US recession, possible China reopening to weigh on Asian economies

ASIA INVESTMENT OUTLOOK US recession, possible China reopening to weigh on Asian economies

China and Hong Kong will recover in a potential broader reopening in Asia.

There will be mixed prospects for Asian economies amidst a plausible recession in the US and the potential loosening of cross‑border restrictions in China in 2023, according to Citi Global Wealth Investments’ 2023 Wealth Outlook.

In 2022, the slower reopening weighed the most on Hong Kong and the mainland. Geopolitical escalation also disrupted Taiwan whilst Korea was bearing the brunt of the tech bear market, especially in semiconductors.

But if China reopens, it could have positive effects beyond its borders by reviving demand and bolstering Chinese imports from the wider region. This development could mitigate some of the impacts of the European and US downturns.

China’s economy may rebound from 3.5% to 4.5% whilst Hong Kong’s economy may reverse from a 2.6% contraction to 2.8% growth.

Asia’s external resilience will stay robust and will likely avoid recession in 2023. The real economic growth of emerging Asian markets will reach 5% in 2023 after decreasing to just below 4% in 2022.

Japan will likely be the most resilient out of all Asian economies, with an above‑trend growth of 1.6%. Other Asian economies are likely to see moderate deceleration.

A potential China reopening will also resume outbound Chinese tourism, which can help recover markets like Thailand, wherein tourism rebounded to 50% of 2019 levels without China’s travel resuming.

Easing of health restrictions will take place in the spring of 2023, following a potential winter wave of infections. This easing is expected due to recent medical advancements and changes in government messaging.

The economic stability of Asian markets has been largely preserved by their ample foreign exchange reserves, which can cover current account and short‑term debt by more than one year.

This helped to buffer the region from the negative effects of the Federal Reserve’s tightening of monetary policy in 2022. Despite a decline in reserves and weakening of currencies, the region is well‑ positioned to weather potential external economic weakness in 2023.

China’s double-digit growth

In Asia, Indonesia is the only market to produce positive returns in USD terms in 2022, increasing by 2%. Other markets like India and Thailand, managed positive local currency returns.

Meanwhile, China, Taiwan, and Korea were grappling with falling local equities and currencies. Earnings results for 2022 seem to corroborate the equity returns with Indonesia, Thailand, and India leading, whilst China and Korea are falling behind.

Next year, the performance of Asian economies will depend much on the timing of the US and China’s cycles, with markets that are most insulated from potential external economic weakness likely to do best.

China may improve after two years of negative earnings and equity performance. There is expected additional progress to restore capital market activity, including more Initial Public Offerings from the technology sector, which could lead to a more visible recovery in 2023 and restore some investor confidence.

After its earnings fall by 7% in 2022, China is likely to see low double‑digit growth, and valuations may rise from distressed levels.

Japan’s equity performance

Japan’s equity performance was around the middle of the pack in Asia, with 15% earnings growth in 2022 that beat expectations. The drag came mainly from a 30% depreciation in its currency through October, which traditionally would have benefited Japanese equities.

But the depreciation in 2022 came from a record tightening in US monetary policy, which weighed on all assets. Japan’s economy was largely unscathed by inflation. The Bank of Japan’s controversial easing policy amid US Federal rates tightening may be vindicated if the US dollar continues to weaken in 2023.

The possibility of a yen recovery, with relatively stable policy and growth, may draw more investor inflows to Japanese equities.

Next year, the performance of Asian economies will depend much on the timing of the US and China’s cycles

The economic stability of Asian markets has been largely preserved by their ample foreign exchange reserves

Global cycle to strain other AsiaPacific markets

Other countries in Asia Pacific that are more exposed to the global cycle may still feel pressure, including Korea, Taiwan, and Australia, where earnings

Asia valuations and favored Asia sectors

Source: Citi Research, Worldscope, MSCI, FactSet

are expected to fall in 2023. Indonesia’s commodity advantage may also be subdued in 2023.

Meanwhile, others in Southeast Asia like Thailand and Singapore may do well amidst broader reopening such as the potential easing of China’s borders.

In the longer term, as the US‑ China rivalry continues, there is an expected drive toward building more domestic production capacity and in friendly markets, shifting the investor mindset from focusing on companies that enable consumers to those that facilitate production, likely supporting industries such as sustainable energy, telecom, core technologies, and select infrastructure.

Weakest currencies to gain most in 2023

Japanese yen, Australian dollar, and Chinese yuan may have suffered in 2022 but they may gain the most in 2023. According to the Bloomberg JP Morgan Asia Dollar Index, Asian currencies weakened 11.3% in 2022 through October. The US Fed’s 400 basis points of rate hikes through November left US yields much more attractive than many Asian sovereign yields.

The resulting negative carry caused capital outflows and impacted Asian currencies, with some central banks repeatedly intervening to support their currencies, such as Japan, China, and Hong Kong.

In 2023, Fed tightening will persist in early 2023 wherein the US dollar may remain supported.

But when US economic data gets weaker and the Fed pivots to cutting, the dollar may see risks.

The early signs of downside risks are already evident in late 2022.

The Japanese yen is likely to experience a strong rebound in 2023. This is because the Bank of Japan has maintained an easing stance, causing short yen positions to reach record levels. As a result, the reversal of the yen’s 30% weakening through October 2022 is expected to be significant.

The Australian dollar is also expected to reverse substantially. After depreciating by 18% between April and October, it rebounded by 8% in one month following the first hints of a peak in US yields.

The Reserve Bank of Australia has also consistently been raising rates and is expected to continue doing so despite the Federal Reserve’s hikes.

Chinese yuan experienced a 16% peak‑to‑trough depreciation in 2022 but could see a comeback in 2023.

Some suspect that China’s rebound may weaken its currency because its import demand will increase whilst exports fall as the US economy weakens.

But the Chinese currency’s depreciation resulted mainly from Chinese government bonds’ 1% positive carry turning to a 2% negative carry versus US Treasury bonds.

Such a gap will likely narrow if China stages a recovery and emerges from deflation, lifting Chinese yields in 2023 whilst US yields likely fall.

Investments

In 2022, the rise of global central bank policy rates and the Fed’s rate hikes of almost 400 bps through November caused all fixed‑income valuations to fall.

Higher US rates also pressured foreign exchange values. In US dollar‑denominated corporate bonds, China’s real estate sector continued to experience high levels of distress due in part to government policies contributing to a loss of market confidence.

This led to large sector price falls in high‑yield and formerly investment‑ grade bonds. After the October Party Congress, China’s financial authorities announced comprehensive measures to stop widening defaults and facilitate restructuring, which led to a rebound in market confidence in November.

For investors with high‑risk tolerance, real estate may offer tactical outperformance if policies enable a rebound in sales and cash flows.

For more conservative investors, US dollar‑denominated investment‑ grade issuers may offer interesting yield premiums to US counterparts of similar ratings and maturities.

Asian sovereigns with strong trade balances and healthy US dollar reserves may also be interesting for adding potential diversification to a global fixed‑income allocation.

Our Favored Asia Sectors (Ex-Japan)

Source: Citi Research, Worldscope, MSCI, FactSet