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I'm your host, Zach Griffiths, and today I will be joined by Zerlina Zhang, our head of Asia Strategy, for an update on her latest views in terms of what she's seeing in Asia from a tariff perspective, how she's thinking about the markets, and her key takeaways from the China two sessions meeting earlier this month. Zerlina, thanks so much for coming on the podcast. Thanks for having me again. All right, well, I always learn a ton from our discussions and love being able to catch up and get your perspective from Asia and Singapore.
But before we get started, can you just outline what the two sessions or the National People's Congress is for our listeners? Yeah, sure. So the two sessions refer to the two major political meetings held annually in China, typically in early March. The first is the annual meeting by the National People's Congress.
This is the highest legislative body in China responsible for making rules, approving government budgets, and overseeing some of the major national policies. The second meeting is the Chinese People's Political Consultative Conference, which is a political advisory body that provides policy recommendations, but without any legislative power. So in a nutshell, the two sessions meetings are important because they set China's economic, political, and social directions for the year. They typically announce GDP growth targets, fiscal policies, and other major reforms.
And from year-to-year basis, sometimes they also indicate government priorities and leadership strategies. Okay, great. That's very helpful. It almost makes me think of the Treasury refunding meetings that happen quarterly.
You have the Treasury that sets the policy, and you have a Treasury borrowing advisory committee that advises on policy. So that took place earlier this month. We're recording on March 18th. What did we learn in terms of economic growth targets and other initiatives that the Chinese government is focused on right now?
Yeah, so sometimes China's policy is a little bit like a black box, but we do get some numerical targets out from these two sessions meetings. So for GDP growth, this is around 5%. The target is unchanged for 20.24, as widely expected by market. With increased headwinds to exports and weak domestic demands, I think this would require ongoing monetary easing and significant higher fiscal stimulus.
But if we look at the fiscal stimulus front, the announced government bonds of R&B 1.8 trillion for the central government and R&B 4.4 trillion for the local governments are higher than last year, but are slightly below expectations, especially the amount allocated for consumption stimulus with only R&B 300 billion. It's a bit disappointing for the market that the planned fiscal deficit was 4% or just 1% higher than last year. So I think Beijing is likely saving some bullets and waiting for U.S. policies, especially tariff, to play out.
The CPI target is revised down to 2% from 3% for the very first time since 2020. We still think this is a bit difficult to achieve, given persistent overcapacity in various industrial sectors and the ongoing export headwinds now. So as a result, I think the possibility of some additional extra budget funding arrangements, such as additional government bond issuance and special lending programs for some of the targeted sectors, are still likely at the bi-monthly NPC meetings throughout this year. And for the 20% of the additional U.S.
tariff announced so far on Chinese goods imports, we expect it to hit China's 2025 GDP growth by 0.7%, which is the base case we have already factored into our 4.7% GDP growth forecast. I think the actual impact should be smaller with potential trade negotiations, extra diversion, and some of the increased macro support policies. And I think it is quite important to note that the retaliatory measures from China have so far been milder than the 2018 trade war. This means probably a path for trade talks with the U.S.
is still open, and this is probably good for market sentiments. All right, so we got a lot of information there. Around 5% GDP growth, that's unchanged, is widely expected. You just said that your expectation for this year is 4.7%, which factors in a 0.7 percentage point hit from the 20% of additional tariffs the U.S.
has already announced on China. And so you'd say the risks to that 0.7% hit are skewed to the smaller side because negotiations are still open, and the response from the Chinese government has not been quite as severe as what we saw during the trade war in the last Trump administration. Is that right? Yeah, correct.
And so the other thing I wanted to just dive into just a little bit more, you mentioned the CPI target revised down to 2% from 3%. That's the first time since 2020. Maybe it's a challenge to get there. In terms of pushing that target back down, is that more like a forecast in the sense that they were unlikely to get back to 2% with everything that we had going on in the world post-COVID?
Just because when we think about inflation targeting in the U.S., obviously we haven't moved our 2% target, but I don't think anyone expected us to get back there, certainly not in 22 or 23. Maybe we can get back there this year. How is that target set or considered? Is it more like a forecast or more like a true target?
I think this is more like a wish from the government. If we look at the CPI inflation or PPI inflation over the past few months, the picture was not so great. One reason is the overcapacity in various industrial sectors. In 2024, China had the luxury to export the overcapacity into different parts of the world, especially auto, EB battery-related, or even capital goods.
