This article first appeared in The Edge Malaysia Weekly on July 4, 2022 - July 10, 2022

HAVING gone through a global health crisis in the past two years, 2022 is not turning out much better.

US equities recently slipped into bear territory after the Federal Reserve turned aggressively hawkish on interest rates this year. Commodity prices, which were already climbing during the pandemic, shot through the roof when Russia invaded Ukraine in February. And China — at odds with the US over politics and trade — remains resolute in maintaining its zero-Covid policy, putting global supply chains at risk of further disruptions.

With commodity prices remaining high, fears of a global recession have led to concerns of stagflation.

Although corporate observers often point out that all economic and financial crises differ in their root cause, the recent ones — namely, the 2008 global financial crisis, the 2009 European sovereign debt crisis and the Covid-19 crisis — share one thing in common: the backdrop of abundant liquidity.

These crises were essentially, or at least partially, addressed by central banks lowering interest rates and providing cheap loans. Notably, the US had four quantitative easing (QE) operations between 2008 and 2020, pumping trillions of dollars to support the markets.

When Jerome Powell took office as the 16th chair of the Fed in 2018, the US was ready to pull liquidity from the financial system. Then came the pandemic in 2020. Central banks had no choice but to stick to their policy of monetary easing, while governments introduced various fiscal stimulus packages.

The easy money and stimulus led to inflation, with assets such as equities being overvalued. Meanwhile, supply chain disruptions, the reopening of borders and pent-up demand sent prices soaring.

With expectations of higher interest rates and slower growth, US equities have slipped into bear territory after falling 20% to 30% year to date. This is in stark contrast to Brent crude oil, which has risen 40%.

The Bloomberg Base Metals Spot Price Commodity Index had gained 27% since early this year to its peak in March, before declining 32% over the next three months due to US recession fears. On the home front, crude palm oil (CPO) has seen volatile trade, gaining 50% to reach a peak at end-April before falling 37% over the next two months.

Apart from such external headwinds, Malaysia also faces political uncertainty.

The Fed’s hawkish stance, the Russia-Ukraine conflict, China’s zero-Covid policy, the ongoing US-China trade war and uncertainty on Malaysia’s political scene are five factors that dictated economic performance and market sentiment in the first half of this year (1H2022), and will likely continue to do so in the second half (2H2022).

The Hawk Is Back

In mid-June, the Fed raised its benchmark interest rate by 75 basis points (bps), its most aggressive hike since 1994, as it moved to douse red-hot inflation. This took the Fed funds rate to a range of between 1.5% and 1.75%, the highest level since March 2020. Fed chair Powell is expected to raise interest rates by another 50bps or 75bps at the central bank’s next meeting this month.

Stocks tumbled in 1H2022 due to fears that the Fed’s aggressive rate hikes could lead to a sharp economic slowdown in the US. Fortunately — perhaps less so for local investors waiting to buy the dip — the FBM KLCI and the FBM Emas Index only fell about 8% to 9%, with institutional funds providing support to share prices.

Have investors priced in a possible hard landing in the US or did they overreact when equities went tumbling?

Dr Yeah Kim Leng, professor of economics at Sunway University Business School, believes that as long as the Russia-Ukraine war remains unresolved, along with the accompanying sanctions on Russia, the global economy and financial markets will be fraught with uncertainties, especially with central banks’ efforts to stabilise inflation.

“One cannot be optimistic given the severity of the impact of the pandemic on the economy and on society, the fledgling economic recovery in many countries and another global shock in the form of the Russia-Ukraine war. Fiscal deficits and debt levels of households, firms and governments have risen after each shock, thereby increasing the risks and vulnerability to financial crises,” he tells The Edge.

Yeah is of the view that the sharp rate hike trajectory mounted by the Fed to tame inflation, which hovered above 7% in May, will inevitably cause the US economy to slow down substantially. “The hoped-for outcome is a soft landing. Further falls in the stock market will likely need to occur for a looming recession to be priced in,” he adds.

In the post-pandemic recovery, the US economy is experiencing historically low unemployment at 3.5% while the shortage of workers has put upward pressure on wages, says Yeah. High inflation, however, has eroded consumer purchasing power and dampened consumer sentiment to levels similar to that during the 2008 global financial crisis.

