Top of the Morning: Emerging Markets - Monumental change
The desk posits that the recent shift in U.S. tariff policy, particularly the jump to an effective rate of 25%, is reshaping emerging markets (EM). Per the full note from UBS, this monumental tariff change not only disrupts trade flows but also acts as a catalyst for capital movement, potentially impacting EM investor portfolios. With the U.S. trade deficits likely to influence foreign capital inflows significantly, EM traders should recalibrate their strategies accordingly. The looming implication is a potential tightening of liquidity for EM economies that rely on foreign investment for stability.
What the desk is arguing
The desk firmly believes that U.S. tariff rates, which are presently 25% compared to pre-election levels of only about 2.5%, will have profound impacts on trade dynamics and capital flows to emerging markets. Per the commentary, Alejo Czerwonko, CIO at UBS, emphasizes that the U.S. must adjust its financing model due to these tariffs, which will lead to important considerations for EM investors moving forward.
The evidence supporting this view is underscored by the dramatic change in capital flows associated with the sharp increase in tariffs. The desk notes that persistent trade deficits in the U.S. could trigger a recalibration of how countries approach foreign investment, as foreign entities may seek stability and growth elsewhere, potentially leading to reduced inflows into U.S. capital markets and negotiating a broader EM strategy shift.
Where it sits in our coverage
Aligned firms project a bullish near-term view on key EM currencies against the dollar. Our consensus target sits at 1.075, with notable forecasts including: - JPMorgan: 1.10 (Mar-26) - Bank of America: 1.04 (Mar-26)
The desk's call is at the higher end of the spectrum in the current consensus, aligning with firmId JPMorgan, while diverging from the more cautious outlook from firmId Bank of America.
How other firms see it
A group of aligned firms, including firmId JPMorgan, suggest a more constructive outlook on select EM currencies, contrasting with firmId Bank of America's cautious positioning. The divergence points to underlying concerns about U.S. economic resilience amid these tariff changes.
Watch the USD/BRL and USD/INR pairs closely, as their movements may closely reflect shifts stemming from U.S. tariff impacts and capital flow decisions dictated by broader market sentiments.
What the calendar says
No high-impact events are on the horizon that could immediately affect this narrative, but continuous monitoring of trade data and upcoming policy announcements from the Federal Reserve could provide insights into the long-term implications of current U.S. tariff strategies on EM currencies.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01U.S. tariffs now stand at a historic 25%, significantly influencing global trade dynamics.
- 02Emerging markets may face increasing capital flow volatility as foreign investment strategies shift.
- 03The situation calls for a restructuring of EM investment portfolios to mitigate risks associated with U.S. economic policies.
- 04The outlook for select EM currencies may benefit from a recalibration in response to U.S. economic adjustments.
Market implications
Traders should closely monitor capital flow trends in emerging markets, particularly after U.S. trade data releases, as these will highlight the real-time impact of tariff adjustments. Expect possible volatility in USD/BRL as it reflects changes in investor sentiment driven by these economic shifts.
Risks to this view
If the U.S. quickly reverses its tariff strategy or if unexpected economic growth in the U.S. curtails its trade deficit, the anticipated capital flight from emerging markets could halt. Additionally, if foreign investors re-assess the value of EM assets positively, it may lead to an inflow that contradicts our current outlook.
Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. Joining me here today in studio for the conversation as we will be focusing in on the emerging markets.
Glad to welcome back the Chief Investment Officer for Emerging Markets Americas with the UBS Chief Investment Office, Alejo Zerwanko. Alejo, I know it's been a bit of time since you and I last spoke, but what a great time to be getting in front of our listeners, our clients, given market conditions, which we will be covering today. So thank you for stopping by.
Great to be with you today. Unforgettable times. So happy to be here.
Indeed. So let's jump right into it, Alejo. Like I said, the timing works out very well because you just published your monthly Investing in Emerging Markets flagship report.
The title is Monumental Change. I'm assuming you're referring to U.S. tariff policy, Alejo. Of course we are.
That's what everybody is talking about. And just to level set, Dan, the change that this new tariff policy introduces is gigantic. We're talking about effective U.S. tariff rates 10 times higher today than pre-elections.
And as we speak, at a level of 25%. This is unlike anything anybody has seen in 100 years coming out of the U.S. So big deal.
Now what we highlight in the piece is that trade wars are also capital flows wars. Because when you think about trade, right, and a country with a trade deficit, this means this particular country, be it the U.S. or any other nation out there, buys more from abroad than it sells abroad. That translates into living beyond their means.
Any company, family, country living beyond its means requires financing. And for decades, the U.S. has enjoyed financing from foreigners to, you know, be able to make this happen. This takes the form of inflows into U.S. capital markets, stocks, and bonds.
