So why have EM bonds done so well so far in 2025? Well, if you remember, the beginning of the year, it wasn't supposed to be like this. Tariffs were supposed to lead to EM devaluations, right? It was supposed to be really rough time. So why did it happen, especially given that that was completely contrary to what the story seemed to be at the beginning of the year. Well, there's some pretty solid reasons behind it.

Number one, by far the most important, CNY, the Chinese currency, is appreciated since November. This is the major trading partner of most EMs other than Mexico and some Europeans. And this is a sustainable policy, this stabilization policy on CNY. In fact, we wrote a piece saying we think it should revalue. But it's a very sustainable policy because they have a lot of reserves, and remember, it's a net creditor in dollars, right? They have more dollars in assets than dollars in liabilities. So CNY's stability and appreciation is number one, very important to a lot of EMs.

Number two, these EMs that trade more with China than with the U.S. are also doing good policy. Low fiscal deficits, low debts and deficits, and a very independent central bank, which is the natural result of low debts. It's not just Chinese economic orthodoxy. It's a lot of EMs have this orthodoxy and as represented in their central banks, maintaining high real rates.

Third reason is tariffs. Tariffs were supposed to hurt EM, why didn't they? Well, I hope all of our viewers know that the negotiators are not going to tell us that there's a discussion, a chapter on currency in these discussions, but I hope it's clear that if a country devalues right after a trade negotiation, they've taken three steps back. So that's being discussed, for example, during Vice President JD Vance's visit to India, the INR appreciated. For example, this year, CNY's daily fix has been regularly stronger than the bank predicted fix. And so in negotiations, these countries are being told they can't devalue their currencies and that's a big fact.

And now let's bring up the fourth and final reason. So you're being told your currency can't weaken against the dollar. And what is your initial condition? Your initial condition is a pile of dollars up to your neck. Otherwise known as the NIIP, that's a popular measure. Do you own, do they own more of us or we own more of them? The NIIPs are incredibly positive in a large number of EMs, mostly in Asia but around the world.

And so they're already long dollars. So just think of the simple game theory. You're long a lot of dollars and you're told that's not going to go up, it's going to go down. What do you do? You reshore those offshore assets to your own shores or to other non-dollar shores. And that's exactly what's happening. What's happening this year is an unwind of decades of mercantilist surpluses accumulated by EMs.

EM vs DM Volatility

So an obvious question is, is this really impressive performance in EM bonds, especially EM local bonds? Is that a one-off or is it set to continue? Well, I think the first most important thing to recognize is this has been happening for five years already, right?

EM bonds, a benchmark of government bonds, dollar and local is up about 2% a year last five years compared to treasuries in the Agg, which are down negative 2% to 3% per year for the last five years.

So this has been happening to the point that EM bond volatility is now lower than developed market bond volatility. We know the carry and returns are higher, but the volatility regime now is extremely different. And yet all you hear is how risky EM bonds are. So this has already been happening. And if you take it back for decades, you'll get the same result.

Volatility adjusted or just outright, obviously outright return, EM has done better than DM.

Are the roots of this deep? They're profoundly deep. Our core thesis has been one of fiscal dominance, characterizing the DMs, the developed markets, and the opposite being the case in the EMs. EMs have low levels of government debt. That's essentially a requirement for an independent central bank that focuses solely on inflation.

And they've done this in some cases for decades. The most advanced are the Asians. After the Asian crisis, pretty much fixed everything. But there's a flip side to this, which is the developed markets are very risky. Not only do we know their vol is high and their performance has been extremely weak, but look at the politics underneath the policy in the developed markets. Very divided and very focused on inflation and on trade-offs.

Look at the policy on top of the politics in EMs. First, most of their leaders are extremely popular, but there is no real debate across the political spectrum about issues like using a central bank to achieve economic outcomes, because that creates inflation and inflation kills political parties, right? That's understood, whereas the DMs are in a much different stage here. So it's not only based on strong fiscal policy, but this fiscal policy is popular in a lot of these countries. Not necessarily because they like austerity, but they don't like the results of heterodox economic policy.

Big EM Market Winners

So who are the big winners in emerging markets? Well, of course, you have to curate. And there are idiosyncratic factors in all markets. But I would give the following as an answer.

The first category of winners are the high beta EM currencies and bonds, particularly in Latin America, so Brazil, Colombia, Chile, Mexico. And they have much higher carry. And their FXs have much more potential for upside. So that's the first grouping.

The second grouping is almost the opposite. A lot of the Asians, Malaysia, Philippines, Thailand, Indonesia, depends, right? That's a tougher call, but that category, those are arguably the new reserve currencies, you could say, or quasi-reserve currencies. Very anchored inflation. You just don't need as much of a premium there, given their far superior risk characteristics. So that's second category.

The third category is duration itself. Now, when you talk to bond folks and you ask them, what do you think of duration, they're going to tell you what they think of the 10-year in the U.S. They're going to tell you about dollar duration. The Mexican 30-year bond rallied 100 basis points this year before the 30-year in the U.S. rallied. Duration is not a monolith. If EM currencies are rallying that anchors inflation and inflation expectations and transmits throughout the whole yield curve. While we've been very cautious on dollar duration for parts of this year and last year, local duration is a very different equation and there we're more constructive. So I would characterize that as a clear winner too.

So there are lot of questions in the financial media about dollar exposure. Is there too much dollar exposure in global investments? And also about the status of the dollar in treasuries as reserve assets. So we often get asked, what do we think about this? Well, we've been thinking about it for a long time, and that's important. Maybe the most important thing to note is this story did not just start a few weeks ago. This has been going on for a long time. Sanctions are part of it, but a number of things are part of it.

We think the proper framing is as follows. The dollar is not going to lose its reserve status, but the dollar will gradually share its reserve status with other deserving currencies. CNY is the most obvious, but there are many others that have really solid fiscal policy and the independent central banks that result. A number of them in Asia, Malaysia would be an example. And that's most likely happening.

The central banks are not going to telegraph us and tell us what their future reserve accumulation strategies are. So I think that's another thing to keep in mind is that when a currency and a bond market becomes a reserve currency, some of the news items you might get that are consistent with that have already happened, and I'll mention the key ones.

You remember last year, almost every week there's a headline, Saudi Arabia and Brazil or Saudi Arabia and China or Brazil and China agreeing to trade in their own currencies. So China sends CNY to Brazil for soybeans and China sends BRL for Chinese manufactured imports.

And what does the central bank do with the BRL or the CNY? Historically, over time, they buy the bonds, right? What helps us surmise this is some of the price action this year. This year, you had so much of a reshoring of these massive dollar exposures from EM countries that a currency like the Malaysian ringgit in one day was up 7%. Hong Kong dollar was pricing a revaluation simply because so many dollars were reshored to Hong Kong shores.

So that's the proper framing for the dollar status conversation in our opinion.

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