Weekly: View from Europe – a tentative trough
- Europe has its fill of formidable challenges ahead
- Independent of Brexit, uncertainties will linger with respect to UK-EU trade and investment
- Economic and financial distress in Turkey could affect the region
- If China stimulus fails to add further momentum to imports, Europe’s upside will be limited
With endless Brexit intrigue and considerable volatility around Turkey, European investors are a busy lot these days. Add to this a stream of weak industrial data from Europe’s largest economies, questions about US-Europe trade friction, debate over NATO defence spending, and hope for China stimulus to help exports, macro themes dominate overwhelmingly.
During our meetings with Europe and UK-based investors this week, we sensed guarded optimism that improving financial market conditions (as bond spreads have narrowed and equity prices climbed this year) and a likely pick-up in demand from China would put Eurozone’s worst behind in 1H19. The search for yield in emerging markets continues unabated and there was particular interest in Asian high yielding economies like India, Indonesia, and the Philippines, along with many questions on frontier markets like Bangladesh, Sri Lanka, and Vietnam.
There was however an interesting line of thought that low yielding, more developed, Asian economies have a structural headwind brewing. This relates to a gradual opening up of China’s debt markets, alongside inclusion in global bond Indices. Investors are seeing considerable demand among their peers, including talk of how eventually Chinese risk free rates will converge to US Fed rates. As China’s current account heads to zero or negative territory, thus creating an organic pull for global portfolio flows, the question is if that would crowd out some EM investments.
We think that high yielding Asian economies still have sufficiently positive real rates to offer attractive risk-reward propositions to global investors. We are however not as sure about the fixed income papers offered by the likes of Malaysia, South Korea, Taiwan, and Thailand. We consider Hong Kong and Singapore as special cases in this comparison due to their status as financial centres, but for the four other economies mentioned above, the coming years may entail more intensified competition for global fixed income funds.
European investors are concerned about economic and financial market distress in Turkey. While not a part of EU, Turkey is a major trading partner of many European economies, and the demand destruction there in the past year has been felt acutely by the regional exporters. Behind economics and finance, the geopolitical spillover from possible turmoil in Turkey could be considerable for the region.
Additional cloud over the horizon relates to the US. European auto industry is anxious about the threat of tariffs; many countries are facing pressure from the US on their dealings with China and Iran; there is also renewed pressure on greater contributions to NATO budget.
With plenty of headache from the US these days, hope lies with China. Fixed income and FX investors are busy taking positions on Chinese debt and currency. Funds are increasing their allocation to China as access and products become available. Analysts are tracking the efficacy of China stimulus as minutely as they cover European and US data. This is particularly important as there are good reasons to believe that the China stimulus will be more consumption (and less investment) focused this time. Hence the likely impact on global commodity and machinery demand may well be less so than a similar-sized stimulus of the past would have achieved. If China’s stimulus fails to add further momentum to its imports, Europe’s upside (through its exports channel) may well be limited.
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