This slump is just a blip

This article first appeared in The Edge Financial Daily, on February 6, 2018.
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IS it a blip, a correction or the end of days?

Stock markets in Asia tumbled yesterday, extending the biggest global sell-off in two years. Equity investors are fretting as Treasury yields approach 3%. Last Friday, 10-year returns touched 2.85%, and the dollar rallied 0.9%.

Some context, however. While the MSCI Asia ex-Japan Index’s 7.5% return in January was good, it is not unprecedented. In January 2001, the benchmark soared 12.8%. Also, US government bond yields have been on a steady rise since the start of the year, and that has not stopped Asia from partying.

The key to Asia’s rally is a weak greenback. When investors pumped US$13 billion (RM50.7 billion) into Chinese stocks last month — the most in at least two years — what they expected was not only capital returns, but foreign-exchange gains. No one is very interested in the Philippines because of the weak peso; as a result, the Southeast Asian nation is home to the region’s worst-performing emerging market this year.

A currency’s strength is dictated by interest rate differentials, in theory at least. And it is unclear the dollar will get much stronger. Based on the Bloomberg Dollar Spot Index, which determines currency weights according to their relative importance to the US in terms of international trade, one-third of the dollar’s value is dictated by the euro. But five-year bunds finally offered you something last week, after being negative since 2015.

Next in line is the Japanese yen, which dictates 18% of the dollar’s value. There have been plenty of murmurings, from this columnist included, that the Bank of Japan will start stealth tightening, especially in a world of rising US interest rates. After all, Japan’s central bank already owns an unprecedented 45% of the nation’s bond market; how much more entrenched can it get?

Interest rates have been climbing in emerging Asia as well. Malaysia and Pakistan have both embarked on tightening cycles while the Philippines is expected to hike by 50 basis points this year. Interest rates in China and India are also on the up, as Beijing limits credit expansion and Delhi can’t stop spending.
You get my point: Just because US rates are strengthening does not mean the dollar will necessarily follow suit.

In fact, rising US rates and a weak dollar would be an ideal case for emerging Asia. US stocks look expensive: Emerging Asia’s 6.1% earnings yield is more alluring than the S&P 500’s 4.5%. Plus the MSCI China Index is still 25% shy of its record 1993 high.

Do not think I am blindly bullish. Last month, I warned of overly optimistic sell-side analysts and said China’s big bank rally was progressing too fast. But unless we see a sustained stronger dollar, this sell-off looks more like a blip. — Bloomberg