Asia-Pacific update: Easy does it

08 December 2017 | Markets and Economy


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Commentary by Qian Wang, Vanguard chief economist, Asia-Pacific.


The synchronised recovery in the global economy – along with low inflation and still accommodative central bank monetary policies – continued to provide a favourable backdrop for asset markets in the Asia-Pacific region in recent months.

Global equities rallied, with the major indices in previous weak spots such as Europe, Japan and emerging markets posting decent performance. However, concerns remain around tensions on the Korean peninsula and a potentially more protectionist stance by the new administration in the United States.

Three recent elections have had only limited impact on regional markets: In Germany Chancellor Angela Merkel won another term with reduced support; in Japan Prime Minister Shinzo Abe scored a resounding win; and in Spain Catalan voters supported an independence referendum.

China: Policymakers continue a fighting retreat

China's economic growth is likely to have peaked in the first half of 2017. Vanguard expects a gradual deceleration in the coming quarters, owing to the effects of financial and regulatory tightening, as well as ongoing secular and structural drags. However, the overcapacity drag might be less intense than in the past, given prudent policymaking and significant adjustments in the affected sectors in the past several years. Cyclically, headwinds to growth continue to strengthen with policymakers pushing for financial stability given the strong base this year.

However, we do not anticipate a sharp slowdown as policymakers continue to remain in a "fighting retreat" mode, providing just enough stimulus to avoid a hard landing. In fact, the People's Bank of China recently announced a targeted reserve requirement ratio (RRR) cut to address some of the unintended consequences from the financial/regulatory tightening early this year, which has led to a tightening in interbank funding conditions. This hurts small and medium-sized banks that rely more on wholesale funding, and micro and small enterprises that rely on those banks or shadow credit for funding. So the targeted RRR cut could provide incentive for some banks, especially small ones, to increase their affordable financing loans.

Japan: Abenomics depends on the politics

Political risks are also back in focus in Japan. Prime Minister Shinzo Abe is looking to capitalise on his Liberal Democratic Party's strong victory in the recent national election as well as disarray in the main opposition parties. The government appears well-placed to implement its agenda with majorities in both houses of the Diet. Nonetheless, political circumstances could stall the much needed progress on the structural reforms put forward by Abenomics.

Australia: Green shoots of growth but risks remain

The drag from falling mining investment is near completion and the lift in commodity prices has brought the income recession to an end. Public investment – primarily via infrastructure investment in the states of New South Wales and Victoria – is also growing solidly and capital spending intentions suggest non-mining investment should start to recover in 2018/2019.

Nonetheless, a slowdown in residential construction and consumption represents a key risk to growth going forward. While consumption continues to be supported by a falling savings rate which has reached a post-crisis low of 4.6%, any further drawdown in savings seems unlikely given the moderating wealth effect associated with rising house prices and still-subdued wages. Indeed, despite a significant improvement in the labour market over the last six months, with employment growth and the participation rate rising sharply, the underemployment remains very high at 8.6% and spare capacity in the labour market continues to weigh on wages growth.

The Reserve Bank of Australia (RBA) will be watching developments in the labour market very carefully as they will have implications for wages and inflationary pressures. In the housing market, risks associated with an overheating market remain, particularly in Sydney and Melbourne. But we are seeing some moderation in house price inflation in response to regulatory restraints on lending growth to high-risk mortgage borrowers. Also, banks are attempting to preserve profitability by resorting to out-of-cycle mortgage rate increases, particularly for investment loans. This is taking pressure off the RBA to ease the pressure on house prices through rate hikes.

Against this backdrop, we believe the RBA is in no rush to raise rates and will continue to balance potential risks to both the inflation outlook and financial stability.

Australian equities lagged behind their global counterparts as de-synchronisation with G4 economies continued to be a feature of Australian economic growth and policy. Nonetheless, the sharemarket still delivered a positive return (just slightly below 1%) for the quarter.

Around the world

The US: Careful tapering as economy strengthens

In a widely anticipated move, Federal Reserve policymakers decided in September to begin reducing the amount of assets on the Fed's £3.3 trillion balance sheet. The reduction will take a gradual and predictable course. Instead of selling assets, the Fed will simply not reinvest all the proceeds from maturing securities, which should help limit its impact on the markets.

The £38 billion roll-off will continue until the balance sheet reaches a level the Fed deems appropriate to implement monetary policy effectively. We believe this to be somewhere between £2.2 and £2.6 trillion by 2020 versus a pre-crisis average of about £600 billion. The decision to move forward with the plan is a further affirmation of the continued strengthening of the US economy. The labour market has continued to tighten and inflation data stabilised in August after a string of weak monthly readings. While the market has been pricing in a December rate hike, it is still not a foregone conclusion at this point if we don't see inflation clearly turning up in the next couple of readings.

US equities recorded a total return of 4.5% over the third quarter amid supportive macroeconomic data, a robust earnings reporting season and further weakness in the dollar. Despite some deterioration in economic indicators towards the quarter end in the wake of hurricanes Harvey and Irma, markets judged that any potential negative impact on growth would most likely be transitory.

Europe: Brexit devil is in the detail

Political uncertainty has come back to the fore in Europe, despite the re-election of Angela Merkel as chancellor in the recent German election. In particular, the situations in Spain and the UK remain problematic. As it stands, the prospect of near-term progress towards a deal between the UK and the European Union on the transitional period appears to be fading. The UK's negotiating stance is far from clear given the hung parliament and lack of support for Prime Minister Theresa May's leadership.

Mrs. May would like to push for a "hard Brexit" but opposition from within and outside her Conservative party may force a change of tack. By contrast, the EU has spent the past year preparing for the negotiation and has remained unified, at least publicly. The UK could still clarify its position and negotiate a good deal, but time is running out. The divorce settlement and trade deal need to be agreed by October 2018 to allow time for UK parliament review and approval before March 2019. This rushed negotiation approach is certainly not ideal, and in our minds raises the prospect of both a "crash Brexit," where the UK falls back on World Trade Organisation rules, or no Brexit, where the UK revokes its planned withdrawal.

European equities also notched up a modest advance on reduced Euroscepticism risks in Germany and a broad-based rebound in both the core and peripheral economies.

Qian Wang
Vanguard chief economist, Asia-Pacific

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