Recovery after the initial shock
The tariff shock on “Liberation Day” was followed by stock market declines worldwide; the US dollar weakened significantly against the euro and the yen, and yields on long-term US government bonds rose. The latter in particular is likely to have prompted the US president to suspend tariffs just a week later, although China was expressly excluded. Since then, stock markets have recovered strongly and risk premiums on Emerging Market bonds have also declined again. However, uncertainty remained (especially among many companies) and, remarkably, the US dollar remained under pressure.
De-escalation between the USA and China
On the second weekend of May, however, the US and China announced a surprisingly quick and substantial easing of tensions in their trade dispute, even if this will only apply for the next 90 days. Both sides are reducing their absurdly high import tariffs from well over 100% to 10% (China) and 30% (US) and have agreed on a framework for concrete negotiations. However, it remains to be seen whether an agreement will actually be reached or whether the 90-day period will be followed by a renewed escalation. It should be noted that there is currently a great deal of geopolitical turmoil. Trade and tariffs are “only” one piece of the puzzle in the emerging realignment of the global power structure. The stock markets reacted with great relief. Several are already trading at new all-time highs (e.g., Brazil and Hungary) or not far from them.
Worst-case scenario averted
Now that the worst has been averted for the global economy, the question remains as to how much damage has been done in recent months. In addition, fundamental uncertainty will remain until final agreements are reached, and even a significantly reduced level of tariffs still represents a considerable burden compared with the situation before Trump took office. However, provided there is no further escalation, the chances are good that China will meet or only narrowly miss its growth target of around 5%, and a US recession could also be avoided, at least for the time being. At least, that is how the financial markets currently see it. They reflect a significantly lower probability of recession in the US and fewer or later interest rate cuts by the US Federal Reserve.
Major turnaround for the US dollar?
Following massive capital inflows into the US in previous years, a countertrend is emerging this year. There are some indications that even if tensions on the trade front ease, many companies, financial investors, and governments will at least somewhat reduce their strong focus on the US and its financial markets, which should tend to weaken the US currency. In the past, a weaker US dollar has almost always been positive for emerging market assets. Overall, there are currently a number of factors suggesting that the US dollar will have a tendency to weaken in the coming years, which is also in the interests of the current US administration. This should provide some tailwind for Emerging Market assets.
Outlook for Emerging Markets remains good overall
The decline in oil prices in the wake of production increases by OPEC+ countries* and lower expectations for the global economy are helping all Emerging Markets that are dependent on oil imports. The mostly moderate to favorable valuations in many Emerging Markets are providing additional support for stock prices. If agreements are actually reached on the trade front between the US and China, this could also significantly improve sentiment toward Emerging Market investments. Speaking of sentiment, the military clashes between India and Pakistan have so far been viewed with relative composure by most investors and on the financial markets of both countries. Our fund management also currently assumes that there will be no further escalation and that the impact on the economy and financial markets in South Asia will be minor. Naturally, there is no guarantee of this, and a certain residual risk undoubtedly remains.
*OPEC+ is an expanded group of oil-exporting countries comprising the members of the Organization of the Petroleum Exporting Countries (OPEC) and other oil producers. OPEC+ was founded to strengthen cooperation between OPEC members and other major oil producers and to promote stability in the oil market.