(Bloomberg) — Markets are largely in the green Friday but strategists warn there’s still a prospect US debt-ceiling negotiations break down over the weekend or result in draconian spending cuts that crimp global economic growth.
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Assets in Asia are especially vulnerable as they will be the first to react to any agreement when they open Monday as the US will be shut that day for a holiday.
Republican and White House negotiators are making progress toward a deal to raise the debt limit but details remain tentative and they are yet to agree on the size of a cap for federal spending, according to people familiar with the talks. Spending cuts required to get the Republican side to agree on a deal could cost as many as 570,000 jobs, a Bloomberg Economics model shows.
“The outcome of any resolution will probably amount to a fiscal contraction that’s not entirely priced in by the market,” said Aninda Mitra, head of Asia macro and investment strategy at BNY Mellon Investment Management in Singapore. “When you’re trying to rebuild cash balances like crazy, that build-up sucks out liquidity at a time when the markets have kind of whistled past the graveyard a little bit.”
Shares in Asia dropped for three days through Thursday amid growing concern over a possible US default, and after Fitch Ratings said it may cut its AAA rating for the world’s biggest economy to reflect the increased partisanship that’s preventing a deal. Regional equities ticked higher Friday, but that was driven more by a rebound in technology shares than optimism over a potential agreement.
The bulk of regional markets are still down for the week amid waning risk appetite, led by emerging markets such as China, the Philippines and Malaysia. Materials and consumer discretionary shares have also been among the biggest losers.
“We’ve never been in a situation of a default — it’s opening a little bit of Pandora’s box,” said Herald van der Linde, head of Asia Pacific equity strategy at HSBC Holdings Plc in Hong Kong. “I can also see that funds say we just don’t want to be in emerging markets and definitely not in smaller ones.”
Investors may want to stick to more defensive positions while there remains uncertainty over where the expected spending cuts will be made, according to Invesco Asset Management.
“It makes sense to own strong cash flow, low volatility, large-cap defensive stocks such as in health care and consumer staples,” said David Chao, global market strategist for Asia Pacific at the money manager in Singapore.
Another potential refuge from a selloff may be in some of Asia’s bonds. The region’s investment-grade dollar debt spreads are at their tightest since the middle of March, while an index of emerging Asia bonds has outperformed a similar gauge of Treasuries this month, according to Bloomberg indexes.
If there’s a further selloff triggered by a debt deal, India and Korea sovereign debt will probably outperform, said Ray Sharma-Ong, investment director of multi asset solutions at abrdn plc in Singapore. “Both India and Korea sovereign bonds are resilient from US Treasury moves, and will benefit from potential bond-index inclusions,” he said, referring to ongoing reviews for those two Asian markets.
There’s no certainty any debt deal will be the end of the issue, especially as bond markets are potentially underpricing the risks related to the final agreement, according to Owen Gallimore, head of Asia-Pacific credit analysis at Deutsche Bank AG in Singapore.
“The resolution can quickly turn into a selloff,” he said. “Bearish calls this year of credit-market woe have not played out yet, and the market in Asia is trading tight spreads into this situation, so the risk-reward isn’t good.”
–With assistance from Marcus Wong.
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