Will emerging markets win with Biden?
Emerging markets (EM) could benefit from a political environment set to become more benign following the victory of Democratic candidate Joe Biden in the U.S. presidential election.
After 10 years of US asset outperformance, we see potential for significant capital re-allocation to EM markets, now that the election results have been confirmed. Of the roughly USD 1.25tn that was deposited into US money market funds at the peak of the COVID crisis in H1-2020, we believe that approximately USD 800bn remains on the sidelines. We expect victory for Biden to drive a surge into foreign assets, foreign currencies and commodities, including gold,
There is already evidence of this capital re-allocation. On Thursday, 5 November, Korean equities experienced their largest daily inflows since September 2013. South Africa’s domestic bond market also recorded its largest day of non-resident portfolio inflows.
Looking ahead, we expect a weaker USD and stronger EM and commodity markets. Overall, global markets are cautiously optimistic on the assumption of a divided Congress, which will make it harder for President-elect Biden to enact his agenda. Positive factors for the markets, particularly EM include:
1. The ‘event risk’ has passed
A confirmed election result mitigates the uncertainty that played into the markets over many months.
2. Prospects of US fiscal stimulus are lower
A divided Congress means a significant fiscal stimulus will be difficult to achieve, subsiding the threat of higher US rates for now. A divided Congress also means it will be much harder for Biden to raise US taxes. A decline in expected US rates volatility has historically been a major source of support to EM. Another factor in favour of EM is that reduced prospects of US fiscal stimulus imply that a greater proportion of the burden of supporting the US economy will fall to the Fed, which means more asset purchases.
3. The outlook for global trade is much more constructive, especially in EM
Biden has indicated he will look to positively reset trading relations with historical US partners. This should reduce the risk premia associated with many EM assets and contribute to further USD depreciation.
Within EM, Asia is set to be the first region to benefit from our predicted shift in asset allocation, as Asia’s markets tend to be a little less volatile than their other EM counterparts.
When the levee breaks
The US election results are broadly supportive of risky assets and foreign currencies; however, risks remain. These include the lack of additional fiscal stimulus and the continued escalation of COVID cases in the US and Europe, likely to keep pressure on the Fed to maintain loose monetary policy well into 2021. The outcome of the Senate elections can still impact the likelihood of a fiscal stimulus: should the Democrats be able to flip two seats in the run-off in Georgia in January, they would gain control in the Senate and therefore the US Congress. It would be a narrow majority, but at the margin it would increase the prospect of domestic policies, which could lead to an increase in US yields and pressure on US asset markets.
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