Sink or swim: Trump 2.0 reality confronts emerging markets

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Emerging markets can’t seem to catch a break, can they?

The Fed kicked off its easing cycle with a 50bps rate cut on September 18th, initially sending U.S. Treasury yields lower - including at the curve's 10-year mark.

The Fed’s large cut eased pressure on EM yields, helping to buoy EM equity markets.

Red October

But that enthusiasm was short-lived, as early-mid October saw releases of strong U.S. numbers for jobs and inflation.

U.S. annual CPI stood at 2.4% in September, a slight rise from the previous month, and rose to 2.6% in October.

And while it’s true that the U.S. only added 12,000 jobs in October, this was partly due to strikes and hurricanes that kept workers off payrolls.

As a result, markets have come to fear that the battle against inflation in the U.S. may be far from over.

These concerns sent U.S. and EM yields, and the dollar index, higher in October, while EM equities dropped.

November Rain

Trump’s victory on November 5th has heaped even more pressure on EM, exacerbating the high-yield, strong-dollar, weak-EM-equities/currencies environment.

The incoming Trump administration looks set to have expansionary fiscal policies, implement sweeping tariffs, and may even threaten Fed independence.

Markets are anticipating that this combination of policies will likely to boost U.S. growth while increasing budget deficits and inflation.

Hence the upward pressure on U.S. Treasuries yields.

For EM, this outlook undermines pegs where currencies are tied to the U.S. dollar, chief among them Egypt, Turkey, and Argentina.

Since international trade is mostly dollar-denominated, a strong dollar increases import costs while making exports less attractive to prospective buyers.

The downward pressure on current account balances and reserve accumulation from export receipts makes it harder to defend currency pegs with international reserves, incentivizing devaluation.

Choking on debt

Yet so many emerging and developing economies are carrying heavy debt burdens, including liabilities denominated in hard currencies such as the U.S. dollar.

When their currencies depreciate against the dollar as is currently the case, the cost to service government debt in local currency - in which government revenues are denominated - goes up.

And the combined local and hard currency debt loads can be painful: 770 million people in Africa live in countries where government debt servicing exceeds health care spending.

As a tariff-laden, Trump 2.0 world takes shape, some growth will shift from EMs back to the U.S.

There is thus a major risk that poverty, migration, and climate crises worsen:

• By 2050, Africa will be home to 25 percent of working-age people worldwide, as opposed to 15 percent today.

• Currently, average GDP per capita on the African continent is only a fifth of the world average.

Given this backdrop, we should expect increased economic divergence among EMDE countries.

Secular growth stories should remain bright in ASEAN and India, whereas the more vulnerable corners of the EMDE landscape - including but not limited to Sub-Saharan Africa - could well require comprehensive debt relief.

HIPC 2.0 may only be a matter of time.