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Weekly investment update – Twin shocks roil Asian asset markets

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Chi LO
 

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The recent spikes in energy prices and US Treasury bond yields have strained emerging Asia’s asset prices and currencies. Rising commodity prices are worsening Asia’s balance of payments dynamics, putting the currencies of large oil-importing countries under pressure. Meanwhile, the rise of the 10-year US T-bond yield to its highest since June is reminding investors of the adverse impact of a ‘taper tantrum’ on emerging market assets. 

While stronger Asian macroeconomic fundamentals suggest that a ‘taper tantrum’ of the kind seen in 2013 over an imminent tightening of US monetary policy might not replay this time, credit events and power shortages in China are complicating matters.

After 20 regions, accounting for over 70% of China’s GDP, recently failed to meet their targets on greening measures, Beijing ordered many factories and coal mines to close so that its carbon-emission reduction targets would be attainable. The coalmine closures have aggravated power outages and forced yet more factories to shut down.

the resulting disruption to production, exacerbated by the recent Covid resurgence, has led to severe problems in global supply chains with delivery lead times lengthening (see exhibit 1). Late deliveries of a particular car chip can, for example, halt entire assembly lines. Such bottlenecks have heightened financial markets’ concerns about global inflationary pressures.

Exhibit 1 China's manufacturing PMI delivery times (index)

Supply chain issues a major drag on activity

Data also shows that delivery lead times have become far longer in developed economies than in China and Asia. The difference between new orders and output – where a positive gap likely reflects producers’ difficulties in catching up with orders – shows that Asia did not seem overly stretched.

The region now has a close-to-zero new orders/output gap. However, the gap in developed markets has continued to widen since early this year, hinting at intensifying supply chain bottlenecks. The main issue appears to be shipping from East to West.

With supply falling behind demand, inflation expectations have grown. Should investors start to doubt the main central banks’ narrative that inflation is ‘transitory’, this could boost the upward pressure on Treasury yields, leading to capital outflows from Asia and short-term regional currency weakness.

While the share of fuel prices in the region’s consumer price index (CPI) baskets is not large, it also is not negligible. Thailand, Singapore, the Philippines and South Korea typically pass higher global energy prices on to consumers. This implies that their economies could see a higher risk of energy-driven inflation.

US fiscal argy-bargy affecting bond markets…

US fiscal frictions have also hurt market sentiment on US bond yields, underscoring the near-term upward pressure. The last week of September saw continued discussions – and thus continued uncertainty – about the Biden administration’s goal to pass both a large bipartisan infrastructure  spending plan and its Build Back Better proposals on social programmes, climate change and taxes.

After a deal was done to kick the can down the road, a deadline now looms in December for the US debt ceiling. Treasury Secretary Janet Yellen has identified this as the date by which the Treasury’s extraordinary measures for borrowing could be quickly depleted if the debt limit is not raised or suspended.

As long as uncertainty about the debt limit persists, some investors will be reluctant to hold Treasury bills that mature in the weeks in which Treasury debt operations could potentially be disrupted.

…including those in emerging Asia

Emerging Asia stocks, especially technology stocks, and currencies are vulnerable under these crosscurrents. The uncertainties could weigh on the region’s bond markets, too.

Already Asia’s tech stocks have been hit hard, Chinese stocks in particular due to Beijing’s regulatory tightening. One positive aspect is that the tech stocks have already experienced months of weakness so their valuations are more reasonable now and further downside could be limited.

Regulatory tightening since President Xi Jinping came to power in 2013 shows that the authorities have been effective in stabilising debt and productivity growth, as well as cleaning up corruption. In all of the three rounds of regulatory measures since 2013, which lasted 12 to 18 months, China’s stock market reacted positively up after suffering initial short-term declines.

If history repeats itself, we may see Chinese stocks embark on a sustained recovery once the current round of regulatory tightening is over. All things being equal, this would have a positive impact on investor sentiment on the region.


Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.

Investing in emerging markets, or specialized or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

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