The US Federal Reserve used its recent policy meeting to surprise markets by hinting that rate increases might begin earlier than expected, in 2023 rather than in 2024. The Fed has also indicated that it is growing more optimistic about US economic growth and employment conditions. These comments prompted financial markets to rethink their expectations of monetary policy and liquidity, and the result was a sharp sell-off in emerging Asian markets as investors remembered how the former Fed chief Ben Bernanke’s similar hints in 2013 caused the “taper tantrums” that rocked Asian equity and currency markets. Although markets have stabilised since then, they remain nervous.
Tighter US monetary policy could be a threat to emerging Asian markets and economies, going by previous experience. However, there are four good reasons why emerging Asia is better positioned today to deal with the likely turbulence in markets than in 2013. The first reason is that, unlike its downbeat condition in 2013, we believe that the global economic cycle is on the cusp of accelerating as the pandemic’s worst effects ease and generating an export boom for Asia. Second, there is less reason than in 2013 to expect a prolonged sequence of rate increases in the US or elsewhere: Therefore, easy liquidity conditions will be maintained and rates will remain at ultra-low levels for years. Third, better fundamentals have also strengthened emerging Asian markets’ resilience to financial turbulence. Finally, we also believe that risks in Asia, while real, are turning out to be more benign than many had feared, despite worries about US-China ties as well as protectionism.
Global economic upswing likely, Asia’s exports set to surge
While not downplaying the risks posed by the higher transmissibility of the Delta variant of the virus and the struggles many developing economies are having as they try to control the pandemic, our view is that the global economy is learning to shake off the damage caused by the pandemic. It is notable that, even with new variants emerging, the pandemic has largely come under control or has started to improve substantially in economies that account for roughly two-thirds of global GDP including the US, Europe, China, South Korea, Taiwan, Australia, New Zealand and some of the smaller nations in other parts of Asia. Separately, the number of new infections and fatalities is falling sharply in India where the pandemic had exerted a horrific toll and there are signs of a recovery emerging there. Basically, the risks associated with the pandemic have come down as officials have learnt how to deal with outbreaks of infections through more calibrated lockdowns, vaccination programmes have been accelerated and better medical treatments introduced to reduce the dangers posed by the virus.
The improved outlook is clear in the hard data. The OECD lead indicator, which predicts economic activity in the developed economies, has risen at a much stronger pace than the rebound just after the 2008/09 global financial crisis. The pipeline of new business that manufacturing and services companies are receiving across the globe is also surging forcefully. Companies are telling surveyors that they are feeling more confident about the future. Consequently, several forecasting agencies are predicting that the US economy will grow by more than 10% (seasonally adjusted annual rate) in the second quarter of this year: that is a sizzling pace for a mature economy. In Europe, several high-frequency indicators show activity returning quickly to normal as restrictions are eased. This is the case even in the UK, where the spread of a new variant has caused infections to move up again after falling dramatically in recent months.
This rebound in global activity is now spilling over more convincingly into rising export demand for Asian products. In the first 20 days of this month, South Korean exports climbed by around 30% while Taiwanese companies recorded further sharp gains in new orders for their exports in May. The global recovery is also benefiting commodity exports in Asia as prices have rallied compared with a year ago for coal, base metals, rubber and palm oil.
Global monetary conditions are likely to remain highly supportive of financial markets for now
If the world economy is really set for such a strong comeback, then shouldn’t we expect inflation to rise and cause central banks to raise interest rates?
Our view is that it is indeed healthy that the Fed is nudging markets gently in the direction of pricing in some tightening. Inflation is likely to move up from its unusually low pace of the past year and will return to a roughly 2% pace in the US over the next year. However, we do not see the recent spike in US inflation to above 5% lasting as it was compounded by a number of one-off factors such as a big spike up in used car prices. In fact, note that some of the commodity price increases that raised alarm bells on inflation recently have already given up some of their recent gains. Most surveys show that inflationary expectations are well-anchored — in other words, workers and companies do not see sustained high prices and are not agitating to push up wages and prices aggressively.
Thus, we do not expect a prolonged sequence of rate hikes in the US or elsewhere, certainly not for several years. There is still considerable unused capacity in most economies, which helps to cap price pressures. Moreover, there is still abundant slack even in the US labour market. That precludes the acceleration in US wage inflation without which a surge in consumer prices is not likely.
