Investors advised to ignore US noise

A US default seems not to have been priced in by Asian investors, despite the current government shutdown. Whatever else happens, QE tapering seems likely to be postponed.
Investors advised to ignore US noise

As the US government shutdown entered its second week, Asian asset owners and fund managers are eyeing the country, and their portfolios, cautiously. But economists, fund managers and analysts maintain that investors should retain their long-term views and ignore the noise from Washington.

A number of private banks advise their clients to maintain exposure to the US. Michael Ryan, head of wealth management research at UBS in New York, urges clients to “look beyond the current DC-inspired drama and focus once more upon gradually improving growth prospects”. This involves being overweight US equities, notably small- to mid-cap stocks and cyclical sectors.

Mark Matthews, head of research for Asia at Julius Baer, adds: “We see enough evidence of a cyclical upturn in the global economy – continued recovery in the US, China, Japan and Europe – that we have been advising clients to add to ‘heavy industry’ sectors like shipbuilding, steel, petrochemicals and construction”.

Most Asian industry participants say the odds of the world’s largest economy defaulting are slim. Yet if politicians in Washington fail to raise the country's borrowing limit by October 17 – just over a week from today – it will risk being unable to pay its debts. The US needs about $60 billion a day to meet its obligations. China, as America’s largest creditor, has a lot to lose.

On the whole, however, Asian asset managers “generally have not priced the possibility of a US default into their portfolios”, Matthews tells AsianInvestor. “So if [a default] happens, we can expect a lot of selling."

The impact on Asian bond prices has been muted so far, notes Lian Chia-Liang, head of investment for Asia ex-Japan at fixed income specialist Western Asset. He argues that bonds had already been repriced in the three months after the tapering hints started in May.

Yet the situation seems to have made issuers cautious. 

UK private bank Coutts notes US investment-grade issuance, for example, slowed to $10.8 billion from $34.5 billion in the week ending October 4 compared to the prior week, while high-yield bond fund flows slowed to $268 million from $3.1 billion the week ending Sept 27. 

On the flipside, however, a prolonged government shutdown could actually lead to an uptick in bond issuance by Asian companies in the coming week, argues one Hong Kong-based bond fund manager. 

“It’s already mid-October, and there are two-and-a-half months left this year. December can be written off, so I suspect that over the next week, ahead of the October 17 debt-ceiling deadline, there could be a lot more issuance,” the source says. 

“From a banker’s point of view, why wait and see what happens? Would you rather not do anything? Or would you rather print the ticket earlier [and get] revenues booked for the rest of the year?”

“The world could be very different in a month’s time,” he adds.

It’s still too early to say how a drawn-out government shutdown would affect Asian bond markets, but Western's Lian anticipates a flight to US treasury-like, high-quality fixed income assets will likely ensue. This includes highly rated sovereign bonds in countries such as Hong Kong, Korea and Singapore.

One impact the shutdown will have is on the start date of the tapering of US quantitative easing. Initially expected to begin in September, Matthews says the debacle in Washington will almost certainly push it back to March.

“[The government shutdown] will crimp investment and consumption in the US," he says. "Not a lot, but enough [to give] the government an excuse to delay the tapering."

Historically, government shutdowns do not have major, long-term impacts on global economies, sources note.

The last US government shutdown happened under the Clinton administration in late 1995-1996. Reasons for that shutdown were similar to today’s – then-president Bill Clinton and the House of Representatives failed to agree on a budget to fund federal services. While seemingly significant at the time, it wound up being a blip, industry observers say.

“I would focus on the numbers,” Matthews says, pointing to US unemployment numbers, which stand at 7.3% today, just slightly above the ideal number of 7%.

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