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EMs show signs of retreating from Trump trade

For emerging markets, fears over the election of Donald Trump have yet to fully materialise.

The prevailing view, says Ousmene Mandeng of EM investment fund New Sparta Asset Management, is that a Trump presidency is “negative for emerging markets”.

Investors could foresee some benefit from a supply-side US boom that adds to world aggregate demand — but a less co-operative, protectionist US will have a structural negative effect and will be bad for the international economy, he says.

However, signs of a tactical withdrawal from the Trump reflation trade are visible in EM currencies, which had been forecast to go into sharp reverse because of Mr Trump’s hardline protectionist positions, a strengthening dollar and expectations that higher US interest rates would suck capital away from the developing world.

The decline in EM assets bottomed in the week after the election and has since “clawed back some ground”, says Win Thin, EM strategist at Brown Brothers Harriman, citing the MSCI EM index of large- and mid-cap equities.

The same is evident in EM currencies. The Mexican peso — a proxy all year for investors’ perception of the risks from a Trump presidency — has steadied in recent weeks, while JPMorgan’s EM currencies index has turned upwards, now standing roughly halfway between its trough in January and the peak in August.

Given the robust dollar rally, analysts at UBS contend the currency is “extremely overvalued”, and that the implementation of Trump’s proposed policies will take time to bear fruition. Many analysts are questioning the narrative of the president-elect being able to deliver an inflation-generating mix of tax cuts and fiscal stimulus.

Any sense of a Trump disappointment trade will resonate in investment opportunities, such as EM’s commodity currencies, such as Russia’s rouble, which have already been lifted by Opec’s cut in oil production. High-yielding EM currencies provide investors with attractive carry-trading opportunities — think India’s rupee and Indonesia’s rupiah — while some parts of the EM universe are less exposed to protectionism (Brazil’s real).

There remain, of course, corners of EM very vulnerable to Trump protectionism, such as Mexico, while Turkey’s lira has its own challenges. China’s renminbi has been on a steady downward path this year and that trend is likely to extend into early 2017, with likely knock-on effects on the Korean won, the Taiwanese dollar and other Asian currencies.

However, Paul McNamara, EM investment director at GAM, says fundamentals for EMs are “not that bad”, with current account deficits easing and imports cut. So far this year, the real, the rouble and the South African rand have gained between 13 and 17 per cent on the dollar.

That said, uncertainty persists over the direction of Trump policy and that will not fade any time soon as the new administration and Congress engage in rounds of horse-trading next year over formulating tax, spending and regulatory plans.

In the immediate term, attention will focus on next week’s Federal Reserve meeting, with investors expecting a nudge higher in overnight interest rates.

“The main worry for EM is not Trump per se, but rather the US interest rates outlook,” says Peter Kinsella, an emerging markets currency strategist at Commerzbank. “The currencies where we see the largest losses since the election are the ones which have the worst current account deficits. That’s not a coincidence.”

Mr Thin says that more important than a December rate rise is what the Fed says next week about 2017.

“The hike next week is fully priced in, but markets are pricing in only one to two hikes next year,” says Mr Thin. “I think risks are tilted to the upside, and that should keep EM FX on the defensive.”

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