How can emerging market investors deal with some of the effects that could stem from the new US administration?
What factors should emerging market investors keep in mind when assessing the potential impact of the new US president? Manpreet Gill, head of fixed income, currency and commodity srategy, Standard Chartered Private Banking, sets out his views. This publication's editors do not necessarily agree with all the views of guest contributors but are grateful for contribution to debate and invite readers to respond. They can email the editor at email@example.com.
The first few weeks of the new US administration have made one issue quite clear – President Donald Trump is keen to deliver on his campaign promises. One of the cornerstones of his declared policy is to negotiate better trade deals for the US with its neighbours such as Mexico and Canada, as well as with key trade partners in Asia.
Where does that leave trade-dependent Asia and the other emerging markets, many of which count the US among their top three trading partners? And how should investors play the emerging trend?
To tackle this question, one needs to first examine the backdrop. There are a few factors favouring emerging markets at the moment. First, emerging market growth is accelerating relative to developed market growth for the first time since 2009 and Asia is set to remain the biggest growth driver for the global economy. Second, emerging market equity market valuations are more attractive than those in developed markets after years of underperformance. Third, many emerging markets, especially outside Asia, are emerging from recessions and/or sharp downturns in their equity, bond and currency markets. Other factors such as increased commodity price stability, greater reform efforts and stability in China are also positives for many emerging markets. Indeed, these factors arguably contributed to emerging market equity outperformance over developed markets for the first time in four years in 2016.
Against these favourable trends there are counter-balancing factors. Apart from the likelihood of trade frictions, the most significant risk facing Asia and emerging markets is interest rates in the US as Trump’s policies could potentially generate faster growth and higher inflation. Historically, higher US rates have tended to be a challenging environment for many emerging markets, given the possibility of triggering capital outflows.
However, we believe capital outflows are not inevitable. There are three factors to keep in mind. First, that many emerging markets (including China) have already faced significant capital outflows. This suggests the most susceptible components may already have left. Second, the gap between the low US rates today and fairly high rates in many emerging markets is quite high. This may offer an additional source of support for emerging markets. Finally, US interest rates would most probably have to rise at a faster pace than what is already expected in order to trigger large-scale capital outflows. Markets are arguably already looking for at least one rate hike from the Fed this year, so an upside surprise from this baseline would likely be needed in order for markets to start worrying about emerging markets.
There could even be situations where US rates go up, but they are not detrimental to emerging markets assets and currencies.
For one, US interest rates could rise but at a much slower
pace than expected. This would imply higher yielding emerging
market currencies (like the Indian rupee or Indonesian
rupiah) may be less vulnerable than lower yielding ones. Second,
emerging growth could continue to accelerate relative to
developed market growth, which would underpin interest in
emerging market equity exposure. Finally, emerging market
currencies may have already priced in a significant portion of
the risks, leaving less room for further downside. The Malaysian
ringgit is a good example of this given just how much it has
already weakened over the past few years.