If the performance of the dollar and US equities has defied forecasts since Donald Trump’s election, the impact on other assets, like US Treasuries and emerging market (EM) securities, has been grimly predictable.
EM corporate debt had been one of 2016’s best performing asset classes, and funds which invest in these countries attracted $47bn from January to October. But Trump’s victory has reversed this trend. Investors seem to have settled remarkably quickly on the idea that Trump equals greater fiscal spending, lighter regulation, more inflation and growth in the US. If this turns out to be the case, it could stifle EMs’ performance by convincing investors returns could be greater in US stocks.
Trump's impact on emerging markets
Before the election, markets expected the President-elect’s protectionist agenda would weigh on Mexico, as exports to its northern neighbour account for 25 per cent of its GDP. But Brazil and South Africa, which have relatively little exposure to the US, have also seen a sell-off in their currencies, as yields on corporate and government debt have risen sharply.
When the Fed slashed interest rates in 2008 to stimulate growth during the financial crisis, EM governments and companies took advantage of cheap dollar borrowing to finance government spending that would boost their growth.
Even if a Trump administration doesn’t see growth – and policies which rely almost entirely on tax cuts, not sufficient spending increases, could certainly achieve this – his programme could still stoke inflation. Many analysts now expect the Fed to hike interest rates in 2017 at a more aggressive pace, starting things off when it meets next month.
EM debts would then become more expensive to service, right at a particularly awkward moment. As a report by the Bank for International Settlements indicates, around $340bn of emerging market corporate debt will fall due between now and 2018 – a 40 per cent increase on the last three years. Higher tariffs might stop EMs from benefitting from any increased consumer demand which might result from Trumpian economic stimulus.
Yesterday saw some stabilisation in bond markets and the Mexican peso claw back some of its losses. One argument is that investors are shaking off some of their certainty about what a Trump victory means for US growth. Neil Shearing, chief emerging markets economist at Capital Economics, meanwhile, argued last week that the sell-off so far has been driven by shock to the news of a Trump win, rather than by a longer-term concern for how his protectionist economic programme may hurt EM countries which export a lot to the US. This, he said, could explain why “riskier” but distant emerging economies, such as South Africa, have been affected.
Will EMs hold up in the long term? It is too early to say how Trump’s agenda would change trade dynamics with EM countries. Ricardo Adrogue, head of EM debt at Barings, thinks markets are overdoing the potential negative impact of Trump and sees a buying opportunity in the Mexican peso and the country’s sovereign and corporate debt issues. “Initial indications show a focus on making companies more competitive in the US, generating jobs and improving productivity – but not necessarily at the expense of changing the rules of the game on international trade.”
Markets have been too wary about Mexico’s prospects, he thinks. Barings estimates that markets have priced in seven to 10 times the real macroeconomic cost to Mexico, if Trump were simply to adjust Nafta, slow migration and deport some illegal immigrants.
Trump has also threatened to impose tariffs on Chinese exports of 35 to 40 per cent. “However, the US is not China’s only export market”, stresses Andy Rothman, investment strategist at Matthews Asia. Indeed, while 20 per cent of China’s GDP may still come from exports, the net figure is much lower because many of the parts used in Chinese manufacturing are imported from elsewhere.
EM trade growth generally may be at a low ebb, but producer price deflation appears to be turning a corner in China, India and elsewhere. Political reformers in Brazil and Argentina are showing a commitment to fiscal prudence, while Indonesia and India have bolstered investor confidence through central bank independence.
Many EMs are in much better shape than in 2013, when investors last withdrew billions in fear of tightening US monetary policy. “Currencies have weakened and commodity prices have come down. Economic activity softened, but is now rebounding. And the need to draw finance from the rest of the world is significantly lower,” says Adrogue, who thinks that local currency now offers some of the best EM opportunities.