Can emerging markets thrive in ‘Trumplandia’?

THE Trump administration in the United States has ushered in significant policy shifts in tariffs, immigration and geopolitical alignments. The reciprocal tariff provisions unveiled in April were harsher than anticipated, and the initial market reaction was not positive.

The broader agenda has called into question not only decades-old alliances, but also the outlook for global growth, as trade uncertainty and potential supply-chain shocks loom. Importantly, these actions have resulted in surprising policy responses and reversals from other global powers.

As a result of questions about the US commitment to Nato, Germany announced a major defence and infrastructure package, the European Union (EU) announced the suspension of fiscal rules for defence spending at the national level. The prospect of substantial fiscal easing has had an immediate impact on the market expectations for EU growth, and more potential for higher long-term rates than anticipated.

China announced stronger measures to promote consumption and further support the property sector. These and any future fiscal and monetary measures should help with confidence and put a floor under growth. The trade war is only beginning, but Chinese policymakers have shown they are willing to pivot to confront the new global landscape.

Can emerging markets withstand a trade war?

Each country’s vulnerability is best analysed through the lens of fundamentals, valuations and qualitative factors.

There is wide dispersion across EM markets in their ability to withstand a trade war. Mexico’s negotiations with the US show there is scope to limit the damage. However, not every country has the same relationship and integration with the US.

The tariffs will have a stronger negative impact on the growth of large, direct US trade partners like Mexico. For other exporters, there will likely be more competition between manufacturers, but EM countries can compensate – significant trade occurs among EM countries, and between EMs and the EU.

EM countries such as middle powers like India, Brazil, Turkey and the Gulf Cooperation Council (GCC) countries have an opportunity to play a larger role on the global stage and to engage with multiple players. There is the possibility to change trade and financial flows.

For smaller, or more highly indebted countries (some countries in sub-Saharan Africa and smaller Latin American countries, for example), the risks are higher. Yet countries with important commodities like rare-earth metals and inputs needed for sectors such as building, electronics and tech can fare better in realignments. EM countries with cheaper labour and which are less integrated into existing camps or supply chains have the freedom to counter their financing challenges.

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Where are the winners in EM debt?

EM debt overall has performed relatively well this year, but with valuations that are vulnerable to a broader market sell-off. It is too early to assess the collateral damage of the latest tariff news, but clearly, the Asia region was targeted more and Latin America, less so.

We are only at the initial stages. On the credit side, yields of more than 7 per cent are still very attractive, particularly the higher-quality, high-yield and low investment-grade segment of the sovereign and corporate issuers. In the sovereign and quasi-sovereign space, issuers in Colombia, Mexico and India, along with select issuers in the GCC, are well insulated.

EM foreign exchange – particularly for the higher-carry EM currencies – has also performed well. The weaker US dollar is calling attention to currencies in EMs that are more insulated from the global macro challenges and have high carry, such as the Brazilian real and Egyptian pound.

Currency accords, if they materialise along with recently announced tariffs, can dampen the US dollar. EM central banks are likely to be more growth focused and in some cases, they have scope to cut rates. Fiscal considerations are key and can be limiting in some instances – as witnessed by last year’s dramatic sell-off in Brazil local rates and foreign exchange over disappointment on the fiscal path.

When investors consider the quality of external balances, the composition of external financing and reserve levels, among other factors, they will find winners – even in this time of uncertainty. Given the ability of many EM countries to align with different “spheres of influence”, the degree of vulnerability is not as great as it might seem.

The writer is head of emerging markets debt, PGIM Fixed Income