After a positive year for emerging-markets (EM) debt, Donald Trump’s unexpected win in the U.S. election has caused an understandable stir. Markets had largely failed to price in a win for the outspoken Republican, despite his warnings of “Brexit times 10.”
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 the markets. But Trump won’t break EM debt. Underlying economies continue to exhibit strong levels of growth, manufacturing indices are ticking higher and emerging markets are generally healthier than they were in previous sell-offs.
Until we know what a Trump presidency will actually look like, it’s difficult to gauge what the future holds.
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 U.S. 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 that he’s reached his ultimate goal.
Trump candidacy vs. presidency
It was encouraging to see Trump take a conciliatory tone in his acceptance speech. He said he will keep certain parts of the Affordable Care Act (also known as Obamacare), signaled he will not replace U.S. Federal Reserve (Fed) Chair 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 the North Atlantic Treaty Organization (NATO). 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. 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 Japanese Prime Minister Shinzo Abe stating that the “TPP has no meaning without the U.S.”
It’s not all about Trump
“Trump Slump.” “EMD Trumped.” The headlines would suggest it’s all over for the asset class. In our view, that couldn’t be further from the truth. The pull factors for emerging markets are still intact, and economic growth is expected to hold steady next year. Spreads on the hard currency sovereign bond index are some 100 basis points higher than they were compared to the pre-tapering days in mid-2013, so investors should expect renewed interest in EM assets once external risks abate.
Elsewhere, EM currencies have largely re-adjusted, bearing the brunt of slower growth and U.S. 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 U.S. 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 a 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 U.S. 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. However, 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 admittedly has some shelf life. This month 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.
Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).
Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.
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