Thinking global, acting local to hedge tariff-induced volatility in the EM complex

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

US trade policy announcements are entering a new phase, with President Trump announcing sector-specific tariffs (steel and aluminium already announced, with other sectors to follow), as well as reciprocal tariffs. To put this into context, reciprocal and sectoral tariffs mark a shift of emphasis away from use of “tariffs as leverage” and towards deploying tariffs to directly address trade practices and imbalances to solve for US re-industrialisation. While no explicit damaging tariffs have been imposed on the EM complex thus far, the dimensions where spillovers becoming meaningful are coming into view. EM local rates have continued to be passengers to the volatility from shifting market pricing around tariff risks. It has been hard for local rate markets to find direction in this environment, but we think that within the EM rate complex, front-end rates offer somewhat lower exposure to the broader repricing, supported by EM central bank rate cuts that have continued this year.

FX views

Notwithstanding US President Trump’s second term still less than one month into force, the uncertain policy environment has not been enough to benefit the broad US dollar (USD) in a sustained way. This has raised the question once again of whether history is set to repeat, and the USD will decline as it did during Trump 1.0, in 2017. From an EM FX perspective, the step backwards in the USD, EM currencies have found some reprieve. Some of this is merely a function of uneasiness with the USD that has strengthened much more than the outlook for Fed Funds implies. Although this provided relief to many EM currencies, the situation remains fluid. There have been reminders how US tariffs can be applied quickly.

Week in review

Saudi Arabia’s fiscal deficit widened to 2.8% of GDP in 2024. A host of inflation readings across EM EMEA were released for the month of January – which apart from Egypt, all displayed a concerning rising price trend for the start of 2025. Romania kept rates on hold at 6.50% with an emphasis on risk aversion. Finally, Russia kept rates steady t 21.00% though maintained its hiking bias.

Week ahead

This week, we will see Egypt announce rates on 20 February (MUFG and consensus: on hold at 27.25%) and South Africa inflation for January (MUFG and consensus: +0.2ppts to 3.2% y/y).

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 USD5.3bn in the week ending 14 February. The breakdown suggests that equities drove the outflows (USD4.6bn), and also debt market saw modest outflows (USD0.7bn).