UBS Global Strategy: What Do US Tariffs Mean for Emerging Market Credit?

This article is UBS's global strategy report released on April 7th. I. Valuation and macro shocks are causing spreads to widen; levels to watch Emerging market credit spreads have repriced by 85 basis points from mid-February, exceeding the upper limit of our expected range of 295-300 basis points (average BBB/BB/B level) in early March, when we believed this was pricing in the extreme tariff scenario (assuming an 80 basis points hit to the US economy). The larger and broader tariffs announced by the US last week (likely to have a 1.5% hit to US real GDP this year) necessitate a reconsideration of spread levels. Despite many uncertainties, if tariffs are not substantially eased, we expect the Q2 2025 average spread for BB/BB/B to rise to nearly half a standard deviation above the 10-year average level, implying roughly 50-70 basis points of upside from current levels, considering: (1) Valuations are still not low (see figure 2); (2) The knock-on effects of the emerging market export chain will be significant (see below); (3) The yield-chasing mentality for credit buying since mid-2023 is now being questioned. However, given the relatively robust balance sheets of emerging markets in this crisis, we would consider absolute value if EM spreads were to widen to 450 basis points (as they did in May 2023, roughly one standard deviation above the 10-year average). II. Growing trade barriers; quantified shocks; focusing on EU retaliatory measures against Eastern Europe A key channel through which emerging market credit is expected to deteriorate is exports. UBS's model shows that the recently announced US tariffs will lead to an 18% contraction in US imports. Based on our calculations (figure 3), just the decline in US imports will have an impact of 0.7%-0.8% of GDP level on emerging market exports at the EMBI level; in cases of full or partial retaliation by the EU and China, this impact will rise to 1.1%-1.3% of emerging market GDP. The impact on Eastern Europe in a retaliatory scenario will be the most pronounced (affecting 0.5% of GDP in a non-retaliatory scenario, and 1.3% of GDP in a full retaliation scenario), highlighting the importance of future EU actions. We still believe that Poland and Hungary will outperform their peers in most scenarios due to Germany's fiscal compensation. Turkish credit is relatively more resilient, especially since the Lira sell-off on March 19, with spreads still 15 basis points below BB bonds. III. Oil price downward pressure more evident; but UAE and Qatar performance will outshine peers The oil market faced a double hit last week. It had to digest news of US tariffs, as well as cope with the decision by the Organization of the Petroleum Exporting Countries and its partners (OPEC+) to ramp up production. We estimate that just the US tariffs alone could explain the $5 drop in oil prices per barrel on Thursday (assuming UBSs forecast of global GDP growth being impacted by 100 basis points holds). While the breakeven prices for US shale oil production provide some support, the international balance of payments analysis around $60 per barrel for oil prices is now crucial (figure 5). We find that the current account positions of Iraq, Nigeria, Kazakhstan, Oman, and Angola could significantly deteriorate. In contrast, the impact on high-quality Gulf Cooperation Council (GCC) bonds is minimal. UAE and Qatar may act as safe havens. Given the increased likelihood of a large increase in Saudi production, we recommend staying underweight on Saudi (figure 6). The next key observation point will be OPEC+s decision on June production levels on May 5. IV. Support for US Treasury yields may be overdone; which countries may face funding issues? So far, the rate dynamics of the three major developed economies (G3) primarily reflect economic growth slowdown rather than tariff-induced inflation increase (the 10-year US Treasury yield has fallen by about 55 basis points since the end of January, primarily driven by real interest rates). This price action has actually led to a decrease in investment-grade bond yields, but in the B/CCC rating range, yields are 71 basis points/252 basis points higher compared to the end of January (figure 1). Given the significant upside potential for US inflation (with year-end core personal consumption expenditure price index at 4.6%), it is unlikely that the US Treasury yields will provide more support. In large part, the primary market for single B rated bonds is likely already closed (figure 7). Kenya and Egypt are particularly vulnerable in this regard (as shown in the heatmap in figure 8). We believe there is still a greater downside potential for single B rated bond performance, especially considering that emerging market funds are currently generally overweight in this rating category (figure 9). Below are the key charts: Figure 1: As US Treasury yields rise due to concerns of economic recession, the yield of investment-grade emerging market bonds has actually fallen; however, the widening spreads in the high-yield bond sector have offset the support provided by US Treasuries Figure 2: Overall, the repricing of emerging market spreads since the low point on February 18 does not necessarily mean that EM credit is now cheap; BBB/BB/B bond spreads are still 12/25/54 basis points lower than the 10-year average level Figure 3: What does the decline in exports from emerging markets due to US tariffs mean? Based on UBS calculations of US, EU, and China imports.The model of mouth contraction estimation shows the impact of emerging markets' exports under different retaliation scenarios. Latin America is most affected in all scenarios, while the impact on exports in Central and Eastern Europe and Asia is related to the level of tariff retaliation.Figure 4: Outlook for Brent crude oil prices (in USD per barrel) Prior to the announcement of tariffs, UBS had lowered its expectations for Brent crude oil prices in the second quarter of 2025 to $70 per barrel, and in the second half of 2025 to $72 per barrel. Since last week, the possibility of a downward trend in prices has significantly increased according to UBS: (1) Faster production increases driven by OPEC +; (2) Significant decrease in demand. UBS preliminary estimates suggest that US tariffs will slow global economic growth by 50 basis points (excluding confidence effects) or 100 basis points (including confidence effects). The latter is expected to push oil prices down by $5 per barrel. Figure 5: Oil prices under pressure again; but UAE and Qatar may play a defensive role in the interest rate performance Figure 5 shows the percentage of GDP on the vertical axis, illustrating the impact of the first round of depreciation in oil prices (permanent decrease of $15 per barrel) on the current account of various countries, as well as the overall situation after OPEC production increases partially offset the impact Figure 6: Saudi Arabia's annual issuance may rise to $30 billion or more (from $14.1 billion at the beginning of the year), with this possibility now more likely Figure 7: A large portion of single B-rated bonds have yields significantly higher than 10%, indicating that primary issuances are more challenging than before; overall situation with BB rated bonds is still reasonable Figure 8: In the single B-rated bond range, Kenya and Egypt appear particularly vulnerable to funding pressures due to their high financing needs relative to reserves Figure 9: Emerging market funds' holdings are another reason to be cautious about single B-rated bonds Figure 9 shows the holdings of emerging market funds relative to the benchmark, with emerging market funds having historically low allocations to AA/A rated bonds, and higher allocations to single B and CCC rated bonds. According to UBS estimates, emerging market funds have historically low allocations to AA/A rated assets, as they are historically high in single B and CCC rated assets. This situation exposes risks in single B and CCC rated assets, as they traditionally have limited domestic investor bases and rely more heavily on international funds. There are also many high allocations in BB rated assets. However, overall, UBS is not too concerned about this as macroeconomic fundamentals are improving in countries such as Morocco, Serbia, and Oman, supporting interest differentials.