Emerging Market Stocks Decline Amid Trump’s Tariff Threats and Strong US Dollar

Emerging market stocks are facing a significant sell-off by investors. Significantly driven by President-elect Donald Trump’s anticipated trade policies, which include a focus on protectionism and an “America First” agenda. Trump’s proposal for new tariffs is seen as likely to disrupt global trade dynamics. This environment, combined with a strong US dollar and rising bond yields, has put considerable pressure on emerging markets.

The MSCI Emerging Markets Index, which tracks emerging market equity performance approximately $7.6 trillion in stocks across nations like China, India, Brazil, and South Africa and other markets, has seen a sharp decline, dropping over 10% from its peak in early October.

This downturn is broadly reflective of the economic conditions in these markets. For instance, Chinese equities, which represent a significant portion of the index, have plummeted by 15% since October, exacerbated by concerns over economic stability and growth rates in China. The index’s performance is also influenced by geopolitical tensions, particularly with China, where companies like Tencent have been impacted by US military designations, affecting investor sentiment and stock valuations coupled with Donald Trumps proposed 60% tariff hike on Chinese imports.

Analysts attribute this downturn to expectations that Trump’s inflationary policies, including tariffs and tax cuts, alongside an already robust US economy, will prompt the Federal Reserve to maintain higher interest rates for an extended period. Consequently, US government bond yields have surged as markets adjust their inflation outlook.

This scenario was further supported by the January 2025 Non-Farm Payroll (NFP) report, which showed stronger than expected job growth, reinforcing the likelihood of sustained high interest rates.

The strengthening of the US dollar, often a result of higher US interest rates and bond yields, has several implications for emerging markets. As the dollar strengthens, emerging market currencies weaken, making dollar-denominated debts more expensive to service and reducing the competitiveness of exports from these countries.

“This environment, marked by rising US yields and dollar strength is undeniably unfavorable for emerging markets,” remarked Emre Akcakmak, a portfolio consultant at East Capital, an emerging markets fund manager. He highlighted that major contributors to the MSCI index, including China, India, and South Korea, have been under considerable pressure.

Chinese equities, the largest component of the index, have dropped 15% since October due to concerns over the country’s economic health. Indian stock market experienced their worst monthly performance since March 2020 in October 2024, continuing on a downward trajectory with both the Nifty 50 and Sensex losing about 6%. South Korean stocks have also experienced substantial losses.

Investors withdrew roughly $3 billion from global emerging market equity funds in the current year, following $31 billion in outflows in the prior year, according to data from JPMorgan.

Investors anticipate that countries may devalue their currencies to enhance export competitiveness in response to US trade measures, further diminishing dollar-denominated earnings in emerging markets. The combination of elevated US rates and a strong dollar will attract investors to US markets and discourage domestic investors from seeking riskier opportunities abroad.

Developed market equities, in contrast, have shown resilience due to the stability and size of their economies, which can absorb such policy shifts with less volatility. The S&P 500, for example, has not experienced the same level of turbulence as emerging markets, as US companies are somewhat insulated by domestic demand and the benefits of a stronger dollar for their international earnings.

Impact of Stronger U.S Jobs Data on the Nigerian Naira

The Nigerian Naira has been navigating through choppy waters as the U.S. dollar gains strength, largely due to recent robust U.S. economic indicators, particularly job market data. Despite the pressures from a stronger U.S. dollar, the Naira managed some stability at the start of the week, trading between N1650-1660 against the dollar in the unofficial market across major Nigerian cities.

However, in the official market, the Naira experienced a slight depreciation, moving from N1,541.2 to N1,543 per dollar, according to FMDQ’s recent data. This dip in the official market reflects the broader impact of the dollar’s surge, a concern for Sub-Saharan African economies, particularly those like Nigeria, heavily reliant on imports.

The U.S. job market has shown formidable strength. The December nonfarm payrolls reported a significant gain of 227,000 new jobs, exceeding expectations and underscoring a vigorous U.S. economy. With U.S. unemployment at a low 3.7%, the demand for labor supports a stronger dollar. Concurrently, the yield on the 10-year U.S. Treasury note reached 4.73% last week, the highest since April 25, increasing borrowing costs for countries like Nigeria with dollar-denominated debt.

This economic scenario in the U.S. has direct repercussions for Nigeria. For starters, higher U.S. yields mean increased costs for servicing Nigeria’s external debt, potentially straining government finances. Moreover, the strength of the dollar leads to increased import costs for Nigeria, contributing to an already high inflation rate. November 2024 saw Nigeria’s headline inflation rate at 34.6%, with food inflation soaring to about 40%, severely impacting the cost of living.

The Federal Reserve’s cautious approach to rate cuts, as hinted in the minutes from their December 17-18 meeting, suggests that U.S. interest rates might remain high. Analysts at Goldman Sachs now expect only two rate cuts in 2025, down from three, due to persistent inflation concerns. This could keep the dollar strong against currencies like the Naira, leading to further volatility.

The Naira’s value at the unofficial market underscores the currency’s instability. A strong dollar exacerbates dollar shortages in Nigeria, leading to Naira volatility. This situation limits Nigeria’s fiscal policy options, particularly as the government aims to reduce inflation from 34.6% to 15% and strengthen the Naira to N1,500/$ from about N1,700 as outlined in the 2025 budget.

The impact on Nigerian consumers is clear; with imported goods becoming more expensive, there’s an increase in both consumer prices and production costs for businesses, which could either lead to higher inflation or reduced consumer spending.

Implications for investors

Given the volatility, diversification beyond traditional emerging market investments might be prudent. This could include looking into sectors within these markets that are less dependent on global trade or focusing on countries less affected by US policy shifts.

With the expectation of currency devaluation in some emerging markets, investors might consider hedging strategies or investing in assets that are less sensitive to currency fluctuations, like the Europe or American stock markets.

While short-term reactions might lead to sell-offs, the long-term potential of emerging markets could still be compelling. Analysts like Kristina Hooper from Invesco suggest that current market conditions might present buying opportunities if one can weather the initial storm.

Investors should keep an eye on how Trump’s actual policies unfold versus campaign rhetoric. There’s speculation that initial aggressive tariff proposals might be moderated through negotiations, which could alleviate some pressure on emerging markets. Despite this, many remain hesitant to re-enter emerging markets due to the heavy reliance on Chinese stocks within indices.

With China in indices like MSCI, understanding the evolving US-China relationship, especially in terms of trade wars and geo-political tensions is crucial. The recent Pentagon’s move against companies like Tencent a social media and gaming giant comprising 4% of the MSCI index led to a sharp decline in their stock price, is a reminder of how foreign decisions can directly impact market performance.

Mark McCormick, head of foreign exchange and emerging markets strategy at TD Securities, stated, “China has become increasingly seen as un-investable by many due to rising geopolitical and economic risks.

while the immediate outlook for emerging markets seems challenging, strategic investors might find value by looking beyond current conditions, preparing for policy shifts, and considering how global economic dynamics will evolve under new US leadership. The key will be in navigating the balance between risk and opportunity in this volatile landscape.

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