Last updated: 09:27 / Monday, 7 November 2016
According to AXA IM

Concerns About a Sharp EM Correction are Overplayed

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Concerns About a Sharp EM Correction are Overplayed
  • Trump may find punitive trade measures counterproductive
  • The strength of the dollar is the main channel through which a US President affects EM
  • In the medium term, the results of this election will have a global impact
  • They areless positive on Mexico due to reform fatigue and concerns around certain Mexican corporate fundamentals

Looking at the potential impact of the incoming 45th US President on emerging markets, the AXA IM Emerging Market debt team believes that trade and immigration policy has proved among the most contentious topics in the US elections. According to Olga Fedotova, Head of Emerging Market Credit Research at AXA IM: “Trump may find punitive trade measures counterproductive.” During their campaigns, Trump has proposed increasing import tariffs, scrapping regional and global trade deals, blocking worker remittances to Mexico, and has hinted at the mass deportation of undocumented workers. In contrast, Clinton has largely promised to oversee a continuation of the status quo. Takinf this into consideration, the specialist believes that concerns about a sharp EM correction are overplayed – "the direct impact of US trade on EM economies is modest, with EM countries sending just 16% of their exports to the US. However, Mexico remains singularly exposed, with 81% of its exports going to the US."

Fedotova believes that if Trump were to keep to his Mexico trade agreements campaign promises, he may find punitive trade measures counterproductive given Mexico is the US’s second largest export destination and trade between the US and Mexico is interlinked. “China and South Korea take second place, with US imports making up 3%-4% of GDP. If Trump were to impose punitive tariffs against China, any counter action could inflict significant pain on US exports, whose third largest market is China. In EMEA, the trade ties with the US are modest, with Israel (1% of GDP) and Saudi Arabia (0.7% of GDP) the most exposed, although two-way links limit the risk to individual industries. For example TEVA, an Israeli pharma company which generates over half of its revenue in the US, produces Multiple Sclerosis drugs which current patents would make difficult to replicate. In Saudi, the trade account is balanced, with oil exports to the US offsetting imports of cars and machinery."

In their view, the strength of the dollar is the main channel through which a US President affects EM. "Assuming some fiscal loosening, the Fed reaction determines the dollar impact. The new President inherits a strong dollar by historical levels and the major drivers of $/EM are turning favorable for EM. There could also be tension around "currency manipulation" and a high risk that the Trans-Pacific Partnership (TPP) is delayed or rejected."

Meanwhile for Sailesh Lad, manager of the AXA World Funds Emerging Markets Short Duration Bonds fund “The severity of volatility and weakness in EM will depend on how quickly and what is implemented regarding the TPP. I recently attended the IMF meetings in Washington DC at which a panel debated whether Trump could rip up Nafta without government approval! This could have negative growth implications for not only EM but also US. If there is no room for fiscal expansion, then the Federal Reserve is the only institution who might be able to kick start the economy. Trade is clearly a point of contention, less so with Hilary than Trump, but it is important to note that US exports are a fifth of Mexico's GDP, but only 4-5% in China and Korea and 2% or lower in the other manufacturing exporters. That said, a shock to global trade would clearly hurt all of EM.”

Overall they expect more volatility in markets in a Trump victory because of policy uncertainty. "In the medium term, the results of this election will have a global impact, not just an impact in EM countries. In my view countries with large external financing needs and high beta such as Turkey and South Africa may suffer and their debt underperform. Diverging foreign policy objectives could see shifts in geopolitical alignment. In our view Asia (ex- China) is least likely to be impacted. Ukraine may also suffer if Trump wins, as he is seen as being more pro-Russia, and therefore Russia could see more up-side than down-side. For example a victory for Trump could usher in a renewed détente with Russia, a relationship that has become increasingly strained under President Obama. While there are some fears about additional financial sanctions under Clinton, the marginal effect of further sanctions is likely to be limited." Russian companies have largely adjusted through deleveraging, with total corporate external debt going down to USD 468bn in September 2016, from USD 678bn reported when sanctions were first imposed in 1Q 2014.2 Lastly, the Middle East could become more unstable with risk of more geo-political issues.

“A Clinton win should mean business as usual for Ukraine, as she doesn’t share Trump’s pro-Russia stance. We have been reducing our exposure to Mexico for both US election risk worries but overall we are slightly less positive on Mexico due to reform fatigue and concerns around certain Mexican corporate fundamentals. Also in Asia, we have been reducing overall exposure as we believe the region is expensive on valuation terms."

Fedotova concludes: “Regardless of the winner, gridlock, pragmatism and self-interest are likely to prevent the market’s worst fears from materialising. Headline risk and volatility may increase, particularly with a Trump win, close trade linkages – 50% of US exports are destined for emerging markets, would make a fundamental shift in trade policy a case of beggaring thy self, rather than thy neighbour.”

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