Investors shrug off IMF concern on debt markets

May 2, 2018

For some strategists, Asian bond markets are justified in currently pricing in only a low probability of a damaging trade war triggered by tensions between the US and China.

Investors shrug off IMF concern on debt markets

Asian investors are keeping a close eye on recent trade tensions between the US and China but they are not yet shifting allocations in anticipation of a possible all-out trade war.

Last month, the IMF used its half-yearly global economic health check to warn of the impact on global debt markets from the increased risk of a trade war.

But fund managers and debt market analysts AsianInvestor spoke to remain sanguine about the potential fallout for the Asia-Pacific region, chiming with the way bond markets have behaved -- the year-to-return on the S&P Pan Asia Bond index, for example, remains positive as yields in the region have continued to drift lower even as those on US Treasuries have risen.

“The big risk is not to Asia but to Europe, notably Germany,” said Ariel Bezalel, head of fixed income strategy at Jupiter Asset Management in London, as he explained why Asian bond markets are currently justified in pricing in only a low probability of a damaging trade war.

With easily the world's largest current account surplus, Germany is a leader in capital goods and vehicle exports but it has also benefited from having a weaker currency than might otherwise be justified through its membership of the eurozone. This was further in the spotlight this week as the euro fell to $1.1981, its weakest level against the dollar since January.

If anything, said Jan Dehn, head of research at investment manager Ashmore in London, Asian markets have overpriced the danger of a trade war.

“Protectionism won’t be as widespread as the market believes,” he said, partly because Chinese President Xi Jingping won't come under undue pressure to exceed any US measures, weaken the renminbi, or dump China's huge holding of US Treasuries in retaliation, such is the strength of his power base.

The rebalancing of the Chinese economy, he added, remained a more important medium-term influence on its bond market than US tariffs, he added.

“Greater consumption will create a current account deficit that will require Beijing to liberalise the capital account to finance it," Dehn said. "The opening of the domestic bond market and the addition of China to international bond indices will result in a rush of foreign money, driving asset values higher.”

SUPPLY CHAINS

Jeffrey Tan, regional investment director at insurance group Ageas in Hong Kong, said he was watching the situation carefully but not yet inclined to adjust his allocations in response.

He nonetheless highlighted US efforts to crack down on the theft of intellectual property by Chinese firms as a key risk for the country's technology sector. So too did Aidan Yao, senior emerging Asia economist at Axa Investment Management in Hong Kong, who also noted the potential wider ramifications for electronic goods parts suppliers in Korea, Taiwan, Singapore, and Japan.

Companies in the Philippines, in contrast, probably benefitted from an extra layer of protection if the worst came to the worst due to President Rodrigo Duterte's efforts to develop closer ties with China as well as his friendly relations with Trump, said Dehn. "The country is more protected than we think.”

In August, the US government launched a “Section 301” investigation into the alleged theft by Chinese firms of US intellectual property, since when US President Donald Trump has threatened to impose tariffs on up to $150 billion of Chinese imports.

In March, the US announced tariffs of 25% on steel imports and 10% on imported aluminium. China responded by proposing a tariff on 125 US products. As Maurice Obstfeld, the IMF’s director of research, told journalists in April: “The first shots in a potential trade war have now been fired.”

Axa's Yao said that, prior to the recent fall in Asian equity prices, the market had under priced the risk of a trade war: “The market had been very complacent: it was not taking Trump’s protectionism seriously.” Recent falls, though, have changed that, he said.

After a storming 2017 and start to 2018, Asian stock markets have struggled to recover from the sharp correction witnessed in early February. The MSCI Asia (ex Japan) index on Wednesday was 8% down from its late-January peak.