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The first half of this year was a story of resilience and recovery, with emerging market stocks and bonds rebounding from the dip of 2018 and delivering better-than-expected returns. In particular, Asian local currency government bonds recorded a total return of 4.70% in USD terms1 in the first six months, as measured by Markit iBoxx Pan Asia Bond Index.
Looking ahead, Asian bonds are expected to retain their support on the back of moderate growth, low inflation, and central banks’ accommodative monetary policies, while the decline in the USD should provide support to Asian currencies in the near term. However, downside risk could increase if trade war tensions escalate.
Uncertainties inhibit economic growth
Weaker global trade flows in 2018 hurt global economic momentum and reined in growth projections for 2019. Now, midway through the year, the threat of a protracted US-China trade war has impacted the US economy. Meanwhile, Europe’s economy could be dampened by insipid growth in certain countries and a lack of clarity on the future of the UK-EU relationship.
This overall slowdown means a decline in demand for Asian exports which, coupled with weaker domestic markets, signals a likely softening of economic growth in the region. Recent data indicates growth is likely to remain subdued. Demand for exports is also weighed down by weaker global demand and a shift in the electronics inventory cycle. Manufacturing purchasing manager index (PMI) numbers — widely considered to be forward-looking indicators — are also likely to be dragged by falling new export orders due to uncertainties surrounding the unresolved US-China trade war.
Further, China’s economy continues to decelerate as it goes through a period of rebalancing. On a more positive note, however, with the latest manufacturing PMI numbers falling into contractionary territory, we expect China to introduce more domestically focused fiscal stimulus measures to help boost growth in the coming months. We expect China’s economy to grow at around 6% this year.
Doves flock across Asian financial horizons
With the US Fed now indicating the prospect of slower growth and increasing market expectations for monetary easing, Asian central banks are likely to maintain dovish monetary policy stances in the face of benign inflation and slowing growth.
Central banks in the Philippines, Malaysia, and India have cut rates in recent months to bolster their economies against an escalating trade war. While we expect Bank Negara Malaysia to be on hold following a cut in its policy rate in May, the monetary easing bias in the Philippines is likely to continue after the central bank unexpectedly announced a pause in June. Most recently, Bank of Korea surprised the market with its first interest rate cut, citing headwinds to external demand, a slowdown in the tech sector, and concerns related to the Korea-Japan trade dispute. Subsequent comments from the central bank indicate a dovish stance will be maintained going forward. Bank Indonesia also made its first interest rate cut recently against a backdrop of a slowing economy and subdued inflation. The recovery of the Indonesia rupiah also creates more policy room for the central bank to lower interest rates in the coming months.
A divergence of regional bond fortunes
If the US-China trade dispute escalates, bond markets in the region could have a mixed outlook — while we envisage falling rates in countries such as Korea, yields could be driven higher in other Asian countries. A worsening US-China trade spat would not only hurt growth but would also harm emerging market sentiment and currencies, putting pressure on countries with high current account and budget deficits. The bond markets in Indonesia and Malaysia, for example, would face the prospect of outflows and rising rates if markets turn to risk-aversion mode because of rising trade tensions and weakening currencies. Malaysian bonds may be further affected by their potential exclusion from the FTSE World Government Bond Index later this year. Thai bonds, on the other hand, may be supported by the ongoing political uncertainty, while Chinese bonds may benefit from policy easing measures.
Trade tensions to determine economic outlook
At the mid-point of 2019, we seem to be in a binary situation where outcomes for the rest of the year depend on how the US-China trade dispute develops. If a deal is reached later this year, the potential for modest economic growth over the next six to 12 months remains good. US Fed policy should remain accommodative to boost the economy, and the positive effects of China’s fiscal stimulus could gain momentum.
If trade tensions persist, they are likely to have a damaging impact on global growth and emerging market sentiment. Central banks will be ready to ease their policies, however, and we expect Asian bonds to be mixed as yields in some countries could still rise on the back of weakening currencies.
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