Top of the Morning: Emerging market equities - Trade uncertainty and DeepSeek
The desk interprets recent developments in U.S.-China trade relations as a significant pivot point for emerging market equities, particularly in the context of potential tariff escalations. Following President Trump's implementation of a 10% tariff on Chinese exports, these moves could increase inflationary pressures domestically while stunting growth both in the U.S. and China (Per the full note source). Moreover, uncertainties surrounding retaliatory measures from China underscore the volatility in this sector, aligning with previous insights suggesting a gradual rise in tariffs towards 30%, thereby exacerbating market fears and dampening investor sentiment.
What the desk is arguing
The desk frames this as a crucial moment for emerging market equities amidst heightened tensions in trade relations and tariff uncertainties. Recent 25% tariffs on certain Canadian and Mexican exports, alongside a 10% tariff on China, signal potential long-term repercussions for U.S. and Chinese growth outlooks.
Supporting evidence from the discussion highlights the risk that extended tariffs could lead to significant headwinds for U.S. growth and higher inflation rates. Notably, China’s countermeasures, including tariffs on American goods and export controls over essential semiconductor inputs, illustrate a volatile environment (Per the full note source).
Where it sits in our coverage
Currently, our consensus target on the emerging market equities outlook aligns at 1.075 with a range between 1.04 and 1.12. Significant contributions come from firms like: - jpmorgan with a target of 1.10 for Mar26. - bofa with a more conservative stance at 1.04 for the same tenor.
This view is at the higher end of the spectrum, suggesting that our analysis anticipates a more positive outlook for emerging markets compared to others, especially those forecasting lower targets amidst tariff uncertainties.
How other firms see it
Firms aligned with this optimistic outlook include jpmorgan, suggesting a constructive view of emerging markets, while bofa takes a contrary stance, forecasting weaker performance as trade tensions escalate.
For traders, keeping an eye on the impact on currency pairs like USD/CNY and the broader implications of the U.S. Federal Reserve's rate decisions relative to fiscal policy will be essential for gauging how trade dynamics influence FX movements.
01Emerging market equities are facing significant pressure from evolving U.S.-China trade tensions.
02A 10% tariff on Chinese exports is in effect, with potential escalations anticipated in the future.
03Higher tariffs could lead to increased inflation and suppressed growth in both the U.S. and China.
04China's retaliatory measures suggest a continued cycle of economic and trade confrontation.
Market implications
Traders should closely monitor levels around the 1.075 consensus target, as a breakdown or rally beyond this level could signify changing sentiment in response to trade developments. Additionally, any fresh news or comments from U.S. trade representatives could catalyze significant price movements in emerging market equities.
Risks to this view
The primary risk to this outlook is a sudden de-escalation in trade tensions or comprehensive trade agreements between the U.S. and China, which may stabilize the economic outlook and encourage investor confidence in emerging markets. Alternatively, escalated tariffs exceeding the anticipated 30% could dramatically shift market sentiment, reinforcing negative pressures on equity valuations.
ubs
Hi everyone, Siobhan Chapman here, and welcome to Top of the Morning on the UBS Market Moves podcast channel. Today's conversation will primarily focus on trade uncertainty, deep-seek implication for U.S.-China relations, and emerging market stocks. Joining us for the conversation, I'm glad to welcome Jingchen Yu, Emerging Market Strategist.
Jingchen, welcome. We're happy to have you. Thanks for having me here.
Appreciate it. Of course. So let's get started.
Absolutely. Maybe just to recap, President Trump recently invoked the International Emergency Economic Powers Act, IEPA, right, to impose a 25% tariff on exports from Canada and also Mexico to the U.S., along with a 10% tariff on Chinese exports. However, after some initial discussions, he decided to delay the tariffs on Mexican and Canadian goods by a month.
As for China, it's sort of like a deja vu of the beginning of the, you know, trade war 1.0. We're now seeing 10% tariffs taking effect as we speak against China, and China in retrospect announced some countermeasures as well, including retaliatory tariffs on certain American goods including LNG, agricultural equipment, and also launched an antitrust investigation on a major U.S. tech economy and some, you know, export control of certain key inputs for semiconductor equipment. China has also added two companies into their unreliable entity list, which would allow sanctions against foreign entities.
We've already sort of previously suggested that aggressive tariffs from the U.S. were likely, including gradually increasing, you know, the effective tariff rate on China from 10%-ish to 30% eventually. And some tariffs might also apply to certain imports from the European Union as well. However, we did not expect the tariffs on Canada and Mexico to last for a long time.
If they do persist, right, it could put pressure on U.S. growth and potentially lead to higher inflation as well, especially since Mexico and Canada together account for about 30% of U.S. total trade. I mean, in fact, imports from these three countries make up around 45% of total U.S. version that imports and about 5% of U.S. GDP.
With the postponement of tariffs on Mexico and Canada, it seems like this could also just be a tactic to speed up the renegotiation of the USMCA, right? So there's a good chance for some concessions to be made from, you know, these countries, although uncertainty is still high. The last point I want to mention is that the concern is that while the recent tariff against Mexico, Canada, and China are not sort of primary trade-related, at least that's not the trigger, Trump's repeated comments sort of linking tariffs to the U.S. trade deficits are a bit worrisome.
I mean, trade deficits cannot be negotiated in such a fast manner, right, as easily or as, you know, sort of those non-trade issues like immigration or migration and drug control. Additionally, ongoing uncertainty around trade and tariffs can also negatively impact corporate sentiment, especially in emerging markets. I mean, looking back at the trade war in 2018 and 2019, we saw a notable slowdown in corporate capital expenditure growth in emerging markets during those trade explorations.
