Principal Monthly Viewpoints (June 2021)
Q: Principal Asset Management (Asia) Investment Management Team
A: Crystal Chan, Principal Asset Management (Asia) Senior Investment Specialist
Q:What are the prospects for the global economic recovery?
A: The global economic outlook has continued to improve since the beginning of this year due to the progress of vaccines and the continuation of large-scale fiscal and monetary policies. The International Monetary Fund (IMF) had earlier raised its global growth forecast for the next two years. However, the timing and pace of the economic recovery in various parts of the world remain unsynchronised, while there are obvious differences in the intensity of growth. China and the United States remain the engines of global growth. The United States’ GDP is expected to surpass pre-epidemic levels in the later part of this year while China's economic growth is leading the way. Other developed and emerging market economies may have to wait until next year to return to their pre-epidemic levels.
Fiscal policy is an important factor in driving the global economic recovery. Various countries have introduced large-scale fiscal measures to support their economies since the outbreak of the pandemic, bringing global public debt to a record high of nearly 100% of GDP in 2020, a sharp increase of more than 10% from the pre-epidemic era. The large-scale fiscal stimulus has significantly increased inflationary pressures, and the increase in bond market yields has tightened financial conditions. However, until the epidemic is effectively contained, fiscal or monetary policies may still need to remain moderately accommodative to ensure that interest rates remain in the lower region to support deficit levels.
Nevertheless, the headroom between the different fiscal policies has created a phenomenon where the pace of the recovery is different between some developed and emerging markets. According to data from the IMF, the scale of the fiscal measures introduced by the United States as of this March is equivalent to 25% of total GDP in 2020. Earlier, President Biden presented his first budget proposal to Congress seeking approval for US$6 trillion, showing that some developed markets can afford to continually increase government spending. Yet, other lower-income countries are having the problem of insufficient fiscal policy headroom. As of this March, emerging markets as a whole has only introduced 4% of the scale of fiscal measures, which places a drag on the regional economic recovery.
The vaccine receptiveness is also a key factor affecting the speed of the economic recovery. In general, the scale of COVID-19 vaccinations has become increasingly widespread. By of the end of May, nearly 2 billion doses of vaccines had been administered worldwide, representing a steady increase of over 12% of the global population. Nonetheless, we are facing the issue of an uneven distribution of vaccines, with high-income countries receiving vaccines more than 30 times faster than low-income countries For example, in the United States, the vaccines can sufficiently cover 46% of the population, but the situation is different in the more populous Asia-Pacific region. The vaccination rate in Asia is low, with an average of around 5% across the entire region. Besides China and Hong Kong, vaccination coverage in many major regions, including South Korea, Indonesia, Thailand, and Taiwan, remains at low level, with some places even below 1%. There is still a high degree of uncertainty about the trend of the epidemic in the region.
Q: Have you changed your views on the Asian region?
A: The number of confirmed cases fell by 90% from the peak in places with relatively high rates of vaccination, such as the United States, while the trend of new cases in regions with lower coverage, such as Asia, remained erratic. At the beginning of May, confirmed cases in India hit a record high of 400,000 per day, which spread faster than before. Other parts of the Asia-Pacific region, such as Malaysia, Thailand, and Taiwan, are also experiencing severe numbers of infections. In response, different countries in the region have further tightened their anti-COVID-19 measures, resulting in another upward trend in the overall Asian pandemic control index, contrary to the situation in Europe and the United States. Stock market performance was also affected, with the U.S. and European stock markets each recording double-digit returns so far this year, while Asian stocks were lagging behind with low-single-digit returns.
In view of COVID-19 situation in the region, we have downgraded our views on Asian stock markets in recent months but remain slightly bullish. We believe that with further vaccination improvement in Asia, there is a chance that the epidemic in the region will be further controlled in the third quarter, and that the relaxation of preventive and control measures will help the Asia Pacific economies regain momentum. For example, the rise in new confirmations has temporarily slowed down in India, Indonesia and Philippines, driven by the continued increase in vaccination uptake.
