The U.S. election resulted in a decisive victory for the Republican party, an outcome with the potential to reshape the country’s approach to trade, immigration, regulation, and other areas. Markets quickly reacted to the results, with U.S. stocks rising to record highs on expectations of lower taxes and deregulation. Prospects for a more expansionary fiscal policy stance, along with the specter of rising protectionism, pushed the dollar and Treasury yields higher. The optimism captured by U.S. stocks did not extend to emerging markets (“EM”), where the risk of tariffs and general policy uncertainty seemed to take precedence over any positive spillovers from better U.S. growth. Taking place days after the election, the Global Strategy Meeting (“GSM”) discussions focused on what may be in store for EM.
Return of U.S. "exceptionalism"?
Just over a week after the vote, the GSM began with a discussion about what recent market swings could signal about future policy mix. The initial reaction to the sweeping Republican win seemed supportive of risk sentiment with a clear preference for U.S. assets, speakers agreed. Since November 5, the dollar strengthened towards two-year highs and U.S. stocks outperformed shares in the rest of the world by nearly 5% (see Figure 1). Some speakers noted that post-election performance simply reinforced the U.S. “exceptionalism” narrative that was already evident for several weeks, best captured by the repricing of the path for the Federal Reserve (“Fed”) – expectations for the endpoint for policy rates jumped to near 4%, about one percentage point higher than in mid-September. Since the short-lived growth “scare” of early August, the U.S. delivered a string of solid growth figures – net economic surprises are near seven-month highs.
The combination of a stronger dollar, higher long-term yields, and the outperformance of cyclical over defensive stocks suggests that markets perceived the future policy mix as reflationary. This highlights the need to monitor long-term bond yields and breakeven inflation measures as factors that could limit the extent of policy changes, particularly unfunded tax cuts. With Republicans controlling congress, the burden of imposing discipline would likely fall on bond markets, one portfolio manager pointed out. The stakes for policy missteps are also higher than in 2017, given the more challenging starting point for the next administration: a much wider fiscal deficit and higher debt levels, inflation still running above target, and higher interest rates. The portfolio manager also noted that it was too early to draw strong conclusions about future policies from recent market action, as investor positioning seemed light going into what polls indicated would be a highly contested election. Accordingly, part of the repricing could simply reflect relief at the election’s clear outcome, considering general concerns over a prolonged count and possible violence.
The U.S policy mix and EM
A key takeaway from a prior GSM debate was that a soft landing in the U.S. – involving falling interest rates, growth holding near trend, and a weakening dollar – created a supportive backdrop for EM assets (TRG’s Macro Conversation: September 2024). Many of the proposed initiatives of the incoming administration, if fully implemented, would create a challenge to the soft-landing narrative. While most of the focus among EM investors has been on tariff risks, one speaker emphasized the importance of assessing the policy package as a whole. Describing it as a policy “experiment,” he said that the jury was still out on whether the net effect would be inflationary and thus dollar positive. The disinflationary implications of deregulation and expanding oil supply – particularly in a market with a weakening balance – could partly offset some of the pressures from tariffs, expansionary fiscal policies, and deportations. With breakeven inflation measures near the upper end of recent ranges (around 2.4% for 10 years) and only a few additional Fed cuts priced in, further repricing may be limited, which could help keep volatility in check. Much would depend, of course, on the timing and extent of the policies, especially those with a more immediate impact, like tariffs and deportations.
The last part of the meeting looked at the experience of 2017, the first year of the prior Trump administration, and what it could signal about 2025. Specifically, one portfolio manager pondered if 2025 could resemble 2017 when EM stocks outperformed by a wide margin despite persistent concerns over tariffs, strict border controls, and a more transactional foreign-policy approach (see Figure 2). One parallel is the prioritization of taxes, which should again be the case since the 2017 cuts expire at the end of 2025. But some participants questioned if, similar to the first Trump administration, the initial set of tariffs (on solar panels and washing machines in early 2018) would again take a year to implement. As policymakers rolled out more protectionist measures over the course of 2018, growth expectations outside the U.S. began to suffer – something that likely contributed to the underperformance of EM stocks that year.
One area of consensus among the participants was that policy uncertainty, including tariff risks, will persist even after the January 20 inauguration. The surprising strength of the U.S. economy meant the soft-landing narrative was already being questioned by markets; expectations of a reflationary policy tilt by the next administration is exacerbating this trend. This combination creates a challenging global environment, which in turn makes country fundamentals and policy choices more important factors of differentiation.
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The information provided herein is for educational and informational purposes only, and neither The Rohatyn Group nor any of its affiliates (together, “TRG”) is offering any product or service hereby. The information provided herein is not a recommendation, offer, or solicitation of an offer to buy or sell any security, commodity, or derivative, nor is it a recommendation to adopt any investment strategy or otherwise to be construed as investment advice. Any projections, market outlooks, investment outlooks or estimates included herein are forward-looking statements, are based upon certain assumptions, and should not be construed as an indication that certain circumstances or events will actually occur. Other circumstances or events that were not anticipated or considered may occur and may lead to materially different outcomes. The information provided herein should not be used as the basis for making any investment decision.
Unless otherwise noted, the views expressed in the content herein reflect those of the participants in the GSM as of the date published and are not necessarily the views of TRG. In fact, the views of TRG (and other asset managers) may diverge significantly from certain of the views expressed in the content herein. The views expressed in the content herein are subject to change without notice, and TRG disclaims any responsibility to furnish updated information in the event of any such change in views. Certain information contained herein has been obtained from third-party sources. While TRG deems such sources to be reliable, TRG cannot and does not warrant the information to be accurate, complete or timely, and TRG disclaims any responsibility for any loss or damage arising from reliance upon such third-party information or any other content provided herein.
Exposure to emerging markets generally entails greater risks and higher volatility than exposure to well-developed markets, including significant legal, economic and political risks. The prices of emerging market exchange rates, securities and other assets are often highly volatile and movements in such prices are influenced by, among other things, interest rates, changing market supply and demand, external market forces (particularly in relation to major trading partners), trade, fiscal and monetary programs, policies of governments and international political and economic events and policies. All investments entail risks, including possible loss of principal. Past performance is not necessarily indicative of future performance.
The information provided herein is neither tax nor legal advice. You must consult with your own tax and legal advisors regarding your particular circumstances.
