23 March 2018
Asia week ahead: Manufacturing data crowds calendar

The global trade war threatens Asia’s export-driven growth, which so far has been on a firm footing and we expect next week's manufacturing data to confirm that 

Global trade war- a threat to Asia's export-driven growth

The Asian markets will remain under pressure from the global trade war. 

Media reports as of writing this article suggest an intensified trade war with the US set to slap $50bn worth of tariffs targeting hundreds of Chinese export goods. Beijing has so far responded with a conciliatory approach by further opening up the economy for foreign competition, but retaliatory measures can't be ruled out. 

An intensified trade war will be a threat to Asia’s export-driven growth, but for now, the manufacturing data from the region is likely to show that growth has so far remained strong this year. 

Taiwan central bank stays put at 1.375%

Taiwan has kept rates on hold for seven consecutive quarters but the economy now faces risk from trade protectionism as it sits between the supply chain of goods traded between China and the US

Rates on hold since July 2016

As expected, Taiwan's central bank kept the interest rate on hold at 1.375%, which has remained unchanged since July 2016.

Taiwan's new central bank governor, Yang Chin-long said the Bank's main task is to keep inflation stable rather than solve the structural problems of the economy. 

Since 2016, inflation has fluctuated between 0% to around 2%, and as we forecast it to move between 1% to 1.5% in 2018, we expect the central bank to continue to stay put.

But risks from trade tension are rising

With the help of the US on tourism, and the electronics sector doing well the economy is in good shape, and we expect it to grow at 3.2% in 2018, which is above the consensus of 2.7%. But the risks are rising as tensions between the US and China escalate over trade. 

Nowadays, the supply chain is complex, and Taiwan falls between the supply chain of electronic goods traded between China and the US. Increasing trade protectionism would ultimately hurt Taiwan's trade volume and profits.

If trade protection actions become visibly negative for Taiwan's economy, then we may need to revise our GDP forecast and the policy rate.

Expect the TWD to appreciate along the soft USD

As trade tensions escalate, the US dollar would be weaker against major currencies. We expect USD/TWD to reach 28.00 by the end of the year and so far our forecast is on track. The spot is 29.149 against our first quarter forecast of 29.00.

Again, if US trade tensions intensify further, we may need to revise USD/TWD downward. But for now, we keep them unchanged.

PBoC follows the Fed by 5 basis points, what’s next

The PBoC raised the 7D open market rate by 5 basis points this morning. This has been expected. Would it extend it to other interest rate tools like last time? How would trade tensions affect interest rates and the exchange rate path?

Demonstrating policy continuity

As expected, the People's Bank of China (PBoC) raised the 7D reverse repo open market rate today by 5 basis points from 2.50% to 2.55%. We wrote on 21st March that this is our view. This shows that there is policy continuity in the central bank in terms of interest rate policy.

The objective of raising 5 basis points is to stabilise China-US short term interest rate as raising 25 basis points would be overdone as the central bank has tightened liquidity through daily open market operations. Short-term rates have already gone up. That explains why PBoC raised rate by 5 basis points.

However, we expect more than that.

We are looking at other short-term interest rates to rise 5 basis points as well, so that the interbank rate curve would move up in parallel by 5 basis points. The interest rate tools that we expect to move up by 5 basis points are the Medium Lending Facilities (MLF) and the Short-term Liquidity Operation (SLO).

If these do not move up, then the short-term interest rate curve would be flattening, which we think is not the objective of the central bank.

For the rest of the year, PBoC would still follow the Fed by 5 basis points as financial deleveraging would mean tighter open market operations and would continue to push up short end rates in China.

Future interest path depends on risks from trade tension

How China reacts to US trade protection actions would affect not only trade but also US companies operating in China.

Overall, trade protection actions affect the supply chain of US and China goods as well as consumer and production prices of the goods. This means the impact is not just limited to the two economies, but to the rest of the world as well.

Goods produced in China ship to many countries, and companies in China could look for markets outside the US to reduce the risk of trade tension. We believe that the Belt and Road initiative may help China exporters to diversify, but results are still to be seen.

This explains why we are not particularly concerned the yuan exchange rate would be affected. But this would affect the interest rate path if economic growth is largely impacted by trade protection actions.

All in all, PBoC shows policy continuity, and we expect future Fed rate hikes to be followed by 5 basis points hikes by the Chinese central banks to avoid overdoing the tightening, which is already in every day's open market operations. If there is anything that would slow down interest rate hikes that would be increasing negative impact on economic growth from trade tension.

The dollar has been largely weak when there has been trade protection actions from the US government, and the trade tensions from the US on China is escalating, so we expect a stronger yuan against the dollar. This is in line with our yuan forecasts. We keep our view that USD/CNY could reach 6.1 by the end of 2018.

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Good MornING Asia - 23 March 2018

It was well flagged, but the $50bn tariffs on China are no less disturbing for all that

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