Is Asia heading toward a trade recession?

Asia is missing the mark on manufacturing. In some areas – China included – it’s as weak as it has been for years. In isolation, China could be headed for a dreaded trade recession. Is broader Asia at risk?

For the first time since 2014, manufacturing in the region - excluding south-east Asian economies which are holding up well - is seeing a synchronised slowdown. Data since the beginning of 2019 show manufacturing Purchasing Manager’s Indexes (PMIs) in several Asian economies have missed expectations. So has inflation.

Manufacturing activity in China, South Korea, Taiwan and Malaysia is heading toward its weakest levels in nearly three years - since the last trade recession in 2015-16.

Other indicators like new orders and the sales-to-inventory ratios point to further downside risk to gross domestic product growth. In the meantime, headline inflation has undershot by a large margin in most economies.

After a number of rate hikes in 2018, real interest rates in Asia are now at their highest since 2009. Markets will likely remain volatile in the short term but outperformance is likely if the US takes a pause in rate hikes or recalibrates its balance sheet unwinding.

Trade talks between the US and China are a wildcard but a market rout and weakening data may nudge both parties towards a welcome deal - even if it is not a permanent fix.

Remember December

December PMIs of Asian economies show manufacturing activity in China, South Korea, Taiwan, and Malaysia is currently in contractionary territory. Using GDP weights, Asia’s overall manufacturing activity is just a tad above the break-even mark.

If not for the Southeast Asian economies still in expansionary zone (save for Malaysia) the region’s manufacturing activity could already have slid into contraction. The last time the region’s PMI was in negative territory was during the 2015-16 trade recession.

In terms of actual trade numbers, over half of the economies in Asia (South Korea, Taiwan, Hong Kong, Philippines, Thailand, Singapore and Indonesia) saw a contraction in exports while exports in the rest (China, India, Malaysia and Vietnam) posted low single-digit growth rates.

All in, the data point to downside risks to GDP growth in Asia in the coming quarters - similar to that seen in 2015.

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“Manufacturing activity in China, South Korea, Taiwan and Malaysia is heading toward its weakest levels in nearly three years - since the last trade recession in 2015-16.” 
IRENE CHEUNG & RAYMOND YEUNG, SENIOR STRATEGIST, ASIA & CHIEF ECONOMIST, GREATER CHINA, ANZ  

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Heightened risks

In China, falling sales orders are beginning to show up in monthly exports data, to the point a period of contraction in Chinese exports similar to 2015-2016 seems likely.

The global electronics cycle remains the key driver of Chinese exports and potential downturn there poses the real risk to its outlook - even if China and the US reach a resolution to their ongoing trade dispute.

The share price of Apple is an interesting gauge of China’s export outlook. The financial market provides the most accurate assessment of the global electronics industry as the share prices of market leaders reflect the views of industry experts on the lifecycles of the products.

A higher trade surplus may help China skirt a current account deficit for the December quarter but the export outlook for 2019 isn’t look favourable. Nonetheless, policymakers look to have no intention to devalue the yuan competitively to maintain financial stability.

The most-recent official data showed Chinese exports fell 4.4 per cent year-on-year in December, compared with a rise of 3.9 per cent in the previous month. Imports shrank 7.6 per cent in the same period.

A trade recession in the country looms. Statistically the decline in China’s export orders data over the second half of 2018 signals a downtrend in exports over the first half of 2019.

The anecdotal reports of Chinese exporters front-loading cargoes ahead of tariff hikes in 2019 may explain the strong exports seen in late 2018. In the months ahead, payback appears likely.

Undershot

It’s not a huge surprise inflation in Asia is easing at a time manufacturing is slowing although the extent of undershooting has exceeded expectations. For the region as a whole, headline inflation had dropped sharply from a high of 2.3 per cent in September to 1.6 per cent in December.

A collapse in energy prices was the main culprit. Indeed, core inflation has remained stable in the past year but headline inflation has now fallen below core inflation.

This, coupled with interest rate hikes in 2018, has seen real policy rates in the region rising to an average of 1.5 per cent; the highest since 2009.

Make or break

Asia is at a key juncture. Policy moves could avert a potential trade recession but the US-China trade talks are a wild card. That said, pressures have increased for both sides to make a deal although neither are likely to find a permanent solution to their disputes.

The US Federal Reserve appears likely to be vigilant to changing dynamics. A pause in rate hikes or a recalibration of balance sheet unwinding will likely usher in a period of $US weakness.

From the perspective some of the rate hikes in Asia in 2018 were aimed at stabilising currencies (as opposed to fighting inflation), a precondition for any monetary easing in Asia is that aforementioned softer $US.

Irene Cheung is Senior Strategist, Asia & Raymond Yeung is Chief Economist, Greater China at ANZ

Views in this article were originally published in ANZ’s Asia Macro Strategy Weekly January 11 2019 and China Insight: Heightened risks of a trade recession January 14 2019. You can read the original reports HERE and HERE.