Don’t forget Asia has animal spirits too. 2016 was year of the Monkey with jumpy events such as Brexit and US elections results. How did Asian bonds perform in this mischievous environment? Quite respectable against the more volatile regional equities and against global bonds.
In 2017, we welcome the Fire Rooster which symbolizes waking early, staying late and working harder for investors to extract returns. As we ploughed through the yearly outlooks, we saw no shortage of negative pieces and predictions for doom and gloom for this region. Admittedly, while we are cautious near term given the treasury yield movements and the stronger USD trends, we venture to provide three contrarian predictions for 2017.
1. Asia to overcome Trump’s trade policies
Trump’s plans will likely cost the region from a trade (protectionism) and flow (Asia=> US asset rotation).
How bad can it get? Although there are different ways to assess this, we think a severe stress-test of current account (CA) ex-US exports and foreign asset holdings vs. FX reserves works well.
The test is extreme in three forms:
1) We assume Asia does not export to the US at all but keeps imports unchanged (unlikely).
2) We assume foreigners exit at the same time for all equities and bonds (also unlikely).
3) We assume instantaneous application of Trump’s key policies (time value).
Findings: Headwinds are manageable even in the extremes
2. No Asian Financial Crisis 2.0 (AFC)
Looking today, the risks of an AFC are notably lower, and although some countries have selective vulnerabilities, it is much less likely to have the same level of contagion.
As a refresher, the 1997 AFC resulted from sharp Balance of Payment (BoP) imbalances beyond external buffers, i.e. simultaneous CA and capital account deterioration.
BoP comparison vs. 1997 AFC
3. Buy on fear in Asian local currency bonds later in the year
As duration and foreign exchange can be significant drivers for local currency bond returns, we see limited need to fight the trend of higher rates and a stronger dollar for now. We, however, need to remember the region has sufficient buffers to weather US trade protectionism and capital outflows. Taken into context, this implies no sovereign defaults or BoP crisis at the regional level.
So what does all this mean for investors? As markets get more clarity on Trump policy and the FOMC, there will be a clearing level on the more hawkish Fed and the dollar. Commensurately, we should see a renewed investment opportunity in the asset class as valuation compensates for the new set of expectations.