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Trade war truce gives EM a "stay of execution"

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      By Emerging Markets Debt Team, Eaton Vance Management

      Boston - Emerging markets held a relief rally in the wake of the much-anticipated meeting over the weekend between President Trump and Chinese President Xi Jinping at the G20 meeting in Buenos Aires. By agreeing to a 90-day truce in their ongoing trade war, the two leaders gave EM investors the best they could realistically hope for.

      The sector has sold off sharply over the course of the year, riled by the U.S. Federal Reserve's interest-rate hikes, the strength of the U.S. dollar, shaky fundamentals in many EM countries and slowing growth in China. The growing trade war added to the worries about the Chinese economy.

      Given the stay of execution from Trump and Xi, EM investors shrugged off those concerns, at least temporarily. On Monday, EM currencies like the South African rand, Mexican peso and Russian ruble were up against the U.S. dollar.

      We expect the boost to be short-lived:

      • Tensions between the U.S. and China have not dissipated. Negotiators have 90 days to agree to "structural changes with respect to forced technology transfer, intellectual property protection, non-tariff barriers, cyber intrusions and cyber theft, services and agriculture." This is a tall order for two countries with so little trust between them.

      • Existing challenges with Fed normalization are still with us. Fed Chairman Jerome Powell's softer tone has also been welcomed by the markets, but the Fed's "data-dependent" approach is likely to still lead to further rate hikes in 2019 as it searches for what it considers a "neutral" level.

      • Fundamentals within EM still have room for improvement. EM issuers like Turkey, Argentina, Sri Lanka, Zambia and Lebanon all have displayed weakness this year. China's slowdown casts a shadow on many EM issuers who are trade-dependent on the country.

      Bottom line: This week's stay emanating from the G20 is likely to be temporary. We expect that the market will reward countries that use this reprieve - however long it lasts - to shore up their fundamentals.