How Trump’s policy agenda impacts emerging markets
By leveraging interest rates, foreign exchange, trade and capital flows, the new US administration can affect the growth of these countries
IN ATTEMPTING to assess how emerging markets will be impacted by the policy agenda of US president-elect Donald Trump – who will be inaugurated shortly – and the Republican US Congress, we need to assess the knowns and unknowns.
We have a good idea that the new US administration will: 1) target select countries/regions with tariffs to attempt to protect and promote US industries; 2) seek to limit and even reverse immigration; 3) use tax policy and deregulation; and 4) promote a strong US dollar.
The consequences will likely be at least an initial increase in inflation, which could slow the Fed’s ability to deliver rate cuts, and are unlikely to meaningfully reduce the fiscal deficit. This means US rates could be higher for longer (though still directionally headed lower) and support a strong dollar, especially as the European Central Bank is more dovish and US growth still exhibits signs of relative strength.
What we don’t know is the sequencing and scale of Trump’s policies, or how other countries will retaliate, and what the feedback loop will look like into the global economy. There will be impacts not just on the emerging world, but also on Europe. A number of global conflicts playing out will also influence the power dynamics of geopolitics and strategic competition between the US/West, China and the “Global South”.
Diversified markets
Emerging markets will be affected through trade, interest rates, foreign exchange and capital flows, all of which can impact growth. These markets are very diversified in terms of resilience, vulnerabilities and sensitivities to tariffs. These countries include manufactured exporters, commodity exporters, service economies and more closed economies. Some have benefited from near-shoring and friend-shoring of supply chains.
Also, as emerging markets span the globe across regions, there are different exposures to trading partners and their ability to attract capital flows.
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For example, many countries in Asia, such as Vietnam and India, have benefited from near-shoring flows that have added to the higher value-added manufacturing and export base. These flows have come from countries in the region, China, and the West, including the US. Such investments may be in the crosshairs of the trade war, but could also be used as a bargaining tool.
Mexico and other Latin American countries, as well as Central and Eastern Europe countries such as Hungary, Romania and Serbia, have also benefited from investment flows and underscore how integrated such emerging markets are with the economies of their main trading partners, such as the US and Europe.
Emerging market fundamentals are relatively sound. There are no serious current account imbalances. Many distressed/defaulted emerging market sovereign restructurings have taken place, and capital account flows have been supported by the official sector and bilateral inflows, along with foreign direct investment and equity flows.
Moreover, one should expect varying degrees of retaliation or reaction. China has indicated it will reinforce and augment its fiscal and monetary policy stimulus measures to counteract the tariffs. While China is expected to retaliate and the Asia region should be more sensitive, we think Europe will be willing to negotiate with Trump.
Emerging markets will be very pragmatic, particularly Latin America, given the linkages and leverage that cooperation with US immigration policy can have. President Claudia Sheinbaum of Mexico has already indicated her willingness to work with Trump after Mexico was called out by Trump for narcotics and immigration flows to the US.
Cautious optimism
Despite these factors – 1) valuations are seemingly “tight” in select segments of emerging market credit; 2) emerging market foreign exchange is vulnerable to US trade policy; and 3) central bank policy is more measured in terms of cuts – there is the ability to generate alpha from the dispersion of performance within and between the various emerging market debt segments. Yields are still high, and the Fed will still deliver cuts such that returns will be attractive. Real yields in emerging market local rates are high, and there is still value in emerging market high-carry foreign exchange.
The combination of knowns and unknowns, with an expectation of a “soft landing” for the global economy, should provide cautious optimism on emerging markets fixed income as an asset class. Focus should be on country-specific fundamentals – including fiscal policy – to determine if there are any policy “weak links” to differentiate countries.
The Global South does have some degree of leverage. They comprise a huge share of trade with each other. In the changing balance of power dynamics and natural resource and demographic realities, the emerging market landscape is too important to ignore.
There are tail risks from a Trump presidency, which is why it makes sense to take on moderate amounts of risk. But this year, there are attractive risk-adjusted return opportunities in emerging market fixed income, even with the November “Red sweep” in the US.
The writer is head of emerging markets debt, PGIM Fixed Income
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