“With the Fed expected to raise rates and withdraw its QE programmes, financial conditions in the US are anticipated to tighten further, and this will have negative repercussions for financial markets in the rest of the world,” he points out.

Singular Asset Management Sdn Bhd founder and chief investment officer Teoh Kok Lin opines that financial markets have almost fully priced in a 75bps hike that is expected to take place at the Fed’s next meeting on July 26 and 27, with the US central bank’s policy rate expected to peak at about 3.6% in 2023.

On whether markets have priced in the risk of an economic contraction, several probability estimates have been well telegraphed. Bloomberg Economics attached a 72% chance of a US recession by the first quarter of 2024. Morgan Stanley estimated a 35% probability of a US recession in the next 12 months. Goldman Sachs recently revised upwards its US recession odds, with the probability of a recession at 30% in 2023 and 50% in the next two years. Economists at Deutsche Bank and Citigroup also see the likelihood of a global recession at about 50%.

“All in all, we are not optimistic, given the high probability of a recession in the US and Europe within the next 12 months as growth momentum decelerates. Having said that, Asia may be fortunate to avoid falling into a recession if China’s border reopening, stimulus and thus recovery step up meaningfully in the next 12 months,” says Teoh.

No End In Sight For Russia-Ukraine War

Just as the world slowly emerges from the Covid-19 pandemic, another black swan event occurred when Russian President Vladimir Putin ordered the deployment of troops into Ukraine in February.

Ukraine is among the world’s top agricultural producers and exporters, while Russia is the world’s second largest exporter of crude oil after Saudi Arabia. The conflict has caused commodity prices to soar and has further stressed global supply chains already strained by pandemic-induced lockdowns.

More than four months into the Russia-Ukraine war, commodity prices have somewhat stabilised. Is the worst over?

Given the importance of Ukraine and Russia to the agriculture and crude oil markets respectively, Value Partners Asset Management Malaysia Sdn Bhd fund manager Kamal Mustadza is of the view that a prolonged war will continue to adversely affect market sentiment and cause commodity prices to remain elevated.

“Geopolitical conflict is often a culmination of fear and ego among a few, and ultimately the price will be paid by the masses — there is no winner. The situation between Russia and Ukraine remains fluid, with no end in sight for now. How it will end remains anyone’s guess, with the likely scenario being an extended conflict in Ukraine, with a long-term political, economic and military standoff between the West and Russia,” he says.

Fortress Capital Asset Management (M) Sdn Bhd investment adviser and director Geoffrey Ng Ching Fung points out that although geopolitical tensions were already rising early this year, the Russia-Ukraine war was unexpected and has exacerbated the current inflationary environment. “Market sentiment has obviously been negatively impacted, with investors preferring to remain on the sidelines,” he notes.

Nevertheless, Ng argues that as long as there isn’t a worsening of the geopolitical situation or an expansion of the war, the current high fuel and food prices may actually help curb consumption demand and, therefore, aid the efforts of the Fed and other central banks in reining in inflation.

However, Sunway University’s Yeah thinks the worst has yet to come as arms are being shipped to Ukraine, as opposed to both sides coming to the table to seek a political solution. “With no end in sight, the risk of escalation and accidents will perpetuate the ‘risk-off’ investment landscape. The high fuel, food and other commodity prices are expected to remain high.

“Therefore, it will be prudent for governments, businesses and people to prepare for further weakening of market sentiment and for the prevailing high price levels to continue through 2023,” he warns.

China’s Painful Zero-Covid Policy

China — the world’s factory — has been imposing the zero-Covid policy to curb infections, but its extreme measures have severely disrupted global supply chains.

In fact, the country’s Covid-related restrictions and lockdowns have hurt factory production and corporate earnings over the past two years. Manufacturers are struggling to get back to full capacity and manpower shortages create longer delivery lead times, while shipping fees are escalating.

During a symbolic visit to Wuhan last week, Chinese President Xi Jinping declared zero-Covid the most “economic and effective” policy for China, as relaxing controls would risk too many lives in the country.

“We would rather temporarily affect a little economic development, than to risk harming people’s life safety and physical health, especially the elderly and children,” he said.

