CONTRIBUTORS
Nicholas Hardingham, CFA
Portfolio Manager, Franklin Templeton Fixed Income
Stephanie Ouwendijk, CFA
Portfolio Manager, Research Analyst, Franklin Templeton Fixed Income
Robert Nelson, CFA
Portfolio Manager, Research Analyst, Franklin Templeton Fixed Income
Joanna Woods, CFA
Portfolio Manager, Research Analyst, Franklin Templeton Fixed Income
Carlos Ortiz
Research Analyst, Franklin Templeton Fixed Income
Jamie Altmann
Research Analyst, Franklin Templeton Fixed Income
Sterling Horne, Ph.D
Research Analyst,
Franklin Templeton Fixed Income
With Donald Trump securing a return to the White House and Republicans taking control of both the Senate and the House, market reactions were swift. US Treasury yields rose, and a steeper yield curve reflected inflation concerns linked to potential trade tariffs and fiscal expansion. Emerging market debt (EMD) initially fell slightly, with higher-quality hard currency assets more affected due to their sensitivity to US Treasury movements. Meanwhile, a stronger dollar pressured EM currencies, impacting local currency bonds.
Now that the election results and initial market responses are known, what can investors expect next? We examine three key policy areas - trade, foreign policy, and domestic policy - and highlight how we are positioning our portfolios in response.
Trade policy: Tariffs on the horizon
Tariffs are likely to be a top priority under a Trump administration, although the scope and timing remain uncertain. We anticipate significant increases in tariffs on China, potentially rising from 25% to as high as 50-60%, with broader tariffs on other countries increasing to around 10%. For the impacted countries. these measures could reduce US trade volumes, weigh on growth, drive up input costs, and weaken consumer spending.
For emerging markets, reduced trade volumes may hit export-reliant economies, with limited relief from currency depreciation. Asian markets, particularly Vietnam, Thailand, and Malaysia, are especially vulnerable due to their high exposure to US trade. China could face renewed pressure, having already suffered setbacks from the 2018-2019 trade war. In Latin America, growth challenges may arise, though Mexico could see some protection under the USMCA trade pact until it is renegotiated in 2026.
Foreign policy: Geopolitical realignments
Trump’s foreign policy agenda is likely to push for a quick resolution to the Ukraine conflict, potentially through peace negotiations. While a deal could support stability in the region, forced negotiations might create additional risks for investors. In the Middle East, escalating tensions in Gaza could lead to broader conflict, negatively impacting regional credits.
We also expect changes in US sanctions policy, with new measures likely against Chinese companies circumventing tariffs and a potential review of sanctions on Venezuela. Trump’s strained relationship with NATO may put pressure on member countries to increase defence spending.
Domestic policy: Tax cuts and tighter immigration
Domestically, we expect Trump to push for an extension of his previous tax cuts, which are set to expire in 2025, partly offset by increased tariff revenues. However, this could lead to rising fiscal deficits, worsening inflation and growth prospects.
Stricter immigration policies, including large-scale deportations, could constrain US labour growth, indirectly impacting Central American economies reliant on remittances. El Salvador, Honduras, Jamaica, and Guatemala are particularly vulnerable, given their high dependence on US remittance flows.
Positioning for emerging market debt
The outlook for a more volatile global environment suggests mixed fortunes for emerging market countries. Those aligned geographically or politically with the Trump administration, such as Mexico, Central America, and Hungary, could benefit, while China remains the most exposed, which may weigh on the broader asset class.
We expect short-duration US dollar-denominated EMD to outperform local currency debt, given ongoing pressure from a stronger dollar. Weaker EM credits may face increased refinancing risks in this higher-yield environment, while Chinese corporates could struggle under the weight of potential new sanctions.
In our portfolios, we remain fully invested, with cash levels at near-record lows. We anticipate greater dispersion in returns across EM countries, identifying both potential winners and losers from the US election outcome. Following the sell-off in US Treasuries, we see value emerging at the longer end of the curve and may look to reduce our duration underweight relative to the index.
While Trump’s victory brings new challenges for emerging markets, we continue to find value in hard currency, high-spread names, particularly in countries that might benefit from a shift in US bilateral relations favouring authoritarian regimes. We remain cautious of refinancing risks in countries needing near-term market access and expect increased volatility in local markets as tariff strategies take shape.
Conclusion
Trump’s return to the White House, combined with a Republican sweep of Congress, sets the stage for significant shifts in US policy that will ripple across emerging markets. While the environment may be volatile, careful positioning and a focus on quality names with favourable political alignments could help investors navigate this evolving landscape.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. Investments in companies in a specific country or region may experience greater volatility than those that are more broadly diversified geographically.
The government’s participation in the economy is still high and, therefore, investments in China will be subject to larger regulatory risk levels compared to many other countries.
The allocation of assets among different strategies, asset classes and investments may not prove beneficial or produce the desired results.
Sovereign debt securities are subject to various risks in addition to those relating to debt securities and foreign securities generally, including, but not limited to, the risk that a governmental entity may be unwilling or unable to pay interest and repay principal on its sovereign debt.