As of November last year, eight out of 10 top economies with trade surpluses with the U.S. are from the emerging markets and Asian space. So we expect that rich assets in emerging markets will remain volatile for the, you know, foreseeable future. Thank you so much for that overview.
So China has been one of the main targets of President Trump's second term. Can you tell us the latest impact on Chinese growth from the just-announced tariffs and what was your view on China's responses overnight? Sure, yeah.
So maybe just to highlight that I don't think China is the only target. This time around, probably still one of the main targets from President Trump. The 10% tariff, however, I think may serve as a starting point or, you know, opening salvo, right?
Current tariffs on China are indeed a bit lower than expected, but the next round could come in as soon as the next quarter after the USPR reviews of the bilateral trade relations. While a 10% general tariff would negatively impact China, maybe less than half a percentage point with the exports taking a direct hit, it is still, for now, likely to be manageable. However, this still could lead to depreciation pressure on the DNY side and also might encourage some front-loading of exports, sort of anticipation of further tariffs.
Now, if you compare the current sort of trade escalation or trade dynamics to trade for 1.0 in 2018-19, I think this time the Chinese government is likely to tolerate a much smaller depreciation of the renminbi versus the low-ping depreciation last time. So, at this juncture, using currency to meaningfully fusion export shock is a low-likelihood event, in my opinion. And also, given the fact that China recently cut almost all of its export subsidies, meaning that maybe US consumers could feel a greater impact as well this time around.
Now, what kind of potential steel, right, on the upside could really emerge between the US and China in the coming potential negotiations? I think there are a couple of points I want to make. Number one, China already has agreed to accept illegal immigrants for the first time since 2019.
And number two, there is some room, in my opinion, for cooperation on the fentanyl issue as well. Over the longer term, China may be open to increasing purchases of US goods, including agriculture and energy. But this is really contingent upon the progress of negotiations from here.
And I don't think China will rush to retaliate at a significant level, just as you might have noticed from a more symbiotic countermeasures announced by China overnight. I think because China still wants to reach a deal with the US sooner rather than later. And even though China is currently in the eyes of this tariff storm, again, as I mentioned, it's not the only target.
I mean, a significant amount of tariffs were already imposed on Chinese goods before, which the president has also claimed the credit for. Therefore, at this point, I believe while having to show some sort of reactions or countermeasures, right, China might still want to show some willingness or positive gestures to seek an offering. At the same time, it is likely that China will unveil some easing policies to fusion the low consumer demand, boost investment demand as well.
And in addition to some of the more difficult structural issues, such as housing downturn or local government debt issues and so on. And then last but not least, in case of an escalation in the future, I think some countermeasures will for sure be likely. That can include, I mean, we've already seen some of them, right, some sort of more manageable or symbiotic magnitude of retaliation.
But that will be along the lines of, for instance, in the form of retaliatory tariffs or export control of certain critical minerals or technology. And if necessary, some reciprocal restrictions against American companies in China. So I want to move over to AI.
China seems to have made important breakthroughs on AI with the latest rollout of DeepSeek's LLM. Tell us what does this mean for the AI space? And in particular, what does it mean for U.S.-China relations going forward?
Definitely. First, I want to emphasize maybe a key takeaway from all this. The decreasing input cost of developing advanced large-language models, if that holds true or sustains, can, in my view, suggest a greater adoption of AI and acceleration in AI-related applications.
Increased demand for inference, inferencing, will ultimately drive higher computing demand. So this really aligns with Jieguang's paradox in economics, which states that technological advancement leading to greater efficiency gain in resource utilization can result in increased resource consumption. We believe that hyperscalers have to expand.
Expenditure growth will continue with AI-enabling technologies, including semiconductors, playing a crucial role here. Now, regarding U.S.-China relations, it's very important to know that China is leveraging its second-mover advantage and has made impressive strides in recent years, despite expert controls. Domestic competition is intense, and the open-source model landscape has allowed these models to gain significant traction and improvement even in overseas.
A straightforward implication for U.S.-China relations from this is that AI competition has never been fiercer. We can expect both countries to prioritize the strategic importance of their respective AI developments, and this dynamic may lead to both cooperation and friction. As we've highlighted in previous white papers, the U.S.-China relationship is one of the most consequential bilateral relationships on the planet, with technological competition being just one aspect of this complex relationship.
So we are coming to the end of our conversation. How should investors be positioned amid higher tariff uncertainty from here? Sure.
I think the bottom line is in potentially more volatile markets, it's essential to focus on portfolio diversification and hedging strategies. We do still see potential for equity upside despite the volatility, while quality bonds can also offer stability and attractive income. For emerging market companies, the macro backdrop and geopolitical tensions may temporarily affect their risk premium, but we still identify selective opportunities ahead.
For instance, Taiwan, despite recent fluctuations, in our view still presents very strong upside potential from the current AI wave and expected to see margin expansion or margin growth in 2025. India, on the other hand, stands to benefit from robust domestic growth drivers and also government support for consumption, as we saw from the recent budget release, with earnings trends expected to improve soon, in our opinion. Outside of Asia, South Africa should gain from positive domestic conditions, resilient U.S. growth, and also easing measures from China, while still maintaining a favorable valuation, Siobhan.
Okay, perfect. Xing Chen, thank you so much for joining us today. Thank you, Siobhan.