But with U.S. tariff or more strength trade relationship with the developed markets, I think exports will significantly slow down this year. That means even more overcapacity in the domestic sector. I think domestic demand is slowly improving, but we are not really seeing the animal spirit back in 2020, 2021, just because property sector, there's still an ongoing downturn.
So I think it will be very difficult for the government to achieve the CPI and PPI targets. But any sign of improvement, I think this still would be encouraging for onshore investors. And this is usually one parameter closely watched by consumers as well as business, because it is a sign of the strength of the economy. Great.
So as you mentioned, and as we really went through in our discussion so far, a lot of major headlines, a lot going on with tariffs, global economic, and geopolitical cross-currents. What has the market reaction been overall in terms of Asia corporates or what you're seeing in China corporates and government bonds? And is it consistent with your key takeaways from two sessions, or does it run a little bit counter to how you view those targets and announcements holistically? Yeah, so China assets have out-ofed from U.S.
and other YAM and Asian peers since February, despite a 10% correction of U.S. equities and the widening of HIG and high yield indices by 10 and 30 basis points respectively. And Chinese equities are doing great, and they are the best performance among Asian equities this year. China's IG spread is steady, and China's high yield tightened by 45 basis points, which is just really surprising among all the global credit classes.
And I mean, we did recommend investors having some exposure in China credits, as we spoke in our last podcast in October. And as we believe top policymakers has turned significantly more pro-gross since September last year. But this outperformance leading up to and post the two sessions, I would say still a quite big surprise, as not many incremental support measures were announced. I think the reasons could be quite technical.
The first is the really fun flow driven by Asian regional investors, increasing allocation to China as a hedge against the U.S. exceptionalism. And we have to note, its position was very underweight among all the Asian regional accounts of the past two years. In addition, Yushu from Chinese corporates are overwhelmed, with some corporates just moving to cheaper Aungshu markets or Shorsi and Ash markets.
And other than that, China Big Tech is also viewed by the market as the biggest winner from DeepSeek. I think we are not pessimistic on China macro, as we do expect policy support to remain strong, and this large wave of high yield China property default risk is likely behind us. But we think the valuation is just way too expensive. For example, China Tech is now trading tighter than U.S.
Tech, which hasn't been the case historically. I think in a scenario of the deep U.S. recession, we don't believe that EMSS, including China credits, could decouple and outperform. So overall, we still prefer staying defensive and selective in China credits in names such as the high-quality China Tech and selected China state-owned developers.
And this is also a stance we have adopted for Asian credits overall. That's interesting to think about shifting allocations to China potentially as a way to hedge against U.S. exceptionalism. I feel like that narrative also applies to what we're seeing in European markets lately.
But over the course of my career, the idea of other markets performing well if the U.S. economy and U.S. financial markets are performing poorly, that's usually not how it happens, or let's say that's not the conventional wisdom on how the global economy and financial markets work. And so I guess to you, does the, let's say, the tightening, particularly in Chinese high-yield or maybe in China tech relative to U.S., you just mentioned that you'd recommend positioning defensively.
How extreme do you kind of view the recent move? I feel like when we talked to Logan on the European side, it certainly feels pretty extreme. But to pinpoint what might unwind that, it's hard to say absent kind of a clear U.S. or global recession.
How are you thinking about how extreme valuations are relatively kind of from a global perspective? I think Asia IG valuation is definitely expensive, but not as extreme as China high-yield or Asian high-yield. Because if we look at Asian high-yield and China, Asian IG and China IG, the technical support is definitely still there. Past two years, we had about 20 to 30 billion of net negative new supply coming to the market.
This year has likely continued to be the case. We do have very strong fund flow from regional accounts, not just Chinese Aungshu accounts, but also credit bank-related accounts in Southeast Asia and Korean Aungshu accounts powering into the dollar bond market. In our recent trip in Seoul, some of the Aungshu Korean investors told us if they do affect swap comparing with the Aungshu Korean bond bonds, there are still some significant spread pickup that will yield pickup in the dollar bond space for Korean insurers. This is also kind of like a case for selective credits in Asia and China IG.
So I think the credit and macro fundamental overall are still quite supportive for IG. We do expect some spread widening, especially if U.S. core yields are going lower. That might set more oil-yield buyers on the sideline.
