UBS Global Strategy: What Do U.S. Tariffs Mean for Emerging Market Credit?

This article is from UBS's global strategy report published on April 7.

I. Valuation and macro shocks drive widening spreads; levels to watch

Emerging market credit spreads have repriced 85 basis points from the mid-February bottom, exceeding our early March estimate of the upper limit of the 295-300 basis points range (average level of BBB/BB/B) by 25 basis points, at which time we believed this was under an extreme tariff scenario (impacting the U.S. economy by 80 basis points).

Last week, the U.S. announced larger and broader tariffs (which could impact U.S. real GDP by 1.5 percentage points this year), necessitating a reevaluation of spread levels.

Despite many uncertainties remaining, if tariffs are not substantively eased, we expect the average spread for BB/BB/B to rise to nearly 0.5 standard deviations above the 10-year average by the second quarter of 2025, indicating an upward potential of 50-70 basis points from current levels, considering the following factors:

(1) Valuations remain not low (see Figure 2);

(2) The ripple effect on emerging market exports will be significant (see below for details);

(3) The yield-driven dip-buying mentality for credit since mid-2023 is now being questioned. However, given the relative robustness of emerging market balance sheets during this crisis, under otherwise similar conditions, we would consider the absolute value if emerging market spreads widen to 450 basis points (which was reached in May 2023, about 1 standard deviation above the 10-year average).

II. Increasing trade barriers; quantitative shocks; attention to EU's retaliatory measures against Central and Eastern Europe

A key channel for the deterioration of emerging market credit expectations is exports.

UBS's model shows that the recently announced U.S. tariff measures will lead to an 18% real contraction in U.S. imports. Our calculations (see Figure 3) indicate that the decline in U.S. imports alone will impact emerging market exports at the EMBI level by 0.7%-0.8% of GDP; in the case of full or partial retaliation from the EU and China, this impact will rise to 1.1%-1.3% of emerging market GDP. The Central and Eastern European region experiences the greatest variance in impact under retaliation scenarios (0.5% of GDP under no retaliation and 1.3% of GDP under full retaliation), highlighting the importance of future EU actions.

We still believe that, due to fiscal compensation from Germany, Poland and Hungary will generally outperform their peers. Turkey's credit is also relatively more resilient, especially since the lira sell-off on March 19, with its spreads still 15 basis points lower than BB-rated bonds.

III. Downward pressure on oil prices more evident; but UAE and Qatar will outperform peers

Last week, the oil market faced a double blow. It had to digest the news of U.S. tariffs while also responding to OPEC+ accelerating production increases. We estimate that the U.S. tariffs alone can explain the $5 drop in oil prices per barrel on Thursday (assuming UBS's forecast of a 100 basis point impact on global GDP growth holds) Despite the support provided by the breakeven price of U.S. shale oil production, our analysis of the international balance of payments for oil prices around $60 has become particularly important (Figure 5).

We find that the current accounts of Iraq, Nigeria, Kazakhstan, Oman, and Angola may deteriorate significantly. In contrast, high-quality bonds from Gulf Cooperation Council (GCC) countries are less affected. The UAE and Qatar may serve as safe havens.

Given the increased likelihood of significant production increases from Saudi Arabia, we recommend maintaining a bearish stance on Saudi Arabia (Figure 6). The next key observation point is OPEC+'s decision on June production levels on May 5.

4. The support for U.S. Treasury yields may be excessive; which countries will face financing issues?

So far, the interest rate dynamics of the three major developed economies (G3) reflect a slowdown in economic growth rather than inflationary pressures caused by tariffs (since the end of January, the 10-year U.S. Treasury yield has fallen by about 55 basis points, primarily driven by real rates). This price trend has actually led to a decline in investment-grade bond yields, but in the B/CCC rating range, yields are still higher by 71 basis points / 252 basis points compared to the end of January (Figure 1).

Given the significant upside potential for U.S. inflation (the core personal consumption expenditure price index is projected to be 4.6% by year-end), the market is unlikely to expect further support from U.S. Treasury yields. To a large extent, the primary issuance market for single B-rated bonds is likely closed (Figure 7). Kenya and Egypt appear particularly vulnerable in this regard (see the heat map in Figure 8). We believe there is greater downside potential for single B-rated bonds, especially considering that emerging market funds are currently generally overweight in these rated bonds (Figure 9).

Here are the key charts:

Figure 1: As U.S. Treasuries rise due to recession concerns, emerging market investment-grade bond yields have actually declined; however, the widening spreads in the high-yield bond sector offset the support from U.S. Treasuries.

The vertical axis of Figure 1 is in basis points, and the horizontal axis represents ratings (AA, A, BBB, BB, B, CCC), showing the breakdown of yield changes since the end of January (spreads, U.S. Treasury yields).

Figure 2: Overall, the repricing of emerging market spreads since the low on February 18 does not imply that emerging market credit is now cheap; the spreads for BBB/BB/B rated bonds are still 12/25/54 basis points lower than the 10-year average.

Figure 3: What does the decline in imports due to U.S. tariffs mean for emerging market exports?

Figure 3 is based on UBS's model estimates of the contraction in imports from the U.S., EU, and China, showing the impact on emerging market exports under different retaliation scenarios. The Latin America region is most affected in all scenarios, while the impact on Central and Eastern Europe and Asia is related to the degree of tariff retaliation.

Figure 4: Brent Crude Oil Price Outlook (USD / Barrel)

Before the announcement of the tariffs, UBS had lowered its forecast for Brent crude oil prices in the second quarter of 2025 to USD 70 per barrel and to USD 72 per barrel for the second half of 2025. After last week, UBS significantly increased the likelihood of price declines: (1) OPEC+ pushing for faster production increases; (2) demand potentially dropping sharply. UBS initially estimates that U.S. 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 USD 5 per barrel.

Figure 5: Oil prices under pressure again; however, the UAE and Qatar may play a defensive role in terms of spread performance

Figure 5 shows the percentage of GDP on the vertical axis, illustrating the impact of falling oil prices on the first round of current account effects for various countries (a permanent drop of USD 15 per barrel) and the overall situation after OPEC's production increase offsets some of the impact.

Figure 6: Saudi Arabia's annual issuance may rise to USD 30 billion or more (USD 14.1 billion year-to-date), and this possibility is now greater

Figure 7: A significant portion of single B-rated bonds have yields significantly above 10%, indicating that primary issuance is more challenging than before; the overall situation for BB-rated bonds is still acceptable

Figure 8: Within the single B-rated bond range, Kenya and Egypt exhibit particular vulnerability in funding pressure due to high financing needs relative to reserves.

Figure 9: The positioning of emerging market funds is another reason for a cautious stance on single B-rated bonds.

Figure 9 shows the positioning of emerging market funds relative to the benchmark, with emerging market funds' allocation to AA/A-rated bonds at a historical low and a higher allocation to single B and CCC-rated bonds.

According to estimates by UBS, the allocation of emerging market funds to AA/A-rated assets is at a historical low, due to a historically high allocation to single B and CCC-rated assets. This situation exposes single B and CCC-rated assets to risk, as they traditionally rely more heavily on international funding due to a limited local investor base. Many BB-rated assets are also at high levels within the allocation range. However, overall, we are not overly concerned, as improving macro fundamentals in places like Morocco, Serbia, and Oman support the spreads