Underlying activities across the region remain strong despite incoming impact of the trade wars. Causing more stress is the rising US policy rate and tightening of liquidity.
Taimur Baig, Irvin Seah
- China: Sino-US trade war is now a reality, but the stakes are in fact greater
- FX: We see a steadfastly buoyant USD in 4Q
- Rates: Asia central banks have to follow the Fed
- Equities: We see near term opportunities with Hong Kong
We begin this month’s round-up by taking stock of regional growth momentum. Our GDP Nowcast models for China, India, and Singapore, updated with data available through this week, show fairly robust performances:
• China slowed to 6.4% in 3Q, as per our real estimates of real GDP growth, but the slowdown is gradual and shows no alarming trends. If exports slow in 4Q or early next year, growth will likely head toward 6%, although the chance of a credit-driven policy stimulus will rise considerably in that case.
• India is unlikely to post another stellar 8%+ outturn in July-September, but a 7%+ print looks likely as per our model. Key sources of slowdown are trade and auto sales.
• As for Singapore, after a few very strong quarters, growth likely slowed to 3% in 3Q on the back of some softening in industrial production. Trade war related developments are yet to affect the dataflow, although it is possible that the strength of the cycle may appear to be exaggerated due to some front-loading of orders ahead of tariff activation.
Emerging markets have had a torrid time this year, but we are afraid that there no respite in sight. In past decades, a US monetary policy tightening cycle alone has been sufficient to cause considerable stress among hard currency borrowers, but this time there additional complicating factors in place.
First, trade wars have deepened, but at the same time are being seen primarily as a China-US skirmish over a broad range of issues, of which tariffs are just one part. In our travels through China, we saw companies considering a combination of margin squeeze, productivity enhancement, and re-routing of trade to deal with impending tariffs in the near term. 10% tariffs seem to not have led to a dramatic worsening of sentiments, but that could well follow if tariffs jump to 25% at some point next year. What was troubling was the growing sense that there are no short-term resolutions to the China-US conflict, and matters such as South China Sea, North Korea, Iran, Belt-and-Road, and technology transfer will be sources of protracted back-on-forth between the world’s two largest economies.
Second issue is oil, which is up about 25% this year, and the risk is once Iran sanctions are put in place and supply from Saudi Arabia and Iraq fall short, prices could jump another 10-20% in 2019. This is a major sense of headache for commodity importing economies (including Indonesia, which produces crude but imports refined oil). Here in Asia, governments are making laudable attempts to slow down demand by passing on the higher price or fiscal adjustment, as well as monetary policy tightening. But given the relative inelasticity of energy import demand, the risk is that the current account deficit for a number of economies will remain high next year. This bodes ill for inflation, currency stability, capital flows, and the overall economic outlook
Third and perhaps most critically is the cost and availability of USD funds. There is no sight of the US Federal Reserve refraining from rate hikes, hence dollar funding will become steadily more expensive through next year. The US Fed has signalled one more hike this year, and its dot plots suggest around 3 additional hikes in 2019.
We think the risk of the frequency and magnitude of Fed rate hikes is rising. US inflation is being driven up by a confluence of cyclical factors (tariffs, labour market tightness, oil, fiscal slippage, and expectations). Against this background, the risk of an upside inflation surprise is much greater than a downward surprise, in our view. The fact that US Fed chairman will host press conferences after every meeting from now on (instead of one per quarter) itself is a signal that the Fed is adopting greater flexibility to explain its forthcoming moves.
Regardless of three or four Fed rate hikes next year, the outlook is clear; USD borrowers will find it progressively more expensive to issue or refinance debt next year. This alone can cause distress among corporates, households, and financial institutions in emerging markets next year, but when it is combined with the pain from higher oil prices and uncertainty from trade wars, a very challenging period appears on the horizon.
We devote some thought to China in the next section, both in terms of the economic and political cost of trade wars, and what it means for policy.