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Many of Asia's leading players are geographically and economically removed from the conflict in Europe. They’re also backed by a stronger policy arsenal, with China in particular continuing to loosen while most other economies are forced to tighten. Nevertheless, the region presents its own set of risks brought on by geopolitical tensions, ongoing energy and food crises, and volatile consumption habits.
China shows tentative signs of rebound activity
China has had a challenging first half of 2022. A supportive policy backdrop should have proven a boost to the Chinese economy. However, its impact has so far been offset by the country’s Zero-Covid Policy (ZCP). Lockdowns across several cities, most notably Beijing and Shanghai, led to a short but sharp economic downturn, especially during April and May.
As China emerges from its spring lockdowns, tentative signs of rebound activity are encouraging. The hope is that loose monetary and fiscal policy can now begin to have their desired effect. We are positive on both China offshore and onshore equities, given positive drivers across fundamentals, valuations and technicals, across three month and 12-month horizons.
Similarly, across fixed income, Chinese bonds appear more attractive than other markets, and our short-term view on CGBs is neutral. The outlook for credit, meanwhile, is improving. Demand should increase with expected fiscal support for infrastructure investment, and spreads on short-term local government financing vehicles (LGFVs) should benefit as a result.
Nevertheless, any optimism sprouting from China’s re-emergence is tinged with uncertainty. We are yet to see how the Chinese consumer will bounce back with ZCP lockdowns still fresh in the mind, nor the impact supportive policy will have. Unemployment too is on the rise, particularly among the youth, with nearly 20 per cent of 18 to 24-year-olds out of work. Moreover, the prospect of a Covid resurgence casts a shadow. Any further lockdowns could pose another major blow to its economy.
Inflation is relative
Rising inflation is starting to leave a serious mark on economies across the globe. Many parts of Asia are also feeling the strain, though some of its economies can pull on leavers that lie beyond the reach of others.
In Japan, inflation is rising to a far lesser degree than other DMs, while Producer Price Inflation in China has, in fact, been falling in recent months, easing fears that cost rises will eventually weigh on the consumer. Consumer Price Inflation in both countries remains well below levels seen across the world’s other major economies.
In Japan, a little bit of inflation has been welcome, following a multiyear period where deflation was weighing on growth. Perhaps unsurprisingly, the Bank of Japan has so far remained steadfastly committed to ultra-easy monetary policy, but the downside has been a sharp devaluation in the yen. That’s making imports more expensive, especially food and energy, and leading to some public discontent. Nevertheless, we think the BoJ is unlikely to divert from its current policy, meaning Japanese government bonds could be a strong performer while other central banks continue their hikes.
Openings and opportunities
China’s emergence from lockdowns is a clear positive for its economy, and Asia is reopening in other ways too.
One area to watch is trade. Washington is considering lowering tariffs on Chinese goods previously imposed by former US president Donald Trump, while new Asia-Pacific trade pacts have been launched this year, such as the Regional Comprehensive Economic Partnership (RCEP) and the Indo-Pacific Economic Framework (IPEF). Travel restrictions are also easing from Japan to Southeast Asia and Australia.
As the region opens its doors, opportunities have begun to present themselves. China’s reopening should have a positive impact on emerging markets as a whole; and we are positive on equities versus Europe given recession in Europe now looks very likely. We see Asian high-yield debt as a potential opportunity for risk takers, though they should still prepare for a bumpy road ahead.
We also think Japanese equities offer an interesting diversification option across DMs. Japan’s economy has relatively high exposure to China’s recovery but avoids some of its risks. We think company earnings in 2022 will come in better than consensus, while valuations look cheap. Yen weakness is a concern, and likely to carry on as rate differentials continue to diverge from the rest of the world and BoJ policy remains stubbornly loose, but at the same time Japanese companies with an international focus could benefit from the lower cost of exports.
View our latest Quarterly Outlook including a deck showing how we are thinking about China's recovery and its investment implications.