But overall, I think the fundamental is still quite constructive. We are a bit more concerned about the aggressive movement of China high yield. I think tightening 45 basis points, while the U.S. high yield is widening 60 basis points from the tight in mid-February, just does not make that much sense.
I think the market right now is taking a lot of comfort that the Aungshu funding condition has been very supportive, not just in China, but also in Philippines, India, Indonesia. One reason is Asian central banks have been easing policy rates following the Fed, and most of them are not as concerned about FX depreciation as in the past. Take Bank of Indonesia and Bank of Thailand as an example. But if we see a stagflation scenario in the U.S., and if the Fed is forced to, say, hike policy rates or even doing a jumbo hike, I don't think the Asian central banks could continue to ease their policy rates, and there could be concerns increasing for capital outflows.
And in that case, the local funding conditions might deteriorate, and people have taken it for granted that high-yield developers can always access the Aungshu market either for loans or bond issuance, but that might not be the case if the local funding conditions get higher. It's interesting to consider the idea that if the Fed has to hike, then that would halt some of the other major central banks across the globe from continuing to ease. In terms of our base case, we are still in the camp that the Fed is on hold this year. That's certainly a fair bit more hawkish than where market pricing is today.
We'll hear from the Fed. And tomorrow, I think the big thing that we're focused on, it seems like, at least in terms of U.S. markets, the key takeaway from tariffs now are growth concerns. And we're a little bit skeptical that the Fed's reaction function has shifted that heavily, as heavily as the market, to growth concerns away from inflation concerns.
So we get a new summary of economic projections tomorrow. We'll hear from Chairman Powell. I think that'll be very important for the near-term path of markets. Obviously, there's still a ton of uncertainty out there, and you mentioned at the outset that you think fiscal policymakers in China are probably saving some bullets until maybe they have a little bit firmer ground beneath them in terms of where trade policy will shake out.
And so I want to shift to tariffs a little bit more holistically. I know you and your team just put out a great piece detailing what sectors are most at risk of tariffs and highlighting a few specific issuers that face heightened fundamental and operational headwinds. I don't want to go through sector by sector, even issuer by issuer, but maybe highlight some of your key high-level takeaways from that exercise. Yeah, sure.
So among the 10 Asian market segments that we put out in the note, we see the most negative impact on Korean corporates. This is also the view or the outlook that we got from a lot of the Korean issuers that we met in our recent Seoul trip, in particular steel, semiconductor, and EV battery supply chain companies. We expect South Korean steelmaker to face significant headwinds from potential U.S. tariffs, not the direct impact on exports because it's quite limited, but more the secondary impact of U.S.
tariffs on auto and home appliance inputs, which are the end customers for Korean steelmakers. The proposed U.S. tariff on semiconductors and U.S. chip controls on exports to China are also major challenges for Korean semiconductors.
And then lastly, a potential or even just a partial repeal of the U.S. Inflation Reduction Act would dampen the credit outlook of South Korean EV battery chain companies. And Chinese corporates are affected by a lot of the negative developments, but I think the overall impact is actually less severe than feared. U.S.
cheap restrictions may impede AI development, but domestic alternatives are rapidly expanding. In addition, the recent breakthrough of DeepSea has also proven that AI development is more driven by innovation rather than infinite compute. Then the impact of U.S. tariffs on Chinese SOEs is actually manageable because they don't have that much revenue exposure to the U.S., but the risk is more coming from a potential U.S.
sanction and the resulting bond price volatility. And U.S. tariffs actually could be a blessing in disguise for China property credits because Beijing might just step up even more property support measures to counter the increased export headwinds. Then lastly, for South Asian corporates, overall it's quite manageable, and these corporates are more insulated because of their domestic focus, but we do see ports, auto steel, and pharmaceutical sectors in India and ports in Philippines are more exposed.
Great, that's very helpful and comprehensive. Zerlina, it seems like the amount of cross-currents we have to balance in terms of potential policy changes, what that means, let's say, U.S. leading the way, certainly in terms of the pace of announcements, but then not only the negotiations, what gets pulled back, how other nations respond in kind, it's been tough to keep track of it all. And so when I think about some of the typical key drivers that we're talking about with clients, tariffs are pretty top of mind, shifting to deregulation and tax cuts later this year, which seem to have been the bigger market drivers immediately post-election in the U.S.
in terms of market optimism, now have shifted to the background as so much focus has been on tariffs. You mentioned you just did a client trip to Seoul meeting with investors and issuers. What were some of the most common questions you got and what was your takeaway of market sentiment from the various meetings you had on that trip? Yeah, sure.
