As the campaign for the Nov. 5 presidential election intensifies in the United States, investors are wondering what the implications might be for global markets.
While the result remains hard to call, with the two candidates closely matched in the polls, market uncertainty will continue. This is particularly the case in emerging market debt.
Anthony Kettle, senior portfolio manager for emerging markets at RBC BlueBay, explains to Morningstar that the main areas that will be impacted by the new configuration of Congress and the White House are:
• U.S. fiscal policy: tax and spending plans
• U.S. trade policy: protectionism and tariffs
• U.S. foreign policy: Russia and Ukraine, the Middle East and relations with NATO
"All of these elements will have an impact on the direction of interest rates and the U.S. dollar," Kettle explains.
"Because the two candidates are tied in the polls, it is difficult to make a safe bet on who will win the election and therefore it is difficult to draw firm conclusions about the direction of the U.S. dollar.
"For rates and credit, however, we have more clarity on the direction of these sub-asset classes during the U.S. election, given the decline in inflation in emerging markets and a benign default rate in emerging credit markets."
What Will Happen to EM Debt if U.S. Tariffs Increase?
Tariffs are likely to have the most immediate impact on EM debt, especially bonds denominated in US dollars.
"In the event of a large increase in tariffs, there will be an appreciation of the U.S. dollar to partially offset the impact," explains Preston Caldwell, senior U.S. economist at Morningstar.
"For example, a uniform 10% increase in tariffs could lead to a dollar appreciation of about 5%. So this is relevant for investors in emerging markets. For dollar-denominated debt, the depreciation of local currencies against the greenback may increase the risk of default."
Reza Karim, manager of emerging market debt at Jupiter AM, lists China and Mexico, which are also among the top exporters to the United States, among the countries that could be most adversely affected. "There could, however, also be some countries poised to benefit from tougher policies against China, for example Vietnam," Karim tells Morningstar.
Karim also points out that in the event of a Trump victory, new tariffs could be imposed even without congressional approval, so an overwhelming Republican victory may not be strictly necessary. On the other hand, if Kamala Harris becomes President "we would expect some sort of continuity from current U.S. policies and therefore less direct impact on markets."
Ukraine, the Federal Reserve and Defaults
The future direction of U.S. foreign policy could affect emerging debt market either positively or negatively. For example, Morningstar’s Caldwell says that the possible termination of aid to Ukraine would significantly increase the country's credit risk. In contrast, Jupiter’s Karim sees the situation in Eastern Europe having sudden developments such as a cease-fire. The governments of Argentina and El Salvador have been close in recent times to Trump and thus could benefit from his victory, Karim adds.
Even as the U.S. election captures markets' attention, managers urge investors not to lose sight of the most important factors moving emerging bonds: the Federal Reserve's monetary policy, which is set to become less restrictive, and economic fundamentals.
(Lower U.S. interest rates make dollar-denominated assets less attractive from an income perspective.)
Anisha A. Goodly, managing director of emerging markets at TCW, sees emerging market growth outpacing that of developed market economies, as well as a falling likelihood of defaults this and next year.
"The global growth forecast for 2024 looks broadly in line with the previous year's forecast of 3.2%. In particular, the economic growth differential between emerging and developed markets is expected to reach its widest level in nearly a decade as some large, developed economies slow down or struggle to recover," she says.
She adds: "More prudent macroeconomic policies have emerged, characterized by conservative fiscal management, a gradual reduction in subsidies, and an increasing commitment to monetary orthodoxy through inflation targeting. As a result, we do not expect any sovereign defaults in 2024 and 2025. In fact, 73% of the rating actions in the emerging environment this year have been upgrades or shifts toward a positive outlook."
Emerging Debt Strategies Ahead of U.S. Elections
Mark Haefele, chief investment officer at UBS Global Wealth Management, says of the recent candidate debate on Sep.11: "Neither candidate was particularly hard-hitting on policy and both avoided moderator questions to focus on their opponent's weaknesses. With the outcome still difficult to predict for both the White House and Congress, investors with Asia-Pacific exposure should position themselves in November with a balanced portfolio that can withstand some political risk."
Faced with an election outcome that remains uncertain, RBC BlueBay has positioned more flexible portfolios to "maintain credit and rate risk and reduce foreign exchange risk".
Hard Currency Vs. Local Currency Debt
Some managers distinguish between US dollar (hard currency) and local currency emerging bonds.
"In our hard-currency emerging market portfolios, we have reduced overweights to a selection of frontier sovereign bonds, for which further appreciation will have to depend on external factors, while we have begun to increase exposure to investment grade sovereign bonds," says TCW's Goodly.
"In our local currency portfolios, however, we are favoring countries with idiosyncratic drivers (such as Egypt, Turkey, Nigeria) over exposures that are more dependent on U.S. rate policy or a general reduction in volatility."
Since it is hard to predict the outcome of an election, Karim explains that it is difficult to change portfolios sharply in favor of a specific scenario. "In general, we maintain a marginally constructive stance on interest rates, given the potential for more accommodative policy in the future, but we prefer to have modest active rate risk."
From a regional perspective, Jupiter finds "still quite a bit of value in relative terms in Europe and, in particular, in some Ukrainian companies." Africa is also of interest, with blue-chip companies in countries such as Morocco, Nigeria or South Africa offering some opportunities. Egypt's local currency debt is also in scope.
On Latin America, Jupiter is "modestly constructive," particularly on Brazil, while being more neutral toward Mexico and Colombia. "These are positions we might reconsider if we see a strong change in U.S. foreign policy, particularly on tariffs," says Karim. He prefers "local idiosyncratic stories” in Asia. "India and Macau are good examples of where to find value today in sectors such as renewable energy, TMT [technology, media and communications] and gaming."
