Equity markets gave up their gains earlier in the week, to end largely flat w/w, as softer economic data points to slowdown in the US and Europe. Hawkish guidance from US and European central banks led government bond yields edged higher. This reinforces our preference of allocating more to Asian assets.
DM conundrum – Softer data yet hawkish policy. US Manufacturing PMI fell to the lowest since May 2020. European Manufacturing PMI was also revised lower to 43.4, while services PMI was revised lower towards 52.0. However, Fed speakers, as well as the minutes of the latest FOMC meeting, continue to signal further rate hikes. In Europe, despite the recent downside surprise in the region’s inflation, policymakers and German Chancellor Scholz reiterated the need for more rate hikes. The hawkish theme was also evident in Australia, as the RBA kept the door open for more rate hikes, which should keep the AUD rangebound.
Are we nearing a peak in bond yields? Unless we see a sharp upside surprise in US jobs data on Friday night and CPI data next week, we believe 4.0% is key resistance for the 10-year US government bond yield. Thus, we would use the recent rise in yields as an opportunity to add exposure to high-quality Developed Market (DM) government bonds.
Supportive data and policy in Asia. India’s manufacturing PMI remained resilient which, combined with recent investor inflows, helped Indian equity markets reach new all-time highs. Similarly, South Korean equities delivered strong returns, helped by their large exposure to the semiconductor sector as AI-related stocks continued to edge higher. China’s Caixin services PMI and NBS non-manufacturing PMI declined from elevated levels, but remained in expansionary territory.
While investors continue to wait for an eye-catching stimulus, there were three subtle, but important, developments – (i) PBoC Deputy Governor Pan was named as the bank’s new communist party chief, indicating he is likely to be the next governor, ensuring policy continuity, (ii) the PBoC continued to set the CNY fix stronger to ensure currency stability, and (iii) media reports indicated that state-owned banks had started offering 25-year loans to local government financing vehicles (LGFVs), reducing refinancing for local governments, who have seen their revenues decline due to lower land sales.
Limited impact of geopolitics. We view China’s curbs on the export of Gallium and Germanium – metals used in semiconductor manufacturing – as part of the ongoing geopolitical tussle and do not see material implications for financial markets. Saudi Arabia and Russia also announced extension of production cuts, which led to a bounce in oil prices, but also signals the softening of underlying global demand
Investment implications. US and European equity market rallies appear to be losing momentum, which, combined with softer economic data and hawkish central bank policies, raise the risk of consolidation. Forward guidance from companies will be key as we enter the Q2 earnings season. Stronger economic data and supportive policy argue for rotating into Asian equities. We prefer to take diversified exposure across Japan, China, India, Korea and other major Asian markets.
The recent rise in government bond yields offers a good entry point to add exposure to longer maturity DM IG government bonds. The support to the LGFV sector is positive for Asian USD bonds, as it reduces the risk of defaults. From a technical perspective, the sharp decline in bond supply (due to more favourable onshore borrowing costs) means the market is likely to see net negative supply, which, along with largely resilient demand, argues for further narrowing of credit spreads.
Market diversity indicators highlight the risk of a reversal of recent weakness in the JPY and CNH, but the recent trend could continue until we get a policy catalyst. We continue to view gold as a hedge and would use any dip below USD 1,900/oz as an opportunity to add exposure.
Comments by Abhilash Narayan, CFA For Standard Chartered
