What type of headwinds does the Trump Administration pose for emerging markets?
Market opinion is divided on the fate of emerging markets under the Trump Administration. With yields stuck at near-zero or even lower levels in most developed markets, emerging market debt has had a good run in 2016.
The iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB) gained 8.5% over the past year (as of Jan 13 close). This compares to the iShares Core U.S. Aggregate Bond ETF (AGG) or the Vanguard Total International Bond ETF (BNDX), which yielded -5% and +1.75%, respectively, over the past year. This clears any doubts over emerging market debt’s stellar performance of late.
However, improving growth prospects for the US under the Trump presidency, at least over the next 2-3 years – which are also expected to drive inflation expectations and Treasury bond yields up – appear to be spelling risk for emerging market debt.
Aberdeen Asset Management weighs in
Frontera’s Editorial Director, Gavin Serkin, recently interviewed Kevin Daly, emerging markets debt manager at Aberdeen Asset Management, to discuss expectations for the global investment climate in 2017. Aberdeen Asset Management is one of the largest asset managers invested in the emerging markets. In the podcast, Daly shared his views on:
- Emerging market (EEM) (VWO) risks for 2017
- Impact of (change in) US policy on Russia
- Outlook for China, given recent U.S. rhetoric towards trade with China
- Headwinds emerging market debt could face in 2017
- Where to invest in Latin America and Africa
Emerging market risks
Two emerging market risks that were highlighted in light of the new U.S. administration are:
Uncertainty on trade policy
The market is watching closely to see what shape the president-elect’s protectionist approach towards trade will take over 2017. Donald Trump’s first 100 days in the Oval Office could be particularly risk inducing, with market uncertainty heightening over his tweets and announcements. This goes on to affect emerging markets currencies as well. Over the past year, the Mexican peso demonstrated a strong negative correlation with Donald Trump’s chances of winning the US elections.
Reflation trade
Since the US elections, we’re seeing a shift out of bonds and into equities, on the back of expectations of a big pickup in US growth. Investors who had been piling into emerging market funds when developed markets seemed to offer low or no growth are now seeing prospects for the US improving. Factors such as fiscal stimulus and reduction in corporate taxes should serve as tailwinds to corporate profitability, thereby, boosting the equity markets.
Moreover, with the US economy growing, inflation picking up and the Fed raising interest rates, we would see treasury yields push higher. Daly mentioned this as “potentially negative for emerging market bonds” (EMB).
