EMD & Trump 2.0: The bark is worse than the bite
In Short
AUTHOR:
Witold Bahrke, Senior Macro and Allocation Strategist at Global Evolution
The political die has been cast: the Republican sweep in the US means the nation’s political direction will change decisively in 2025. Donald Trump’s return to the White House is likely to result in more headline risk and investors should be nimble, preparing portfolios for a more volatile market environment. On the other hand, the segments of EM debt having suffered the biggest drawdowns in the last few weeks have begun to look attractive - provided Trump’s tariff policies will be less disruptive than meets the eye.
Taking stock: Is Trump 2.0 priced?
US voters have made their choice. The nation’s politics will undergo a seismic shift in 2025 as Republicans won the trifecta of White House, Senate and House of Representatives. From an EM debt (EMD) investor perspective, we believe the most important consequences will be more restrictive trade and immigration policies, while fiscal policy is set to remain loose (as per our election roadmap).
Financial markets, and EMD in particular, have repriced accordingly. In fact – and admittedly with a tiny bit of hindsight - markets already started pricing in a Trump victory in the second half of September when his odds of winning the election began to rise in earnest (see figure 1). Since then, EM currencies have sold off by roughly 5 percent and 10-year US Treasury yields climbed from 3.75 percent to almost 4.50 at their post-election peak. In total-return terms, EM fixed income unsurprisingly saw losses with local currency bonds particularly hard hit, suffering a drawdown of more than 5 percent since September 20.
Still, the drawdown in local currency EMD almost exactly matches what we envisioned under such an election outcome. This begs the question of whether Trump 2.0 is already priced into local currency EM sovereign bonds. History offers scant evidence of this kind of political shift, but in light of the market reaction, we lean toward a ‘yes’ – at least from a short-term pricing perspective.
Figure 1: 2024 US Election & EM Fixed Income Returns
Policy direction set - destination unknown
Medium term, it almost goes without saying that politics and policies will decide whether value has emerged in parts of EMD. The underlying assumption is that the global economy remains robust and a recession will be avoided. When assessing the path forward of US politics, there’s little doubt about its direction over the coming four years; it’s widely expected by market participants that trade and immigration policies will become more restrictive.
Therefore, it will be the destination, i.e., how restrictive US policies will end up being, that defines whether we have medium-term buying opportunity in segments that have sold off the most.
It might take a while for investors to identify the destination of fiscal and immigration policy. Trade policies, on the other hand, might change soon after Trump’s January 20 inauguration as the president has considerable discretion over tariffs. Economically speaking, the impact on inflation will be felt rather quickly. Among the three key policy areas identified in our election roadmap, trade restrictions are also likely to have the greatest impact on the rest of the world.
The other key policy areas are also important but are more relevant when looking beyond the tactical horizon. The economic impact will likely take longer to play out. Meaningful fiscal policy adjustments, for instance, require budget reconciliation, i.e., backing from Congress, and are not immune to filibustering1 due to a slim Republican majority in the Senate. In the same vein, reduced employment growth due to immigration curbs or even outright deportation will lower growth and lift inflation over the medium term rather than have any significant short-term impact on the key macro variables. This is not to say that markets won’t make attempts to price in fiscal and immigration policies. Still, trade policy might be a clearer signpost for the destination US politics under Trump 2.0.
