When emerging markets look safer than the US

If an emerging market government was throwing economic caution to the wind, interfering in central bank decision making, borrowing unsustainably, picking trade fights with its closest trading partners, it would be on the debt market naughty step. It would cost it more to borrow, investors would move out, and the country may need to resign itself to slower growth as a result. Yet the US appears to get away with it – is some recalibration of the relative risks of emerging and developed markets required as a result? 

Debt discipline

Emerging market countries that have played fast and loose with monetary and fiscal policy have taken years to rebuild their credibility. Argentina, for example, remains largely excluded from international debt markets. Even after President Milei’s savage reforms, the country can’t borrow in US dollars, and is struggling to pay back the $57bn it owes the International Monetary Fund (IMF), according to the Financial Times. 

Why the US plays by different rules

The only country to which these immutable rules do not apply appears to be the US. Since the start of his administration, Donald Trump has repeatedly threatened the independence of the Federal Reserve and now appears to be on an ill-fated mission to stack it with his cronies to secure an interest rate cut. His ‘Big Beautiful Bill’ cuts taxes at a time when the US deficit is $37 trillion and he has failed to secure any meaningful cuts in spending*. 

There is also the tariff chaos. Trump has introduced protectionist measures, which have disrupted global supply chains. This has had a knock-on impact for companies, who are now facing higher costs, which they may or may not pass on to consumers with a resulting impact on inflation and economic growth.  

Shifting growth and debt dynamics in emerging markets

Emerging markets are, in general, following a far more economically orthodox path. The team on the M&G Emerging Market Bond fund, says: “At a time when investors are growing increasingly concerned about the sustainability of US debt, EM countries benefit from relatively low levels. The average debt-to-GDP ratio of emerging market and middle income economies is 75%, while that of advanced economies is 110%². Stable debt levels create a buffer to absorb global shocks.”

This disparity may keep widening because emerging markets are also growing faster than their developed market peers. According to the IMF, emerging and developing economies grew 4.3% in 2024, while advanced economies expanded by just 1.8%. In 2025, they are forecast to grow 4.1%, compared to just 1.5% for developed countries**. 

Equally, emerging market companies have shown themselves to be safer than developed market companies. M&G adds: “EMs have continued to display a lower default rate compared to developed markets, with the 12-month trailing speculative-grade default rate coming in at 0.9% for EMs, versus 4.3% in the US and 3.8% in Europe.”

There are also signs of the economic power balance shifting at the margins. Although Donald Trump has been able to bully smaller emerging markets, he has struggled to bend China to his will. Mark Hammonds, co-manager on the Guinness Asian Equity Income fund, says: “China has made genuine technological progress, and so has more economic strength and less dependence on the West. China has more options in terms of the different export markets it can serve. And supply chains have diversified since the first trade war and since COVID, permitting companies much greater flexibility.

“We shouldn’t overplay this: China’s economy clearly has the potential to be harmed by a trade dispute, particularly if it should escalate to the level seen in early April, where there is effectively an embargo on trade with the US. Nevertheless, China does not face the same constraints that the US does: in the US, risk of inflation is flaring up again, particularly if interest rates are to come down again, and the fiscal situation is chronically challenged – probably even more so with the recent spending bill – so the US ultimately has less room to manoeuvre.”

Rethinking risk premiums in global markets 

Against this backdrop, the labels ‘emerging’ and ‘developed’ markets don’t seem as valid today as they have been historically. Emerging markets have historically attracted a significant risk premium over developed markets, and it is difficult to argue that this should be as high as it has been in ‘normal’ conditions. 

Markets have already started to react. The Financial Times reported that the risk premium for emerging market debt has hit a 20-year low***. It said emerging market companies are rushing to issue new bonds to take advantage of these lower borrowing costs. Aggregate yields are just under 6%, with the average spread over US treasuries under 2% for the first time in almost two decades. 

For stock markets, it is more difficult to disaggregate the risk premium. However, it is clear that emerging markets are staging a revival. The MSCI Emerging Markets index is up 17.5% for the year to date, compared with just 10.9% for the MSCI World index (in US dollars)^. That said, using price to earnings ratios as a guide, markets are still assigning a chunky risk premium to emerging markets – the forward p/e for the MSCI EM index is just 13x compared to 19.2x for the MSCI World^. In other words, there is still room for investors to adjust their view on the relative risks of the two different markets. 

Ian Hargreaves, manager on the Invesco Emerging Markets fund, says: “We believe emerging market equities currently offer double-digit earnings growth, with reasonable valuation levels across much of the universe. However, the asset class continues to trade at a significant discount to global equities, particularly the US market.” 

He says the group remains mindful of geopolitical risks and the uncertainty that may come with the US government administration’s pursuit of protectionist policies, but adds: “EM corporates generally have healthy balance sheets and competitive advantages which could make them more resilient than is being implied in valuations. Moreover, if specific channels of global trade are forced to reconfigure away from China, other EM countries could benefit.”

It would be a step too far to suggest that emerging markets deserve an equal or lower risk premium than developed markets. The US in particular still has real economic firepower. Developed markets have higher per capita wealth, and may have more economic levers to pull. However, in the equity market at least, emerging markets still attract a significant risk premium that has scope to narrow. 

*Source: FiscalData, US Treasury, 2 September 2025

**Source: IMF, World Economic Outlook Growth Projections, July 2025

***Source: Financial Times, 16 August 2025

^Source: index factsheet, 31 July 2025