So I think a few... surprises or some of the consensus view. I think the biggest surprise is the South Korean clients are quite dobbish on U.S. Fed and they have a quite dobbish rates view.
So Korean investors are expecting three Fed rate cuts and because of the weak consumer sentiment and tariff uncertainties, their forecast for 10-year U.S. Treasury is at a low 4%. I think this is also much lower than most of the other Asian clients. And investors do agree with our U.S.
strategy view that tariff could be a persistent inflationary impulse, but most of them are paying more attention to growth concerns. And because of this view, I think the second surprise is most of clients are overweighting duration. This is very different from the rest of Asian clients who are basically dreaming duration because of the rates volatility. So I think they are also seeing more opportunities at the valley and the long end.
Some of these securities, houses, and insurance are actively switching from the short end to the valley and the super long end. And some of the insurers are positioning for the super long end on the past 30-year type of credits. And I think it is very limited within the Asian credit space. So the resulting is a lot of them are looking into U.S.
IG and some of the U.S. IG names as well. And the consensus view is quite cautious about credit risk, but they do not expect fairly significant spread widening as in our Asian IG forecast of 25 to 35 basis point, that type of widening. The onshore real money investors are overall more defensive towards credit risks than other regional accounts.
Most prefer staying up in quality, such as a BBB plus segment and a BBB for high yield. And other than that, they expect Asian IG spread to trade only moderately wider, about 10 basis point, and some think this will still go sideways because of the negative supply. And the other common theme with the other Asian investor is a very strong home bias. Most Korean investors are investing in Korean financials and corporates, but also diversifying quite rapidly into the other part of Asia.
So the usual go-to area is Japanese and Australian financials. Some of them are looking at Middle East banks, and a lot of them are doing U.S. IG, but for the more recognized names and sectors, such as consumers and U.S. big banks, as well as the global banks of bank capital instruments in the euro bond space.
So I think overall, the view is, no dovish view on duration was a little bit of a surprise, but overall, the defensive stance on credit and diversification outside the home base and outside the Asia-extriced space are quite common with the rest of Asian investors. So did you get some pretty firm pushback on our call for no cuts in a 475 10-year at year-end 25? Yeah, we did get that, but we also got that around April last year during our meeting in Korea, but I think luckily we were not that wrong or kind of right last year. So hopefully we're still right this year.
Fingers crossed. It's interesting. We've had a lot of discussions with clients lately. I think we hit 480 maybe earlier this year and have come down quite a bit since.
I think it's been interesting that we haven't really been able to break sustainably below 425 on the 10-year. And so we put out a piece a week or two ago highlighting that we certainly see the risk to our 10-year call as skewed to the downside because I think you are starting to see potential early signs of a growth slowdown and therefore some of these growth concerns to the extent they're already priced into the market may be justified. But I think there's some weather-related noise in the data, at least with respect to personal consumption expenditures. And when we look out to the second half of this year, Treasury is going to be in a position where they need to consider increasing options across the curve.
And so I think that for now, concerns about deficits in the U.S. and supply are kind of on the back burner as focus has shifted more to growth. But we think that tariffs are going to be a more persistent inflationary concern. And I think the supply story could become a bigger market driver in the second half of this year, which is one of the big reasons why we haven't bailed on our 475 call but are instead highlighting risk to the downside.
And so that's something that's certainly been top of mind here as well. Oh yeah, I would just want to say we do get comments from clients that the rates volatility is so high and it might just undershoot and overshoot. So throughout the year, everybody might be right on their U.S. 10-year forecast.
I feel like that's kind of been the case the past couple of years. You can just pick a three to four month period in the year and your call will have been right in that period. So it's hard to stay on top of all the various moves and to kind of have whatever move in your favor be the one that kind of capsulates around your end. It feels a little bit like luck.
Zulina, this was a great discussion. Always appreciate your perspectives. And thank you for coming back on the podcast, for sharing everything that we learned from the two sessions takeaways, what's going on with tariffs, and your takeaways from your latest meetings. Thank you, Zach.
And thank you all for tuning in to No More Risk Better. We'll catch you next time. We'll catch you next time.