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Emerging-market traders brace for pain after US tariff hikes

Analysts see volatility, challenges ahead with some investors trimming back bullish bets amid other potential risks to emerging-market assets

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Failure to reach a deal would hit most emerging-market currencies, says Brendan McKenna, a currency strategist at Wells Fargo in New York. The Mexican peso, the Brazilian real and the Asian currencies would likely suffer most.

WITH the US increasing tariffs on China as per its earlier warnings, emerging-market investors are bracing for more volatility after a week that's sent shock waves through risk assets.

Tariffs on more than US$200 billion in Chinese goods rose to 25 per cent from 10 per cent as of 12:01 am New York time on Friday. The move came even after US President Donald Trump insisted a trade deal was still possible this week.

While an optimistic tone before the tariff hike had helped trim some of Thursday's losses, and indexes of developing-market currencies and equities maintained intraday gains on Friday after the US move, it wasn't enough to make much of a dent in weekly declines. Stocks are down in all major emerging markets this week, paced by a plunge in Chinese shares.

Only five of the 22 developing-nation currencies tracked by Bloomberg have strengthened versus the dollar, with just two eking out a gain of more than 0.2 per cent. MSCI gauges for emerging market stocks and currencies were trading near their January lows on Friday in Asia.

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"I don't see any turnaround in sentiment," Tsutomu Soma, Tokyo-based general manager of the investment trust and fixed-income department at SBI Securities Co, said. "Agreement is unlikely for a prolonged period between the two economies and that means tough times remain ahead for emerging-market assets."

"Volatility is the name of the game," said Michael Reynal, a portfolio manager at Sophus Capital in Des Moines, Iowa. "It's difficult to tell if the wave of news out of Washington is short-term tactical moves - a la 'art of the deal' - or part of a longer-term strategy to genuinely shrink Chinese links to the US economy. Bottom line, it's impossible to predict gyrations over the next few days."

Failure to reach a deal would hit most emerging-market currencies, said Brendan McKenna, a currency strategist at Wells Fargo in New York, adding that Mexican peso, the Brazilian real and the Asian currencies would likely suffer most.

Following the deadline, China immediately said in a statement it would be forced to retaliate, but didn't specify how. The move came after discussions between President Xi Jinping's top trade envoy and his US counterparts in Washington made little progress on Thursday, with the mood around them downbeat, according to people familiar with the talks. The negotiations were due to resume on Friday morning Washington time.

Bulltick LLC analysts Kathryn Rooney Vera and Gregan Anderson remained positive on emerging markets, saying a deal was "within reach" and the uncertainty in the trade negotiations "should be regarded as normal".

Either way, some investors are trimming back bullish bets amid other potential risks to emerging-market assets ranging from a fresh inversion in the US yield curve to a slowdown in global growth, recent strength in the dollar and a slump in commodity prices.

Dollar likely to weaken

"EM will remain challenging as long as the dollar is strengthening," said Jordi Visser, chief investment officer at the US$1.7 billion-hedge fund Weiss Multi-Strategy Advisers in New York. "At some point soon, I expect the dollar to begin a weakening trend. For that to occur, the Fed will need to begin to move though."

Still, investors shouldn't count on central bankers coming soon to their rescue, even though they have already shifted to a dovish stance, according to Rebecca Patterson, chief investment officer at Bessemer Trust in Gainesville, Florida.

"For them to provide an additional lift to sentiment and risk assets, we'd probably first need to see signs of economic pass-through from the trade war and/or much lower inflation," Ms Patterson said. "They would have to do even more than what is already discounted in the markets." BLOOMBERG