Trump’s Tariffs and the Emerging Market Economies
Since president Trump declared ‘Liberation Day’ on April 2, the dark clouds already looming on the horizon of the global economy have grown thicker and darker. Given their substantial dependence on world trade, as well as their greater economic and financial vulnerabilities, the emerging market economies (EMEs) could be especially hard-hit by the Trump administration’s new trade policies. As I will argue below, however, there is a reasonable chance that Trump can impose a ‘new normal’ of higher trade barriers without touching off the chaotic market disruptions that followed Liberation Day. Under those circumstances, while the EMEs will likely suffer the same dampening of trade, production and growth as many advanced economies – including the US – most of them will likely avoid the traumatising financial crises that plagued these economies in earlier decades.
My cautiously benign view starts with the fact that global financial markets are linked tightly and, in recent decades, the most important drivers of volatility in emerging financial markets have been disruptions in US markets. As shown in Chart 1 below, over the past several decades, movements in EME corporate credit spreads, an indicator of potential financial distress, have been highly correlated with US high-yield spreads.1
Research conducted with my colleague, Aatman Vakil, confirms that this tight linkage remains even when we control for US monetary policy shocks, the VIX measure of US stock market volatility, and the level of the dollar (for details, see Kamin and Vakil, 2025). In fact, we show that movements in US corporate credit spreads have been the most important driver of movements in EME spreads, accounting for nearly all of the rise in EME spreads during the global financial crisis in 2008–09 and the Covid-19 panic in early 2020. To be sure, especially in the latter case, spreads in both places were responding to global common shocks, but it seems reasonable to assess that movements in US credit markets set the tone for global markets.
1. US and EME corporate credit spreads
© Central Banking Publications graphics
These considerations suggest that as long as US financial markets can avoid further disruption, EME markets will likely be able to avoid severe volatility as well. So far, prospects for continued stability are encouraging. Chart 2 hones in on developments since Trump took office. Right after Liberation Day, market turmoil simultaneously drove up spreads for both US and EME corporate credits. Since then, however, as Trump has backed away from his most extreme threats of “reciprocal tariffs”, markets have calmed down while the US stock market has climbed back to new heights. In this environment, both US and EME corporate credit spreads have also fallen back, and are now quite narrow by historical standards.
2. US and EME credit spreads during Trump 2.0
© Central Banking Publications graphics
The extreme reaction of financial markets after Liberation Day appears mainly to have reflected shock and surprise that Trump would take such a capricious, chaotic and disruptive approach to trade policy. Since then, investors have become more accustomed (or numb) to the president’s unique style, and they have taken the drum beat of Trump’s more recent tariff threats in stride. With trade deals with the UK, Japan, the European Union and others being completed, markets are relieved that tariffs will be rising less than Trump has threatened and that a trade war appears to have been averted. Estimates by the Budget Lab (2025)now suggest that at current expected levels, the higher tariffs will push US real GDP growth down by 0.8% and boost prices by 2%: these effects would be unfortunate but probably not severe enough to roil US financial markets.
In consequence, barring future disruptive policy shocks, there is a good chance of continued market calm going forward. Moreover, the developments of the past few months suggest that even if volatility were to return to US financial markets, the spillovers to EMEs would likely be less worrisome than in the past. During the turbulent weeks immediately following Liberation Day, the rise in EME spreads – about 50 basis points – was quite limited, both by historical standards and in comparison with the 110bp widening of US high-yield spreads. It seems that the Trump turbulence did not hit all risky assets equally, but rather singled out US-based assets for special treatment.
That possibility was confirmed by the change in behaviour of the dollar after Liberation Day. Chart 3 below plots the sensitivity of the dollar’s value against EME currencies to changes in the VIX, estimated for 30-day moving windows over the course of the past four years (see Kamin, 2025, for details on this methodology). For most of this period, the sensitivity was positive, indicating that when market volatility rose, risk-averse investors shifted from risky EME currencies into safe dollar assets and the dollar appreciated. But for a couple of months after Liberation Day, this sensitivity plunged into negative territory. Thus during this period, EME currencies actually rose against the dollar in response to heightened market volatility. All told, the dollar has lost about 4% of its value against the EMEs since Liberation Day, and because a lower dollar tends to bolster EME finances on balance, this depreciation has also been helpful for EMEs.
3. Estimated sensitivity of the dollar (against EME currencies) to the VIX
3. Estimated sensitivity of the dollar (against EME currencies) to the VIX
© Central Banking Publications graphics
Of course, as evidenced at the end of the series charted above, the estimated sensitivity of the dollar to the VIX has recovered in recent weeks, as investors have made their peace with tariffs and volatility has subsided to more normal levels. But if markets were to once more be roiled by shambolic Trump administration policies, it is reasonable to expect that, again, the EMEs would escape the worst of it. The more worrisome concern is the longer-term effect of the Trump tariffs on the global economy and trading system. The EMEs have been prime beneficiaries of globalisation, the openness of international markets and the ongoing growth of productivity, incomes and demand in the US and other advanced economies. Even if the Trump tariffs do not trigger a recession, they could slow the pace of globalisation and economic growth around the world, and that would pose severe challenges for EMEs.
Notes
- EME corporate bond spreads are drawn via FRED from the ICE BofA emerging markets corporate plus index option-adjusted spread, a capitalisation weighted index of spreads on dollar- and euro-denominated bonds issued by both investment- and speculative-grade issuers. US high-yield corporate bond spreads are drawn via FRED from the ICE BofA US high yield index option-adjusted spread.
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