The United States is such a colossus it has outsized effects on the rest of the world. Despite its many challenges, it remains the world’s largest economy and so its market matters more for Asian exporters than others. Its technological prowess and innovations in business models are unchallenged.
Listed American companies are so adept at leveraging these advantages to create shareholder value that the US equity market retains unquestioned dominance over all others. The US dollar is still the world’s anchor currency, so interest rates there pretty much determine how other countries’ rates will move. In geopolitics, it remains the world’s only real hegemon: Potential rivals such as China are still unable to match its dominance in global diplomacy and security.
This is why the three turning points in the US that are approaching will matter to us in this region — the elections in November, a likely turn soon in monetary policy and a shift in its economic growth trajectory. Of these, the political one is the greatest concern while the policy and growth inflections are likely to be helpful to the Southeast Asian region.
The election poses grave economic risks to the region
President Joe Biden and former president Donald Trump are now confirmed as their respective party candidates in November’s presidential elections. Only a health crisis or some other shock will alter the contest.
Elections are about eight months away but some things seem clear. The election campaign has begun early, so the rest of us will have to deal with a long season of politicking. Moreover, because the race is very tight and the stakes are so high, each side could be tempted to go to the extremes to win. Thus, expect the electioneering to also be nasty — as it is, each side is attacking the other in vitriolic terms.
So, the first takeaway is that this unpleasant campaign will create uncertainty and keep businesses on edge. Nervous firms might defer capital spending until there is political clarity. If this is the case, then the economy may take a hit well before the actual election, although as we argue below, other factors could shape the economy’s direction.
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It is futile to try and predict the winner now as the campaign is still evolving. The election will not be settled according to who wins the most votes from individual citizens but by how many states the candidate carries and how many electoral college votes each state has. However, given longstanding voting patterns, we know more or less how most states will vote.
So, the election outcome will hinge on just six states where the contest is too close to call — Nevada, Arizona, Georgia, Pennsylvania, Minnesota and Michigan. Biden won these states in 2020 but polling now suggests Trump has small leads in most of them. Still, Biden can squeak through to the narrowest of wins if he hangs onto all the other reliably Democratic-leaning states and secures Pennsylvania, Minnesota and Michigan.
So, here is the second big takeaway — these swing states were once major industrial states where there is much resentment against free trade which is perceived to have allowed unfair competition from the likes of China to destroy jobs. And that is why the Biden administration will likely pursue a tough line on trade in the run-up to the elections, especially where China is concerned. The trouble is that other trading nations in Asia which are linked to China through supply chains may become collateral damage in the process.
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In fact, trade will be a big issue in this election and after. If Trump returns to power, analysts expect him to rescind the most-favoured-nation status (MFN) for China, which allows China mostly tariff-free access to the US market. Without MFN status, tariffs on China would immediately surge to 30% or 40% levels in many cases. That would be horribly disruptive for the countries in this region which export parts and components to China. And that is even before the 10% general tariff that Trump says he will impose on all countries exporting to the US. It could be even worse. Trade wars could break out since other countries, not just China, will almost certainly retaliate against such an unprecedentedly aggressive trade policy. The global economy would take a big knock — from the fall in trade as well as the devastating effects on business investment and hiring.
The geopolitical consequences for the region could also be a worry
In the near term, the US will be seen as distracted and divided by its domestic election issues. Given that the administration is already greatly stretched by the wars in Ukraine and Gaza, its rivals such as Russia, China, Iran and North Korea could see the coming months as the opportunity to press their agendas more aggressively. These countries know that the rising tide of isolationism in the US makes Biden wary of being accused of dragging his country into a war. Iran and North Korea, in particular, may believe that actions they take are less likely to provoke a harsh American military response as the elections approach. Russia may be tempted to take bigger risks in Ukraine. Closer to home, China may step up pressure on Taiwan in the coming months.
But the longer-term implications are more worrying. Trump has openly questioned the value of Nato, the US-led military alliance in Europe which has helped deter aggression there. Even if such scornful rhetoric is meant only to pressure European countries into spending more on defence, it has shaken confidence in the American security guarantee. After Trump’s meeting with the ultra-nationalist Hungarian Premier Viktor Orban, Orban claimed that Trump would cut off aid to Ukraine. Such a threat has an immediate effect on morale in Ukraine and can only encourage Russia to pursue the military option there.
