Opposing forces

Volatility is making a comeback across markets as investors grapple with competing tail risks and tailwinds.

On one side, there’s been an escalation of the conflict in the Middle East, reaccelerating inflation in the US, a hawkish turn from the Federal Reserve, and the rising threat of another US-China trade war. On the other is a strong US economy, steady global growth, and healthy corporate earnings.

Amid these opposing forces, global equities have corrected as much as 5% from their recently set all-time highs. The jolt has been felt across asset classes, with 10-year US Treasury yields spiking and the dollar broadly strengthening. Asia ex-Japan equities have also retraced 2% from their early-April peak, and regional currencies have depreciated 3% against the dollar year-to-date.

But despite the rising risks, we still think global and regional macro conditions remain more constructive than not. This anchors our view that equity indexes will move modestly higher from current levels—offering specific opportunities to buy on dips—and for quality bonds to deliver high-single-digit total returns through year-end.

In Asia, entry levels have improved further for discounted growth themes backed by structural trends. These include “Asia’s Super 8” of leading AI beneficiaries, large -cap Indonesian and Japanese banks, and Chinese SOEs focusing on capital management—all of which present dip-buying opportunities after the recent consolidation. Meanwhile, investment grade bonds are our most preferred asset class and also stand to benefit from capital gains if growth risks begin to overpower the tailwinds.

A higher-for-even-longer Fed vs. regional growth

For Asia, the most significant risk is a Fed that stays higher for too much longer. While three straight US inflation prints above expectations have quickly reversed last year’s dovish pivot, we still think disinflation will resume in the months ahead and rate cuts are only delayed, not cancelled. Our updated forecasts call for two rate cuts starting in September (our previous forecast was for three cuts starting in June).

This delay does translate into a similar policy lag in Asia. We now see 1–2 backloaded rate cuts across the region on average in 2024, versus 2–3 previously. That, however, does not derail an ongoing Asian export, industrial, and real growth recovery, thanks to a supportive US economy and improving Chinese growth (we recently revised up our China full year forecast to around 5%). That should benefit cyclical, export-oriented, sectors like tech, and currencies like the KRW and SGD. Meanwhile, banks in domestically geared markets like Indonesia are typically among the best-performing segments in a higher US rate environment.

In a risk case where the Fed does not cut at all this year, Asia would likely stay on hold too. However, more resilient US growth would stoke a stronger regional export and industrial uplift—and accordingly regional interest rate cuts may not even be needed. An even less likely tail scenario where the Fed resorts to another hike could see select Asian central banks—Indonesia, India, the Philippines—follow suit to preempt against disorderly currency moves. This acts as a policy anchor for the IDR and INR, which also benefit from stable balance of payments, contained current account deficits, and high FDI. To limit dollar risk (we now expect greenback strength to persist into 3Q), we position these two high-yielders against low-yielders like the CNY and TWD.

War shocks vs. regional disinflation

Meanwhile, the main risk to Asia from the widening conflict in the Middle East is via a potential oil price shock. With CPI currently sitting at pre-pandemic cyclical lows of 2–2.5% across the region on average, we estimate a moderate rise in oil to USD 90/bbl and persistent dollar strength would directly add ~50–100bps to headline inflation numbers. That alone may not be enough to prompt regional rate hikes, but a bigger oil surge and a significant flight to the dollar could validate a case to tighten.

Asian currencies are also particularly sensitive to higher oil prices. That’s because every economy in the region (except Malaysia) are net importers, and could face an average 0.3% (of GDP) deterioration in their trade balances for every 10% increase in the price of oil. Here, Thailand (–0.8% of GDP) and South Korea (–0.6% of GDP) look especially vulnerable.

Made-too much-in China vs. Made-in-America

Now more than half a decade on since former President Trump first imposed tariffs on USD 380bn of Chinese goods, the long overshadowed tail risk of another US-China trade war has also returned to center stage.

The US and its allies are accusing China of dumping its excess capacity in solar panels, batteries, and electric vehicles—industries vital to the American manufacturing agenda—and proposing a sharp increase in tariffs on Chinese steel and aluminum, alongside other protectionist measures. Presidential candidate Donald Trump, meanwhile, is threatening targeted levies of more than 60% on China if re-elected. Beijing is quietly rejecting the “Made-too much-in-China” claims as it continues to pursue “new productive forces” to address its economic challenges at home.

We think broad-based and punitive duties on China could be counterproductive given the re-direction of trade flows since 2018–19, and the potential impact on US consumers. Still the drumbeat of protectionism will likely only get louder in an election year and conditional tariffs tied to US demands, such as an increase in US energy or food purchases, appear increasingly probable.

This would arguably be a relatively benign outcome versus current threats, but a rise in tariff uncertainty is still likely to hit sentiment and result in volatility across Chinese assets contending with a still-fragile consumption recovery. We therefore continue to position in defensive Chinese SOEs that are shielded by active capital management plans, resilient earnings, and medium-term operational tailwinds. Trade tensions also present a risk for the yuan, which we think will weaken in the months ahead, as the People’s Bank of China begins to guide USDCNY fixings higher to catch up to USD strength.

Buy-the-dip opportunity

All these risks have collectively prompted a broad-based de-risking, with global tech stocks disproportionately affected. Though some question whether AI is at the peak of the classic hype cycle, we see little evidence to suggest the fundamental growth story has changed and view the pullback as akin to July 2011 or 2016, when quality tech stocks dipped for exogenous reasons (Fukushima crisis, North Korea tensions). Now trading at 22.5x 2025 P/E with a strong 18% y/y earnings growth profile, we remain most preferred on tech and think this is the buy-the-dip moment underexposed investors have been waiting for.

One opportunity to diversify tech exposure exists in South Korea, where valuations are at a 63% discount relative to global equities (versus an average 46% discount in the past 15 years). Here, the government’s Value-Up push to reduce the so-called “Korea discount” is gathering steam, and the market boasts a buoyant memory sector benefiting from strong near-term momentum in DRAM pricing and linkages to AI demand.

Indonesian equities have also declined in recent weeks, due to a mix of higher US yields and a weaker rupiah. But we maintain our constructive view on the banking sector, given robust loan growth, an above-average return on assets, and a gradual consumer recovery. Any potential rate cuts toward the end of 2024 could potentially lower banks’ cost of funds and alleviate liquidity pressure.

Diversify to weather a changing environment

As the market swings between different risk scenarios, we believe volatility will likely persist in the short term. In such an environment, portfolios that are well diversified across geographies and asset classes, and include effective hedges such as gold—which we see as a good long-term diversifier despite potential short-term consolidation—are better positioned to weather a changing macro environment.

Written with Mark Haefele , our Chief Investment Officer.

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