Bloomberg reported that Xi’s comments will likely dash hopes that China is cautiously embarking on an exit plan. Economists surveyed by Bloomberg predict China’s economic growth to be just 4.1% for this year, lower than the government’s target of around 5.5%.

“Xi’s comments in Wuhan suggest that China’s top leadership sees Covid as a legitimate reason to miss the economic growth objectives and that China’s overall Covid stance is unlikely to change any time soon,” says Louis Kuijs, Asia Pacific chief economist at S&P Global Ratings.

“In turn, that means that new outbreaks will continue to pose serious risks to the economy and that economic sentiment will continue to be affected,” he adds.

So, how will global supply chains be shaped in a post-pandemic world? What should businesses do to avoid and manage breakdowns in their manufacturing cycles? Is regionalisation the answer to supply chain risk mitigation?

Singular’s Teoh observes that global supply chains have started to be restored as countries reopen, but the speed of recovery will still hinge on China’s stance on its zero-Covid strategy, as well as the geopolitical developments stemming from the Russia-Ukraine conflict, including the sanctions against Russia and the curtailment of energy to Europe.

“Given such a backdrop, I think the first step is to go beyond one’s immediate supplier to assess the entire value chain’s exposure to supply chain shocks, develop alternative supply sources, and keep sufficient inventory,” he advises.

“Evaluate your capital structure, loans and credit, in light of interest rate increases and the need to maintain enough cushion. Keeping up with global developments, geopolitics, economic policies, international suppliers’ policies, is also key,” Teoh adds.

As China continues to impose its zero-Covid policy, Value Partners’ Kamal says the supply chain disruption is far from over and companies around the world will be forced to re-examine their sources for goods to mitigate this risk.

“Regionalisation does provide some answers, but bear in mind that the biggest challenge for companies is to make their supply chains more resilient without weakening their competitiveness — controlling the cost of production remains key,” he analyses.

Kamal adds that companies should consider diversifying their supply base by not concentrating on a single country or region, while holding adequate amounts of inventory and developing digital supply chain strategies as ways to mitigate the supply chain risk.

Rethinking The US-China Trade War

Over the past two years, the ongoing trade war between the US and China has largely been overshadowed by the Covid pandemic and the Russia-Ukraine war.

Between 2018 and 2020, the US and China fought the biggest trade war since the 1930s, hiking tariffs, upending markets and threatening to plunge the global economy into recession.

The Phase One Trade Deal was signed in January 2020. A year later, Donald Trump left office and Joe Biden was inaugurated as the US president.

Nevertheless, the retaliatory tariffs between the two countries have not been lifted under the Biden administration as they emphasise strategic competition rather than head-on confrontation and decoupling in dealing with China’s rising economic power and geopolitical influence.

But as the US faces the fastest inflation since the 1980s, will it be more willing to tolerate or take a softer stance in the trade war?

Given the threat of spiralling inflation and stagflation facing the US economy, lifting the tariffs on Chinese imports would be a viable policy option to dampen inflationary pressures, says Sunway University’s Yeah.

However, he believes economic rationale is unlikely to prevail over the China-containment-at-all-costs policy circle holding sway in the White House.

“Given that the trade war has turned out to be ineffective as shown by the rise in imports from China, it is likely that the Biden administration will shift its focus to other containment strategies such as limiting technology transfers, curbing activities of Chinese technology companies and strengthening its sphere of influence through initiatives such as [the] Indo Pacific Economic Framework,” says Yeah, who believes it will be in US interests to tackle its high inflation problem by easing its trade war with Beijing, as the reduction of tariffs will lower consumer prices of Chinese imports.

More importantly, a reciprocal response will help to expand US exports to China.

“The higher exports in turn will spur economic activities and reduce the likelihood of a recession. This is the veritable win-win outcome in trade,” says Yeah.

While the US-China trade war seems to have taken a back seat for now, Value Partners’ Kamal says it does not mean it is over.

“Biden’s hands are pretty much tied, both on the domestic front as well as on the international stage. If there is one thing that can unite both sides of the political divide, that would be their bipartisan stance towards China,” he comments.

Therefore, any perceived weakness in dealing with China will be exploited by his critics and detractors, consequently delivering a crushing blow to the current US administration, especially with midterm elections looming, says Kamal.

