After a positive year for emerging market (EM) debt, Donald Trump’s shock win in the US Presidential Elections has caused an understandable stir. Markets had largely failed to price in a win for the outspoken Republican, despite his warnings of a ‘Brexit x10’.
From an EM debt perspective, the outlook has certainly changed. The Trump Tantrum has seen a widespread sell-off in EM bonds, currencies have taken a hit, and there’s been a heavy dose of uncertainty injected into markets. But Trump won’t break EM debt; underlying economies continue to exhibit strong levels of growth, manufacturing indices are ticking higher and EM’s are generally healthier than in previous sell-offs.
Still, until we know what a Trump presidency will actually look like, and which of his policies he’s genuinely serious about, it’s difficult to gauge what the future holds. EM assets will remain exposed to rates volatility in the short term as the market digests and reacts to rising US Treasury yields, which have climbed sharply. Valuations may look attractive following the post-election sell-off, although this reflects the level of uncertainty hanging in the air, especially over trade policies. The dust will settle with time, however, as should Trump’s raucous rhetoric now he’s reached his ultimate goal.
Trump candidate vs Trump President
It was encouraging to see Trump take a conciliatory tone in his acceptance speech.
It was encouraging to see Trump take a conciliatory tone in his acceptance speech. He said he will keep certain parts of Obamacare, signalled he will not replace Federal Reserve Chairman Janet Yellen before her term expires in 2018, and he will not impose big tariffs according to one of his economic advisors. Additionally, Trump personally stated to Obama that he will recognize NATO1. His choice of chief of staff has also been sensible, selecting an insider who can work with Congress and Senate.
Despite the early signs being more reassuring than what the popular media might suggest, there are glimpses of the ‘hard’ Trump. While the Mexican bricklayers are still twiddling their thumbs, the President-elect has vowed to renounce the Trans-Pacific Partnership (TPP) trade deal – a signature policy of Obama – on his first day in office. The reaction of fellow members has been one of concern and frustration, with Japan’s Shinzo Abe stating the “TPP has no meaning without the US”.
It’s not all about Trump
“Trump Slump”, “EMD Trumped” – the headlines would suggest it’s all over for asset class. That couldn’t be further from the truth. The pull factors for emerging markets are still intact, and economic growth will hold steady next year. Spreads on hard currency sovereign bond index are some 100 basis points higher than they were compared to the pre-tapering days in mid-2013, so expect renewed interest in EM assets return once external risks abate.
Elsewhere, EM currencies have largely re-adjusted, bearing the brunt of slower growth and US dollar strength that has endured over the last five years or so. The recent currency weakness reduces the likelihood of any interest rate cuts in the immediate term, but it should not ultimately derail prospects for interest rate cuts in the likes of Brazil, Argentina and Russia. Indeed, the latter has the added benefit of a perceived détente in relations with the US. For countries like Brazil and India – which have seen sharp declines in their current account deficits and a big improvement in deficit financing since the ‘Fragile Five’ days in 2013 – the impact of any Trump trade policies directed toward Mexico and China will have minimal impact. As a result, the continued currency weakness, particularly for those currencies that may be unfairly dragged into any Trump trade wars, should provide attractive entry levels.
Risks remain, though. Currencies could suffer another blow if Trump instructs the US Treasury to label China a currency manipulator. This would likely prompt Chinese authorities to allow a more market-determined rate, leading to an inevitably weaker currency. China’s economic growth will also be an important driver. It is stable for now though, and is expected to remain so ahead of the Party Congress in October 2017. The lack of visibility on whether Trump will impose a trade tariff on the nation will also be monitored closely but, if he does, it is likely to be well below the initial 45% stated during his campaign.
EM debt has gone through a series of shocks in the past and will survive the latest tremor, although this one has some shelf-life admittedly. December will see Italy turn out for the referendum vote, while the Federal Open Market Committee meeting will combine with the usual slow trading conditions typically experienced as we approach the end of the year. These factors, along with further Trump-related uncertainty, may temper risk appetite in the coming weeks.
Stay tuned for further twists and turns, but don’t forget there will be some good investment opportunities amid the whipsawing.
Editorial credit: JStone / Shutterstock.com
1 The North Atlantic Treaty Organization