Kheng-Siang Ng

Investors are finding the concerns that bedevilled markets in 2018 are still real and present, most notably the uncertainty around trade disputes, Brexit and the prospect of softening US economic growth.

Opinion is growing that the US Federal Reserve (Fed) will slow down its policy tightening. Indeed, the rates market recently priced in the probability of an interest rate cut later this year. As growth slows, and since the Fed’s most recent communication suggests a less hawkish stance, emerging market local currency debt may find support. 

GLOBAL GROWTH SET TO SLOW

With most advanced economies continuing to post some recovery last year, monetary policy tightening became one of the key trends. However, the cutting back of global liquidity levels creates a more challenging environment for many asset classes, and will potentially dampen global growth.

In the US, data still points to an improving economy; for example, January payroll and accelerating wage growth figures were above-consensus.

A number of factors including the Tax Cuts and Jobs Act may increase capital expenditure, and higher government and consumer spending are likely to fuel the US economy, seeing it potentially outperforming other territories. This expansion is expected to moderate to 2.6% in 2019, compared with last year’s robust 2.9%. 

IS THE FED TIGHTENING TOO QUICKLY?

Despite encouraging economic data, investors and US President Donald Trump viewed Fed rate hikes as too much, too soon. The median dot plot forecast in 2019 is for two rate rises, and Fed funds futures are even pricing in a small risk of a cut over the coming year.

Comments by Fed chair Jerome Powell in January 2019 also supported the view that the Fed may slow down or pause its tightening cycle. He stated: “With muted inflation readings that we've seen coming in, we will be patient as we watch to see how the economy evolves.” This suggests the central bank may adopt a more cautious stance, in contrast to the four increases it delivered in 2018.

LESS HAWKISH US FED SUPPORTS EMERGING MARKETS

2018 was a challenging year for emerging market assets, with stocks, currencies and bonds all under pressure. The key reason for the underperformance was a stronger US dollar, that came on the back of tighter monetary policy and strong US economic growth. The increasing risk of a global trade war triggered additional concerns for emerging markets and the repricing of local currency bonds.  

However, if changes in the US growth prospect cause the Fed to adjust its pace in raising rates, emerging market assets may see a rally. 

TRADE WAR REMAINS A MAJOR HEADWIND

However, there remain critical risks to Asia’s outlook. Ongoing trade tensions between the US and China may have a significant impact on the region’s growth.

An escalation of trade tariffs could further moderate growth in China. We expect the country to grow at 6% in 2019 easing from 6.6% last year, although the outlook is still uncertain and much depends on how severe the trade dispute becomes. We also believe China’s policymakers will continue to support the economy and the market by deploying a range of policy tools. 

2019: A RECOVERY FOR ASIAN LOCAL CURRENCY DEBT?

2019 started on a more positive note for Asian bond markets and Asian bond yields are expected to fall on the back of less hawkish central banks stance given easing inflation.

A shallower Fed rate path this year may support the recovery of Asian local currency debt. The sell-off in emerging market assets last year has brought down the valuations to more attractive levels, adding to the appeal of the asset class.  

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