Hong Kong Economic Journal - The Strengthening of the USD Could Impact Southeast Asia Capital Flows 強美元或令東南亞資本外流 – 信報

May 08, 2018

The Strengthening of the USD Could Impact of Southeast Asia Capital Flows

Markets show signs of moderate growth after the synchronized global recovery being felt across Asia. The outlook for Asian markets remains nuanced and country-specific. 
In China, there is a moderating growth picture as we head through 2018, alongside both CPI and PPI inflation also weakening. However, with the PBOC’s RRR cut last month and signaling of future easing to come, the policy response to this slowing growth picture is now kicking in and of a certain comfort. As a result, China’s growth will eventually stabilize and risk asset sentiment should do so too.

In Hong Kong, capital markets are increasingly influenced by the flows into and out of the mainland.  The increasing Northbound and Southbound quota, as well as QDII quota, is further evidence of a desire to deepen financial markets and to bring China’s Mainland financial markets into the global fold. This is a precursor to the partial inclusion of A shares into MSCI indices from the end of May and this theme will probably continue.

The Korea economy is also slowing, especially since the strong impulse to global trade witnessed in 2017 is moderating.  Korean export growth for March came in at a respectable 6.1% yoy and even slower for April.  This is down from a peak of 35.0% yoy in September 2017. The Monetary Policy Board members have become decidedly dovish in light of the slowing economy, the worsening of labour market conditions and the ongoing uncertainties on the inflation outlook.
As for Japan, the strong earnings revisions cycle from 2017 is starting to fade due to a combination of the early signs of a moderating global growth upcycle.  There is also a sense of rising political and monetary policy uncertainty creeping in.

Overall for Southeast Asia, it could be vulnerable to capital outflows in the event of a firmer USD persisting. One exception is India which could perform reasonably well this year on a relative basis. It is emerging from a self-inflicted growth slowdown post the implementation of Goods and Service Tax (GST) and Demonetisation. Recent growth data, albeit variable, is generally seeing an improving trend. Industrial production growth has exceeded 7% yoy for the last 3 months. However, inflation still needs to be watched over the coming months.

Outlook for USD

After a prolonged period of a softer USD, which has been very supportive for risk assets, any sustained strengthening of the USD could see a reversal of thematic capital flows and the risk of an air pocket in risk assets. The consideration is far from academic in view of the central role that a strengthening  played in sparking the Asia’s 1997 crisis, as well as Latin America's own financial woes a decade earlier. When the dollar slides, liquidity flows into emerging markets, pumping up growth and assets. As the dollar rallies, it can draw much-needed capital away from the developing world.
US corporate earnings were very strong in Q1 aided by a weak USD.  Whereas a stronger USD could lead to more balanced earnings revisions outlook for the US, which has been the key driver of earnings revisions globally so far in 2018.

In addition, the recent strength in oil price even before the peak US driving season demand suggests that we do run the risk of hardening of inflation in the US over coming months, as well as Europe in H2 2018.

How should the investor position?

There is a need to take a more cautious positioning in markets over the next 3 months.  It is recommended to continue taking a diversified multi-asset based approach, focusing on companies and sectors with strong earnings revisions cycles, areas of relative value and a focus on total (income and capital) returns.  These factors will provide a certain level of defensiveness. Investors may also consider to adjust their cash levels.  This serves as fire power to take advantage of any excessive corrections. It is believed that the US economy will be an outperformer though in 2018.

After the sell-off in government bonds, it is also high time adding a bit more exposure to high quality bonds given the generally underweight positioning by investors.  It also serves as portfolio protection.

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