Tension is building over the US debt ceiling, spurring investors as far away as Asia to prepare for the worst — even if a resolution is the base case and US markets will take the first hit from any potential default.
(Bloomberg) — Tension is building over the US debt ceiling, spurring investors as far away as Asia to prepare for the worst — even if a resolution is the base case and US markets will take the first hit from any potential default.
Strategists have begun to tell clients ways to position for the fallout, pointing to 2011 when S&P Global Ratings downgraded the US credit rating as negotiations became deadlocked. The playbook includes betting on the traditional havens of the yen, gold and Swiss franc, as well as more creative trades such as going long on the Indian rupee and South Korean bonds.
“The frequent political showdowns on whether to raise the $31.4 trillion debt ceiling raises the question whether the US really is a risk-free issuer,” said Hilde Jenssen, head of fundamental equities at Nordea Asset Management. When S&P downgraded the US, “Asian equities dropped initially on the news before rebounding. Regardless of the rating agency’s decision, we are prepared to face volatility in Asian stocks over the next few months,” she said.
The House of Representatives on Wednesday passed a Republican-backed debt limit bill, intensifying a standoff with the White House that opposes the legislation. The bill has no chance of passing the Democratic-controlled Senate.
Here are some trades that strategists recommend for Asia:
Yen, Gold
The yen and gold both advanced after S&P put a negative outlook on its US credit rating in April 2011 and climbed again following its downgrade in August. The Bloomberg Dollar Spot Index also gained after the rating-cut amid broader haven demand.
Japan’s currency is likely to outperform if the likelihood of a US default increases, Nomura Holdings Inc. strategists including Craig Chan in Singapore, wrote last week in a research note. Traders will expect a default to be short-lived, while raising the odds for a US rate cut in 2024. With lower Treasury yields, the yen will benefit.
Whether the dollar rallies once more as it did in 2011 is up for debate.
In the event of a prolonged government shutdown, or credit-rating changes, the dollar may not benefit from haven demand this time, said Khoon Goh, head of Asia research at Australia & New Zealand Banking Group Ltd. in Singapore. “Traditional safe-haven assets such as gold, yen and Swiss franc will most likely gain.”
Quality Stocks
Back in 2011, Asia’s higher-quality stocks outperformed with defensive sectors from July to September and that may be the case again, said David Chao, a global market strategist for Asia Pacific at Invesco Asset Management in Singapore. “Asia-Pacific market participants should prepare for liquidity conditions in the US to tighten as the debate plays out.”
Asia’s stock volatility has been falling this year along with that in the US, creating a potential underpricing of risk if fears of a US default intensify.
Societe Generale SA sees that as an opportunity, recommending relative volatility-linked derivatives trades in South Korea and China called variance swaps, with expectations of bigger price swings in the latter country.
At the same time, “the best performance for this pair trade is if we don’t have a big US selloff on the back of the debt-ceiling debate” as Korean stocks are more vulnerable to general risk aversion, said Jitesh Kumar, an equity derivatives strategist at SocGen in Paris.
Asia High Yielders
Should the dollar slide, that may provide a tailwind for higher-yielding currencies such as the rupee, according to some.
India’s currency stands out due to its low volatility and higher carry, which makes it attractive, said Ray Sharma-Ong, investment director of multi-asset solutions at Abrdn Asia Ltd. in Singapore. Korean bonds may also gain, especially given signs the central bank will pause its tightening cycle, he said.
Read More: Goldman Says Big US Tax Haul Means Debt-Limit Deadline in July
Investors boosted holdings of bonds from Korea, Indonesia, Thailand and India during the peak of the banking turmoil last month, a show of confidence in emerging-Asian debt despite wider market volatility.
Any initial increase in volatility or risk aversion if debt-talks deadlock is likely to be negative for Asian bonds, but they will rally once a resolution is found, according to Nomura. “High yielders such as India and Indonesia are likely to outperform in Asia rates, as sentiment globally improves with the event risk passing,” the strategists wrote.
Buying Opportunity
In the past, Republicans and Democrats have always managed to reach a solution to avoid a government default. Assuming that will happen again, any sell off in risk assets prior to that may be seen as a buying opportunity.
“Investors should prepare some dry powder to buy assets that may be oversold during this period of volatility,” such as what happened to emerging-market and small-cap stocks in the previous debt-ceiling debate, Invesco’s Chao said.
(Updates to add Asia volatility data in 10th paragraph, strategist quote in 11th.)
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