Trump’s victory is likely to trigger volatility in emerging markets in the coming months, but may be positive in the medium and long term.
For now, it is almost certain that the first months since his inauguration as US president this January will cause significant pain in other countries. Some will rush to make trade and other concessions to avoid the worst of the tariffs, with China likely to bear the brunt. Some of the pain will be felt in currencies, since the more severe the tariffs, the more likely the dollar will appreciate, at least initially. Devaluations in other currencies will put pressure on those who borrowed in dollars, especially in emerging economies.
But despite the jitters, emerging markets may emerge victorious from Trump’s second presidency. Thus, although Trump is likely to use tariffs as a weapon to obtain trade concessions, he is not willing to let the dollar rise too much and the US lose competitiveness. A new agreement on currencies is even possible, something similar to the New York Plaza agreement between economic ministers and governors of the G-5 central banks –France, Japan, Germany, United Kingdom and USA-, who agreed to depreciate the dollar in relation to the yen and the German mark through intervention in the currency markets. In this sense, a depreciation of the dollar, which reverses its 15-year upward cycle, would trigger a virtuous circle of solvency for emerging market debt issuers, improving the dynamics of their currencies and boosting the prices of their assets.
At the same time, US debt dynamics – which Trump will most likely worsen – will make emerging market sovereign debt more positive. Our base case is an erosion of the US debt position. Despite Trump’s promise of more efficient government and less bureaucracy, his hands are tied on major public spending figures, such as Social Security. Added to this is that he will pressure to reduce taxes. So the Congressional Budget Office estimates that the US debt burden, at 100%/GDP, It can increase up to 143% if Trump’s policies are implemented. If it manages to stimulate growth, the deficit can be reduced proportionally, but it is not likely.
However, emerging economies, which represent 58% of world GDP, will continue to grow. Its institutions are increasingly credible. Their central banks were generally quicker to respond to the spike in global inflation by relaxing their monetary policies. Its fundamentals are even better than in developed markets, with a lower debt burden, higher growth rates and better demographic prospects. These are relatively liquid markets, which in fixed income capitalize 7 trillion dollars, plus 7.6 trillion in variable income, with a long way to go, since the S&P 500 alone has a capitalization of about 48 trillion dollars. So even sovereign funds are increasingly shifting their portfolios towards emerging markets. Keep in mind that the erosion of faith in US Treasury debt is likely to motivate the search for alternatives. And, since other governments in developed economies also have large debt burdens, the choice is developed market credit and emerging market sovereign debt.
It is true that a deterioration in the debt position in the US would increase the yields to maturity of its bonds, with an increase in interest rates in the US – which is historically negative for emerging market assets – but the fundamentals in these countries, With reliable central banks and controlled national budgets, in addition to the expansion of domestic demand for their local currency debt, they make their bond markets less sensitive to interest rates in the US. In any case, a US debt crisis would be destructive to assets in general, and it would be in the interest of the rest of the world to prevent an extreme outcome.
In any case, the deterioration of US debt fundamentals challenges its exceptional nature, which has been able to keep the dollar well above its fair value. The enormous US debt burden cannot continue to grow forever, not even for too many years, without adjustment. So while Trump’s policies are likely to immediately fuel volatility in emerging assets, they will emerge winners once the dust has settled.
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