Risk for EM Assets Simmers as Trade Tiff Turns Into All-Out War

LAGOS (Capital Markets in Africa) – The threat that a battle over trade between the world’s biggest economies will escalate is hanging over emerging-markets’ battered assets.

President Donald Trump hinted the final total of goods that would be slapped with duties could eventually reach $550 billion. That exceeds all of U.S. goods imports from China in 2017. But it’s not just the tit-for-tat duties that’s worrying investors. Some say that import tariffs on Chinese goods will reduce the U.S. economy’s current-account deficit at a time when the Federal Reserve is raising interest rates, which will boost the dollar’s appeal.

“The big driver will continue to be the dollar,” said Paul McNamara, a London-based fund manager at GAM UK Ltd. “The market seems to be coming to the view that tariffs will strengthen the dollar — which we’d call plausible rather than a given — and a strong dollar is bad for emerging-market currencies.”

Developing-nation currencies weakened for a sixth week, the worst performance since 2015, and stocks fell for a fourth week. The risk that Donald Trump’s administration would broaden the trade war is likely to weigh on the outlook for emerging-market currencies, making U.S. investors less willing to diversify into higher-yielding foreign assets, said Mansoor Mohi-uddin, the head of foreign-exchange strategy at NatWest Markets in Singapore.

There’s more bad news that may add to the exodus. Data due this week will probably show that U.S. inflation accelerated in June at the quickest pace since 2012, reinforcing the Federal Reserve’s outlook for gradual interest-rate increases, economists project. And U.S.-North Korea talks hit their first major stumbling block, with Pyongyang dismissing American demands after two days of talks as “cancerous” and “gangster-like.”

On Monday, however, emerging-market assets caught a break amid a lull in the trade war. It’s been relatively quiet since the U.S. and China hit each other with tariffs on Friday, which spurred the biggest gain in currencies since May on a closing basis, and a 1.3 percent advance in developing-nation stocks.

 “How far it has to run is anyone’s guess, but make the most of it; the rally will falter as tensions pick up anew,” Sue Trinh, the head of Asia foreign-exchange strategy at Royal Bank of Canada in Hong Kong, wrote in a note Monday.

Erdogan’s Turkey

• Turkey purged more than 18,000 people from government jobs on Sunday for allegedly posing a security risk to the state, a day before PresidentRecep Tayyip Erdogan takes office as an executive president with vastly expanded powers. Investors will be waiting to see if he forms an economic team with enough credibility and freedom to tackle surging inflation and bring in fiscal discipline
  • A decree published in the official gazette on Saturday makeschanges to some existing laws to transfer authorities of various state bodies, including the cabinet, to the president’s office
• The lira, the worst-performing emerging-market currency this year after Argentina’s peso, may react to any perception that his old policies will continue. Current-account data to be released Wednesday may be another catalyst

Central Banks Decide

• The central banks of Malaysia and South Korea are set to hold their separate policy meetings on July 11 and 12, respectively. Nomura Holdings has pushed back its call for a 25 basis-point rate increase by the Bank of Korea to November from July amid sluggish domestic demand, low inflation and uncertainty over the U.S.-China trade tussle
  • Bank Negara Malaysia will likely keep the overnight policy rate at 3.25 percent for the rest of 2018 as it continues to monitor the state of the economy and as the new government rationalizes expenditures, according to a July 5 note from Oversea-Chinese Banking Corp.
  • READ: Ringgit’s Resilience Under Threat as Case for Rate Cut Grows
• Argentina-watchers will keep an eye on Tuesday’s central bank meeting, where policymakers are expected to keep rates at 40 percent in the face of an ever-plunging peso
• Central banks in Israel, Kazakhstan, Poland, Peru, Serbia and Ukraine will also set monetary policies

Pulse on the Economy

• Emerging-market investors face a blizzard of Latin American data this week, topped by May retail sales figures from Brazil on Thursday, which will help determine the impact of a truckers strike that led to the biggest plunge in industrial production in a decade. A weakening economy, coupled with political uncertainty ahead of this year’s presidential election, is pushing the real toward a key level of 4 per dollar
• Traders also get industrial production and inflation data in Mexico, with prices probably showing a pickup in June after the peso plunged on Nafta worries. TIIE swap rates are still pricing a good chance of a 25-basis-point hike sometime this year
• South Africa’s mining industry will be in focus with Thursday’s release of data on production details for May. The country’s dependence on commodity exports makes it particularly sensitive to the unfolding trade war between major powers. The rand’s implied volatility is among the highest in the world
• Egypt will publish June inflation data on Tuesday amid concern the sharp declines seen in recent months is about to end because of higher fuel prices. Consumer-price growth has been steadily falling since peaking at 33 percent in July 2017. It stood at 11.4 percent in May, well within the central bank’s target range of 10%-16% by year end

Source: Bloomberg Business News