We spoke to Asia Society on key regional and global events impacting Australia and Asia going into 2016, including:
1. INTERNATIONALISATION OF THE RMB
Capital account deregulation has been picking up the pace in China, as has Chinese currency (RMB) internationalisation, as discussed at the recent Thomson Reuters – Europacifica RMB Thought Leadership seminar. One of the keynote speakers – Kathy Walsh – forecasts a foreshortened horizon for full internationalisation, and this is underscored by the IMF’s recent decision to include the RMB in the Special drawing rights (SDR) basket. Australia has the opportunity to gain a first-mover advantage in the Chinese financial services market for a limited window of time (until full internationalisation). Opportunities abound and the only question is whether Australian firms will move fast enough in the right areas. As the RBA and officials correctly recognise, Australia desperately needs to diversify its economy away from mining. This could be a golden opportunity.
2. FED INTEREST RATE HIKE
We are watching next week’s Fed meeting like hawks, but doves linger on in the longer end of the interest rate curve. The Fed wants to normalise rates as quickly as possible without hurting the economy, but there are questions over whether the US economy (and overseas emerging and commodity-based economies for that matter) is strong enough to handle prospects of a series of hikes. If the hike is a solitary one, then the market may call the Fed’s bluff. Why only hike once? Isn’t this admission of a mistake? Fed rhetoric will have huge bearing on how this affects the US rate curve, emerging markets, commodities, and every manner of risk asset that has been funded by the deluge of global liquidity. Emerging Asia moves on the Fed, Australian markets and the AUD move on the Fed, and commodity prices move on the Fed – this is the one we cannot ignore.
3. BANK OF JAPAN (BOJ) AND THE EUROPEAN CENTRAL BANK (ECB)
I put these two together because they constitute the “other liquidity” that might still be forthcoming. Both of these central banks are committed to fighting deflation in their respective regions, and the EUR and JPY look like funding currencies to the market. So if there is true policy divergence – if the ECB and BOJ get more aggressive in their easing as the Fed hikes, then this could prolong the cheap money party. This will affect Australia given the huge inflows funding from abroad to Australia’s current account deficit. Even with the Fed hikes, the ECB and BOJ could continue the party. Asian stock and bond markets will be influenced by the interplay between Fed, ECB and BOJ rate policies, and whether “cheap money” persists or not.
4. OPEC AND OIL SUPPLY
The long end of the interest rate curve across many developed economies languishes due to debatable reasons. Is the economic recovery strong enough? Are deflationary/disinflationary tendencies still a threat? But one positive interpretation we might take is the softness in commodity prices as dampening long-term inflation expectations – if this disinflationary element is not driven by poor demand, then we can expect real wages to rise in developed economies, which is positive for the consumer (if not for banks, who must withstand pressure on their profit margins). Thus, keep watching oil supply developments and price moves to gauge whether they are demand or supply driven. If supply-driven, then we can be more positive on stocks, longer-end bonds and buy risk assets on dips.
The other side of this for Asia is the development of clean energy technologies – Japanese and Chinese clean energy stocks have already been beneficiaries of easy money, but might also be beneficiaries of investment to shift away from fossil fuels. If so, these are good hedges to commodity-heavy portfolios.
5. PRODUCTIVITY AND CRUNCH TIME FOR ABENOMICS
The buoyant Nikkei has recovered from a low base, and many credit Abenomics. However, once the Fed hikes, even if the BOJ leaves stimulus in place a volatile time for risk assets (including stocks) will ensue. This could separate winners from losers in the Japanese market, where from 2012 until now stocks were more or less in favour as an asset class. Abe’s structural reform credentials might come under question, which is a good thing in my opinion, given the heavy dependence on monetary stimulus that this supposedly three-pronged strategy has used.
Both Japan and Australia may have to face the music when in regard to boosting productivity in lagging industries, in terms of productivity. In Australia, overinvestment in mining and under-investment everywhere else has created a slump in total factor productivity, that Australia will have trouble exporting its way out of (given China’s policy shift). Japanese firms have managed to benefit from the rise of asset values given greater (global) monetary stimulus, but productivity among under-performers (in non-manufacturing, non-IT) still remains lacklustre. Hard choices will have to be made in both countries as global liquidity starts receding and unproductive firms, sectors and economies start to feel the squeeze.