How Trump will change global markets

Donald Trump’s election is making investment strategists re-think their asset allocation across asset classes and regions. This is not surprising since as the President of the world’s largest economy, the policies Trump initiates and the decisions he makes will have a large bearing on the performance of various global asset classes.

Risk aversion is surging in the days succeeding the US elections and financial markets appear to be bracing themselves for the worst. This fear is reflected in the flight of money out of riskier assets such as emerging market equity and currencies in to dollar denominated assets.

Historically, Republican Presidents have been more supportive of financial markets; believing in lesser controls and initiators of pro-rich policies. But this time, markets had been rooting for Hillary Clinton, despite her intention to tighten rules on Wall Street firms and banks, increase taxes on the rich and to penalise companies that moved operations overseas to evade tax.

This was because investors wanted continuity, more than anything else. Clinton represented a liberal USA that used its position of dominance with a sense of responsibility, a country that paid adequate attention to the interests of other Nations while working towards its progress. Trump on the other hand believes that US has to assert its dominance.

His talk about renegotiating the North American Free Trade Agreement, putting the Trans Pacific Partnership on hold, increasing tariffs so that its deficit against other countries disappears, could put the current trade pacts in jeopardy. He does not seem to have a clear idea about dealing with US’ debt or how he plans to spend on infrastructure and slash corporate and income taxes without increasing the deficit.

It is for these reasons that global markets recorded a sharp decline as the votes of the Presidential elections were being counted. The S&P 500 hit the lower circuit, down 5 per cent and other global equity markets sold off and gold and dollar spiked as it became apparent that Donald Trump was on his way to the White House.

The sharp turnaround in equity markets on November 9, once Hillary Clinton conceded defeat was initially caused by a pull-back due to traders unwinding their sell positions. But the movement of various markets over the last few days suggests that investors are now turning fearful. Financial markets are expecting the Trump era to be quite problematic, especially for emerging markets.

The uncertainty in financial markets is aptly captured by the ongoing turmoil in the global bond market.

The US 10-year government bond yield is up 27 per cent since November 4, rising from 1.77 per cent to 2.25 per cent by November 16. The reasons given for this spike were that investors were betting that Trump will push through large infrastructure spends on roads, bridges and so on. This was expected to give a boost to inflation which would in turn lead to higher interest rates.

While part of the surge in bond yields could be due to those reasons, a global risk-off trade also seems to be contributing to this spike. The home country bias tends to be strong when investors are fearful of prospective turbulence, making them take money back to their country. Now, around half of the global investible funds belong to investors from US, so it is not surprising that money tends to go back to US when investors are fearful. Investments in assets denominated in home-currency are also insulated from currency risk, adding to their attractiveness.

There has been similar sell-off in government bonds of other countries as well; with sovereign bond yields of most countries gaining between 20 to 90 basis points in the past month. This could also be due to fear that there could be an erosion in the value of currencies of other countries due to dollar’s strength, which would further erode the value of the foreign investments in bonds. India’s government bond yield has however been insulated from this turmoil, declining 31 basis points, thanks to the demonetisation move by the Centre.

Since the Trump win will usher in an era where the US moves ahead strongly, the dollar has been surging strongly since the beginning of this month; the dollar index moved from 96.89 to 100.33 over the last few days. A strong dollar spells trouble for other currencies as well as gold.

But the emerging market currencies have been the hardest hit since November 8. Mexican Peso took a sharp knock, losing over 10 per cent, due to Trump’s anti-immigration rhetoric. Other emerging market currencies have also been sliding, losing between 1 to 8 per cent against the dollar as investors fear that exports of these countries will be hit due to Trump’s protectionist policies. The rupee is also sliding rapidly, down almost 2 per cent, with India’s IT service exports to US currently under a cloud.

Sliding currency values have in turn taken a toll on equity markets in emerging markets causing a large-scale pandemonium. Mexico’s IPC index has lost 15 per cent since November 9 while benchmarks of Indonesia, Brazil, Indonesia and South Africa lost over 5 per cent.

Surprisingly, US equity markets have continued to surge with the Dow hitting a life-time high of 18,923 on November 15. It’s apparent that investors think that Trump’s policies will boost long-term growth in the US. But a strong dollar will erode the profitability of US companies and growing fiscal profligacy under Trump might not help the country’s budget. It is therefore only a matter of time before investors realise that the Trump rally in the US is over-done.

That said, the changing equations seen in the past week, where US assets turn the preferred class with money moving out of emerging markets, is likely to continue for some time.

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