S&P: Risks for Emerging Markets Loom Despite Looser Fed Policy

The Fed’s shift to a “looser monetary policy” stands to help emerging markets, but those economies are far from out of the woods because of looming risks that include the threat of “heightened U.S. protectionist measures” and “geopolitical tensions,” according to a new S&P Global Ratings report released Monday.

Although the Fed’s “more dovish stance is supporting capital flows” to these markets, “easing financing” woes and “alleviating pressure” on currencies, “key risks” to the emerging market economies also include weaker economic data in developed countries, Jose Perez Gorozpe, the firm’s head of credit research for emerging markets, and Tatiana Lysenko, a senior economist and director, said in the report.

Financing conditions have relaxed for the time being due to the response of the Fed and European Central Bank (ECB) to what was a “weakening growth and inflation outlook, and both central banks are poised to remain highly accommodative this year and next,” the S&P report said.

But the analysts warned that “investors’ appetite for emerging-market risk is increasingly contingent on further monetary easing.” Rising risks to global growth amid trade disputes and geopolitical tensions have prompted moves of both central banks, they said. Amid all the remaining “pressure points and mutually reinforcing factors, investor sentiment toward riskier assets is set to be fragile,” the report said.

Overall “macroeconomic conditions remain soft and outlooks have weakened across key emerging market economies,” the report went on to say, adding: “External and domestic risks persist, and some of the risks to growth that we have previously identified have started to migrate into our baseline.”

One major specific issue continues to be U.S.–China trade negotiations of which the “outcome remains uncertain,” the analysts noted. Although there were “promising signs” after the G20 meetings, the “fragile truce” between the two countries is “now tumbling [and] trade tensions are again escalating and new tariffs loom,” the analysts pointed out. Any “potential agreement” between the U.S. and China is dependent upon “many factors that transcend purely economic interests,” they noted, explaining: “For China, the key risk is that the combined effects of investment restrictions, export controls, and tariffs will rewire supply chains to competitors and weaken manufacturing investment, particularly in the technology sectors that are crucial for the country’s economic growth.”

Meanwhile, after the Trump administration’s threat to impose tariffs on Mexican exports was “defused,” the U.S., Mexico and Canada Agreement (USMCA) “should be moving forward,” the report said. After all, Mexico’s Congress already approved the trade agreement and Canada is just waiting for the U.S. to do the same, it noted. But U.S. Democrats still have concerns about Mexico’s labor laws, as well as environmental and intellectual property factors, the report noted.

The Trump administration may also not be done targeting other countries over trade. Additional trade disputes, including the possibility that the U.S. imposes tariffs on European Union auto exports, “shouldn’t be discounted, and would indirectly affect European auto supply chains in Eastern Europe and Latin America,” the report said.

Capital expenditures have particularly “softened” in more trade-dependent emerging economies in Asia-Pacific and sectors in China exposed to trade tensions, the S&P analysts went on to say. Some countries seem to have benefited from the “trade diversion” we’ve seen, the report noted, pointing as an example to exports to the U.S. from Vietnam and Malaysia that have “picked up at the expense of China.” On other hand, exports from Argentina and Brazil to China have grown at the expense of the U.S., the report said, adding “it remains to be seen whether these developments are sustainable.”

The recent cut to the U.S. interest rate by Fed Chairman Jerome Powell and his “more accommodative monetary stance in developed economies going forward has opened space for monetary easing in emerging markets,” the report said, noting central banks in several emerging market economies, including Brazil, Indonesia, Russia, South Africa and Turkey recently lowered policy rates, and “more easing is in the cards,” the analysts predicted. But they added: “To what extent emerging market economies are able to ease monetary conditions will depend on domestic factors.”