The smooth sailing for Asian emerging markets this year has Citigroup Inc. analysts getting antsy. They’ve identified four major risks that could lead to a more turbulent second half.
While resilient growth, benign inflation, a carry-friendly environment, Chinese reforms and market-friendly political transitions could still be the dominant themes for the region over the rest of 2017, the outlook is “uncomfortably sanguine,” analysts led by Asia-Pacific chief economist Johanna Chua wrote in a July 21 report.
Here’s a look at four key risks facing Asian markets:
How far will major central banks including the Federal Reserve and European Central Bank go to tighten policies while structural drags on inflation and growth exist? The Fed’s move will have greater impact in Asia as the dollar is the more important currency. “A sudden shift in expectations can be a source of market volatility without accompanying positive spillovers to fundamentals in the region,” the report said.
Emerging Asian economies have benefited from prudent policies leading to stronger balance sheets in the past few years, however economic gains haven’t been redistributed equally. That leaves many countries vulnerable to more populist policies. This may be especially true in China and Malaysia, where both countries are “visibly more accommodative than the norm” as they go through political transitions while defending the dominant regime.
Market observers have expected China’s regulators to err on the side of caution in the run-up to the 19th Party Congress later this year, leading to some complacency among investors as stocks rallied. Once the congress is underway, “there is risk that policy priorities will shift toward more financial regulatory tightening versus growth stability, which could take markets by surprise,” the report said.
Kim Jong Un
Finally, the wildest card in the bunch is the “unbridled bravado” of North Korean dictator Kim Jong Un. With diplomatic solutions appearing distant, “scenarios that could be contemplated” include the U.S. pursuing tougher sanctions, pressuring China to embargo oil exports to the North, and even military options. The market impact of any hint of military escalation would be widespread risk aversion and dollar buying, leading to initial yen strength that would then reverse as conflict spreads, the report said.