While the allies and adversaries of the US have been watching the unfolding drama in the White House with mixed emotions, the response of emerging-market debt investors has been rather more straightforward: joyful relief.
When Donald Trump ascended to the US presidency, the policy agenda on which he had campaigned posed a significant threat to the asset class.
By putting ‘America first,’ the new administration would adopt a more protectionist stance that could hurt those emerging market nations with which the US runs trade deficits, in particular Mexico. By splurging on infrastructure and slashing taxes, the administration could quicken domestic economic growth, spurring the US Federal Reserve (Fed) to raise rates at a brisk pace, stoking further strength in the dollar and raising the cost of capital globally.
Very little of this has come to pass. Distracted by various probes into contacts between his election campaign and Russia, and hamstrung by a dysfunctional White House and increasingly tense relations with the US legislature and judiciary, Trump has failed to chalk up any legislative achievements in his first six months in power.
The inability of the Republican-dominated Congress to repeal and replace the Affordable Care Act, dubbed ‘Obamacare,’ has made the passage of game-changing tax reform appear increasingly unlikely. At the same time, tough talk from the administration on ditching pacts such as the North America Free Trade Agreement has been moderated, with renegotiation now more probable.
Although ‘soft’ economic data, based on surveys of businesses, improved sharply following the presidential election, as firms anticipated a bevy of supportive measures and stronger economic growth, ‘hard’ data did not match this rise, with GDP and inflation figures missing estimates.
In response, investors have downgraded their view of the Fed’s rates outlook, with the monetary guardian now expected to tighten policy at a materially slower pace than was deemed probable at the start of this year. The central bank itself has repeatedly made clear that it is in no rush to raise rates, even as it gradually unwinds its US$4.5 trillion balance sheet.
Against this backdrop, it is little wonder that the dollar, whose value in part reflects investor sentiment towards the US economy, has reversed all of its post-election gains: the US dollar index is now flirting with levels last seen in early 2015.
Emerging market debt has flourished in this environment, in which the US experiences ‘Goldilocks’ growth – neither too hot, nor too cold – and the Trump administration is thwarted from carrying out its more damaging policies on trade.
Should the gridlock in Washington continue, emerging market bonds are likely to notch up further gains into 2018, in our view. We see no reason why the White House should not carry on lurching from self-inflicted crisis to self-inflicted crisis with the current president in place, despite his appointment of a new chief of staff.
What is more, as the US backs away from its decades-old role of global leadership, other developed economies are taking steps to fill the void. Japan is seeking to revive the Trans Pacific Partnership trade accord, without the US, while leaders such as France’s Emmanuel Macron, Germany’s Angela Merkel and Canada’s Justin Trudeau are asserting the broadly liberal values on which the world economy is based.
Such action suggests global growth may remain on track. Of course, in the event that Trump’s woes intensify – the former reality TV star faces a not insignificant risk of impeachment – the equity market could stumble, hurting other risky assets such as emerging market bonds. Yet it is far from obvious that the world economy would ultimately suffer under this scenario: the evidence from previous such episodes in Washington is inconclusive.
In the meantime, investors in emerging market debt can bask in the warmth of the world economy, shielded from the Trump administration’s plans by its own incompetence.