Three key factors still drive Asia’s macroeconomic outlook: trade tensions, the policy response in China, and global central bank easing. Together, they will continue to dictate growth, trade tensions and China’s limited, domestic focused policy response will do little to lift regional growth.

One positive catalyst: central banks, most notably the Fed, are now set to ease. A move towards monetary stimulus completes a remarkable shift from earlier this year, when more tightening was expected. The spillover of expected Fed easing, combined with benign regional inflation, might allow monetary easing across most of Asia. That, in turn, might partially (not fully) offset the negative aspects of trade uncertainty and slowing global growth. 

Any one of these shifts would complicate the outlook for markets. The combination is particularly difficult for investors to navigate. Take, for example, the U.S. and China trade war. History has few, if any, precedents for such a battle between the world’s two largest economies—especially when economies and supply chains are deeply interconnected.

These unusual circumstances create three challenges:

  1. Estimating the immediate outcome of U.S.-China talks and the prospects for resolution or escalation
  2. Estimating how the conflict will damage growth and earnings
  3. Perhaps most impactful, trying to estimate how long-term tensions and possible economic “decoupling” could affect the global economy

Any one of these would be difficult for markets to “price.” The combination, in addition to rapidly evolving monetary policy, make for a very challenging outlook for Asia. 

The most pronounced of the three trends is the ongoing U.S.-China trade and technology conflict. The direct impact of tariffs and policy uncertainty are beginning to have a clear negative impact on regional growth, although the redirection of trade is creating some relative beneficiaries.

At the epicenter of both the trade and tech conflict, Asia is feeling the impact through three channels–weaker exports, reduced business and consumer sentiment, and declining fixed asset investment.

Increased domestic consumption and a burgeoning middle class across Asia have made the region less dependent on trade. However, exports are still the main driver of Asia’s business cycle. For example, Exhibit 1 highlights the clear correlation between dollar export growth in Asia, MSCI Asia (ex-Japan) earnings, and index performance. 

Exhibit 1: How export growth affects earnings and index performance

Source: Bloomberg. Data as of July 6, 2019.
Line chart shows equity index, earnings and exports from January 2009 to January 2019.

When trade growth weakens, it is unusual for Asia, the world’s most trade dependent region–to do well. Headwinds to exports have been wide-ranging. In addition to supply chain redirection, capital expenditure across developed markets, which tends to drive imports, has also slowed sharply.

Still, there is a glimmer of hope in the outlook for trade. Although escalation risks have clearly risen, we think there is a narrow base case that there will, eventually, be a deal that would mutually reduce tariffs (See our latest commentary on trade tensions).

A reduction in supply chain uncertainty and a removal of tariffs would unambiguously boost global trade above current levels.

Second, most of the downturn has been about export prices, and in particular semiconductors, which are nearly as important for East Asia as oil is for the Middle East (see Exhibit 2). 

Exhibit 2: Exports in semiconductors have dropped dramatically in Korea

Source: Bloomberg. Data as of July 6, 2019.
Line chart shows export performance (non-semiconductor and semiconductor) in Korea from January 2012 to January 2019.

However, trade indicators give some signs of a rebound. Trade volumes showed early signs of improvement in Q2. With oil prices rebounding and semiconductor prices bottoming out, export values and thus regional equities could gradually recover.

In the beginning of the year, we highlighted in our 2019 Outlook how Beijing policy would be one of the most important factors affecting the outlook for Asia. In particular, we looked at the tools policymakers would useto stimulate the slowing economy.

China has launched a large stimulus program every three years since the crisis, as its economy cyclically slowed around the credit and housing cycle (see Exhibit 3). These stimulus efforts often had large spillover effects, lifting regional (and global) growth. As the trade war rages on and attempts to deleverage take their toll on the economy, China’s reaction will be key for the region. 

Exhibit 3: China’s home sales and credit growth

Source: Bloomberg. Data as of July 6, 2019.
Line chart shows China’s home sales growth and credit growth from January 2011 to January 2019.

So far, in line with our expectations, the policy response has been much smaller and the composition is different from past stimulus rounds. It is smaller because of the already high debt levels and housing prices bordering on bubbles in many markets. The total room for monetary easing is simply smaller than in the past.

For this reason, most of the stimulus has been through fiscal policy, and notably via tax cuts. Because tax cuts are a relatively new form of stimulus for an economy that is used to government spending on infrastructure, it was unknown how much would be saved versus spent.

It turns out most has been saved due to high levels of uncertainty. The impact of this shift in policy is twofold: first, Chinese growth is continuing to slow, which marks a change from previous rounds of stimulus (when growth notably accelerated). Second, the global impact is much smaller; stimulus focused on domestic consumption and tax cuts is helping to stabilize growth at home, but doing little to boost the global cycle.

With global growth slowing amidst trade uncertainty and weaker Chinese growth, regional central banks are turning dovish to cushion the downturn.

Weakening global growth and soft inflation has increased the room for central banks to cut rates. Following the dramatic shift by the Fed moving from expectations of hikes at the end of last year to expectations of multiple cuts by the end of 2020.

This shift by the Fed can mitigate currency depreciation and outflow pressures on regional Asian economies and removes a hurdle for central banks to ease.

As we now expect the Fed to cut this year, it opens the door for rate cuts from the Bank of Korea, Bank of Indonesia and the Central Bank of China (Taiwan) potentially among others. In addition, with growth risks tilted to the downside, the People’s Bank of China (PBOC) is positioned to ease more aggressively, while still keeping an eye on financial stability risks. As trade uncertainty lingers past the G20 détente and global growth continues to show late cycle dynamics, Asian central banks have some room to stimulate growth.

These three forces will likely shape the economic and market outlook over the rest of 2019; trade uncertainty, despite the recent détente, will continue to negatively impact sentiment and business investment, Chinese growth will continue to slow and the changing composition will amplify the slowdown for the global economy.

Partially offsetting these negative trends will be regional central banks looking to cut rates. Amidst the themes, country and asset class selection will be key. Countries that benefit from supply chain redirection (such as Vietnam) or that can offer resilient earnings growth (such as India, Indonesia, or Thailand) can offer some opportunity amidst the uncertainty.