By Saikat Chatterjee
HONG KONG (Reuters) - There is much uncertainty in Asia over what U.S. President-elect Donald Trump will do when he takes office next year, but markets seem sure of two things – his policies will be inflationary, and there are unlikely to be any big winners in the trade-driven region.
U.S. Treasury bond yields have surged to their highest levels since January on expectations Trump's spending promises will push U.S. inflation higher, and emerging Asian currencies have fallen, partly because uncertainty always prompts a flight to safer assets, but also because Trump's campaign rhetoric has stoked fears of a more protectionist trade environment.
"As the global opportunity cost of capital rises alongside Treasury yields, and as the dollar surges simultaneously, investors once again will fear another exodus of capital from emerging markets,” Citi analysts said in a report, noting that the U.S. 10-year treasury yield has risen by 45 basis points in less than two days on expectations of expansionary fiscal policy.
The effect is already being felt in Asia. The Malaysian ringgit fell more than 5 percent against the dollar in the offshore market on Friday, prompting a blowout in spreads and forcing the central bank to limit offshore-based transactions to check the slide.
The Indonesian rupiah <IDR=> has also come under selling pressure, prompting authorities to sell dollars to stabilize it.
Hong Kong and Singapore, Asia's two city-state trading hubs, are among the most exposed, however, not only because of their big trade links with the United States, but also their use of the dollar in policymaking. Hong Kong has a direct currency peg with the greenback, while Singapore uses a currency basket in which the dollar forms a substantial component.
"Trump's fiscal and pro-business policies will lead to higher inflation and interest rates, putting Singapore and Hong Kong at the front and center for any adjustment," said a portfolio manager at a U.S. firm in Hong Kong.
Not only is a rising U.S. dollar equivalent to tightening monetary conditions in those cities, but if the Federal Reserve raises rates faster than had been expected, it will drain the cheap funding that has kept emerging markets flush with cash.
Corporate leverage within Asia now accounts for half of the region's debt to GDP, and companies in China and India have taken on the most debt, according to bond giant, PIMCO.
Moreover, rising interest rates on U.S. debt will erode the relative appeal of higher-yielding debt in Asian countries, causing an outflow of capital.
For example, the yield gap between 10-year U.S. debt and a simple average of the three highest yielding countries in Asia - India, China and Indonesia - has narrowed by 41 basis points to 350 basis points in just two days.
Taiwan and Indonesia have seen the biggest capital inflows so far this year, at more than $10 billion each, according to economists at Credit Suisse, which makes them most vulnerable to a rapid reversal.
"We have started to see some reversal to the large inflows into Asian equities and debt in the last few days, but it would be difficult to say at this point whether it is sustainable," said Jonathan Garner, chief Asia and emerging market equity strategist at Morgan Stanley, who expects a further 5 percent downside to the emerging markets equity index from current levels.
Beyond the immediate market impact, there is another risk overshadowing much of Asia; how will Trump keep his campaign promises to rework trade deals and punish countries such as China?
While exports to the United States from Asia excluding China have fallen steadily in the last 15 years, China still accounts for half of the U.S. trade deficit with the world, and any signs that Trump might follow through with protectionist policies could trigger a currency war.
On Friday, Beijing fixed the yuan's daily midpoint at a six-year low, but on a trade-weighted basis it still remains near an all-time high hit last year.
Some economists say pursuing more protectionist policies may play into China’s hands to promote the use of its currency in international trade.
“The RMB internationalization drive may receive a boost if the U.S. becomes more isolationist and China’s political standing increases,” said Mark McFarland, Asia chief economist at Union Bancaire Privee.
(Reporting by Saikat Chatterjee; Editing by Will Waterman)