Trade Wars’ Tactical Retreat Cry

Early year stock and bond returns paused their extended double digit momentum as the US administration revisited trade conflict fears by slapping tariffs on aluminum and steel, following less headline-grabbing action against solar panel and washing machine imports. At the end of February the MSCI and GBI-EM indices tallied 1.5% gains as external corporate and sovereign and frontier equity benchmarks were down. Other factors contributed to diminished enthusiasm, including growth data leveling off after months of positive economic activity surprises lifting the global forecast to 5%. With new Federal Reserve chair Powell highlighting strength which could lift rates further than the original “dot plot” path, local currency instruments were re-priced. The key question for exporters hit by Washington’s action is retaliation as a combination of commercial and diplomatic considerations, and China in particular has signaled such response while retaining negotiation options pending release  of the section 301 report expected to list in detail intellectual property violations. Beijing has already dispatched President Xi’s lead economic adviser in an effort to reverse tougher investment stances as well with a succession of pending financial services and high-tech deals unable to pass muster with the Treasury Department’s CFIUS panel. Aluminum and steel are only fractional shares of emerging market exports, and affected countries could ease fiscal and monetary policies to offset the near-term blow. Asian PMI readings were previously slowing from last year’s torrid electronics supply chain cycle pace, and in Indonesia and India authorities had been contemplating rate hikes to narrow consumer import-fed current account deficits. In EMEA, South Africa, Turkey, Russia, Bahrain and others could be affected at the margin by the industrial metals fallout, but asset allocation will more be driven by delicate political junctures over the coming months. Retail investors registered occasional outflows through February especially in ETFs, but sovereign and corporate issuance has boomed at $50 billion and $80 billion respectively.

African borrowers lined up for Q1 include Kenya, Nigeria, Cote d’Ivoire and Senegal despite 20-year retrospectives on the original HIPC official relief which ultimately covered 30 countries, with Ghana for example cutting its burden to 10% of GDP. Later it led the inaugural bond parade, and with commercialization private creditors now are bigger holders than the traditional Paris Club, IMF and World Bank. The latter’s debt sustainability analyses have consistently understated potential distress from these more expensive obligations, as Ghana and Mozambique went into workout operations. Corporate valuations are stretched with Latin America the favored region and Asia dominating placement. Commodity names are one-quarter of the CEMBI and prices are solid, while healthy balance sheets overall should keep defaults below 5%. Credit rating direction is almost neutral, but deleveraging banks are risky picks with declining financial ratios. So-called cross-over investors with global mandates have entered in force, but local institutions are prominent buyers across major regions. Supply should again be in the $450 billion range this year, and specialized ETFs could increase their presence with only $50 billion in external bond vehicles currently in the market. “Green bonds,” half dedicated to renewable energy, could take off with more standardized information as funds position for that space, while distressed ones concentrate on Venezuela restructuring scenarios, where half value recovery would seem to be contingent on regime change.