Trump rhetoric to determine fate of EM FX - SocGen

Research Team at Societe Generale, suggests that the Trump victory would impact EM currencies and primarily that of risk sentiment, international trade, and geopolitical security, and secondarily through expectations of US interest rates and local domestic implications.

Key Quotes

“1st order reaction: Sustained weakness. Looking ahead, we anticipate two phases / orders of reaction for EM markets. Paralleling the aftermath of the surprise UK referendum Brexit vote, in this case, the first order of reaction is likely to be dominated by risk aversion. We expect the sell-off in MXN to continue, with USD-MXN possibly reaching 23.0 over the near term. High-yielding EM currencies are likewise expected to depreciate (e.g. ZAR, BRL, IDR), along with currencies of countries whose security benefit from US involvement (e.g. KRW, TRY). Much depends on the tenor of Trump’s comments over the coming days with respect to his election promises on immigration, trade, and foreign policy.”

“2nd order reaction: EM FX stabilizes and could enter a temporary relief rally phase. Post the initial phase of severe market risk aversion, which may last for several days or more, investors are likely to refocus on the medium-term questions of global monetary policy. Our SG Economics team believes that the Trump presidency is likely to cause postponement of the anticipated December FOMC interest rate hike, and may also delay ECB tapering. The market is likely to lower the assigned probability of Fed rate hikes over the coming days. In an extended environment of accommodative monetary policy from developed markets, most EM currencies (apart from MXN) will have less downside and could enter a relief rally phase if global growth conditions remain favourable.”

“Higher risk premium and USD-EM are biased higher. A Trump victory has introduced higher uncertainty and risk premium into policy-making – through channels including trade and geopolitics – which will likely result in weaker EM currencies than otherwise. Our base case scenario remains for USD-EM to head gradually higher over the medium term, with selective high yielders (BRL, RUB, INR, IDR) outperforming low yielders. On a regional basis, we continue to believe that Asian EM FX will underperform currencies of other regions.”