, over the long term, question, you know, US exceptionalism could indeed yield positive results for the asset class. We know that global asset allocators have been very long, US equity markets, that's been the best game in town for the past quarter century. And it's been absolutely right to be overweight then. But if economic policy in the US continues to cloud the outlook for the U.S. equity market, investors are really going to have to look at alternative places to make returns. And HMD could be a natural beneficiary of this. The search, granted, that's probably not today's trade. But over the coming quarters and years, we do think that global allocators will have to look at this asset class and new. All right, well, that feels like a good place to wrap things up for the, for the podcast.

Paul: For this episode, I'd like to thank you for for joining us today. Thank you. Paul, and thank you to everyone who took the time to listen. And, if you enjoyed today's conversation and please download our other podcasts from our website or wherever you may normally get your podcast from. Thank you.

This podcast is provided for general information only and assumes a certain level of knowledge of financial markets. It is provided for informational purposes only and should not be considered as an offer, investment, recommendation or solicitation to deal in any of the investments or products mentioned herein and does not constitute investment. Research. The views in this podcast are those of the contributors at the time of publication, and do not necessarily reflect those of Aberdeen. The companies discussed in this podcast have been selected for illustrative purposes only, or to demonstrate our investment management style, and not as an investment, recommendation or indication of their future performance. The value of investments and the income from them can go down as well as up, and investors make it back less than the amount invested. Past performance is not a guide to future returns, return projections or estimates, and provide no guarantee of future results.

 

Important information 
FOR PROFESSIONAL INVESTORS ONLY. NOT FOR USE BY RETAIL INVESTORS. 
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). 
UNITED STATES RESIDENTS 
The purpose of this website is to provide general information about the US-registered investment advisers which are part of abrdn, and the strategies they manage. The information provided is not intended as an offer or solicitation for the purchase or sale of any financial instrument. 
Past performance is not indicative of future results, and there can be no guarantee as to the accuracy of market forecasts. Opinions, estimates, and forecasts may be changed without notice. This site does not provide financial or investment advice and does not take into account the particular financial circumstances of individual investors. Before investing, investors should seek their own professional advice. The views and opinions expressed are provided for general information only, and do not constitute specific tax, legal, or investment advice to, or recommendations for, any person. We suggest that you consult your financial or tax advisor, accountant, or attorney with regard to your specific situation. 
In the United States, abrdn is the marketing name for the following affiliated, registered investment advisers: abrdn Inc., abrdn Investments Limited,  and abrdn Asia Limited 
Standard & Poor’s credit ratings are expressed as letter grades that range from “AAA” to “D” to communicate the agency’s opinion of relative level of credit risk. Ratings from ‘AA’ to ‘CCC’ may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the major rating categories. The investment grade category is a rating from AAA to BBB-. Alternative investments involve specific risks that may be greater than those associated with traditional investments; are not suitable for all clients; and intended for experienced and sophisticated investors who meet specific suitability requirements and are willing to bear the high economic risks of the investment. Investments of this type may engage in speculative investment practices; carry additional risk of loss, including possibility of partial or total loss of invested capital, due to the nature and volatility of the underlying investments; and are generally considered to be illiquid due to restrictive repurchase procedures. These investments may also involve different regulatory and reporting requirements, complex tax structures, and delays in distributing important tax information. 
AA-070525-193089-1