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Asian Bond Watch
Fed's pause and inching US-China trade resolution improve liquidity
8 Apr 2019
The ongoing trade dispute between two of the world's largest nations is a significant force influencing market movements. US and Chinese officials have held rounds of trade talks trying to lay out a deal and put an end to their months-long spat. US President Donald Trump said his team is getting very close to a deal with China but recently he warned that he is thinking of keeping the tariffs on China for a substantial period of time until he decides China has enforced the terms of the deal.
President Trump's vacillating stance on tariffs adds a bit of cloud to the prospect of an end to the trade war and there may be more bumps in the road before the US-China trade deal is sorted. However, if a lasting resolution emerges, investor confidence and economic growth may rise.
Is a trade deal around the corner?
The ramping-up of trade tensions since last year has caused a shrinkage in global trading activity. According to China's General Administration of Customs agency, the volume of trade between the US and China fell to US$76.50 billion between January and February 2019, a 20% drop when compared with the same period in 2018.1 The agency's data also shows China's exports to the US declined by 14.1% to US$59.30 billion in the same period, while the US exported just US$17.18 billion worth of goods to China, a 35% decrease from last year.1
While the trade war's impact on China's economy is not doubted, a slowdown in global growth has also affected trade performance. China's February data revealed a 20.7% drop in exports from a year earlier, the biggest decline since February 2016.1 Imports fell for the third straight month, sliding by 5.2% from the previous year.1 China's economic growth also remains in a long-term slowdown.
China stimulus provides support
From a short-term cyclical standpoint, we expect China's latest fiscal and monetary stimulus to provide some support at home, and across the region. Total social financing for January saw a sharp increase as this stimulus started to come through, although February's figure was lower than expected. Overall financing for the first two months of 2019 has been Rmb 1 trillion (US$148.5 billion) higher than the same period in 2018. Much of 2019's financing has gone into short-term loans for companies, so the stimulus is unlikely to be prolonged given the already high levels of corporate leverage.
Recent comments by the Chinese premier Li Keqiang also suggest this latest stimulus is very different from that of 2015/2016. It is designed to cushion the effects of slower growth on highly levered businesses and to preserve jobs rather than to boost overall economic growth. China recently lowered its expected growth rate for 2019 to 6%-6.5%, and so we would not expect further aggressive stimulus from authorities unless they have to defend the lower end of this range.2
Unlocking pent-up demand
In the US, an inverted yield curve in the latter half of March followed a dovish surprise from the Federal Reserve (Fed). This triggered widespread fears of a recession, causing stock markets to retreat.
We believe the picture appears more stable than what some negative headlines might imply. While December's data was unexpectedly weak, this was most likely hurt by the US government shutdown and seasonal factors. Jobs data suggests companies are still hiring, and manufacturing employment, in particular, remains strong. Additionally, US retail sales showed signs of stability in January, while in February consumer prices rose for the first time in four months, albeit at a modest pace.
We interpret these factors to mean that while headline growth has decelerated in the US, the economy continues to hum beneath the surface, and we believe this pent-up demand could be unleashed by a permanent resolution to the US-China trade disagreement.
Positive outlook for EM foreign exchange
With the Fed on pause, and the US-China trade dispute inching toward resolution, the improving liquidity picture is strengthening our case to be constructive about emerging markets (EM), while remaining aware of both macro and country-specific risks such as upcoming elections in India.
The US economic expansion is now the longest ever, at 117 months, so the Fed may take its time before it moves on rates, whether up or down, although the US consumption story appears intact for now.
More accommodative policy should be positive for EM foreign exchange against the dollar unless EM growth weakens substantially from here on.
1 Source: China's General Administration of Customs, as at 28 February 2019.
2 Source: State Street Global Advisors, https://www.ssga.com/blog/2019/03/cautious-on-emerging-markets-until-fundamentals-pick-up.html
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