Trump's Red Wave Pushes Emerging Market Stocks To 2-Month Lows: Volatility 'Expected To Remain Elevated'

Emerging market stocks have dropped to levels last seen in mid-September, with the downturn exacerbated by Donald Trump's victory and a Republican sweep of the U.S. Congress.

The iShares MSCI Emerging Markets ETF (NYSE:EEM) has slumped 7% over the past month, with the iShares MSCI China ETF (NYSE:MCHI) and the iShares Mexico ETF (NYSE:EWW) underperforming — down 10.1% and 7.8%, respectively.

Trump’s win and full Republican control of Washington, D.C. raise critical questions for emerging markets (EM). What does a more protectionist U.S. policy and potential fiscal loosening mean for emerging economies, currencies and credit conditions?

Why Are Emerging Markets Falling?

Trump's election has sparked concerns over possible shifts in U.S. fiscal and trade policies that could have a ripple effect on global markets.

“The prospects of looser fiscal policy and more trade protectionism have increased short- and long-term U.S. interest rates, putting upward pressure on borrowing costs in EMs,” according to Elijah Oliveros-Rosen, chief emerging markets economist at S&P Global Ratings.

Higher U.S. interest rates tend to strengthen the dollar, making it more expensive for emerging markets to service dollar-denominated debt. This tighter financial environment has already started affecting emerging market currencies, which have weakened across the board against the dollar.

EM Currency Depreciation: A Major Concern

Following Trump's win, most EM currencies — especially in Central and Eastern Europe and Latin America — have depreciated significantly against the U.S. dollar.

Investors worry the Federal Reserve may delay rate cuts in response to Trump’s policies, which could include new tariffs or stricter immigration rules. A stronger dollar and potential trade barriers pose serious risks for EM economies reliant on exports and foreign investment.

The Mexican peso, in particular, has been hit hard by Trump's election, as uncertainty over trade and immigration policies toward Mexico has made investors skittish.

Private fixed investment in Mexico, which has been strong over the last two years due to nearshoring, could lose momentum until there's more clarity on U.S. policy.

“During the Trump 2016-2020 administration (excluding the pandemic), private fixed investment in Mexico declined 4.5%,” S&P Global wrote in a report.

Tightening Financial Conditions For EM

The rise in U.S. interest rates is tightening financial conditions for EMs, which rely heavily on affordable credit to finance growth.

With borrowing costs rising, fiscal vulnerabilities in these markets could become more pronounced, potentially limiting governments' ability to stimulate their economies.