Insights

A dip in U.S. growth will have an impact on Asia's own rates of expansion, but the slowdown will also provide room for the region’s policymakers to cut interest rates.

Originally published on September 24, 2024 by Fidelity International.

Written by Lei Zhu, Head of Asian Fixed Income and Noah Sin, Investment Writer.

In the Battle of the Red Cliffs, a mythologized episode in Chinese history that mirrors David and Goliath, a small navy defeats much stronger opponents by summoning the eastward-blowing wind, setting ablaze entire enemy fleets. Almost two millennia later, “borrowing the east wind” continues to be the Chinese expression of choice for smart strategies that leverage external forces to one’s advantage.

For those investing in Asia, the fourth quarter of 2024 may well suit that approach. Risks are compounding outside of the region, from a slowdown in U.S. growth and a pivot in monetary policy to the prospect of geopolitical shocks to the system. A tactical, defensive posture – positive on bonds, selective in equities – could help investors make the most of these circumstances and prepare for better days ahead.

Free from the Fed

Asia’s central banks have been constrained by a hawkish U.S. Federal Reserve (the Fed) for some time. Cutting their interest rates would have meant widening the gap with the U.S. and risked a sell-off in their respective currencies. That situation changed in September when the Fed finally delivered a 50-basis-point interest rate cut. With the exception of the Bank of Japan (BoJ), Fidelity International believes most Asian central banks will feel comfortable trimming policy rates following the Fed’s cuts, given their positive real rates. Indonesia has even moved slightly ahead of the Fed’s decision, reducing interest rates by 25 basis points to 6% in the same week, its first rate cut in more than three years.

The natural conclusion is that investors should feel more confident adding duration in high-quality bonds, from sovereigns to investment grade. Any reverberation of U.S. economic pain is likely to be more keenly felt in equities, where earnings of exporters could take a hit. The stock market still has plenty to offer, especially companies that benefit from artificial intelligence, the energy transition and shifts in supply chains. But we’re putting more focus on valuations and stocks’ margins of safety to withstand further near-term shocks.

Slowdown

How Asia performs also depends, of course, on China and Japan, the two largest economies in the region. China is struggling to gain momentum as consumers and homebuyers remain cautious. With just three months to go until the end of the year, the country’s around 5% per cent annual GDP growth target looks challenging. Fidelity International has lowered the probability of its “controlled stabilization” base case (from 65% to 55%) and raised the risk of a serious slowdown (to 35%). Reflation remains a remote possibility (at 10%).

Chinese policy makers have been working hard to restore confidence. In September, China lowered the down payment threshold for home purchases, cut interest rates further and promised to provide more liquidity in the stock market. While China continues to refrain from unleashing huge credit stimulus, these measures underscore officials’ focus on domestic demand, which is supportive for sentiment. “Lower for longer” interest rates – which remain positive when adjusted for inflation – will keep the Chinese bond rally going. For equities, defensive sectors such as banks and utilities are more resilient. More change could come in the October politburo meeting or the Central Economic Work Conference towards the end of the year. But don’t expect drastic policy shifts while external uncertainties, such as the U.S. election, weigh over financial markets.

Having escaped the deflation trap, Japan is guarding against inflation, which is set to stay above the Bank of Japan’s 2% target next year. That should lend the BoJ confidence to hike gradually over the coming quarters and draw the country closer to positive real rates. The volatile market reaction to the central bank’s 15-basis-point increase in July could slow, but not reverse, Japan’s path on interest rates. In equities, smaller companies that haven’t benefited as much in the rally over the past year will likely catch up. However, any shift in U.S. trade policy could have implications for Japan, while the change of premiership could present another tail risk for domestic markets.

Structural stories

The promise of structural forces supporting Asia is real, from the demographic dividend in India and Southeast Asia to the advent of AI and the energy transition. But as markets grow more alive to near-term risks, Fidelity International expects more scrutiny of these structural stories. Fidelity International has already seen this play out in AI, as investors rotated out of semiconductor-heavy Taiwan and Korea and into Asean markets expecting a more imminent boost from monetary policy.

Likewise, Fidelity International is hopeful on India’s long-term prospects. Its fundamentals are solid, and its pace of growth (forecast at 7% this year) is not to be scoffed at. But after an extended rally, valuations in some corners of the stock market may be too hot to handle. Lurking in the background is the risk from the unwinding yen carry trade, as speculators exit popular – and crowded – stock markets. The outlook for Indian bonds may be more favourable on the back of their addition to global benchmarks and positive real interest rates.