Trump Resurgence Sinks Emerging Markets as Dollar Surges

(Bloomberg) — Emerging markets were hit hard by the return of the “Trump trade” on Wednesday as the dollar and U.S. yields rose after the election of Donald Trump.

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Eastern European currencies led the losses, making a gauge of emerging market currencies post its worst day since February 2023. However, the Mexican peso, often seen as the most vulnerable to Trump’s trade policies, reversed earlier losses of 3.5%. Gains of up to 0.5% during the American session.

Traders remain uncertain about the outlook for risk assets under the new Trump administration. His pledges to impose stronger restrictions on imports and immigration are fueling bets on higher US borrowing costs and a stronger dollar, weakening the appeal of the asset class.

“A Trump presidency will implement tougher and broader tariffs than during the last Trump administration,” with China being targeted more than other countries, said Rajeev de Mello, chief investment officer at Gamma Asset Management. “Expansionary fiscal policy will lead to higher bond yields, especially for bonds with longer maturities, which will result in a double blow to emerging markets through a stronger US dollar and higher US yields.”

MSCI’s index of emerging markets stocks fell 0.6%, dragged down by Asian stocks as traders priced in punitive tariffs for the world’s second-largest economy.

It was Trump’s trade war against China during his first term that halted the rise in emerging market stocks and sparked a weak performance against the United States that continues to this day. Chinese stock indices in Hong Kong fell by more than 2.5%.

Volatility

Traders have been bracing for a Trump victory in recent weeks, with currency volatility rising in the run-up to the vote, likely to soften the blow as the session wears on today.

Republican tariff proposals would hit Mexico – the United States’ largest trading partner – particularly hard. During his election campaign, Trump said that automakers building factories in Mexico pose a “dangerous threat” to the United States.

“There was a reduction in risk-off in some Latin American currencies in the days and weeks leading up to the election, so this may help explain the move,” said Brett Rosen, Latin America economist and strategist at EMSO Asset Management.

The Mexican peso rose 0.2%, while the Brazilian real erased its losses to lead gains among the currencies of developing countries. The MSCI EM FX Index remains lower on the day, less than 1% away from erasing its 2024 gains as Eastern European currencies retreat.

“The initial reaction was probably too big for one day,” Andres Pardo, head of Latin America macro strategy at XP Investments, said of the Mexican peso. “It is likely that some investors used the sell-off as an attractive entry point for short-term trading, due to the continued upside the currency continues to offer.”

Ukraine

Meanwhile, Ukraine’s bonds rose across the curve on Wednesday, leading emerging market gains. Trump has repeatedly stated that he would quickly end the war between Russia and Ukraine if re-elected, and force Europe to bear more of the cost of pushing this conflict.

Other high-yielding credits that are seen as benefiting from the Trump administration, such as Argentina and Venezuela, also rose.

Emerging markets already face a host of macro challenges, many of which could be exacerbated by Trump’s policy proposals. China’s economy remains mired in a deflationary spiral despite hundreds of billions of dollars in monetary stimulus, while conflicts in Ukraine and the Middle East put geopolitical risks top of mind for investors.

Even the Fed’s long-awaited interest rate cut ultimately proved to be a non-starter for those who hoped it would kick-start an emerging markets recovery. Now, Trump’s pledges on tariffs, immigration and tax cuts may put pressure on inflation. US Treasury yields rose – with 30-year Treasury yields rising by the most since March 2020 – as his win revived inflation risks.

The US election result “opens the door to a stronger US dollar, higher US real interest rates, and tariff policies that disproportionately hurt emerging market exporters,” said Ed El-Husseini, a New York-based strategist at Columbia Threadneedle. “We are likely to see further weakness in the asset class, across domestic rates, FX and higher credit beta.”

–With assistance from Matthew Burgess, Colin Jocko, Karim Karakaya, Carolina Wilson, and Philip Sanders.

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