Ahead Today
G3: US ISM Manufacturing, Eurozone Manufacturing PMI
Asia: Asia PMIs, China Caixin Manufacturing PMI, Indonesia CPI, Hong Kong 4Q GDP, India HSBC PMI
Market Highlights
In what is shaping up to be the first salvo of many in a likely broader and swifter Trade War 2.0, President Trump hit Canada and Mexico with tariffs up to 25%, while imports from China will face a 10% tariff over and above existing US tariffs. Canadian oil and energy products will face a lower 10% levy. These tariffs were announced on 1 Feb, and will apply from 4 Feb. These measures were taken to address the issue of borders and fentanyl according to the Trump administration, and includes a clause indicating possible further increases in tariffs if countries retaliate. On that note, Canada announced 25% tariffs against US$106bn of US goods including American beer, wine and bourbon, and fruits and fruit juices, together with non-tariff measures such as boycotts of American products. Mexico’s President Claudia Sheinbaum has instructed the economy minister to implement a response plan, including retaliatory tariffs, but also called for cooperation with the US. The response from China was interestingly more measured, vowing “corresponding countermeasures” without elaborating, while also pledging to file a complaint at the WTO.
While we await the full response by markets given how several Asian countries are still out on holidays, we suspect the path of least resistance for now is for Asian currencies and risk assets to weaken, together with a greater risk premia to account for future meaningful tariff moves beyond what we have seen.
The net impact to markets including in Asia will also depend on factors such as how long these tariffs are sustained for, and with that whether there is space for meaningful carve outs and exemptions perhaps as businesses increasingly feel the squeeze. We note that the US is reliant on imports from China, Mexico and Canada across a wide range of products, such as fruits (eg. avocados), toys, lumber, furniture, and oil/energy (in the case of Canada). The automobile sector’s supply chain in particular is significantly intertwined across the borders of US, Mexico and Canada, with 22% of new cars sold in the US built in Canada or Mexico and auto parts crossing borders several times.
In the short-run, some countries in Asia ex China with existing manufacturing spare capacity may be able to partially substitute for US imports from China, Mexico and Canada. Countries such as Vietnam, Malaysia and India, with existing production capabilities in textiles and electronics, coupled with Thailand on automobiles, come to our mind. Nonetheless, we suspect that these trade re-allocation effects will likely be orders of magnitude smaller than at least the initial first order impact of supply chain disruptions given how interlinked the North American countries currently are.
China’s response will also be important not just for itself, but also for the rest of Asia. A more concrete push to implement more stimulus – as we suspect could happen - may help to put a floor on negative risk sentiment and Asian FX weakness.
Regional FX
Asian currencies were generally weaker in the lead-up to the announcement on 1 Feb, with USD/CNH rising to 7.322 (-0.7%), while China sensitive assets such as MYR (-1.5%) and KRW (-1.6%) weakened meaningfully.
The key development over the weekend was the announcement of India’s Budget for FY2025/26. The government maintained a commitment to reduce the fiscal deficit to 4.4% of GDP for FY2025/26, from an estimated 4.8% in FY2024/25, and these numbers were in line with our expectations. The budget also continued the new administration’s pivot towards supporting consumption with a focus on inclusive growth. As such, the focus has also tilted away somewhat from public infrastructure, with slower growth in public capex. Nonetheless, the fiscal position was also partially helped by a 2nd bumper year for dividends from RBI, coupled with somewhat optimistic assumptions on income tax collections.
Among several key measures, the government cut taxes for low-to-middle income households, which according to the government will likely cost it around INR1trillion (~0.3% of GDP) worth of revenues. The macro impact will depend on whether and how much households spend these savings. There were also other important supply-side reform measures, such as the announcements of new income tax bill to simplify compliance, greater fiscal support for labour intensive manufacturing sectors such as textiles and toys, 100% FDI limit for insurance sector, changes in custom duties, and allocation to raise productivity in the agriculture sector.
We see these announcements as broadly neutral to perhaps a marginal positive for INR, and maintain our forecasts for USD/INR to rise further to 88.50 through 2025. We expect RBI to cut its repo rate by 25bps later this week bringing it to 6.25% from 6.50% currently.
