When does strong US growth get too much for Asia?

A KEY investor debate recently has been about the implications of stronger US growth on Asia.

Under the Biden administration, additional fiscal stimulus of US$1.9 trillion has been added to the US' growth equation.

Stronger US growth typically bodes well for Asia's exports, until markets start to worry about the impact from higher US rates and a stronger US dollar.

Indeed, the 2013 taper tantrum, still fresh in the minds of investors, is an example of how rising US rates can prove challenging for some parts of Asia.

A stronger US dollar has also historically led to less attractive relative performance of non-US-dollar risk assets.

Contrary to market perceptions, we believe stronger US growth and rising US rates can be positive for Asia's economies.

In the past 20 years, we have seen four different episodes where there were rising Fed policy rates and/or rising US 10-year yields, alongside benign or improving US growth momentum. These instances were: During the 2003-06 Fed hike cycle; 2009, when macro was beginning to turn around in the wake of the global financial crisis (GFC) slowdown; the 2013 taper tantrum; and 2015-18, when the Fed first began to hike rates post-GFC.

The 2003-06 and 2009 episodes were benign for Asia. The 2013 taper tantrum was challenging, and 2015-18 saw a mixed impact.

Our takeaway from the four historical episodes is that context clearly matters and Asia's macro stability is one factor determining whether the region benefits from stronger US growth or gets hurt by rising US rates.

Notably, the episodes in 2003-06 and 2013 are two extreme opposite examples of how Asia's domestic macro stability conditions influence the macro outcomes.

During the 2013 taper tantrum, weak macro stability given wide current account deficits and high inflation in some Asian economies led to pressure on the currencies when the Fed began to talk about tapering intentions.

This eventually forced some Asian central banks to tighten disruptively, posing headwinds to Asia's growth and growth differentials improved in favour of the US.

However, 2003-06 was a different ballgame altogether. Asia had corrected for macro excesses, having come out of the Asian financial crisis, and macro stability conditions had improved.

Hence, Asian central banks did not have to tighten disruptively when US rates were rising, leaving the region's economies to enjoy the benefits of strong US demand.

As a result, Asia's GDP growth continued to accelerate, helped by strong US demand, and growth differentials improved in favour of Asia, even as US rates rose.

Fast forward to today, macro stability indicators in Asia are mostly better than in 2013. Inflation is mostly lower, current account imbalances are less stretched, and foreign reserve buffers are more comfortable.

This reduces the risk that Asian central banks need to tighten disruptively amid rising US rates, allowing Asia to ride on stronger US growth and better external demand.

Indeed, our US economics team expects above-consensus GDP growth of 7.3 per cent for the US in 2021. They also expect import growth to rise 17.7 per cent year on year and the US current account deficit to widen to 3.7 per cent of GDP in 2021.

This will not only help Asia's GDP growth accelerate above trend this year, but it will also enable the growth laggards in South and South-east Asia to catch up to North Asian economies.

This is because Asia, as one of the most export-oriented regions in the world, tends to be more highly levered to the global growth cycle. Some of the most export-oriented, and hence more high-beta economies in Asia, are also in South-east Asia.

The Fed's dovish average inflation targeting framework is further icing on the cake. Typically, as current account deficits widen and savings fall, real rates would need to rise to attract more savings.

However, the Fed's dovish approach means US rate rises are likely to be more gradual and orderly than before, allowing the US current account deficit to stay wider for longer. This would benefit Asia.

Moreover, easy global liquidity conditions stemming from dovish Fed policy would also disproportionately benefit the liquidity-strapped Asian economies, such as India and Indonesia.

To these, the investor pushback is that the reopening of the US economy will spur more incremental demand in services rather than goods. This would curtail the spillover benefits to Asia's exporters. Besides, the rollout of Asia's vaccination programme is slower than in the US. These factors may limit how high beta Asia's recovery is in this upcycle.

In our view, more incremental demand in services does not mean that goods expenditure will fall. Goods expenditure will still grow because US households are likely to unleash a spending flurry given the US$2.3 trillion in excess savings they are sitting on.

Vaccination progress may be slower in Asia. However, instead of herd immunity, we think achieving the lower bar of vaccinating the most vulnerable parts of the population and ensuring medical systems do not get overwhelmed will significantly reduce risk aversion and drive domestic demand recovery.

So when does strong US growth get too much for Asia?

In our view, the risk is when strong US growth results in a disruptive shift in tightening expectations. Our global chief economist, Chetan Ahya, believes this risk could be triggered if momentum in underlying US inflation picks up and threatens to breach 2.5 per cent, accompanied by lower US unemployment rates.

• The writer is Asia economist at Morgan Stanley