Emerging Bonds Look Primed for Losses as Trump Tariff Fears Grow

(Bloomberg) - The outlook for emerging market local-currency bonds is souring as investors dump bets on interest-rate cuts, fears of a tariff trade war grow, and the dollar surges.

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A Bloomberg index of developing-nation local debt has tumbled 3.5% since the start of October, trimming the year's gain to less than 2%. The slide has accelerated since the election victory of Donald Trump, whose "America First" policies are seen as harmful for emerging markets, and whose economic agenda has pushed up the dollar and Treasury yields.

"I'm losing faith in EM local debt as the high likelihood of a new trade war will weaken their currencies and delay the pace of rate cuts," said Rajeev De Mello, a global macro portfolio manager at Gama Asset Management SA in Geneva. "Higher US bond yields associated with expectations of higher US deficits also put upward pressure on EM local bond yields."

Concern over the likely impact of Trump's policies has seen traders dial back bets on rate cuts across emerging markets. An index of one-year swaps from 18 emerging economies has jumped more than 16 basis points this quarter, set for its largest quarterly gain in more than a year, based on data compiled by Bloomberg.

The surge in the dollar following Trump's election victory is fueling speculation central banks across the developing world will be compelled to delay any anticipated rate cuts to support their beleaguered currencies.

Barclays Bank Plc this month scrapped its earlier prediction for Bank Indonesia to lower its benchmark rate in November and December, citing the impact of the stronger US currency. The easing trajectory for South Korea and Taiwan is also becoming more challenging, economists at the bank including Brian Tan and Shreya Sodhani wrote in a research note published Nov. 8.

Fears over a weakening exchange rate and rising inflation risks convinced Brazil's policymakers to speed up their tightening cycle with a 50 basis-point rate hike on Nov. 6.

Fund Outflows

The outlook for emerging-market bonds is also worsening as surging Treasury yields threaten to siphon funds away from developing-nation assets. The US 10-year yield climbed to as high as 4.50% on Friday, from as low as 3.60% in mid-September. A growing chorus of analysts is tipping it to climb above 5% in coming months.

"The median pain threshold for 10-year EM bonds is 4.40%, which is close to where 10-year Treasuries are trading," Societe Generale SA strategists led by Phoenix Kalen in London wrote in a research note published Nov. 8. If sustained, the US yield surge is likely to weigh on emerging-market debt inflows, they said.

The average yield on emerging-market government bonds is now about 10 basis points below that of US Treasuries, compared with an average premium of about 230 basis points over the past decade, based on Bloomberg indexes.

Perhaps the main fear for emerging-markets investors is the impact of the higher tariffs that Trump has pledged to implement. The President-elect has threatened tariffs of 60% or more on goods from China and a universal 10%-to-20% levy on imports from all other countries, though the details are still unclear.

"The risk premia on all EM assets will be higher as a consequence of Trump policy uncertainty," said Jon Harrison, managing director for emerging markets macro strategy at TS Lombard in London. "Trump has both the motivation and ability to act quickly and decisively on a broad policy agenda — so we expect sweeping tariffs and accelerated US-China decoupling."

Asian economies and currencies — even outside China — are seen as particularly vulnerable to higher US tariffs due to the region's heavy dependence on trade with the world's biggest economy.

"Even though inflationary pressures in Asia are low, Asian currencies could face added risks if Trump enacts protectionist policies," said Tan Min Lan, head of the Asia Pacific chief investment office at UBS AG in Singapore. "Overall, we see a negative to low single-digit total return for the asset class in the next 12 months," Tan said, referring to Asian local-currency bonds.

What to Watch

Investors will be watching for any signs of greater price pressures as Malaysia, Poland and South Africa all release inflation data

Monetary policy decisions are due in Hungary on Tuesday, Indonesia on Wednesday, and Turkey and South Africa on Thursday. China's loan prime rate will also be published on Wednesday

Thailand, Chile and Colombia will all publish third-quarter GDP figures

-With assistance from Srinivasan Sivabalan, Prima Wirayani and Catherine Bosley.

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