(Bloomberg) — Markets are largely in the green Friday, but strategists warned there is still a possibility U.S. debt-limit talks could break down over the weekend or spending cuts could drag down global economic growth.
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Assets in Asia are particularly vulnerable as they will be the first to react to any settlement when they open on Monday as the US will be closed for a holiday that day.
Republican and White House negotiators are making progress toward a deal to raise the debt ceiling, according to people familiar with the talks, but details are tentative and they have not yet agreed on the size of a cap for federal spending. Bloomberg economics models show the spending cuts needed for the Republican side to agree to a deal could cost up to 570,000 jobs.
“The outcome of any resolution will probably amount to a fiscal contraction that is not fully decided by the market,” said Aninda Mitra, head of Asia macro and investment strategy at BNY Mellon Investment Management in Singapore. “While you are frantically trying to rebuild cash balances, this build-up sucks out liquidity at a time when the markets are whistling past the graveyard.”
Shares in Asia fell for three days on Thursday amid growing concern over a possible US default, and after Fitch Ratings said it may cut its AAA rating for the world’s biggest economy to reflect heightened bias. which is blocking a transaction. Regional equities ticked higher on Friday, but that was driven more by a rebound in technology stocks than optimism over a possible agreement.
Most regional markets are still down for the week amid a lack of risk appetite led by emerging markets such as China, the Philippines and Malaysia. Materials and consumer discretionary stocks have also been among the biggest losers.
“We’ve never been in a default position – it’s opening a bit of Pandora’s box,” said Harald van der Linde, head of Asia Pacific equity strategy at HSBC Holdings Plc in Hong Kong. “I can also see funds saying that we don’t want to be in emerging markets and certainly not in smaller markets.”
According to Invesco Asset Management, investors are inclined to take more defensive positions while uncertainty remains over whether the expected spending cuts will materialise.
“It makes sense to own large-cap defensive stocks with strong cash flows, low volatility, such as health care and consumer staples,” said David Chao, global market strategist for Asia Pacific at Money Manager in Singapore.
Another potential refuge from the selloff could be in some bonds in Asia. The region’s investment-grade dollar debt is at its tightest level since mid-March, according to Bloomberg Indices, while an index of emerging Asia bonds outperformed a similar gauge of Treasuries.
India and Korea’s sovereign debt will probably outperform if further selling from debt deals triggers, said Ray Sharma-ong, investment director, multi asset solutions at abrdn plc in Singapore. “Both India and Korea sovereign bonds are resilient to US Treasury moves, and would benefit from potential bond-index inclusions,” he said, referring to ongoing reviews for those two Asian markets.
According to Owen Gallimore, head of Asia-Pacific credit analysis at Deutsche Bank AG in Singapore, there is no certainty that any debt deal will be the end of the issue, especially as bond markets are potentially discounting the risks related to a final agreement. Are.
“The resolution can quickly turn into a selloff,” he said. “The bearish calls in this year of the credit-market crisis haven’t played out yet, and markets in Asia tend to have tighter spreads in this situation, so the risk-reward is not good.”
–With assistance from Marcus Wong.
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