Donald Trump’s election win signifies an inflection point for the global political economy, but we believe a changing and challenging investment landscape can offer new opportunities for investors in emerging market fixed income.
Since the fall of the Berlin Wall in 1989, globalisation has led to the ever-freer movement of people, capital and goods. These trends have raised asset prices and reduced goods price inflation; they have also raised living standards in the emerging market (EM) world. In the developed market (DM) world they have subdued real wage growth and increased income inequality. These trends have been exacerbated since the global financial crisis by central bank quantitative easing (QE), which has further distorted asset prices and reduced government incentives to make the necessary structural reforms to equip the DM workforce to prosper in a globalised world.
How will emerging markets change under a Trump presidency? We take a look at four of the fundamental changes we believe are likely to occur in the short to medium term.
Federal Reserve policy
We expect a US fiscal expansion of over 2% in 2017/8 in an economy that is already close to full employment. In our view, the Federal Reserve (Fed) reaction function will change from knee-jerk dovishness to tightening to offset fiscal expansion. We expect 4 rate hikes in 2017, significantly more than is priced in by the market. We also expect Trump’s forthcoming appointments to the FOMC (and eventual next chairman) to be QE sceptics, and we expect yields to rise across the US yield curve. We expect the market to move from consistently pricing market rate expectations below the Fed’s ‘dot plots’ to consistently above. This will create financing challenges for weaker EM credits.
Whilst Trump’s exact intentions on global trade agreements are currently unclear, we do expect global trade volumes to decline. This trend has actually already been in place since 2012. While global trade rose from 17% to over 55% of global GDP between 1960 and 2012, it has declined approximately 5% in the past 5 years; we expect this will continue as global tariffs are set to rise in order to ‘protect’ the domestic worker. Attention must also be paid to the capital account side of the ledger, as lower global trade volumes also lead to lower global capital flows, both into financial markets and through foreign direct investment. Low real interest rates throughout the world have been a direct consequence of the ‘global savings glut’; this trend will seem less apparent. We expect a global rise in term premia.
Trump’s assertions on European and Asian defence agreements and overtures to Russia now make the post-1945 settlement seem uncertain. Our sense is that we may move into a multipolar ‘great power’ world. Geopolitical manoeuvring between large regional powers including China, Russia, India, Pakistan, Turkey, Iran and Saudi Arabia is set to increase. Sometimes this will involve the US and sometimes it won’t. Previous spheres of influence will be challenged, sometimes covertly and occasionally openly. Country risk assessments will have to include this geopolitical uncertainty.
We believe the current populist wave will remain mostly a developed world phenomenon, as EM consumers have generally benefited from globalisation. Additionally, individuals in many major EM countries simply do not have the democratic means of expressing dissatisfaction. Nonetheless, investors need to remain alert. The Arab Spring and the 2013 protests in Brazil and Turkey show that it is possible to organise quickly in the age of social media.
David Dowsett is co-head of Emerging Market Debt, BlueBay Asset Management