The recent drop in emerging market stocks to levels last seen in mid-September has been attributed to the impact of Donald Trump’s victory and the Republican sweep of the U.S. Congress. This downturn has seen the iShares MSCI Emerging Markets ETF (NYSE:EEM) slump by 7% over the past month, with other ETFs like iShares MSCI China (NYSE:MCHI) and iShares Mexico (NYSE:EWW) also underperforming.
Trump’s win and the full Republican control of Washington raise critical questions for emerging markets (EM), particularly regarding how a more protectionist U.S. policy and potential fiscal loosening could affect emerging economies, currencies, and credit conditions.
The election of Trump has led to concerns about possible shifts in U.S. fiscal and trade policies that could have a ripple effect on global markets. The prospects of looser fiscal policy and more trade protectionism have increased short- and long-term U.S. interest rates, putting upward pressure on borrowing costs in EMs.
Higher U.S. interest rates tend to strengthen the dollar, making it more expensive for emerging markets to service dollar-denominated debt. This has led to a tighter financial environment impacting emerging market currencies, which have weakened against the dollar.
Following Trump’s win, most EM currencies have depreciated, especially in Central and Eastern Europe and Latin America. Investors worry that the Federal Reserve may delay rate cuts in response to Trump’s policies, leading to a stronger dollar and potential trade barriers that pose risks for EM economies reliant on exports and foreign investment.
The tightening financial environment has also impacted EM credit ratings, with the rise in U.S. interest rates tightening financial conditions for EMs that rely on affordable credit for growth. This could limit governments’ ability to stimulate their economies, as borrowing costs rise and fiscal vulnerabilities become more pronounced.
Looking ahead, EMs face a mixed outlook. While volatility in emerging market assets is expected to remain elevated in the near term due to uncertainties surrounding U.S. policy details, structural growth tailwinds such as demographics, technology, and the global energy transition could offset some risks. Supply-chain shifts and nearshoring trends may also help some EMs attract investment.
In conclusion, the specific policies announced by the next U.S. administration could either further amplify or reverse the recent tightening in financial conditions, with implications for EM growth and credit conditions. Ultimately, the ball is in Washington’s court, and how EMs fare going forward will largely depend on Trump’s policy choices in the coming years.