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Q3 2022 Update from the Asia Trade Floor

Asia Portfolio Manager Stephen Chang discusses the impact of higher U.S. rates on Asia, PIMCO’s current views on China’s economy, and the key takeaways from our latest Secular Outlook.

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Text on screen: Stephen Chang, Portfolio Manager, Asia

Text on screen: What are the key takeaways from our latest secular forum?

Chang: The bottom line is: The world is fragmenting and what this ultimately means is that investors should focus on building portfolio resilience rather than reaching for yield.

In PIMCO’s latest secular outlook, titled ‘Reaching for Resilience’, we articulate our vision of markets over the next three to five years, and we discuss how the war in Ukraine has widened global geopolitical fractures.

Text on screen: Key Takeaways from our latest Secular Outlook

  • Elevated risk of recession due to central banks fighting inflation and geopolitical shocks
  • Governments and corporate decision-makers will focus on safety and resilience

What this entails is, firstly, in our view, there is an elevated risk of recession over the next two years – not only because central banks are intensely focused on fighting stubbornly high inflation, but also because there's a higher risk of geopolitical shocks from all kinds of directions in this environment.

Secondly, in this environment, we believe governments and corporate decision-makers will increasingly focus on safety and resilience, including increasing defense spending and diversifying supply chains. These trends may augment economic inefficiencies and increase inflationary pressures.

Text on screen: Key Takeaways from our latest Secular Outlook

  • Elevated risk of recession due to central banks fighting inflation and geopolitical shocks
  • Governments and corporate decision-makers will focus on safety and resilience
  • Investors will look to build more robust asset allocation with fixed income playing a key role

Going forward, we believe investors will look to build more robust asset allocation as they face a more uncertain environment for macro cycles, market volatility, and central bank support. We believe fixed income will play an important role in making diversified portfolios more resilient, especially at these higher yields, and that investors should build in some inflation protection into their portfolios.

Text on screen: What are our current views on China?

Chang: Inflationary pressures seem to be easing in China and inflation overall is much lower than in many developed markets – for example, in June, year-on-year inflation was 9.1% in the U.S., compared with 2.5% in China. As COVID-19 curbs continue, modest consumer demand is unlikely to lead to a rapid rise in domestic inflation.

The share of national GDP from areas affected by lockdowns has come off the peak from early in the 2nd quarter. China's factory activity expanded in June for the first time in four months, albeit it was only marginally above the neutral line of 50.  Export volumes at China’s ports remained strong through the first half of the year, showing resilience in the global manufacturing supply chain. In contrast, domestic growth has been weaker, resulting in slower imports and a larger trade surplus. 

While we need to be cognizant of periodic lockdowns in China, we think the nation’s supply chain can be adjusted. The Chinese government has prioritized production and delivery of export goods, and the robustness of China’s supply to the global goods market has been tested repeatedly since 2020, through waves of COVID outbreaks, power outages and regional geopolitical crises. However, logistical challenges and the threat of ongoing virus-related disruption, given China’s zero-COVID strategy, pose lingering headwinds.

Text on screen: How are higher rates in the U.S. impacting Asia?

Chang: Within Asia, we have seen significant divergence in inflationary outcomes and central bank actions.

Text on screen: Divergence within the APAC region:

  • More hawkish central banks: South Korea, New Zealand, Australia
  • More dovish central banks: Japan, China, Thailand

Countries like South Korea, New Zealand and Australia have been more closely tracking the US pattern, with rapidly rising inflation that has led to fairly aggressive central bank rate hikes.

On the other end of the spectrum, you have Japan, China and Thailand where central banks remain less hawkish. Japan is not expected to change from its negative overnight rate policy and yield curve control.  In China, the PBOC continues to have more of an easing bias and we could see further stimulus measures. Despite rising inflation, Thailand’s central bank appears to be taking a cautious approach, pledging not to impede the country’s economic recovery.

Text on screen: Divergence within the APAC region:

  • More hawkish central banks: South Korea, New Zealand, Australia
  • More dovish central banks: Japan, China, Thailand
  • Middle ground: commodity-exporters like Indonesia and Malaysia

For commodity-exporters such as Indonesia and Malaysia, they sit somewhere in the middle. Inflation is rising but remains low compared with many other economies, such as the US and Europe. While some hikes in central bank rates are to be expected, the magnitude is likely to be relatively modest. 

Overall, inflation for many of these countries should see some moderation before the end of the year, in light of some of the headwinds for global growth.  What one needs to watch for is that with the aggressive Fed rate hikes, there has been a persistent strength in the US dollar vs Asian currencies.  This could translate into imported inflation down the line.

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