In my last article, published on 2 April, I warned of an impending slump in stock markets and emerging market currencies. While it was clear that tariffs were coming, what Trump presented as reciprocal tariffs came as a shock to capital market participants, myself included. I had expected a hard line, but not such an outrageous idea.
Unfortunately, it is unlikely that Trump will deviate from his hard-line stance. However, he is likely to have been impressed by the sharp fall in stock markets and the simultaneous rise in interest rates. The rise in bond interest rates in particular could cause problems. This is true both for emerging markets, whose interest rates are very sensitive to interest rate rises in the USA, and for the USA itself, where almost a third of all bonds issued will expire this year. A third of the year has already passed, and bonds that previously had an interest rate of just under 2% now have to be refinanced at over 4%. This will further increase the interest burden on the US, and if bond interest rates do not fall soon, Trump and his administration will breach their self-imposed goal of reducing the US debt burden.
It’s hard to step out of the trade warrior’s corner when you’re fully committed to it.
The Global Economy is Losing Momentum
Uncertainty emanating from the USA will impact the global economy. The dispute with China, in particular, will put a strain on global supply chains. Hardly anything is currently being exported from China to the US, which will lead to supply problems with many primary products from May onwards. Although there seems to be a growing willingness to talk, particularly on the part of the US, I do not expect the talks to produce results any time soon, since China is demanding the removal of trade barriers before entering into negotiations.
We Should Still Expect Higher Volatility
Emerging market yields may come under pressure several times in the coming weeks and months. Emerging market currencies react to higher US bond interest rates. If the dispute with China is not resolved soon, the USA may face another wave of interest rate hikes. This would be particularly damaging if the economic downturn in Q1 were to continue into Q2 and the US were to fall into recession. This would weigh heavily on stock markets, bond yields (due to falling tax revenues and rising government spending) and the USD. The USD could weaken quite considerably against major currencies such as the EUR, JPY, CHF and GBP.
The USD does not need to weaken significantly against emerging market currencies. Depending on the overall trend, they could strengthen slightly or fall sharply against the USD. I expect renewed and probably accelerated depreciation against the euro for emerging markets in 2025, which should maintain high levels of willingness to engage in hedging transactions in view of relatively high interest rate differentials. However, if there is an opportunity to terminate hedging transactions profitably within the hedging horizon and a devaluation movement has progressed to such an extent that it is no longer likely, it also makes sense to consider terminating them now.
This is not speculation; it is risk management based on facts that must be recognised, understood and respected.
Risk protection will be of paramount importance over the next six months. However, if the risk materialises, it should also be about protecting liquidity.
