World’s Riskiest Bonds Lure Traders Back After Tariff Turmoil

The year 2025 has been marked by a dramatic pendulum swing in global markets: from the chaos of escalating tariffs to a cautious recovery in high-risk assets. Emerging market bonds, once battered by trade wars and policy uncertainty, are now attracting traders seeking yield in a low-growth world. But behind this rebound lies a fragile equilibrium—one where tariff negotiations, central bank moves, and shifting capital flows are the difference between a sustainable rally and another crash.

The Tariff Tantrum and Its Aftermath

The turmoil began in early 2025 when U.S. tariffs on imports surged to historic levels, with the average effective tariff rate hitting 22.5%—the highest since 1909. The April 2nd “comprehensive tariff” policy alone raised consumer prices by 1.3%, costing the average U.S. household $2,100 annually. For emerging markets, the pain was amplified: China’s exports to the U.S. collapsed, Canadian potash producers faced retaliatory duties, and Mexican auto manufacturers grappled with 25% tariffs on non-USMCA-compliant goods.

Yet by Q2 2025, a subtle shift emerged. Emerging market bonds outperformed U.S. Treasuries, returning 1.58% for the week ending April 20—a 75 basis-point premium over comparable-duration government bonds. The rally was fueled by three key developments:

1. Trade Tensions Ease (Just Enough)

The WTO’s forecast of a 0.2% decline in global trade for 2025 hints at a stabilization in cross-border tensions. Critical negotiations—like U.S.-Japan tariff exemptions and EU-U.S. methane standards coordination—have bought time for investors. As BlackRock’s Investment Institute noted, traders are now “pricing in a muddle-through scenario,” with spreads between emerging and developed market bonds narrowing by 20-30 bps in Q2.

2. Central Banks Step Up

Emerging markets have proven they can counteract external shocks. Turkey’s surprise 25-basis-point rate hike in April—its first in 18 months—sent the lira soaring 5% against the dollar. The move, aimed at curbing inflation and stabilizing investor confidence, underscored a broader trend: proactive monetary policy is mitigating the fallout from tariffs. The European Central Bank’s own rate cut to 2.25% further eased global financial conditions, indirectly supporting capital flows to riskier assets.

3. Capital Flows Rebalance

Chinese investors, who had slashed allocations to U.S. private equity amid trade tensions, are now redirecting capital to emerging markets. Meanwhile, the World Bank’s push to fund gas and nuclear projects in energy-exporting nations—like Kenya and Cambodia—is shoring up fiscal stability. The result? Outflows from high-yield corporate bonds and loans slowed to $3 billion in April, a sign that investors are tentatively returning to risk-on trades.

The Risks Lurking Beneath

This recovery is far from assured. The WTO warns that if trade disputes escalate further, global trade could shrink by 1.5% in 2025, with North American exports plummeting 12.6%. The data is stark:

• GDP drag: U.S. tariffs alone reduced 2025 GDP by 0.9%, with long-term output still 0.6% below pre-tariff levels.
• Income inequality: Lower-income households bore 2.6x the tariff burden of top earners in 2025, a regressive impact that could fuel political instability.
• Currency volatility: Despite the Turkish rate hike, the MSCI Emerging Markets Currency Index remains 8% below its 2024 peak.

Where to Bet—and Where to Stay Cautious

Traders are picking winners based on three criteria: policy resilience, diversification, and debt sustainability.

• Mexico and Canada: Their USMCA-aligned sectors (e.g., autos, energy) are benefiting from carve-outs in U.S. tariffs. Mexican bonds, which saw yields spike to 7.8% in early 2025, have retreated to 6.9% as investor confidence recovers.
• India: Domestic demand and favorable monsoon rains are insulating its economy from global trade shocks. The RBI’s inflation-targeting framework has kept yields anchored at 6.2%, making its bonds a “safe” high-risk pick.
• Avoid: South American and African frontier markets remain vulnerable. Argentina’s debt restructuring and Nigeria’s currency volatility highlight the risks of overexposure to politically unstable economies.

Conclusion: A Fragile Rally, but a Rally Nonetheless

Emerging market bonds are back in play—not because the tariff wars are over, but because traders are betting on policy makers to contain damage. The numbers tell the story: a 75-basis-point premium over Treasuries, narrowing spreads, and stabilizing currencies all point to a market that’s pricing in a “less bad” outcome.

Yet the risks remain immense. A full-blown trade war could still derail this recovery, as the 0.6% GDP drag from tariffs shows. Investors must stay nimble, favoring countries with strong fundamentals and hedging against volatility. As the old adage goes: the market can stay irrational longer than you can stay solvent. In 2025’s emerging markets, that’s truer than ever.

Data sources: World Bank, IMF, U.S. Treasury, BlackRock Investment Institute, The Budget Lab.