Italian crisis and US-China trade rift roil Asian markets

Singapore

THE fear factor reigned in Asian markets on Wednesday on the back of new and old worries: Italy's political commotion re-ignited the prospects of a euro zone existential crisis, amid a risk-riddled trading environment already spooked by US-China trade tensions, geopolitics and rising US interest rates.

The steep overnight losses in Wall Street and European stocks took a toll on markets. Investors ran for the hills with the euro plunging to levels not seen since July 2017, and Italy's borrowing costs rose even as fellow euro zone member Spain faced a political crisis of its own, with a no-confidence motion against its premier building up. It was an echo of 2011/12, the Greek debt crisis, during which there was a spike in bond yields, including that in Italy, Spain and Portugal.

Asian markets were a sea of red on the back of contagion fears, with the MSCI's broadest index of Asia-Pacific shares tumbling 1.5 per cent.

The markets were further spooked by escalating US-China trade tensions after US President Donald Trump announced that a list involving US$50 billion in tariffs on Chinese imports will be released in mid-June, with duties to be imposed "shortly thereafter". The statement came merely 10 days after Chinese and US officials issued a joint statement with a "positive tone" on the trade issue.

Singapore's Straits Times Index shed 2.12 per cent - its third fall of 2 per cent in a 10-week span - while China's Shanghai Composite tumbled 2.5 per cent and South Korea's Kospi retreated 2 per cent.

None was as hard hit as Malaysia, which tumbled 3 per cent.

There was also a sell-off among Asian currencies, with the Philippine peso being the hardest hit, slipping to a near 12-year low.

The Japanese yen remained a traders' best friend as investors flocked to safe-haven plays, and the Singapore dollar depreciated against the greenback as the global risk aversion sparked a sell off in emerging market assets.

Even so, FXTM global head of currency strategy and market research Jameel Ahmad said he does not expect Asian currencies, like the Singapore dollar, to face "heavy risk to losses" as some other asset classes.

With the threat of a possible "Italexit" from the European Union (EU), the euro/US dollar slipped to a 10-month trough of 1.15, and then made a slight rebound to 1.16. The euro was in fact already in correction mode from its 14 per cent appreciation in 2017, but the latest pullback was unexpectedly severe.

DBS economist Radhika Rao said: "The euro zone was the beacon of strong growth and stability last year, but that optimism fizzled out this year, with a softer economic start compounded by the spectre of re-elections in Italy, one of the biggest economies in the currency bloc.

"How deep the impact is on Asia will hinge on the how protracted the uncertainty is and how long the flight to safety lasts," she said. She added that for Asia, corporates with European operations may be hit by a weaker euro and broader macro uncertainty.

Italy's political crisis blew up after its elections in March produced no clear winner; the events of the recent days have set the stage for fresh polls as early as July.

A chief worry with the looming re-election - apart from the fact that it leaves Europe's third largest economy in a limbo - is that it could turn into a de facto referendum on whether Italy should leave or stay in the EU's common currency area if euro-sceptic parties gain a stronger foothold. This would be the bloc's next biggest challenge since Britain voted to quit the union two years ago.

Another concern is that Italy, one of the world's most indebted economies, may pull back on fiscal reforms - its austerity drive - and install populist measures such as tax cuts and more infrastructure spending. These could provide headwinds for European equities, given the potential instability to the euro zone, which in turn would have an adverse impact on overall financial markets.

Eli Lee, Bank of Singapore's investment strategy head, said: "With the odds of new Italian elections markedly higher over the weekend, what was previously viewed by the market as mostly Italy-specific risks now have larger implications on Europe and represent much greater stakes."

But some deem the sell-off on the back of worries over the direction of the single currency as overdone.

Julius Baer's fixed income research head Markus Allenspach, for example, expects the situation to calm down. He said: "We do not expect Italy to leave the euro. Italy has a high savings rate, a high ratio of home-owners and thus simply too much to lose ... We expect the political drama to become background noise and stay with us for some months."

He also does not expect a repeat of the European debt crisis of 2011/2012, because euro zone members have reduced their imbalances, created support mechanisms, and the European Central Bank (ECB) has shown its ability "to do whatever it takes".

JP Morgan's Asset Management Global Markets strategist Kerry Craig echoed similar sentiments: "It's worth noting this Italy is not the same Italy of 2012. And the region as a whole is in a better place."

The bigger issue may well be the timing of Italy's elections and the recent weakening of Europe's economic momentum and their impact on the ECB's policy normalisation timeline.

Ms Radhika said: "Worries that the Italian politics might spill over into a bigger crisis will leave policy-makers on the defensive. Taper talks and policy normalisation is likely to be kept on ice until more clarity emerges."

READ MORE: