Trump’s China Rhetoric Is the Next Risk for Emerging Markets

(Bloomberg) -- While the coronavirus has ruined the outlook for emerging markets in the first half of 2020, growing acrimony between the U.S. and China may dominate the second.

Even as economies come out of shutdowns and vaccine development makes progress, some investors are now preparing for the return of political rhetoric and international brinkmanship as key risks. They’re betting President Donald Trump, seeking re-election this November, may be tempted to intensify his criticism of China to take some heat off his handling of the pandemic.

Any escalation of the conflict may delay a recovery in the global economy, push investors toward haven investments such as U.S. Treasuries, and strengthen the dollar. Emerging markets, where an equity rally has already stalled and currencies continue to drift lower, could bear the brunt of this shift.

Here’s what money managers are saying about the changing geopolitical winds and how that could affect emerging markets:

Julian Rimmer, a trader at Investec Bank Plc in London:

Trump needs distractions from his mismanagement of the Covid crisis and his strategy looks straightforward: distract and “flood the zone.” So expect the “Obamagate” trope to recur endlessly and the relentless portrayal of China as an economic enemy. Economists will have to factor poor bilateral relations into their growth forecasts for this year and beyond, because it will impair growth no matter how transparent and cynical the tactic. Markets want a V-shaped rebound but the fiercer the rhetoric, the flatter that recovery curve will be.

Carl Wong, head of fixed income at Avenue Asset Management Ltd. in Hong Kong:

President Trump will continue to put China under the spotlight and increase tension between the two countries. Simply put, he needs to divert voters’ attention from dire economic conditions to external pressure. By creating an imminent risk of war, he could possibly get re-elected. In terms of how to play it: Ideally, I would have a bi-polar portfolio construction. I would put half in risk-off assets and the other half in special-situation plays which are idiosyncratic in nature. The key is to avoid beta risk, which looks expensive no matter your focus on corporate bonds or equity nowadays. Hopefully, this would achieve capital preservation while opportunistically making decent return.

Claudia Calich, a London-based money manager at M&G Ltd.:

Any major escalation could bring another bout of repricing, particularly in the equity markets which had recovered some of the earlier losses. Asian currencies and certain credits had outperformed over the last few weeks on the belief that they are ahead of the curve on the covid pandemic. So they could give back some of this outperformance.

Christopher Shiells, an analyst at Informa Global markets in London:

Trump will play the Virus card and blame China for U.S. economic woes, and then use the rebound in the second half to try and win the election. This will be a broad weight on EM sentiment, as US-China relations were for most of 2018/19. Thus, once again relative value plays will be the theme within EM although we expect selling to be broad based.

Nigel Rendell, a senior analyst at Medley Global Advisors in London:

The economic climate does not look good for Trump. With tens of millions losing their jobs, Trump needs to deflect attention elsewhere. Using China as a whipping boy -- be it for the coronavirus or potentially other issues, such as trade -- is a convenient distraction. In the event of a major dispute, (countries with poor fundamentals) will suffer the most, through pressure on their exchange rates and asset prices. There is also an additional risk in that equity markets seem to be unjustifiably optimistic at present despite the fact that the global economy is entering the biggest recession in living memory. EMs are vulnerable to a sudden reversal of this broader positive sentiment.

Anders Faergemann, a money manager at Pinebridge Investments in London:

The concern over the US-China relationship will mainly affect Asia. It will not alter the underlying view that sovereign high-yield spreads are too wide compared with U.S. high yield and will not deter investors from seeking higher yields within EM. At worst, it may lead to more of a home bias in both U.S. credit and the dollar but it should not drive returns for EM high-yield markets. Here we see growth, funding access and declining redemption fears as the main drivers of returns.

Lale Akoner, London-based investment strategist at BNY Mellon Investment Management:

EM is not a homogeneous asset class, even in a global-pandemic environment. Right now, several factors distinguish EMs: Effectiveness of lockdown, health-care capacity, and seriousness of leadership. On top of this, vulnerability to trade collapse, a strong dollar and oil-price declines will also pressure some EMs more than others. So even in an environment of rising U.S. and China political tensions, we will continue to look for opportunities in countries that are immune to the idiosyncratic factors.

Simon Quijano-Evans, chief economist at Gemcorp Capital in London:

While (a heightening of tensions) is possible from a geopolitical point of view, the economic realities are likely to reduce the chances of a full escalation as no-one can afford it. When a vaccine is put in place, people will heave a sigh of relief, the economy can pick up again and we might see a reincarnation of the trade-war rhetoric and action. Then, one approach for investors would be to hedge against possible political or geopolitical noise through buying credit-default swaps in countries such as China or Brazil.

Lutz Roehmeyer, Berlin-based chief investment officer at Capitulum Asset Management GmbH:

This conflict is ongoing and would happen anyway, with the corona crisis or not. The question is only how bad the communication will get. So investors have to live with that and I think already incorporated this into their thinking. We expect another sell-off but not because of U.S.-China conflict; simply because the rescue measures will fade, asset prices have gone up already and the losses in income, insolvencies, restructurings, rating downgrades, dividends etc., accompanied by a constant ugly news flow, are still to come.

©2020 Bloomberg L.P.

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