Why Asia should suck up Tantrum II

Financial Mirror (Cyprus) - - FRONT PAGE - Mar­cuard’s Mar­ket up­date by GaveKal Drago­nomics

Asian cur­ren­cies took a hit last week as the on­go­ing global bond mar­ket sell-off forced cap­i­tal out­flow. Yet un­like the “ta­per tantrum” of two years ago, the re­gion has nav­i­gated this sell-off with limited col­lat­eral dam­age—emerg­ing Asia’s bench­mark bond in­dex has fallen by -3% in the last two weeks com­pared with a -19% peak-to-trough slump in 2013. A fair ques­tion is whether heav­ily lever­aged Asia is the next shoe to drop. So long as cur­rent ruc­tions do not turn into a rout, spark­ing a global risk-off, Asia re­mains a good bet as the macro back­drop is far bet­ter than two years ago.

This may seem coun­ter­in­tu­itive since ag­gre­gate Asian debt lev­els are back to those seen just be­fore the 1997/98 Asian cri­sis, while in North­east Asia, de­fla­tion­ary winds are blow­ing hard. The dif­fer­ence with past cri­sis pe­ri­ods can be seen across a range of macro set­tings: (i) Asian economies mostly run flex­i­ble ex­change rate sys­tems and have tended to sup­press their cur­ren­cies’ value to al­low the build-up of re­serves, (ii) In­done­sia and In­dia were over­heated in 2013 but have acted to crimp de­mand, which has helped ex­ter­nal bal­ances to sharply im­prove, and (iii) economies with ex­ter­nal sur­pluses such as South Korea have forced banks to ad­dress a ma­tu­rity mis­match prob­lem where they have bor­rowed short and lent long.

An­other dif­fer­ence this time is the pos­i­tive im­pact of the fall in the price of oil and other com­modi­ties. Dis­in­fla­tion and even out­right de­fla­tion in sev­eral Asian economies, caus­ing real in­ter­est rates to swing pos­i­tive, has granted pol­i­cy­mak­ers space to ease rates, which should mean that a 2013 pol­i­cyin­duced slow-down can be avoided.

For in­vestors, com­fort can be taken from the macroout­look, but also the fact that nom­i­nal yields on bench­mark Asian debt, de­spite re­cent ruc­tions, re­main sig­nif­i­cantly higher than on de­vel­oped mar­ket equiv­a­lents.

To be sure, prob­lems may emerge if the dollar re­sumes its ap­pre­ci­a­tion track due to the Fed­eral Re­serve mov­ing to nor­malise pol­icy, while Asia shifts to­ward eas­ing. Since most Asian cur­ren­cies to some de­gree are dollar-linked, the stan­dard Asian re­sponse would be to en­gen­der a de­pre­ci­a­tion that boosts ex­ports and crimps im­ports. How­ever, such a mer­can­tilist ap­proach may be less ef­fec­tive than usual as both Europe and Ja­pan are play­ing the same game, hence less­en­ing Asia’s scope to de­value its way out of trou­ble. Also, the last 18 months have seen a gen­eral col­lapse in Asian cur­rency volatil­ity, and so any dis­rup­tion to th­ese calm seas could pro­duce un­fore­seen events, with a self-re­in­forc­ing cy­cle of cap­i­tal out­flow, cur­rency de­pre­ci­a­tion and fall­ing as­set prices. Still, the move to a gen­eral risk-off is not our cen­tral sce­nario and we ad­vise in­vestors to switch into US dollar de­nom­i­nated, high-grade Asian debt which still pays an ap­prox­i­mate 200bp pre­mium over trea­suries.

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