Emerging Markets have had a stellar start to the year so far with both hard currency and even local markets, FX and rates, posting strong even double digit returns. For many, particularly at the start of the year and the Trump presidency, that might have appeared beyond belief give the world was facing the prospect of trade autarky, lower growth and higher inflation as a result, and considerable geopolitical risks in the Middle East, Russia-Ukraine and potentially elevated tensions between the US and China, over Taiwan, et al.
Why have we seen such outperformance?
I guess in markets a lot is about expectations. And the worst expectations for trade wars have not yet come to pass, which has built momentum into a recovery trade after the market lows in April. Therein first, while the US effective tariff rate is expected to go from 2-3% at the start of the year to likely 17%, this is much lower than could have been the case given the initial threats from Trump back in April - the effective US tariff rate could have been double what now seems likely. And second, the rest of the world have behaved and tried to appease Trump - giving him his tariff increase but mostly (with the exception of China) - avoiding retaliation. The US tariff policy shift is being isolated while the rest of the world continues in a business as usual, free trade mode.
Reflecting that, assumptions of global growth are now being revised back up from the dismal forecasts predicted earlier in the year. See the IMF’s WEO herein, with the message being global resilience in the face of policy unorthodoxy in the US. Global growth is certainly not stellar, but it is not as bad as prior forecasts had assumed.
https://www.imf.org/-/media/Files/Publications/WEO/2025/update/july/english/text.ashx
Dollar weakness has been another key backstop for Emerging Markets. The DXY dollar index is down over 10% since Trump took office. For indebted EM countries that cuts dollar debt service charges. It has also anchored local currencies in most EMs and we have not had the usual EMFX shock which would normally have accompanied such a huge global policy shock as the U.S. transforming its tariff regime and ethos. EM currencies have generally held strong, this has helped provide an anchor against inflation and enabled EM central banks to generally maintain an easing bias in the face of weaker global growth. It also helped that most EM central banks had beat their DM counterparts by getting ahead of the curve in fighting the post Covid inflation surge. In EM, orthodox monetary policy responses had produced strong disinflation trends, again leaving scope for rate cuts. Arguably Trump’s tariff policies, are inspiring dumping now by China which is also exporting disinflation to the rest of the world, ex the U.S.. Again producing greater scope for rate cuts from EM in the face of weaker global growth. The irony here is that policy orthodoxy in EM, is producing results in terms of lower inflation, anchoring growth, while the U.S. under Trump seems to be going the other way - seeking to oust Powell, to force lower rates while inflation is rising, and firing the BLS chief because the Supreme Leader does not like the data. We saw this script before in many EMs, particularly Turkey and Argentina, and it did not end well.
One pertinent question surely is why the dollar is weak when the Trump administration argue that their policies of lower taxes, lower rates, tariffs, and deregulation will inspire US growth, and pull in huge investment flows to the US. Notable therein after recent foreign trips, and in exchange for tariff deals, Trump managed to secure trillions of dollars in investment pledges. If the Trump agenda works the trade defict should be lower and the capital account should boom with investment inflows. The dollar should strengthen. It has not I think because the rest of the world does not buy the Trump policy script. The rest of the world seems to be voting with its feet and selling the dollar because it thinks that tariffs will slow US growth, increase inflation, and kicking migrants out and attacking independence of universities undermines the very basis of US growth exceptionalism over the past hundred years or so. The US has cherished learning and has welcomed the worlds talent through immigration. The rest of the world seems to want to diversify away from US and dollar assets - also perhaps fearful that the Fed will be forced to cut policy rates despite rising U.S. inflation reducing the real rate attraction of holding the dollar. And I think EM assets have benefitted from this diversification trade away for the US, as it will from lower Fed policy rates, which helps pump liquidity into EM, which is what is happening.
Now the rest of the world could well be wrong, and if US growth follows the Trump script, the reversal of capital flows back to the US, and away from EM could be painful, and likely therein the biggest risk the current love of EM assets.
But just thinking of some of those investment pledges made to Trump by the likes of the Gulf states. Is it really realistic to think that the UAE will invest $1.4 trillion in the US, four times its own GDP? Or Saudi $600 billion, half its GDP, when MBS is already having to cut his cloth in spending on his own priority Vision 2030 programme. Similarly $1.2 trillion promised from Qatar, six times its own GDP. Likely these numbers were pulled from thin air, and are just repackaging of existing commitments and investments in US treasuries and markets by their sovereign wealth funds. It is unlikely these will be new flows to the dollar, perhaps actually the reverse as we see efforts there to diversify away from the dollar as a reverse currency.
The irony of EM reaping the rewards of policy orthodoxy as an anchor for confidence and investors now as Trump tariffs bite is that we are actually seeing more broadly reform across EM. Argentina, South Africa,Turkey, the Gulf states, Pakistan, Egypt, Sri Lanka are embarking on turnaround economic programmes. Fiscal consolidation, privatisation, liberalisation, deregulation, and monetary policy orthodoxy are central therein. For the first time in years we are seeing a consistent reform wave across EM.
And fortunately also if we think of countries which were in/close to debt distress, most of these countries are emerging successfully from debt restructuring, included therein are Barbados, Surinam, Ghana, Zambia, and again Sri Lanka.
And returning to tariffs, the countries most vulnerable to the imposition of U.S. tariffs are in Asia - nine of of ten of the US’ largest trade deficits globally are with economies in Asia. And note here that typically these same Asian economies run large current account surpluses and have large FX reserve buffers, and hence they can easily absorb the costs of isolated US tariffs without much risk to broader macro economic stability. Yes, US tariffs are painful for many of these countries, but as is they do not post systemic risks. They have buffers and can adjust as long as the U.S. move does not become a global generalised trade war, which does not seem to be the case,
Finally, on the geopolitical front, the US and Israeli attack on Iran did not evolve into a broader war. Events in Gaza are incredibly disturbing and the suffering of Palestinians incredibly upsetting but again the conflict has remained contained to the region. Similarly, I guess for the war in Ukraine, as NATO allies have not been drawn into a direct conflict with Russia, and while Ukraine has launched long range missile and drone attacks on Russian energy infrastructure, actually this has largely been confined to attacks on refineries which has had the result of forcing Russia to export more crude oil, putting downward pressure, if anything on global oil prices. And if Trump has threatened devastating sanctions on Russian energy exports, he has actually done very little. Indeed, his latest August 8 deadline for 100% tariffs on Russian energy exports came and went with Trump appeasing Putin with the present of a great power summit in Alaska. As is Russia only suffers a US 10% tariff, which is lower than the 15% levied on US allies in Europe. Trump talks tough but carries a small stick - a noodle, according to the FT, and TACO seems to be the case when it comes to Trump and Putin. Would Trump actually do anything to hurt Russia, and impact on global oil and commodity prices, impacting the price of gas for Americans at the pump. The market thinks not, and it is hard to disagree.
So in summary there is lots to explain EM durability and asset performance in the face of the remarkable policy unorthodoxy we are seeing in the US. The rest of the world has voted with its feet, in selling US assets, as they don’t buy the MAGA pitch book. If they are wrong though the reverse trade could be painful for EM.
Really great piece, Tim!