Emerging markets seek next catalyst as dust of midterms settles

As President Donald Trump’s party lost full control of Congress, investors began reassessing opportunities in emerging markets amid a slew of headwinds from his trade policies to the end of easy money.

Emerging-market currencies and stocks rose while the dollar wobbled as Democrats wrested control of the US House and Republicans maintained their grip on the Senate.

While investors welcomed the removal of the uncertainty surrounding the vote, focus is now shifting to possible policy gridlock amid an escalation of the US-China trade friction and further removal of stimulus by the Federal Reserve.

“Investors are going to be relieved to have mid-term election news out of the headlines,” said Hannah Anderson, a global market strategist at JPMorgan Asset Management in Hong Kong. Still, “nothing’s going to change on the trade front. Fears and sentiment about trade are going to continue to be reflected across the EM complex, at least for the next couple of months,” she said. Below are investor and analyst comments on the impact of the mid-term elections:

Nicholas Ferres, chief investment officer at Vantage Point Asset Management in Singapore: “The developments might take the sting out of the dollar risk for EM”. The fund scaled up its wagers on Chinese and other developing-nation equities after the October sell-off, before taking some profit as the market bounced this month. It maintains a “positive tactical bias” on emerging markets. “I am not aggressively bullish EM” amid concerns about the deteriorating growth outlook. The fund also added a net long position in 30-year US Treasuries.

Saed Abukarsh, the co-founder of Dubai-based hedge fund Ark Capital Management: “We are looking at a consolidation in EM and further gains in the Mexican peso and South African rand”.

The fund holds “small” wagers that seek to profit from gains in the peso and rand. “The House/Senate vote was priced in. The real cat in the hat is the Fed, and the risk is that we could see the back end of the curve dip again”. “The risk is that the Fed may begin to rein in their language on potential future hikes in 2019. The risk is that the Fed takes a strong look at the housing numbers and begins to make that a focal point”.

Jan Dehn, head of research at Ashmore Group in London: “The most obvious implication for EM is that the second of three major risks, which have been holding back investors from returning to EM local markets in the second half of 2018, is now behind us”.

The first of these risks was the Brazilian election, and the final one for the year is position squaring, which typically occurs toward year-end but unlikely to have lasting or fundamental implications.

“The green light for EM local mar- kets just got significantly greener”. As politicians begin to focus on the 2020 election and seek to keep the US economy buoyed, Republicans will likely push the Trump administration to pursue more cautious economic policies, particularly on trade.

Investors should lower their US growth expectations, as the Fed may do so with the reduced likelihood of large stimulus measures; the probability of recession is also higher, at the margin.

“These factors will weigh on the dollar and support EM currencies”.

Arthur Lau, Hong Kong-based co-head of EM fixed-income at PineBridge Investment: This is likely to be positive for emerging-market bonds which have suffered since President Trump came into power.

If the US dollar softens, or it strengthens at a slower pace, this will help local currencies, for example Indonesia’s rupiah, which has rallied. Trump’s implementation of tax cuts is likely to be “challenging,” reducing the positive impact on the US economy.

Mitul Kotecha, senior emergingmarkets strategist in Singapore at TD Securities: A divided Congress is unlikely to change the outlook for emerging markets “significantly” as the Trump administration retains a lot of power over trade policy. Should a split Congress result in less dollar bullishness at a time when positioning is heavily long, this could help emerging-market currencies eventually.

Shane Oliver, head of investment strategy in Sydney at AMP Capital Investors: “It all depends on how Trump reacts, because he might regard the loss of control of the House as a negative, which could mean he becomes even more extremist and dial up the populism even further”.

“That’s probably the biggest risk, which could possibly mean that he goes in even tougher in terms of dealing with China”.

Samsara Wang, emerging-market strategist at Credit Agricole CIB in Hong Kong: The result is expected to support emerging markets as Trump’s political power will weaken and there is less likelihood he will take a tougher stance against China.

If the US and China agree to a trade deal at the Group of 20 meeting at the end of November, it will boost developing-nation assets further, especially the yuan. The market is set for a “short period of consolidation,” with the Fed likely to keep rates on hold on Thursday before hiking again in December.

Hamish Pepper, head of FX and emerging-market macro strategy research for Asia at Barclays Plc in Singapore: The dollar is expected to continue to strengthen against emerging-market currencies while remaining range-bound against its Group-of-10 peers.

Additional fiscal stimulus is unlikely to come under a divided Congress, with Barclays assigning a small probability to bipartisan support for a modest infrastructure plan.

But the US economy should continue to outperform the rest of the world as the boost from the current fiscal expansion remains.