We have a cautious outlook for Mexico, given the country’s upcoming presidential election and the uncertainty surrounding the renegotiation of the North American Free Trade Agreement (NAFTA). While we expect many sections of the agreement, such as rules of origin, to be updated, we also believe a version of the agreement will remain in place. Mexico represents only 10 percent of the U.S. trade deficit, and we believe that the Trump Administration will focus more on the trade deficit with China. Mexican Sovereign bonds offer higher yields than comparable U.S. Treasury debt, but the country will face unchartered territory for the first year or two after the next Presidential election, because the current front-runner is campaigning on a populist platform, which concerns many investors.
The dependence of the Mexican economy on trade with the United States becomes even more apparent when considering differences in trade diversification across LATAM countries. Approximately 80 percent of Mexican exports are destined for the U.S. market and 47 percent of Mexican imports originate in the United States. On the other hand, Brazil sends only 13 percent of its exports to the United States and 18 percent of its imports originate in the United States. For perspective, the shares for China are 19 percent and 10 percent, respectively.
Cross-border supply chains partially explain why the Mexico-U.S. trade relationship dominates the U.S trade relationships with other LATAM countries. Integrated production often involves components crossing the border multiple times, which boosts the gross trade numbers.
We would expect the four LATAM countries discussed above to be the most affected by a global trade war. Mexico would clearly experience a disproportionate shock, emphasizing the importance to Mexico of NAFTA's successful renegotiation.
The new U.S. steel and aluminum tariffs are not expected to have a big impact on LATAM. Only Brazil and Mexico are counted in the top five exporters of steel to the U.S. and both have been exempt from the new tariffs. No LATAM countries are counted in the top five exporters of aluminum to the United States.
Impact Of A U.S. Trade War On Other Emerging Markets
In general, we expect larger countries, such as Brazil and India, to experience less of an impact on their economies and bond markets.
Smaller economies more open to trade, such as the Netherlands and Vietnam, will feel a larger impact due to a trade war, and their bond prices may decline. We would also expect Asian economies like Taiwan and Malaysia to be hurt by a U.S.-China trade war as these countries supply much material to the Chinese production of final goods.
Deborah Watkins is an economist and emerging markets specialist at LM Capital Group LLC.