Emerging-Market Stocks Rally With U.S. Election on Knife-Edge
(Bloomberg) -- Emerging-market stocks headed for their biggest gain in more than two months and an index of developing world currencies erased this year’s losses as concern faded about a surprise victory for incumbent President Donald Trump.
While the U.S. presidential race is still too close to call, assets rebounded from a selloff that accelerated when Trump claimed victory and said he would petition the Supreme Court to intervene. Going into the election, challenger Joe Biden had a solid lead in polls, and many investors expected a Democratic sweep of the presidency, Senate and House. But results so far suggest that’s unlikely, while Trump’s statements increased the probability of a drawn-out legal battle to decide the winner.
The Mexican peso -- a key emerging-market currency barometer due to high liquidity and a 24-hour trading day -- whipsawed overnight, losing as much as 5% before bouncing back. Brazil’s real and South Africa’s rand led gains in developing world currencies.
“Legal challenges to the vote count could keep volatility in emerging market assets high in the very near term,” said Alejo Czerwonko, the chief investment officer for emerging markets Americas at UBS Global Wealth Management in New York. “That said, we’ll eventually get past that and the likelihood of higher U.S. fiscal spending, a faster economic recovery and higher inflation expectations should all support emerging markets into 2021.”
MSCI’s currency gauge rose 0.4% after losing as much as 0.8% earlier. The Indian rupee and Chilean peso were the biggest decliners. MSCI’s index of emerging-market equities was up 1.6%. The risk premium on developing-nation sovereign bonds narrowed one basis point.
“Risk sentiment should broadly remain supported as long as it is just a delay in getting the election outcome,” said Dirk Willer, a strategist at Citigroup Global Markets in New York. “But there is a risk to broad sentiment if the process drags beyond this week with potential for legal challenges.”
Stocks have rallied this week amid speculation a Biden victory would allow lawmakers to pass a U.S. stimulus plan and reduce geopolitical uncertainty. Senate Majority Leader Mitch McConnell, who won his re-election bid, said a stimulus bill is needed before year’s end.
“Markets are moving from pricing a blue sweep as the most likely scenario to pricing political paralysis amid risks of a contested election,” said Witold Bahrke, a Copenhagen-based strategist at Nordea Investment Management. “It’s difficult to talk about any winner across emerging markets if Biden doesn’t win the White House race or if we get a contested election.”
South Africa’s rand reversed a drop of as much as 2.2%, breaching 16 per dollar for the first time since March, with favorable local economic data supporting the currency.
Below are some views from emerging-market investors and analysts on the vote outcome so far:
“We’re seeing a positive reaction in EM to some more clarity with regards to the U.S. election outcome in the near future,” said Jens Nystedt, a senior portfolio manager at EMSO Asset Management in New York. “Lower likelihood of sizable fiscal stimulus caps U.S. interest rates. Hence, we’re seeing increased demand for EM duration.”
Eyes on Vaccine
Shamaila Khan, the direct of emerging-market debt at AllianceBernstein in New York, says she’s still positive on EM bonds.
“There will still be stimulus even without a blue wave, just the timing and scope will be different,” she said. “A Biden presidency could lead to lower headline risk on China. The most important risk that we are looking at is the vaccine, however, to further drive EM performance.”
Yerlan Syzdykov, London-based head of global emerging markets at Amundi Asset Management, said a divided-power scenario or a contested outcome would fuel volatility and push appetite for the dollar higher in the short term.
“The worst-case scenario is one of persistent dollar strengthening, putting EM central banks with a dilemma of responding to economic impact of the Covid-19 and stabilizing FX and capital markets, leading to higher volatility in EM currencies,” he said.
Some EM currencies, however, like the Russian ruble, will show resilience and are likely to outperform in this environment, he said.
Lingering Dollar Strength
The uncertainty will lead to a “more tentative” risk environment, which will spill over to emerging markets, said Simon Harvey, a currency-market analyst at Monex Europe Ltd in London.
“While the resurgence in the dollar this morning isn’t necessarily indicative of how FX markets are going to trade this period of uncertainty, as it should be read in the context of a large unwind in yesterday’s dollar decline on expectations of a Blue Sweep, it arguably has a greater predictive power on how EM will trade,” Harvey said. “EM FX is much more dependent on U.S. fiscal stimulus boosting the global growth outlook and for this reason, the narrative of dollar strength may linger for longer in the EM space than in the G10 due to political uncertainty in the U.S.”
Unwinding Bullish Bets
The offshore yuan and Korean won are likely to see more unwinding of bullish positioning as the U.S. election unfolds, Citigroup said, even as the North Asian countries have a better control over the pandemic.
Trump’s support was underestimated in pre-election polls, though the outcome will likely become clear by the end of the week if it comes down to just Pennsylvania, strategists Gaurav Garg and Sun Lu wrote in a note. Concerns over the risk of “persistent unpredictability” under a second Trump presidency would weigh on the yuan and won.
Buying the Dip
A Biden win wouldn’t guarantee the stimulus bill that emerging-market investors are banking on, said Christopher Shiells, an analyst at Informa Global Markets in London.
“The positive EM picture was for the blue wave and thus a new wave of stimulus, but even if Biden is declared the winner, the Senate looks like it will remain Republican so there will be no easy path to stimulus,” Shiells said. “Still, I believe that EM investors will stay looking beyond this and towards year-end look ahead to the 2021 economic recovery. If there is progress on a Covid vaccine then it will be a positive EM picture and thus some may take the U.S. election volatility as an opportunity to buy.”
China and the U.S.
If Biden doesn’t win, implications for emerging markets would be limited said Tuan Huynh, chief investment officer for Europe and Asia-Pacific at Deutsche Bank International Private Bank in Frankfurt.
A Trump win would maintain the status quo, with further tensions between the U.S. and China, he said. Biden may not change the U.S. stance toward China but the tone would be “more civilized,” he added.
“Prolonged uncertainty and a dispute over who has won the election is the worst case scenario,” while an outcome without a clear Congressional majority is also negative for markets, said Hasnain Malik, the Dubai-based head of equity strategy at emerging-market research firm Tellimer.
“Those markets closest to and most reliant on the U.S., like Mexico, may worse but this is really a global dampener,” Malik said. “But, in any event, a weaker U.S. dollar appears in store and that should benefit most emerging markets.”
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