Don’t overestimate negative impact of US election on EMs

After a decent rally in emerging markets (EMs) over the summer, autumn clouds have gathered on the EM horizon. First, the Federal Reserve spooked markets in August with warnings of an impending rate hike (only to backtrack again). In the past week, focus has shifted to the US election", with the first presidential candidate TV debate, and to the possible damaging effects of a more restrictive US trade regime and possible global trade war on EM countries.

In our view, a Donald Trump presidency could significantly impact selected EMs, while the impact would be much more limited under Hillary Clinton. Trump has laid out his antifree trade rhetoric in a seven-point trade plan, calling for renegotiation of the NAFTA agreement, cancellation of the trans-Atlantic Pacific trade pact (TPP) and aggressive action against China and other countries seen as playing an unfair trade game. Clinton has also voiced concerns about the impact of trade on US workers but with much less conviction than Trump.

Which EMs are most exposed to US trade action? In our view, Mexico, given its large trade share with the US and Trump’s sharp rhetoric against the country, and Asian and other Latin American countries. Less affected by US trade action are Eastern European EMs, which have relatively little trade with the US, given that their main export markets are European countries. Furthermore, given Trump’s positive view of Vladimir Putin, Russia could benefit from a more positive investor reaction in the short term, though we see a smaller effect in the longer term given concerns in Congress.

Increasing ‘south-south’ trade means more restrictive US and EU trade regimes would have less of an impact on EMs. According to UNCTAD, while only c.40% of EM exports went to other EMs in 1995, now two-thirds of exports are destined for other EMs. One could ask whether this is not just agriculture and raw materials but EM manufacturing exports have grown in importance over 30 years. Hence, a more restrictive trade regime in advanced economies would have less of an impact on EMs than before, provided EMs stick together and keep their borders open to each other.

We think there is still a case for EMs. External factors are mildly conducive from a gradual Fed hiking cycle (we see good reasons for the Fed to be on hold at December’s meeting), to a continuing rebound in the Chinese construction sector (very important for metal-producing EM), although with some moderation in 2017; and finally a stable to slightly improving outlook for commodity prices. Also, many EMs enjoy a virtuous cycle, as FX stability/strengthening has led to lower inflation, facilitating easier monetary policy, in turn increasing growth and spurring further capital inflows and FX strengthening. We think this is notably true for commodityproducing countries, such as Russia and Brazil.

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