A rebound in consumer demand would be positive for China’s financial markets, in our view.
Foreign investors, chastised by global volatility and zero-COVID policies, are and remain largely underweight China. Consumer demand and other signs of the strength and durability of the recovery would likely result in portfolio rebalancing in favor of China.
However, there are risks to this outlook, which are best understood in the context of China’s broad political framework.
Monitor property for signs of stability
The framework was shaped by President Xi Jinping’s goal of achieving a balance between growth and equitable social outcomes. As a result, investors should expect more moderate and sustainable growth and a focus on supporting innovation and manufacturing, increasing per capita income, reducing wealth inequality and pursuing further market reforms.
The political environment can be viewed as positive in the long-term, but may lead to some short-term uncertainties. As mentioned, China’s real estate market has suffered significantly over the past two years, mainly due to regulatory intervention. This intervention was consistent with President Xi’s goals of social justice.
But growth remains a government priority. This was confirmed at the government’s recent Central Economic Work Conference and underscored by the faster-than-expected reopening. This is also evident in the housing sector, where the People’s Bank of China and the China Banking and Insurance Regulatory Commission recently took measures to support the “stable and healthy development” of the sector.
For buyers and investors, these measures include lower mortgage rates, lower mortgage prepayment rates, relaxed home purchase eligibility and home purchase cash grants. For property developers, this includes making it easier to comply with lending restrictions imposed during the crackdown.
While these actions are encouraging, we believe investors should continue to watch carefully for signs of stability in the housing sector when assessing the overall balance of risks and rewards in the economy.
Inflation should be harmless
Another risk is that the reopening will lead to a rise in inflation in China, as has happened in other countries after the pandemic. But in our view, any inflationary effects should be harmless. While it is possible for the core CPI to trend higher, we do not believe it will rally to levels seen in developed markets.
One reason is that while household savings in China have increased, government support for individuals and businesses during the lockdown has been significantly less than in the US and Australia, for example.
Another reason is that food inflation dynamics in Asia, including China, differ from other countries. For example, food inflation in emerging markets outside of Asia has risen dramatically over the past two years in response to the war in Ukraine and supply chain problems. The same applies to the prices of the western staples wheat and corn. However, food inflation in Asia and the price of rice have remained stable.
In our view, there is little likelihood that inflation will rise sharply in China. Consequently, we assume that the political environment will continue to support growth.
Asia’s boats are likely to rise with China’s tide
Due to the different inflation and yield curves of the countries, Chinese government bond yields are lagging behind those of US Treasuries for the time being. For this reason, we believe that the near-term opportunity for fixed income investors created by the reopening of China lies not so much in the Chinese bond market as in the credit and foreign exchange markets of its Asian trading partners.
China’s largest trading partner is the 10-member Association of Southeast Asian Nations (ASEAN), and four non-ASEAN Asian countries are among China’s 13 top trading partners. China, in turn, is the most important trading partner for eight of these countries and either the second or third largest trading partner for the others.
We expect the country’s reopening to ease supply chain pressures across the region and provide a direct boost to some industrial sectors. One area likely to benefit is tourism as China’s outbound tourism recovers from the collapse it has suffered due to COVID.
Increased trade with China would be positive for those countries’ corporate bond markets and their currencies should also benefit. With US dollar strength appearing to be coming to an end in the near term, the main headwinds Asian currencies faced in 2022 have dissipated and EM Asian currencies have appreciated significantly.
We are consistently positive for Asian currencies. And should the US dollar recover, we expect high-yielding Asian currencies to outperform their regional counterparts on a total return basis.
Asian markets could outperform in 2023
With China reopening and the likely challenge for the rest of the global economy in 2023, we believe there is ample scope for both foreign and domestic investors to invest in the region. Stronger growth in China should translate into stronger growth in Asia, creating conditions that we believe could see Asian markets outperform in 2023 and beyond.
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