US tariffs and their impact on Emerging Markets

There had been much speculation in the lead-up to the announcement. However, what President Trump announced on April 2nd and in the days that followed exceeded the expectations and fears of most observers and market participants. In a sweeping move, the US president introduced massive tariff increases on imports from dozens of countries, not just China.

Trump could possibly offer some of China's key trading partners relief on tariffs if they in turn impose import tariffs on Chinese goods. However, China itself is already involved in intensive talks with other countries – Vietnam, for example – to counter any such plans.

Market development US dollar: stocks and bonds in the US decline

To describe the specific tariff measures in detail would go beyond the scope of this report and would also be of little use, as withdrawals, exceptions, additions, and changes have been announced almost daily since then.

The initial reaction on global stock markets was negative, but remained within manageable limits, with the global Emerging Market index falling by around 10%. Since then, most Emerging Market stock markets have recovered a significant portion of these losses.

The announcements have hit the US dollar, US stocks, and long-term US government bonds particularly hard so far. The White House's latest “America first” policy has thus far led to an “America last” outcome, at least on the financial markets.

China's response: counter-tariffs

Beijing's political response was predictably harsh, as had been announced in advance. China immediately responded to Trump's tariff increases with similarly strong tariff hikes on US products, but at the same time signaled its willingness to engage in talks. China's leadership is likely to be much better prepared for such a confrontation than it was during Trump's first term. The same seems to apply to many Chinese companies. This is likely to have contributed to the relatively moderate reaction on China's stock markets so far, as has the fact that China's leadership has signaled far-reaching support for the domestic economy. The demonstrative show of solidarity between President Xi and domestic technology companies, which was staged very publicly months ago, has also apparently had a positive impact on the previously rather negative mood in the country and in China's corporate sector.

Economic recovery in China at risk?

In initial estimates, analysts expect growth in China's gross domestic product (GDP) to decline anywhere between 1% and 1.5% in 2025. In all likelihood, the Chinese leadership will counteract this with fiscal and monetary stimulus measures and attempt to still achieve its previous growth target of around 5%. This is likely to require strengthening the domestic consumption and, in return, reducing the domestic savings rate. So far, this goal has been achieved primarily through various trade-in programs, in which consumers receive significant discounts on new consumer goods when they trade in their old items. The scope of these programs has been doubled compared to last year to around 40 billion US dollar. Beijing is once again placing much greater emphasis on its own private sector for innovation and economic growth than it has in recent years.

When selecting stocks in China, we continue to favor quality companies that are global market leaders and only have limited exposure to the US market. We also continue to favor Chinese internet companies with high positive cash flows that are less susceptible to macroeconomic fluctuations. We are also focusing on stocks that benefit from special trade programs and sectors that will remain in the Chinese government's spotlight for the time being, such as the localization of semiconductor production.

Many uncertainties remain

The long-term impact of US tariff policy remains difficult to calculate, including possible second- and third-round effects. In the immediate term, there is a noticeable reluctance to invest in export projects of any kind, especially those with links to the US. The White House's erratic approach and the arguments it has put forward have led to a loss of confidence in the US, which is reflected, among other things, in the sharp decline of the US dollar.

Recently, the US dollar was extremely expensive in fundamental terms and therefore “ripe” for a correction. In this respect, one should not read too much into these exchange rate movements. Regardless of the specific triggers, however, the weakening US dollar should tend to provide tailwinds for bonds and equities in Emerging Markets. At least, this has usually been the case in the past.

On the other hand, the recent rise in US government bond yields for medium and long maturities is currently providing some headwinds. However, it remains to be seen whether this is only a temporary movement. While a weaker US dollar is likely to suit the new US administration quite well, the rise in US yields triggered visible unrest and probably also led to some of the tariff increases being suspended for the time being “to create room for negotiated solutions,” as the official statement put it.

Outlook for Emerging Markets remains good overall

In general, we believe that Emerging Markets remain fairly resilient to an escalating trade conflict with the US, even in light of the drastic announcements. The weaker oil price amid declining expectations for the global economy is helping all Emerging Markets that are dependent on oil imports. Central banks and governments in a number of large Emerging Markets, such as China and India, have considerable scope to take countermeasures. The mostly moderate to favorable valuations in many Emerging Markets are supporting stock prices.

That said, there are also numerous risks. It is currently unclear how the US Federal Reserve (Fed) will respond to a possible rise in inflation in the US as a result of the trade conflicts. The US financial markets currently expect interest rate cuts and believe that the Fed will focus primarily on the increased economic risks and view the inflationary effects of the tariff policy as a one-off anomaly. The risk of a US recession has undoubtedly increased significantly in recent times. The extent to which this will actually materialize will probably depend primarily on further actions of the US administration. Geopolitically, the conflicts in the Middle East and Ukraine pose additional risk potential, especially if there are further escalations. Trump's latest rhetoric toward Iran and the deployment of strategic US bombers to the region have recently increased the risks in this regard.

On the other hand, there could also be positive developments, such as a new Iran agreement or a settlement of the war in Ukraine. In the wake of such developments, risk premiums for Emerging Market equities could fall noticeably and share prices could receive a boost, especially in the Central and Eastern European markets.

In the Emerging Market bond segment, however, yield premiums for hard currency bonds have widened significantly in recent weeks. Considerable outflows were also observed in this segment. The situation is unlikely to ease quickly, and given the almost daily changes in the news, sharp price fluctuations are likely to continue for the time being. In comparison, there has been relatively little movement in local currency bonds and hardly any net capital outflows so far. Local bond prices appear to be well supported, not least by the potential for interest rate cuts. Needless to say, exchange rate risks must be kept in mind with these bonds. Some countries have recently experienced quite sharp devaluations due to country-specific factors, for example the currencies of Türkiye and Argentina.