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Insight 11.10.2017

Fed Signals to Shrink Balance Sheet, Asian Currencies Fall

Fed Signals to Shrink Balance Sheet, Asian Currencies Fall

Asian Market Review and Outlook - September 2017

Market Review

World equity markets extended year to date gains as coordinated global expansion continued to filter through into earnings. The US Federal Reserve left rates unchanged during its September meeting but signalled that domestic conditions validated the central bank’s plan to begin reducing its balance sheet. Global stocks recovered from early month concerns over the economic damage caused by a series of devastating storms to hit North America and the Caribbean islands while prospects of Trump’s pro-growth policies lifted the DXY to its first monthly gain since February. The MSCI Asia Ex-Japan Index underperformed world markets and slipped back 0.3% in September.

MSCI China returned 0.6%. The PBOC scrapped two trading restrictions that had been intended to discourage bearish bets against the RMB, as the currency depreciated 0.95% over the month. The central bank’s decision came after August foreign exchange reserves increased by $10.8bn, the seventh consecutive month of positive gains. The producer price index in August gained 6.3%, helping drive profits higher and enabling corporates to process their debt burden.

MSCI India dropped 1.6% as the impact of demonetization and the goods and service tax (GST) implementation continued to weigh on economic activity. The Reserve Bank of India last cut rates in August and is expected to ease policy further in order to spur growth. Anticipation of lower borrowing costs and prospects of a wider budget deficit weakened the India rupee 2.2%, its sharpest monthly slide in almost a year.

MSCI Korea outperformed the region, rebounding 3.6% in September following a 1.7% drop in August. Concerns over North Korea's bellicose statements continued to weigh on investor sentiment. However, stocks rose as earnings from the tech sector met expectations. South Korea’s economy grew 0.6% in 2Q17 from the previous quarter, as higher facilities investment and household consumption were offset by a slowdown in construction.  MSCI Taiwan experienced profit taking, falling 3.0%, its first monthly decline this year.

MSCI Southeast Asia squeezed out a positive return of 0.3%. MSCI Thailand led ASEAN equity bourses, returning 3.2% on prospects of a general election in 2H18. MSCI Philippines rose 2.5% on increased optimism over Philippine tax reform, providing better clarity on infrastructure spending.  MSCI Indonesia returned 0.2%. Indonesia’s central bank surprised markets by cutting interest rates 25 basis points, its second consecutive cut.


Most Asian currencies depreciated in September after the USD rallied for its first monthly gain since February. Janet Yellen reaffirmed her intention of gradually reducing the Federal Reserve’s balance sheet while the Trump administration put forward a tax reform proposal, both lifting the dollar index higher. Geopolitics weighed on investor sentiment for most of the month, as tensions between the US and North Korea have yet to improve.

Yellen’s decision to reduce the US central bank’s balance sheet comes despite concerns that inflation continued to linger under the surface. Citing continued growth in nonfarm payroll employment and subsequent declines in the national unemployment rate, Yellen argued that the underlying strength in the US economy and fading slack in the labour market would lead towards a pickup in wages and consumer prices.

A major risk for Asian equities would be a rapid, central bank led withdrawal of market liquidity corresponding to waning momentum in the economic recovery. Though the risk is a real one, it is clear that conditions remain largely accommodative, as global liquidity essentially offsets any Fed-lead withdrawal, and the backdrop therefore remains expansive.

The European Central bank (ECB) has decelerated its monthly bond-buying programme down to €80bn a month ($50bn), implying that coordinated central bank tightening has yet to commence as the ECB alone is effectively offsetting the Fed.

Going into the final quarter of 2017, Asian equities collectively remain an attractive asset class as optimism stems from sustainable political momentum and resilient economic data. For China, the key event ahead is the 19th National Congress taking place in the middle of October, when President Xi Jinping will be re-elected as party general secretary for a second five-year term. The meeting agenda will likely reiterate the party’s objective of reducing systemic financial risks and improving living standards, particularly those impacted in industrial sectors facing overcapacity. While the National Congress appears unlikely to put forward detailed economic policies, the following meeting, the Central Economic Work Congress (CEWC), held in November certainly will. Markets will closely monitor the CEWC as it has previously proved to be a strong indicator of investment themes for the rest of the year.

China’s economic momentum should bode well for investors over forthcoming months. The PBOC’s decision to relax previously implemented policies aimed at discouraging capital flight suggests that policymakers are less worried about sharp devaluations. Supply side reforms and the subsequent recovery in commodity prices have translated into a pickup in industrial profits, which climbed 24% YoY in August, the most in four years, demonstrating that such implemented reforms have helped the general economy.

Similarly, investors will be monitoring India, as the economy is marred by the impact of demonetization and GST. India’s economy expanded 5.7% over the June quarter, softer than market expectations so increasing the likelihood that the Reserve Bank of India will cut interest rates later this year. With structural reforms potentially weakening growth, this means that the output gap is widening at an accelerating pace and adding increasing deflationary pressure to the economy. The GST was in general a headwind as firms managed down inventories before implementation, and is likely to push back the restocking cycle into later this year.

Factors adding to regional growth include a pickup in export driven economies, particularly in Korea and Taiwan, in part from a new tech production cycle as a result of the release of the iPhone 8 and iPhone X. The demand for semiconductors has also surprisingly lifted product orders from Singapore and other ASEAN manufacturer countries, reflecting the extent of the sector’s integrated supply chain. This is an investment climate supportive of a positive outlook for Asian economies as regional policies that support growth are still intact. Asian economies continue to maintain policies that strive to support economic reforms, such as addressing credit misallocation in China, bankruptcy and tax law in India and chaebol reform in South Korea.

Precise details of the US tax plan have yet to surface, adding questions about the extent that Trump can firm up on his reform agenda. Cutting government spending in the middle of a hurricane relief effort would be politically difficult, while increasing the budget deficit would similarly be a challenge given the President’s low political capital. The DXY move in September therefore seems somewhat exaggerated as the move also incorporates an early month deal to postpone the deficit ceiling with Democrats. In addition,  the euro has weakened following Angela Merkel’s victory as German Chancellor for a fourth term but with a smaller majority in parliament.

More about Emerging Markets


Christopher Chu
Fund Manager - Asia



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