Global fixed income investors are beginning to view some emerging markets as safer than many wealthier countries, a major shift that sets the stage for the next phase of asset class outperformance.
This trend is most clearly evident in sovereign and corporate bonds from AA-rated countries such as the United Arab Emirates, Qatar, Taiwan, South Korea and the Czech Republic.
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They achieved stronger total returns this year than similarly rated developed country credits, both in dollars and local currencies. For some of these countries, dollar borrowing costs are close to those in the United States, long considered the safest market of all.
Moreover, there are signs that there is a broader convergence of risks, which includes even economies with lower credit ratings.
The outperformance stems, in large part, from the progress made by large regions of the developing world in reducing debt, controlling inflation, and improving current account balances. But it is also a result of the unprecedented financial downturn in the G7 countries, where debt-to-GDP ratios are expected to continue to rise in the coming years, which will erode their safe haven status.
“If I wanted fiscal conservatism and traditional economic policy, I would go to the emerging world today, not developed markets,” said James Athey, portfolio manager at Marlboro Investment Management.
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He increased his allocation to emerging market debt, purchasing bonds denominated in Mexican pesos, as well as local bonds from Chile and dollar-denominated bonds from South Africa.
In terms of annual gains, 2025 is on track to be the best year in emerging markets since before the pandemic.
In the dollar sovereign debt market, investors are now demanding the lowest premium in seven years on US Treasury bonds. For AA-rated issuers, this spread fell to a record low of 31 basis points. Since the end of 2024, the average yield on local currency debt has remained below bond interest rates, with this discount reaching a record high in August. China, Thailand, Malaysia and Lithuania are among the countries that borrow domestically at lower interest rates than the United States.
The emerging market world has many fragile credits, especially in Africa and Latin America, where the risk of over-leveraging and political instability remains constant. Only a few SWFs have an AA rating, too few to allow investors to allocate significant amounts of capital.
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Moreover, investors tend to treat developing countries as a single group, selling indiscriminately when sentiment worsens, and dumping strong credits alongside weak ones.
Much of the outperformance this year is due to a weaker dollar and lower US interest rates. This has reignited a process called the carry trade, or carry – when financing is obtained in low-interest-rate currencies and invested in high-interest economies, profiting from the difference -, attracting capital to high-yielding markets such as Lebanon and Argentina. Finally, factors such as the long duration of bonds and the low supply of new debt also contributed.
Despite this, there is a tangible shift afoot: rather than simply chasing carry trades, many investors say they are sticking with emerging markets because key macroeconomic fundamentals are shifting in their favor.
For example, inflation fell below advanced-economy levels—a rare reversal that has occurred only once in the past 35 years—even as central banks kept interest rates, on average, 2.1 percentage points above developed-market levels.
The advantage also extends to the external and financial front. While emerging economies, on average, run current account surpluses, richer countries run deficits. Budget deficits are similar between the two groups, but growth is much stronger in the developing world, where output is expected to grow about 2.5 percentage points more this year.
“Ironically, emerging markets, once seen as defaulters, are now the ones with primary surpluses and under-control inflation, while developed markets run persistent fiscal deficits,” said Marco Roegger, director at William Blair.
No change is as striking as in the United States, where President Donald Trump’s trade and tax policies are expected to dramatically widen the country’s deficit. Government debt now exceeds 100% of GDP, the budget deficit is approaching 6% of GDP, and annual debt service costs have exceeded $1 trillion for the first time in history.
– If someone does not mention the country and shows American indicators, it will not come close – said Eric Weissman, director of MFS Investment Management, which manages 660 billion US dollars. – You could say something similar about the UK or France.
Weizmann runs a developed markets portfolio, but has used his flexible powers to buy high-quality emerging market debt at the expense of G10 countries.
The past few months have brought many examples of risk convergence with the United States. In October, investors accepted a premium of just 17 basis points over US Treasuries over South Korea’s five-year bonds – an all-time low.
And it’s no surprise: the country’s debt-to-GDP ratio is expected to reach 55% this year – half the G7 average – and the country is recording a current account surplus of 6%.
Likewise, Abu Dhabi sold 10-year bonds at 18 basis points over US bonds – the lowest spread ever for this duration among emerging markets. China also priced its three-year dollar issuance exactly in line with bonds, eliminating the premium that investors demanded last year.
The fact that some emerging market bonds are now trading at the same level – or even lower – as US bonds for the same duration is a sign that there is strong demand for diversification, according to Nick Essinger, head of emerging sovereign debt strategy at JPMorgan Asset Management.
High-quality emerging countries have been improving structurally for years, and the market is finally catching on, Eisinger said.