Tariff on, tariff off – what’s next for emerging markets?

EHSAN KHOMAN
Head of Commodities, ESG and
Emerging Markets Research –
EMEA
DIFC Branch – Dubai
T:+971 (4)387 5033
E: ehsan.khoman@ae.mufg.jp

 

SOOJIN KIM
Research Analyst
DIFC Branch – Dubai
T: +44(4)387 5031
E: soojin.kim@ae.mufg.jp

 

LEE HARDMAN
Senior Currency Analyst
Global Markets Research
Global Markets Division for EMEA
T: +44(0)20 577 1968
E: lee.hardman@uk.mufg.jp

 

MUFG Bank, Ltd.
A member of MUFG, a global financial group

Macro focus

Early weeks of Trump 2.0 signal greater uncertainty, bolder (and less targeted) tariff threats, a US foreign policy that appears more assertive as well as China showing signs it wants to negotiate. What’s next for emerging markets? Gauging risks from targeted tariffs on semiconductors, suggests Taiwan and South Korea are most exposed (if the aim is to reshore high-end chip fabrication). An extensive tariff on the pharmaceuticals complex would hamper Europe greatly, but within EM, Singapore and Hungary appear most at risk. Finally, a repeat of tariffs on aluminium and steel would reverberate greatest in Brazil, Mexico, South Africa and the UAE (though the size of the impact would be negligible). More broadly, trade-exposed EM countries most susceptible from a growth dimension remains China (the most tariff-targeted EM), alongside the CEE region, East Asia and Mexico. In such a volatile operating environment, EM central banks are set to be more alert to the adverse demand-driven growth shocks than inflation shocks, to further easing cycles.

FX views

Emerging market currencies have continued to outperform at the start of this year following the heavy sell-off in the final three months of last year. It has been the strongest period of performance for emerging market currencies since April and May of last year. Fears over tariff disruption have eased for now but downside risks have not gone away. Higher Fed rates for longer to remain weight on EM currencies. Hawkish policy shift from Central European Central banks helping to strengthen regional currencies.

Week in review

A robust set of PMI activity indices were released across the MENA region for the month of January. Kuwait’s draft budget for the fiscal year 2025/26 (commencing 1 April) anticipates a central government deficit of KWD6.3bn (USD20.5bn), with a new debt law being touted. Inflation in Turkey fell to 42.1% y/y in January, with Central Bank of Turkey (CBRT) Governor Karahan reinforcing a data-driven approach to monetary policy. The National Bank of Poland (NBP) kept the rate at 5.75% in line with our (as well as consensus) expectations. Finally, the Czech National Bank (CNB) cut its policy rate by 25bps to 3.75%, consistent with our (as well as consensus) expectations.

Week ahead

This week will be busy across EM EMEA, with data for four sets of variables scheduled for releases across the region. First, there are interest rate meetings in Russia and Romania on 14 February. Second, inflation data will be released across the region throughout the week –Egypt (10 February); Hungary (11 February); the Czech Republic (12 February); Romania, Poland, Israel and Russia (all on 14 February). Third, GDP figures will be available in Poland (13 February) and Romania (14 February). Fourth, current account data will be out in Turkey on 13 February.

Forecasts at a glance

The external backdrop for EM has shifted abruptly – the soft-landing pro-risk environment and pricing of non-recessionary Fed cuts has given way to concerns around tariff risks (and likely retaliatory action), higher-for-longer US rates and a strong US dollar. This sets the stage for a challenging EM backdrop in 2025. There are dimensions that could make Trump 2.0 less disruptive. Given the reduced direct trade exposure of the Chinese economy to the US and expectations that there will be a monetary and fiscal response by Chinese policymakers to offset the tariff growth shock, the economic and financial market disruptions will, on aggregate, be less severe than Trump 1.0.

Core indicators

The latest weekly IIF flow data signalled that EM securities witnessed outflows of USD3.8bn in the week ending 7 February. The breakdown suggests that equities drove the outflows (USD3.5bn), and also debt market saw a modest outflows (USD0.3bn).