By Libby George
LONDON (Reuters) - Investors hoping for a "Goldilocks" moment for emerging markets in 2025 following years of global interest rate hikes are grappling with significant uncertainty ahead of Donald Trump's impending return to the White House.
The dollar's rigorous rally, and worries over U.S. tariffs, potential unfunded spending sprees and slowing interest rate cuts from the Fed knocked a string of emerging market currencies and weighed on some bonds as the election results rolled in.
Now, investors are tallying up the likely costs of Trump's policies for developing world assets.
"Although we've been positive on emerging market assets this year, and performance has been strong, we have to think about next year and position ourselves in a more cautious way in both local currency and hard currency," said Yerlan Syzdykov, global head of emerging markets at Amundi, Europe's largest asset manager.
The prospect of a 'red sweep' - with Republicans also taking control of the House, in addition to the presidency and the Senate - would be a "bit of a game changer", Syzdykov said.
Investor inflows to emerging markets have been rebounding after painful years of low risk appetite during the 2020 COVID-19 pandemic that stayed subdued as central banks worldwide hiked rates. This led investors to keep their money in safer developed world assets.
Net portfolio inflows into developing economies' stocks and bonds, which fell to virtually nothing in 2022, have rebounded to just under $250 billion through September this year, above the $177 billion for all of last year, according to data from the Institute of International Finance.
"Before the election, there was a lot of optimism around emerging markets," said Anders Faergemann, senior portfolio manager with PineBridge Investments, noting that emerging market growth differentials versus the developed world were at their highest in a decade.
JPMorgan's emerging market hard-currency bond index has returned around 6% this year, while local government bonds are treading water.
This might mirror 2016, when EM local currency bore the brunt of Trump's surprise election win, Allianz (ETR:ALVG) Global Investors said in a note to clients.
Faergemann said the Trump win left China under pressure, and emerging market currencies, including Poland's zloty and Hungary's forint, which slumped to a two-year low, are at risk due to their reliance on trade - and the risk of Trump tariffs.
Mexico's peso - a bellwether for emerging market currencies - dropped as much as 3.6% this week after Trump's sweep became clear, but quickly retraced losses. The decline was much less pronounced than the near-8% drop it suffered in 2016.
Many are watching closely for clues on Trump's spending - and the impact that could have on the Fed interest rate trajectory; higher fiscal deficits could lead to slower rate cuts.
"Higher rates and a strong U.S. dollar are a headwind...(as are) some of the proposed policies like tariffs," said Sonal Desai, chief investment officer for Franklin Templeton Fixed Income.
STRONGMAN TRADE
But some optimism remains.
Countries such as India could benefit from Trump's hardline approach to China, Amundi's Syzdykov said, while Argentina has also lured investors back with spending cuts and reform.
"There are certain sectors, countries that could benefit from a Trump victory," said Shamaila Khan, head of fixed income for emerging markets and Asia Pacific at UBS Asset Management. "You can generate a lot of value in an emerging market portfolio."
A sea change in geopolitics could fuel other turnaround stories.
Ukraine's international bonds and GDP warrants rallied strongly after Trump's win, lifted by optimism he could hasten the end of its war with Russia.
Argentina's stocks and bonds also rallied as investors cheered potentially closer ties between Trump and Argentina's brash libertarian President Javier Milei - part of what has been dubbed the "strongman trade."
FEAR AND GYRATIONS
Bankers had hoped that this year's debt issuance boom could continue into 2025. But some worry volatility before and after Trump's January inauguration - traditionally a heavy issuance month - could impact primary market issuance.
Barclays (LON:BARC) estimates that emerging market sovereign international bond sales will reach as much as $160 billion this year, and around $130 billion next year.
High debt costs could further crimp emerging markets' access to cash, which is already a key worry for the likes of the International Monetary Fund.
But overall, investors say the fear, market gyrations and risk aversion that followed Trump's 2016 win were less likely this time round - meaning developing countries and assets inside them with a good narrative can continue to attract capital.
"We've seen Trump before, so we've seen that movie before - and we survived," Amundi's Syzdykov said.