Asian Bond Watch: Sustained stimulus to soften COVID-19 impact

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This is a sponsored article from State Street Global Advisors.

Kheng-Siang Ng
Asia Pacific Head of Fixed Income
State Street Global Advisors

While the full impact of the virus remains unclear, it will likely force China to maintain a degree of policy support into the second half of 2020, and possibly beyond.

The novel coronavirus (COVID-19) is still in the early phase of accelerating infection rates and, sadly, increasing number of deaths. While much is still unknown, authorities have responded within China, across the globe and in international cooperation.

As global investors, we apply a macroeconomic lens to our assessment. Although the virus outbreak will almost certainly knock China’s quarterly economic output, the medium- and long-term view could be much less negative.

One risk going into 2020 was the possibility that the Chinese government would reverse course and cut, if not eliminate, its stimulus programmes. It is now highly unlikely that we will see a sudden stop to the monetary, fiscal and regulatory stimulus that has helped drive the Chinese recovery since mid-2019.

The importance of public health in China has materially raised the bar for the central, provincial and local governments to effectively manage the acute effects of the epidemic. President Xi and the central government exercise centralised power and we expect them to mobilise government resources to limit the economic fallout.

In terms of economic impact, the epidemic will likely cause Chinese economic growth to drop significantly to below 6% during Q1 2020, requiring the Chinese authorities to revisit their plans for ending their stimulus actions. In 2019, fiscal easing was roughly equal to 2% of GDP, with another 0.5% slated for 2020. Along with the Chinese central bank’s monetary policy actions — lowering lending rates and reserve requirements (down 2%) for banks — this combined fiscal-monetary stimulus has helped stabilise Chinese growth and the global recovery.

The phase one US-China trade deal was going to be the trigger to cut back on stimulus, but the epidemic makes that prospect unlikely. Instead, we can expect policy support to continue into the second half of 2020 and possibly beyond. Together with the cyclical recovery post epidemic, this means China could well be a growth driver over the whole year, compensating for its role as a source of slowdown in Q1 2020 (assuming the virus effect reverses within two to three months). In the long term, it reaffirms the “policy put” that has guided Chinese actions for the past decade.

The immediate impact of the spread of COVID-19 is a global one, though it may be felt stronger in Asia due to the geographic proximity to China (where the virus started) and the close trade and social links of Asian economies with China. The spread of COVID-19 was exacerbated by it occurring around the holiday season at the end of 2019 and Lunar New Year in January — when millions were on the move. We expect personal consumption and services sector (from shopping, restaurant to tourism, etc.) in Asia to be the most affected part of the economy, while some manufacturing companies may be affected by not having full staff strength. This would exert downward pressures on GDP and inflation in Asia.

Asian governments and central banks are expected to take counter measures to provide fiscal support as well as lowering interest rates, supplying ample liquidity into the system to prevent panic selling of financial assets. In this region, we have had Malaysia, Thailand and the Philippines cutting interest rates since late January 2020 and we expect other central banks to soon adopt looser monetary policy stances as well.

Asian local currency bond yields are expected to decline on expectations of slower growth, lower inflation and rate cut expectations. At the same time, the Asian authorities may allow Asian currencies to depreciate moderately in line with lower growth expectation and to support exports. These measures are expected to help Asian economies weather this unexpected turbulence and keep growth stable.

Investment implications: a renewed search for yield
Even before the coronavirus outbreak, global fixed income investors were settling on the view that low – or even negative – interest rates may be a structural condition for the foreseeable future.

Continued, stimulative central bank activities around the world in the form of either policy rate moves or quantitative easing – such as the European Central Bank’s (ECB) Corporate Sector Purchase Programme – should reap benefits, including keeping GDP growth near its potential.

Expectation of lower rates will spark a renewed search for yield. Emerging markets are naturally at the fore with opportunities for both income and total returns. Asian bonds are expected to remain supported by the region’s central banks.

Virus-induced asset price moves are likely to correct once the growth rate of infections slows. Thereafter, Chinese policy support should provide a tailwind for global equities as well as the renminbi, with positive knock-on effects for other emerging market currencies. We expect Chinese bonds to be supported by policy easing. In addition, the country’s bonds have the attraction of inclusion in global indices, pointing to an ongoing increase in foreign participation.

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