“However, as Biden is facing intense pressure to bring down inflation in any way he can, his administration is reviewing whether to drop some of the billions in tariffs on China to ease inflationary pressures. Some compromise may eventually be made, especially on those deemed as serving no strategic purpose, but drastic change is unlikely to happen,” he says.

GE15 Now Or Later?

Last August, Datuk Seri Ismail Sabri Yaakob was sworn in as Malaysia’s third prime minister in 18 months. The political instability in the country is said to be driving away investors and weighing on the country’s economic outlook.

Given the fluid political situation, certain camps have called for an early general election. Amid all the noise, the question looming over the nation is whether the 15th General Election (GE15), which must be held by September 2023, will be called as soon as in the next six months or later in 2023? And is one better than the other for the country as a whole?

Notably, Ismail Sabri had on June 24 announced the government’s decision to maintain the electricity and water tariffs in Peninsular Malaysia. A new price ceiling was also announced in efforts to bring down the rising cost of living.

CGS-CIMB Securities Sdn Bhd analysts Ivy Ng Lee Fang and Nagulan Ravi highlight that the government’s plans to raise subsidies to cover the cost of living will be viewed positively and could boost market sentiment in the short term. They add that the decision is expected to help sustain consumer purchasing power and reduce operational cost pressures on Malaysian corporates in 2H2022.

“This, combined with the return of foreign workers, could boost the competitiveness of the Malaysian manufacturing sector in the export market. The above measures could also signal an early general election for Malaysia in 2H2022,” they write in a report dated June 27.

On the same day, S&P Global Ratings revised upwards its rating outlook on Malaysia’s long-term sovereign credit ratings to “stable” from “negative”, reflecting its expectation that the country’s steady growth momentum and strong external position will remain in place for the next two years.

The credit rating agency also notes that while political fluidity remains, uncertainties regarding policymaking have somewhat subsided.

“In September 2021, the government signed a memorandum of understanding (MoU) with the opposition. The MoU addresses bipartisan cooperation on Budget 2022, political stability and long-term political reforms. Hence, we expect fewer disruptions to policy directions until at least the next general elections,” S&P states.

Under the MoU, the federal government and Pakatan Harapan opposition agreed to not hold the GE before July 31, which many took to mean that the agreement expires on this date. However, Minister in the Prime Minister’s Department (Parliament and Law), Datuk Seri Dr Wan Junaidi Tuanku Jaafar and Minister of Communications and Multimedia, Tan Sri Annuar Musa said this is not the case.

Due to evolving political dynamics, Sunway University’s Yeah says it is difficult to say if it is better to hold GE15 in 2H2022 or in 2023.

An early election will be positive for the economy and stock market if the outcome allays investors’ concerns about the fragile government and policy uncertainties. On the other hand, if the early election does not result in a strong and credible government, both the economy and the stock market will languish, perhaps even more severely as the “wait and see” investors take flight.

“Having the GE uncertainty settled, the new government with a five-year mandate will therefore be able to tackle the economic headwinds and undertake difficult structural reforms without the fear of voter backlash. Investors and financial markets will find favour with policies and structural reforms that strengthen economic growth and resilience,” he notes.

Conversely, says Yeah, holding the general election next year will allow the current government to focus its efforts on confronting the challenges posed by rising global inflation and slowing growth in 2H2022.

“It will also allow the economic recovery to strengthen in 2H2022 without being distracted or derailed by the general election, especially if political instability is magnified by leadership tussles and infighting among coalition parties,” he explains.

In addition, party dynamics could stabilise next year as the conundrum posed by the possibility of party leaders facing corruption charges taking over the reins of government would likely be resolved, says Yeah.

Fortress Capital’s Ng acknowledges that the political uncertainty and past actions of various political parties in recent years have cast a cloud of negativity among local and in particular, foreign investors.

“A general lack of focus on the economy due to political manoeuvring has caused the Malaysian economy to be on cruise control and the private sector left to find their own way,” he says.

“With GE15 being fairly imminent, the jury is still out on whether anything concrete and positive can arise from the elections that will result in a government that can improve policymaking and increase the country’s economic well-being,” Ng adds.

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