July 24, 2024 | Emerging Markets Debt
Head of the Emerging Markets Debt Team, Portfolio Manager
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Questions about the potential implications of a second Donald Trump administration for emerging markets (EM) debt have intensified in the past few weeks, and our team has been debating the topic. Here are our thoughts.
At this point, we believe victory for Trump in the upcoming U.S. presidential election appears to be the base-case scenario.
While there is some uncertainty about Trump’s policy agenda in his second presidency, the direction of travel seems clear.
Trump has been vocal about interest rates and tax rates, international trade terms, regulation, energy, and foreign policy (including financial aid).
Despite displaying strong opposition to U.S. Federal Reserve (Fed) Chairman Jerome Powell in the past, Trump has recently softened his rhetoric, publicly saying that he would let Powell serve out his term. Moreover, there seems to be limited legal scope for interference: U.S. law states that a sitting president can dismiss any Fed official, but only for “cause”—not because of policy differences.
Previous episodes of politically induced volatility have translated in important opportunities for alpha generation.
However, we believe investors should expect a strong attempt to renew Trump’s flagship 2017 tax cuts and further reduction in corporate taxes.
Higher tariffs on imports also appear to be very likely, although the magnitude would likely vary across trading partners.
Investors should also expect a strong push toward deregulation and ample incentives for domestic oil exploration.
Lastly, on the foreign policy front, investors should expect a reset in the relationship with Ukraine, Taiwan, and the North Atlantic Treaty Organization (NATO).
In the United States, higher tariffs on imported goods would likely lead to a temporary increase in inflation. Higher prices should, in turn, impact demand, potentially temporarily denting economic growth. We would not expect the Fed to react to such transitory inflationary pressures.
On the other hand, lower taxes could be conducive to improved economic activity. However, large, unfunded tax cuts could also have a negative impact on the U.S. fiscal deficit.
EM countries should be less directly exposed to higher tariffs given the significant growth in intra-EM trade.
Globally, higher tariffs could negatively impact trade. Countries running large trade surpluses with the United States would likely see the biggest impact on their economies. China, and to a lesser extent Europe, could be particularly affected. In these places, we would expect to see significant fiscal and monetary policy reaction to offset the impacts of higher tariffs imposed by the new U.S. administration. EM countries should be less directly exposed given the significant growth in intra-EM trade observed over the past few years.
Overall, in the event of a Trump victory we would expect marginally weaker global growth and temporarily higher inflation. In this context, we would expect an acceleration of the global monetary policy normalization process, leading to lower global interest rates. We believe the Fed would likely remain behind the curve, which should provide additional support for the U.S. dollar. Depending on the magnitude of tax cuts in the United States, we could also see a (bull) steepening of the U.S. Treasury yield curve.
It is important to note that the implications of a Trump administration for the U.S. and global economy will depend on the administration’s actions. While Trump appears to be the frontrunner ahead of the November elections, it is at this point very difficult to assess how the balance of powers will shape up in the U.S. Congress. A lack of majority in Congress should ensure proper checks and balances and prevent the implementation of more radical polices.
EM debt is an asset class driven by two predominant macro forces: global economic growth and global liquidity conditions. Regardless of the outcome of the upcoming U.S. elections, we have a constructive near-term view on global economic dynamics (we anticipate only a marginal deceleration) and expect an improvement in global liquidity conditions.
We do not believe the outcome of the U.S. presidential elections will change our expectation for lower global rates and improved liquidity conditions in the second half.
We expect the global disinflationary process to continue and anticipate policy rate cuts in developed economies. The gradual removal of monetary policy restriction should lead to lower global rates and improved liquidity conditions in the second half of the year. We do not believe the outcome of the U.S. presidential elections will change this view.
We have a strong preference for EM external sovereign debt because of the diversification of the investment universe and lower exposure to China. The EM external sovereign debt investment universe is very diversified, consisting of 162 issuers spanning over 70 countries. China is more representative in the EM corporate credit and local currency universes.
We also have a strong preference for hard-currency-denominated debt because we expect the U.S. dollar to remain supported by a strong U.S. economy and a cautious Fed.
Our outlook for the 10-year U.S. Treasury yield has not changed, and we continue to believe that there are attractive opportunities for investors to increase exposure to long-duration securities to lock in attractive real and nominal yields.
Still, the U.S. elections could generate significant volatility in the marketplace. We have recently reduced risks in the portfolios and will be looking very closely for opportunities to reinvest. Previous episodes of politically induced volatility have translated to important opportunities for alpha generation.
Marcelo Assalin, CFA, partner, is the head of William Blair’s emerging markets debt team, on which he also serves as a portfolio manager.
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