Emerging Markets

Why reports of emerging market weakness in the Trump era may be greatly exaggerated

President Donald Trump arrives aboard Air Force One at the Philadelphia International Airport, January 26, 2017.
Jonathan Ernst | Reuters

Like the premature report of Mark Twain's death more than a century ago, rumors of the demise of emerging market growth in the era of President Donald Trump may be greatly exaggerated.

Trump dropped a hint recently that the policies of his administration — which is embracing trade protectionism abroad while fostering faster growth at home through tax cuts and infrastructure spending — would distance itself from a strong currency.

The "strong dollar" policy, rooted in the Clinton era, has had varying levels of support from subsequent administrations. Still, a muscular greenback is also a concern for developing economies, which are already struggling to adjust to the prospect of higher U.S. interest rates.

All things considered, however, it appears developing markets are holding up well under the potential strain. Capital Economics pointed out this week that over the last month, the MSCI Emerging Markets Index has jumped more than 6 percent in local currency terms, led by a 10 percent surge in Latin America.

Given that the dollar's gyrations have significant spillover in international markets, it raises the question of how frontier markets, many of which are reliant on exports, will respond if their currencies turn volatile under Trump's policies.

Analysts say Mexico is one of the countries most vulnerable to a stronger greenback — evidenced by the tumble this week after a canceled visit by Mexican President Enrique Pena Nieto in the wake of the dispute over Trump's plans for a border wall.

Still, a broadly stronger greenback is far from assured. According to James Barrineau, co-head of emerging market debt at Schroders Investment Management, a weaker dollar is not as catastrophic for some economies as it might seem on its face.

"While most people think that Trump trade policy will be negative for emerging markets, that is not at all clear," Barrineau told CNBC recently.

"If the policies are perceived to be contractionary to growth, they could weaken the dollar — and that is a positive for emerging markets," he added. "It could also speed EM to EM trade deals as an alternative to a protectionist U.S., which could be beneficial over the longer term. In short, it is way too early to call them unambiguously negative."

International growth, meanwhile, is sluggish to nonexistent, which means the dollar's gains could be capped. Since setting a multiyear high in December, the has traded sideways, underscoring how aggressive policy moves by the U.S. may be counteracted by weakness abroad.

"The divergence between developed market central banks could narrow if inflation rises in Japan and Europe and central banks continue to back away from" quantitative easing, Barrineau said. "That would keep the dollar roughly stable, and as we saw in 2016 from February to November, a stable dollar is very good for EM currencies."

Kevin Daly, senior investment manager at Aberdeen Asset Management, said the low-growth, stronger dollar environment that's persisted over the last several years has allowed emerging-market currencies to adjust.

It may provide insulation from the coming wave of Trump protectionist policies, and even potential buying opportunities, he told CNBC.

"The recent [EM] currency weakness reduces the likelihood of any interest rate cuts in the immediate term, but it should not ultimately derail prospects for interest rate cuts in the likes of Brazil, Argentina and Russia," Daly said.

"For countries like Brazil and India — which have seen sharp declines in their current account deficits and a big improvement in deficit financing …the impact of any Trump trade policies that are directed toward Mexico and China will have minimal impact," he added.

Still, with more Federal Reserve monetary policy tightening on the horizon, emerging market equipoise may not last. Analysts at Capital Economics believe U.S. fiscal stimulus combined with rate hikes "bodes particularly ill, given that [bond] spreads are well below their long-term averages in many EMs."