Overall, liquidity conditions will therefore continue to support asset prices globally as well as in emerging Asian markets.
Asian economies are more resilient to possible taper tantrums
Asia’s resilience to external shocks has been steadily improving in recent years. Circumstances today are different from 2013 when several Asian currencies plummeted and confidence fell quickly when markets started fearing rate hikes in the US. A major reason is that central banks have built credibility with investors. They have a better track record today of controlling inflation. They have also improved the way they communicate with markets — so they are seen as more transparent. In addition, countries such as India and Indonesia have taken steps to improve their fiscal position through, for example, the removal or reduction of fuel subsidies in addition to other tax reforms such as the introduction of the goods and services tax in India. On the external front, these same countries have reduced their current account deficits, cutting down their vulnerability to volatile capital flows.
Asian risks are turning out to be less worrisome than we thought
First, geopolitical risks for Asia, while still a concern, are beginning to steady.
That East and Southeast Asia will be a major arena for the growing contestation between the US and China is a given: It poses greater risks for the less powerful nations in the region that will have to worry more about potential clashes in their backyard. All true but, despite the many commentaries that breathlessly warn about the dangers lurking in that big power tussle, we have a different take on it. We see this competition, serious as it is, settling down into a new equilibrium where the risks of a full-blown conflict are contained and where there are even some potential advantages for emerging Asia.
First, the Biden administration’s tough but calibrated approach to China, in combination with its revitalised alliances, has sufficed, we believe, to deter China from overt aggression. Sure, China will pursue “grey-zone” tactics such as stepped-up air and naval intrusions in disputed areas but it will be more wary of provoking the more purposeful US that President Joe Biden has shaped by engaging in more forceful displays of aggression as it did, for example, in the South China Sea a decade ago. While the Biden foreign policy team has deliberately maintained “strategic ambiguity” about whether it will defend Taiwan against a Chinese invasion, its recent arms sales, new legislation in support of Taiwan and the general determination to stand up to China have raised the risks for China of any belligerent move there. The tougher US posture has also influenced Japanese policy — the Suga administration had been expected to adopt a softer tone with China but has instead been just as firm as its predecessor. A senior minister has floated the idea of raising defence spending above the informal limit of 1% of GDP while ruling party officials have openly discussed the possibility that Japan might assist Taiwan in the event of a Chinese invasion.
Second, the Biden administration has increased the strategic priority accorded to East and Southeast Asia. It was no coincidence that Biden received both Japanese Prime Minister Yoshihide Suga and South Korean President Moon Jae-in as among his earliest foreign leader guests. The administration’s Asia policy is also led by experienced Asia hands such as Kurt Campbell, who has increased the confidence of the US’ allies in Asia.
Third, the US and its allies have also made clear that they will match China where they can with largesse for emerging economies. Whether it is donations of vaccines or the Western riposte to China’s Belt and Road Initiative, this sort of competition with China could lead to more aid or other kinds of financial support for emerging Asian nations.
Second, protectionism and de-globalisation risks are being better managed.There are some signs that protectionism will be less of a threat to Asian economies than we once feared. Trade officials in the Biden administration have tightened some technological restrictions on Chinese companies but have not pursued wider and more aggressive trade restrictions against China. It has also avoided using the “currency manipulation” accusation to justify trade measures against Asian economies in its most recent report on currencies.
The agreement between the US and Europe to resolve the longstanding dispute over subsidies for aircraft manufactures was also a positive sign. The G7 agreement on global taxation could also help avoid damaging trade frictions — the US had threatened to impose tariffs on European countries pursuing a digital sales tax on US tech giants. Moreover, the likely progress in expanding the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP) is also a net positive for Asian trade.
Conclusion: More turbulence but Asia can cope
In short, Asian asset prices and currencies will probably face a period of greater volatility for several months. The unusual nature of this pandemic and the slowdown it has caused will make it more difficult for investors to interpret the data on economic activity, job creation and inflation. So, episodes of market confusion are possible, which could lead to more ups and downs in financial markets.
But, if investors and businesses in the region look beyond this near-term excitability in markets, what they will find is that the fundamentals in emerging Asia are improving. Downside risks exist but can be contained while the economic upside is likely to be better than expected.
Manu Bhaskaran is CEO of Centennial Asia Advisors