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Asian Bond Watch: Slowing growth and less hawkish US Fed shape investors’ dreams for 2019

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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

Investors woke to a new year to find the bad dreams that haunted global markets in 2018 were still present — most notably uncertainties around trade disputes, the unsettling Brexit effect, and the prospect of softening US growth.

Following four rate hikes in 2018, the US Federal Reserve (Fed) recently announced a temporary halt in its interest rate rises and the rates market priced in the probability of an interest rate cut later this year. As growth slows and the Fed adopts a less hawkish stance, emerging market local currency debt may find support.

Global growth set to slow
Monetary policy tightening was one of the key trends last year as most advanced economies recorded a degree of recovery. The cutting back of global liquidity levels, however, has created a more challenging environment for many asset classes and could hinder global growth.

Data still points to an improving economy in the US with higher-than-expected wage growth figures released in early January. Factors such as the impact of the 2017 Tax Cuts and Jobs Act may also increase capital expenditure, and higher government and consumer spending should fuel continuing US growth, although it is expected to be moderate at 2.6% compared with 2.9% last year.

Too much tightening too soon?
Despite the encouraging economic data, some investors consider last year’s Fed rate hikes to have been too much too soon — a view President Trump shares. The median dot plot forecast predicts two rate rises in 2019, and Fed funds futures are even pricing in the small risk of a cut.

At the end of January, however, Fed Chair Jerome Powell confirmed the Fed was suspending plans for further rate hikes, saying the case for them had weakened, while insisting the Fed had the “luxury of patience” in deciding whether to raise them again.

A brighter outlook for emerging market assets
2018 was a challenging year for emerging market assets, with stocks, currencies, and bonds all under pressure. The key reason for their underperformance was a stronger US dollar, driven by tighter monetary policy and robust economic growth. The rising risk of a global trade war triggered additional concerns for emerging markets and the repricing of local currency bonds.

However, as changes in the prospects for US growth cause the Fed to adjust its pace in raising rates, emerging market assets may see a rally.

Trade tensions continue to send a shiver through markets
Those positive signs, however, are tempered by critical risks to Asia’s outlook for 2019, in particular the continuing trade tensions between the US and China which may have a significant impact on the region’s growth.

An escalation of trade tariffs could further inhibit growth in China. We expect China’s growth to ease from 6.6% last year to 6% in 2019, and although the situation remains fluid, much will depend on how severe the trade dispute becomes. We believe Chinese policymakers will continue to deploy a broad range of policy tools to support the economy.

A year of recovery for local currency debt in Asia
2019 has started on a more positive note for Asian bond markets. Asian bond yields are expected to fall on the back of slowing growth and the less hawkish stance of central banks given easing inflation.

A shallower Fed rate path this year may also support the recovery of Asian local currency debt. The sell-off in emerging market assets last year has brought valuations down to more attractive levels, adding to the appeal of this asset class.

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