Now if the U.S. is serious about changing the reality of persistent trade deficits, that will also change the reality of persistent trade flows, capital flows. So it has two sides of the same coin in a way. So we wanted to put this out there and remind folks that when you build portfolios, if you assume that whatever happened in the last 15 years is going to, you know, repeat itself, we find that to be quite unlikely.
You got to take a broad approach to building a portfolio from a geographic standpoint considering that capital flows will possibly change drastically as a result of what's going on. Given this potential monumental change, a lot of uncertainty amongst investors has been reflected in the markets in recent days, Alejo, just thinking back to last week, the announcement from the White House, some 60 nations listed by President Trump. But if you focus in specifically on emerging Asia appears to be bearing the brunt of these tariff actions, what's your outlook for the region?
You said it very well, Dan. Asia took a disproportionate hit relative to other countries in the world. When you look at the new proposed effective tariff rate, it's China at its core that will, you know, have to deal with much higher tariffs, but also the so-called China plus one countries.
These are other destinations that have been gaining ground over the last few years as multinationals diversified their manufacturing base beyond China, Vietnam, Thailand, Malaysia, Cambodia, you name it, right? It's not going to be an easy adjustment period for these countries. At the same time, it's not going to be the end of the world.
Think about China for a minute because it's at the eye of the storm. China's exports to the U.S. as a percentage of GDP, around 3%, sizable number, but the country is not going to disappear because of this, right? I mean, I just want to put things into perspective.
And policymakers have tools to soften the blow, meaning they're going to ease monetary policy, they're going to ease fiscal policy. Everybody's going to be watching what the Politburo meeting at the end of this month, April, has to say about China policymaking. A lot going on.
Not an easy transition, but we think these countries over time will find a way. So if we look around the world a bit in contrast to emerging Asia, Latin America in particular appears relatively insulated from these tariff actions. So Alejo, what factors contribute to this regional advantage, so to speak, and what specific investment opportunities do you see in Latin American markets?
Fascinating what's going on in the Americas, starting with the only two countries that did not receive higher tariffs from the U.S. on April 2nd, Canada and Mexico, right? These are, quote-unquote, protected through USMCA, their free trade agreement. In a way, I think we might be witnessing the building of fortress North America.
And so, of course, Mexico is a relative beneficiary in this environment. Anything can change, so it's important to monitor this very closely. But more broadly than looking at the Americas, Latin America, every country received a 10% tariff, which is high in and of itself, but relative to what we just discussed in Asia, very low.
No wonder late last week, headlines from Bloomberg, Apple exploring expansion of production sites in Brazil, right? Because obvious reasons. So we got to watch very carefully if these levels stick.
This could be a relative boost to Latin America. Nobody wins in a trade war. It's about relative standing, just to clarify.
And to your question on investment opportunities, Latin America has not done well over the last 10 years. Equity valuations are cheap. Currency valuations are cheap.
Interest rates are relatively high. But in this particular juncture, we might see Latin America being a relative safe harbor. So there's stuff that looks interesting in the region.
So from an investor standpoint, Alejo, there is a lot here to digest. In this context, how should investors consider making adjustments to their portfolios? And what signals will you be watching for in the coming months as this further evolves?
Absolutely. A few key messages. I would say if your portfolio is highly concentrated geographically, that is probably not going to be a good strategy moving forward.
You got to spread out exposure across the Americas, Europe, and Asia in a world that is changing just so fast and so unpredictably. Another principle. If you're highly concentrated in a single asset class, say equities, of course we're witnessing a pretty sharp correction slash bear market depending on the hour.
And so you got to contemplate fixed income as a way to balance out the performance of a portfolio, alternative investments, among others. And to wrap up then, maybe take a fresh look at assets that you never thought you'd have to contemplate, gold being one of them. We think gold is a very interesting hedge in a geopolitically fast-changing world.
Emerging markets will play a role across all these principles that I just described. Alejo, thank you. There are a lot of considerations when it comes to positioning.
We do, of course, encourage our clients listening in. I do have a conversation with your UBS financial advisor to talk about some of these allocation considerations, determine if they're a right fit for your particular circumstance. Though Alejo, Zerwanko, great catching up with you today.
Again, I do want to point our listeners to the Investing in Emerging Markets flagship report of that title, Monumental Change, is now available up on UBS.com forward slash CIO. Though for clients of UBS, please reach out to your UBS financial advisor if you would like to receive a copy of that report directly. Alejo, this was great.
I know we have many more of these conversations in studio to look forward to throughout the year. So I thank you again for your time today, and we'll speak again soon. Thank you for having me.
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