The Russia-Ukraine crisis and its implications for emerging Asia and China
Escalating geopolitical tensions over the past weeks saw the United States warn that Russian military action against Ukraine posed an immediate threat. We examine how a conflict might affect the broader emerging-Asia universe and China.
Our assessment in terms of market volatility and risk
In such a multidimensional subject, with sovereignty coming under threat, it’s challenging to develop a one-case-fits-all outcome, and any future market volatility and price action will likely reflect developments. In the event of a conflict, it could involve further escalation, leading to a breakdown in diplomatic deliberations, followed by military action. Coupled with this would be any subsequent response from Ukraine’s Western allies and reactive measures such as sanctions. The length and magnitude of these sanctions would depend on the severity of the escalation. Markets have been building in a geopolitical premium at this stage, with fundamentals taking a step back. But, so far, the situation has been either regionally or locally contained.
We naturally expect to see broad risk sentiment being compromised in the event of a conflict with safe-haven trading taking the lead. Initial uncertainty surrounding the severity and extent of the episode should trigger increased volatility. In our view, spillover will also be evident in the commodity complex feeding into oil and natural gas, as these are center stage.
A potential spillover affecting other parts of EM, especially Asia and China
When we assess such externalities that could shock individual markets beyond their domestic borders, we need to be mindful that any knock-on effects will ripple out globally. Such a shock has the potential to force synchronized monetary policy action and derail, at least temporarily, the current path toward normalization across developed and emerging markets (EM).
In the least-appealing scenario, broad risk sentiment will come under pressure until we see greater clarity on the severity of the situation. This will be most evident in the commodity channel that will, in turn, disproportionally affect importing nations. Oil, for example, is already carrying a US$5 to US$10 premium that reflects the uncertainty surrounding Ukraine-Russia tensions.
In regard to China, the meeting between Russian President Vladimir Putin and Chinese President Xi Jinping, which took place just before the opening ceremony of the Beijing 2022 Winter Olympics, reflects the importance of this relationship for both parties, particularly in economic terms.
From an energy perspective, we saw an enhanced relationship that will see Russia deliver an additional 200,000+ barrels of crude oil per day to China, plus a boost in Russian natural gas exports to the country.
Safe havens for fixed-income investors within EM
Initially, we expect to see little or no discrepancy across the EM complex in the event of a conflict, given the nature of the external shock; however, fundamentals will play a more prominent role once the dust settles. Indeed, in terms of resource producers, we expect to see the stronger, export-driven economies lead the way. At this stage, we need to be aware that some central banks across EM (primarily outside of Asia) have embarked on an aggressive tightening journey that’s well ahead of the U.S. Federal Reserve. These policy moves have been introduced to tame powerful inflationary dynamics that can extend even further on the back of continued upward pressure on energy prices. We believe this environment could reinforce the diversification benefits that select fixed-income assets within the EM-debt universe can offer.
China fixed income as a potential safe haven
In our view, China is an evident pick from an Asia-centric perspective given its already desynchronized business cycle (relative to other major economies). This reflects the People’s Bank of China’s (PBoC’s) supportive monetary policy stance as the country prepares for China’s 20th Party Congress, which is set for autumn 2022.
In the event of a conflict, there will likely be flight-to-safety trade in risk assets, including a sell-off in China’s U.S. dollar-denominated credit market. That said, the performance of local currency Chinese government bonds (CGBs) and policy bank bonds should be relatively stable (within the EM-debt universe), as Chinese sovereign bonds have performed well over the past few years when there have been instances of broad market volatility, such as the COVID-19-driven March 2020 market sell-off. In contrast to the United States and Europe, the PBoC is currently in easing mode, which will likely support the performance of CGBs, even within a more volatile market environment. As global investors are broadly underweight in China bonds, we believe that medium-term flows to the asset class will remain positive.
Investors also need to be aware of the potential impact on oil prices and inflation as a result of rising tensions between Russia and Ukraine. Indeed, over the past 18 to 24 months, onshore China bonds have performed relatively well in U.S. dollar terms on an unhedged basis in periods when U.S. inflation has been rising. This points to the asset class’s potential to be a hedge against rising inflation for global investors.
In summary, Chinese sovereign bonds have the potential to provide investors with relative stability and to act as a safe haven within the broader EM debt universe.
A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange-trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other preexisting political, social, and economic risks. Any such impact could adversely affect the portfolio’s performance, resulting in losses to your investment.
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