(Bloomberg) — Markets are largely in for Green Friday but strategists warn there is still a possibility that US debt ceiling negotiations could collapse over the weekend or lead to drastic spending cuts that stifle global economic growth.
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Assets in Asia are particularly vulnerable because they will be the first to interact with any agreement when it opens on Monday as the US will be closed that day for a holiday.
Republican negotiators and the White House are making progress toward a deal to raise the debt limit but details are tentative and have not yet agreed on the size of the federal spending cap, according to people familiar with the talks. A Bloomberg Economics model shows that the spending cuts required to get the Republican side to agree to a deal could cost as many as 570,000 jobs.
“The result of any decision is likely to be a financial downturn that is not fully priced in by the market,” said Aninda Mitra, head of macro and investment strategy in Asia at BNY Mellon Investment Management in Singapore. “When you’re trying to rebuild cash balances like crazy, that buildup is sucking up liquidity at a time when the markets are going through the graveyard a little bit.”
Stocks in Asia fell for three days through Thursday amid growing concern about a possible US default, and after ratings agency Fitch Ratings said it may downgrade its AAA rating of the world’s largest economy to reflect the growing partisanship blocking a deal. Regional stocks rose on Friday, but that was driven more by a recovery in technology stocks than optimism about a potential agreement.
The bulk of regional markets remain lower for the week amid waning risk appetite, led by emerging markets such as China, the Philippines and Malaysia. Consumer discretionary materials and stocks were also among the biggest losers.
“Pandora’s Box”
“We’ve never been in default – it opens up a little part of Pandora’s box,” said Herald van der Linde, head of equity strategy in Asia Pacific at HSBC Holdings Plc in Hong Kong. “I can also see funds saying we don’t want to be in emerging markets and certainly not in small markets.”
Investors may want to stick to a more defensive stance while there remains uncertainty about where the expected spending cuts will take place, according to Invesco Asset Management.
“It makes sense to have strong cash flow, low volatility, and defensive, large-cap stocks like healthcare and consumer goods,” said David Zhao, global market strategist for Asia Pacific at Money Management in Singapore.
Another potential refuge from the sell-off could be some Asian bonds. Dollar debt spreads in the region are at their lowest since mid-March, while the Emerging Asia Bond Index has outperformed a similar measure of Treasury bonds this month, according to Bloomberg Indexes.
If there is another sell-off triggered by a debt deal, then sovereign debt is likely to outperform India and Korea, said Rai Sharma Ong, investment director of multi-asset solutions at abrdn plc in Singapore. “Both Indian and Korean sovereign bonds enjoy resilience from US treasury moves, and will benefit from potential inclusions in the bond index,” he said, referring to the ongoing reviews of these two Asian markets.
There is no certainty that any debt deal will be the end of the problem, especially since bond markets are likely to underestimate risks related to a final agreement, according to Owen Gallimore, head of credit analysis for Asia Pacific at Deutsche Bank AG in Singapore.
“The decision can quickly turn into a sale,” he said. “This year’s bearish calls from the woes of the credit market have not happened yet, and the market in Asia is trading tight spreads in this situation, so the risk and reward is not good.”
– With the help of Marcus Wong.
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