More importantly, it raises doubts over the credibility of the US security guarantees to Japan and South Korea as well as its willingness to stand by Taiwan. If these powers lose confidence in the US protective umbrella, they will have to re-think their national security strategies. Even once-unthinkable ideas such as going nuclear would become plausible.
Lower inflation and a resilient economy – the Fed will cautiously ease monetary policy
The other turning points are economic in nature and are likely to be benign for our region.
The first economic inflection is monetary policy. After a phase of brutal hikes in interest rates, the Federal Reserve Bank is now more confident that inflation will slowly return to the Bank’s target range. Yes, inflation is not falling as quickly as hoped but the overall trend of falling inflation is still clear. The key will be the labour market — demand for labour seems to be gradually cooling, helping to contain wage inflation. Labour productivity has improved in recent quarters, which means that unit labour costs are not rising as fast as before: companies thus have less reason to raise prices.
Thus Fed officials seem to be coming round to the view that while they may not achieve their desired inflation rate as quickly as they had wanted, tight money has largely done its job and there is therefore scope to ease policy. Statements by Fed Chair Powell and his colleagues suggest the first rate cut could come as early as June and that there might be one or two more for the rest of this year. Financial markets have priced this in but lower rates will still be impactful for the real economy. Borrowing costs would fall for companies, which would tend to support more capital spending. Highly indebted individuals and companies will get a respite and with less money going on interest payments, there would be more firepower for consumer spending. Lower rates could therefore mitigate some of the risks posed by the political uncertainty described above.
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The next question is the direction of the economy itself. Against all expectations, the American economy has withstood the impact of the steepest rise in interest rates in 40 years. Rather than suffer a recession as many had forecast, the US economy grew at around its trend rate of growth of just above 2% in 2023. Although early 2024 was expected to see slower growth, the latest “nowcast” estimate of first-quarter economic expansion is around 2.5%, which is quite robust for a mature economy such as America’s.
The key to resilience has been consumer spending. The large government handouts during the pandemic provided households with sufficient savings to help them weather the effect of higher rates. Their continued spending helped companies’ sales and profitability. That meant that corporations continued to hire workers, ensuring that the labour market remained tight. In fact, unemployment remains close to the lowest levels ever in the US — something which few economists expected. Although high inflation in 2022 cut into real spending power, this has improved and wages are now rising faster than prices. With low unemployment, consumers are also feeling more secure about their jobs and incomes, which also helps to support consumer spending. Thus, while the American consumer will not spend as vigorously as in 2023, she or he will spend enough to keep the expansion going.
American companies also continued to invest in new capacity unlike previous rate hiking cycles — capital spending did slow but did not contract sharply. This could be because technological advances, of which artificial intelligence is only one, have opened up many new opportunities for profits, encouraging higher capital spending despite higher costs of capital and greater policy and political uncertainty.
So, what can go wrong?
Apart from the political risks mentioned above, there are two areas of concern.
First, financial conditions will still be tighter than they were before the Federal Reserve started raising rates. Such increases in interest rates also tend to take a while before their full effect is seen. Sectors such as commercial real estate are already suffering stress. We cannot rule out another episode similar to last year’s crisis in some regional banks which led to the collapse of Silicon Valley Bank and indirectly led to Credit Suisse being taken over by UBS.
Second, concerns are gradually increasing over America’s political and economic fundamentals which underpin the US dollar’s dominant position as the world’s reserve currency. But there is more chatter in media commentaries of how American public sector debt is soaring. As the election campaign progresses, it will be clear that the political class in the US has no appetite to confront the erosion of its financial position. Candidates will be hawking either tax cuts or spending increases, with little said about the implications of ever-rising public sector deficits. At the same time, the US trade deficit is also growing. Financial markets may change their sanguine view of the US dollar as the Fed cuts rates and markets focus on the twin fiscal and trade deficits. That could lead to a spike in long-term rates that could hurt economic growth - even as the Fed cuts its short-term policy rate.
Be prepared for both scenarios
While the near-term economic impact of the US is likely to be benign, the election is another matter. The candidates hold starkly different positions on critical issues for our region — the credibility of the US security guarantee to its Asian allies, the US as a stabilising force in world politics, the outlook for trade which is the lifeblood of this region and the economic and political fundamentals that sustain the US dollar as the world’s reserve currency.
Like the rest of the world, we in Southeast Asia will just have to hope for the best and prepare for the worst.
Manu Bhaskaran is CEO of Centennial Asia Advisors
