CONTRIBUTORS
Robert O. Abad
Product Specialist
Western Asset
Kevin J. Ritter, CFA
Portfolio Manager
Western Asset
United States
Well before the nearly disastrous events in Butler, PA, the US presidential race had been heating up, with the (then) Democratic and Republican nominees Joe Biden and Donald Trump locked in a tight battle, according to the polls. While it's still too early to predict what will happen by November, what we do know is that Trump has been vocal about plans for aggressive trade measures if he wins in 2024. Therefore, it’s useful to consider ahead of time what impact such policies might have on asset prices, especially in emerging markets (EM).
The two candidates have significantly different trade policies, which could impact EM asset prices. Trump’s proposed 10% across-the-board tariffs and 60% China tariffs might be the starting point in negotiations, but we should expect more trade frictions under a Trump 2.0 scenario compared to a continuation of the Biden administration. In our view, tariffs would likely (1) weaken EM exchange rates (boosting the US dollar), (2) increase prices paid by consumers and (3) decrease margins/profits for exporters and producers.
As we discussed in a blog post earlier this year, Trump's trade views are well-known and lack the element of surprise that characterized his previous impromptu announcements on social media. Moreover, after experiencing a Trump presidency, governments and corporations worldwide have implemented contingency plans to manage global trade and supply-chain disruptions through nearshoring strategies. That said, Exhibit 1 shows the returns of EM and other asset classes following Trump’s victory in the November 2016 presidential election. Although medium-term factors may counterbalance some of these fluctuations, we suspect the initial market reaction to be similar in direction and scale as the 2016 move. With upcoming presidential debates, conventions and polling over the next three months, we expect some of the Trump premium to be reflected in asset prices.
Exhibit 1: Market Reaction to Trump’s Win in 2016
Source: Bloomberg. Changes shown represent October 31 to November 30, 2016. As of November 30, 2016. S&P 500 Index; DXY is represented by the US Dollar Index; US high yield (HY) is represented by the Bloomberg US Corporate High Yield Total Return Index Value Unhedged USD; EM Rates are represented by the J.P. Morgan Government Bond Index-Emerging Markets; US Trsy Index is represented by the Bloomberg US Treasury Total Return Unhedged USD Index; US investment grade (IG) is represented by the Bloomberg US Corporate Total Return Value Unhedged USD; EMBIG Div is represented by the J.P. Morgan Emerging Market Bond Index; EM foreign exchange (FX) is represented by the J.P. Morgan GBI-EM Global Diversified FX Return. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results.
EM has been shaken by renewed American exceptionalism so far this year, which pushed US rates higher by about 50 basis points (bps), using the US Treasury (UST) 10-year yield as a proxy, and created a broader headwind for EM trades (rates, foreign exchange and spreads). As US growth and inflation data started to turn lower (which supports USTs and theoretically would boost risk assets across the board), EM carry trades were hit by idiosyncratic developments in select EM countries such as fiscal concerns in Brazil and the surprise Mexico election outcome. In effect, the broader local markets rebound was limited.
Exhibit 2: EM Performance Year to Date
Source: Bloomberg. As of July 9, 2024. EM Frontier is represented by the J.P. Morgan Next Generation Markets Index; CEMBI Brd (USD Corp) is represented by the J.P. Morgan Corporate EMBI Broad Diversified Composite Index; EMBI Global Div is represented by the J.P. Morgan Emerging Market Bond Global Diversified Index; EM GBI (Local Markets) are represented by the J.P. Morgan Government Bond Index-Emerging Markets. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results.
Looking to the third quarter, EM carry trades should be able to recover as US data aligns more closely with our base-case scenarios, creating a more favorable backdrop for carry trades. However, the upcoming US elections could disrupt EM asset price recoveries as protectionist policies from a potential Trump 2.0 presidency would negatively impact EM. Given these crosscurrents, we anticipate attractive total return opportunities across the EM landscape, where tactical trading strategies can be rewarded.
Definitions:
One basis point (bps) is one one-hundredth of one percentage point (1/100% or 0.01%).
Carry refers to a bond market tactic where you borrow and pay interest in order to buy something else that has higher interest
The US Dollar Index (USDX, DXY, DX, or, informally, the "Dixie") is an index (or measure) of the value of the United States dollar relative to a basket of foreign currencies. The index is designed, maintained, and published by ICE.
The Bloomberg US Corporate High Yield Total Return Index Value Unhedged USD is a component of the US Corp High Yield Index that is designed to track a more liquid component of the USD-denominated, high yield, fixed-rate corporate bond market.
The J.P. Morgan Government Bond Index-Emerging Markets (GBI-EM) indices are comprehensive emerging market debt benchmarks that track local currency bonds issued by Emerging market governments.
The J.P. Morgan GBI-EM Global Diversified FX Return is the foreign exchange (FX) component of the J.P. Morgan GBI-EM Index.
The Bloomberg US Treasury Index Total Return Unhedged USD is a component of the Bloomberg US Treasury Index, which measures US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury. Treasury bills are excluded by the maturity constraint, but are part of a separate Short Treasury Index.
The J.P. Morgan (JPM) Emerging Markets Bond Index (EMBI) Index tracks total returns for U.S. dollar-denominated debt instruments issued by emerging market sovereign and quasi-sovereign entities: Brady bonds, loans and Eurobonds.
The J.P. Morgan Next Generation Markets index (NEXGEM) measures the US dollar-denominated external sovereigns debt from frontier markets.
The J.P. Morgan Emerging Markets Bond Index (EMBI) Global Diversified Index is a uniquely weighted version of the JPM EMBI Global Index, which tracks total returns for U.S. dollar-denominated debt instruments issued by emerging market sovereign and quasi-sovereign entities: Brady bonds, loans and Eurobonds. The index includes all countries except those that have been classified by the World Bank as high income for the past two consecutive years. The diversified index limits the weights of those index countries with larger debt stocks by only including specified portions of these countries’ eligible current face amounts of debt outstanding.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Equity securities are subject to price fluctuation and possible loss of principal. Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Changes in the credit rating of a bond, or in the credit rating or financial strength of a bond’s issuer, insurer or guarantor, may affect the bond’s value. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.
U.S. Treasuries are direct debt obligations issued and backed by the “full faith and credit” of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasuries, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.