Beyond the epidemic, we should not ignore the trend of the US dollar when investing in Asia. After second quarter, the US dollar index fell back to the 90 level again, while Asian currencies immediately recovered from their first-quarter losses and regained their upward momentum. In the U.S. fiscal and monetary policy direction remains unchanged, the short-term US dollar index may be hovering at the level of 90, temporarily lacking the conditions for a significant rebound, favoring the flow of capital to high-growth markets such as Asia. In fact, Asia is the region outside the U.S. that has seen larger capital inflows so far this year. As of the end of May, the Asia-Pacific stock market recorded net inflows of over US$100 billion. We believe this is related to the outlook for economic growth in Asia, higher dividend levels in the region and relatively attractive fundamentals. As the Asian epidemic eases, the region may have the potential to outperform other major markets again.
Q: Economic growth in China is slowing down, can the RMB remain strong in the future?
A: Since the second quarter, as the US dollar began its downward trend, the offshore RMB (CNH) exchange rate climbed from 6.5 to 6.6 per US dollar to 6.35 per US dollar, an increase of more than 3%, setting a three-year record high. With reference to the CFETS exchange rate index, which reflects the RMB's relative exchange rate to a comprehensive package of trading partners, has risen to a more than five-year high. In order to ease the pressure on the RMB’s appreciation, the People's Bank of China raised the foreign exchange reserve requirement ratio for the first time in 14 years, and official newspapers have also published several commentary articles to try to manage market expectations.
In reference to China’s April foreign currency deposit balance of US$1 trillion, raising the foreign exchange reserve requirement ratio by two percentage points would be equivalent to freezing about US$20 billion in domestic liquidity. With the tightening of US dollar liquidity in the banking system, the cost of domestic foreign exchange funds may increase, which is aimed at reducing the selling pressure of US dollars in the domestic and foreign exchange market, to ease the pressure of RMB appreciation. After the announcement of these measures, the US dollar rebounded against the RMB for several days, but with the support of various basic factors, the People’s Bank of China (PBOC)’s move may not be able to reverse the expectation that the RMB will sustain its short-term appreciation trend.
China's economy was able to emerge ahead of the rest of the world from the depths of the pandemic last year. With the base effect, China’s economy grew 18.3% in the first quarter of this year. In particular, the performance of domestic foreign trade has improved significantly resulting in the continuous buildup of a trade surplus. Although economic data in different fields has shown that China’s economic growth rate may slow down after entering the second quarter, the annual economic growth rate may still be as high as 8%. Therefore, China’s policy put emphasis on long term structural issues, such as high leverage and potential asset price bubbles, even though they would like to maintain economic stability. It is not difficult to infer that both fiscal and monetary policies will continue to be normalised or even gradually tightened.
The year-on-year broad measure of money supply (M2) increased 8.1% in April, which hit a two-year low. Compared with March, both growth of credit loans and private financing dropped significantly by about 45%. We believe that the PBOC will continue to adopt different policy - during the year to maintain moderate liquidity, with the overall direction being neutral to tight. China’s April producer price index (PPI) hit a three-and-a-half-year high, rising by 6.8% year-on-year. Despite the current moderate upward inflation rate, the PBOC may inevitably further tighten monetary policy to respond to the continuously growing demand and the upward trend in raw materials prices that may gradually be reflected in the PPI later this year.
Based on the expectations of escalating inflation in the United States, the US domestic 10-year bond interest rate has continued to increase since the beginning of the year, which has narrowed the spread between China and the United States. However, the current fiscal and monetary policy directions of the United States and China are significantly different, whilst the increase in US bond interest rates has begun to settle after entering the second quarter. Certainly, the spread between China and the United States will remain at a relatively high level, which is still attractive for foreign investors to increase their holdings of RMB assets and would aggravate pressures on RMB appreciation. Ever since last May, with respect to the offshore RMB, the exchange rate has rebounded from a low of 7.2 US dollar and once climbed up to 12%. Based on the perspective of technical indicators, the RMB has the possibility to test the 6.3 US dollar level in the short-term.
In the medium and long-term, the trend of the RMB will largely depend on the future direction of US monetary policy. Considering that core inflation must remain above 2% for a longer period, we still tend to believe that, for the time being, interest rate will not be possible to increase until the latter part of 2023 at the earliest. As US economic output resumes to its pre-epidemic levels, the Federal Reserve (Fed) can gradually reduce the scale of bond purchases by next year. The Fed may deliver a message to the market of policy tightening in the fourth quarter of this year, with an increasing possibility of a strengthening US dollar at that time. Therefore, the RMB may give back part of its appreciation later this year, while the year-end target exchange rate is provisionally set at 6.5 US dollar.
(Written on 3rd June 2021)
Senior Investment Specialist
Principal Asset Management (Asia)