With the US presidential elections looming, a rate hike by the Fed may not be the only problem for EMs on the horizon. A Trump presidency would negatively impact EMs globally, analysts suggest.
Although a Trump victory could delay any future Fed hike – there is a 65% chance of a rise in December – the dollar would still strengthen against most EM currencies, exposing EM’s perceived vulnerability to global shocks, according to a Capital Economics research paper.
“The risk is that a Trump victory could trigger a significant outflow of funds from EMs to the US,” said Jose Brito, chief economist at Millennium BCP.
Despite the low yield environment, Brito noted that US Treasuries still offer a decent pick-up over other DM and even some EM economies.
Although the dollar would still be preferential to local currency EM assets following a Trump victory, other assets would be better still.
“Were there to be a Trump presidency, there would likely be strong demand for safe-haven assets such as gold or the Japanese yen, which would probably spike as they did after Brexit,” said William Jackson, senior EM economist at Capital Economics, who agreed that EM currencies would depreciate versus the dollar alongside other DM currencies, with bonds also faring poorly.
Regardless of where investors flee, the depreciation of EM currencies would lead to the same scenario that EMs faced at the beginning of this year according to Brito. Some are likely to be significantly more affected than others.
Jackson noted that China and Mexico stand out because specific measures have been proposed against the countries.
A Capital Economics report noted that if Trump were to impose a planned 45% tariff across all Chinese imports, Chinese GDP could fall by 3%. However, this is unlikely, and monetary policy could be eased to compensate.
The renminbi may also be allowed to depreciate by the Chinese if there is the threat of a trade war, according to the report.
Unsurprisingly however, the biggest EM loser of a Trump presidency would be Latin America, and more specifically Mexico.
Mexico has benefitted greatly from NAFTA, and 80% of its exports currently go to the US. As trade agreements can be reversed by a sitting president without congressional approval, Mexico’s economy is dangerously exposed to Trump’s whim if elected.
However, the inevitable fall in the peso that would come with a Trump presidency – it has already been tracking sentiment and currently stands at 18.5844 to the US dollar according to Bloomberg – would actually cushion Mexico’s economy.
The peso was down by 12% against the dollar year-on-year in September, and a weaker peso not only increases the country’s external competitiveness – it also boosts the value of dollar-denominated remittances and benefit Mexico’s tourism sector.
This could lead to higher inflation, which is already expected to reach above the Central Bank’s 3% upper target over the coming quarters. Inflation has already increased 2.97% year-on-year in September, up from 2.73% year-on-year in August according to Trading Economics.
Although Mexico’s markets are likely to bear the brunt of a Trump presidency, the rest of Latin America is unlikely to fare as badly as it has closer trade ties with China.
Peru and Central America would feel some effects from lower remittances, while Argentina and Brazil would only be impacted indirectly through a global rise in risk premiums, according to the report.
