Asian Markets Rebound After Recent Sell-Off

A rally across Asian markets is starting to look precarious as some analysts caution that China reopening euphoria will give way to the sober reality of a looming global recession.

Stocks are on track for their best month since 1998, and currencies have advanced the most since 2008, as bets for a softer Federal Reserve tightening and China's pivot away from Covid Zero have sparked a buying frenzy. That's pushed a key Asian equity benchmark and some currencies into overbought territory from oversold in just a matter of weeks.

The recent market reversal has been driven by tentative optimism rather than firm grounds, and in part by the short-covering of bearish bets. This means that the gains may not be sustainable unless the Fed lives up to expectations of a smaller interest-rate hike, and Chinese authorities continue to relax virus restrictions in the face of a spike in infections.

"The recent market moves are very large and they expose investors to the risk of a correction," said Eugenia Victorino, head of Asia strategy at Skandinaviska Enskilda Banken AB in Singapore. "When global growth is set to weaken, it is difficult to see currencies continue to rally if Asia's export powerhouses are under pressure."

The MSCI Asia Pacific Index has surged in November, outperforming its US and European counterparts. Hong Kong has seen some of the biggest gains, with a gauge of Chinese shares entering a technical bull market earlier this week.

Asian currencies have been on the rise against the dollar in November, with the index up 3.4% so far. This is the steepest monthly advance since 2008. The relative strength indexes of the Thai baht and Taiwan's dollar have breached levels that suggest the currencies have been overbought. South Korea's won is set for its largest monthly advance in 13 years.

After a tough year, investors are eager to jump in and avoid missing out on a rally. Although markets retreated Wednesday, the drop was modest, with the MSCI Asia gauge falling less than 1%.

But as the initial excitement dies down, more careful scrutiny will be given to every small change in the Fed's signals and China's pandemic policy shifts. This could lead to increased market volatility.

Chetan Seth, Asia-Pacific equity strategist for Nomura Holdings Inc., said that it is unclear if the recent rally is the beginning of a sustained trend. He noted that there is still some uncertainty surrounding US inflation and the Fed's hiking cycle. Additionally, Seth pointed out that we have not yet seen a full reopening in China, so it is difficult to know when and how that will happen.

Economists are revising up their inflation forecasts for the United States, according to a Bloomberg survey. The survey showed that the median forecast for inflation this year is now 2.3 percent, up from 2.2 percent in a survey taken last month. The revision comes as the economy continues to strengthen and as prices for some key commodities, such as oil, have risen in recent months.

Economists surveyed by Bloomberg expect US inflation to remain higher than anticipated over the next year, while recession risks continue to increase in the face of rising borrowing costs. Meanwhile, despite the latest loosening of restrictions, China is expected to continue its policy of rooting out the virus into next year.

Asian assets have been underperforming for months, but many money managers believe they are primed for a rebound. The growth potential for developing economies in Asia remains large, and over the medium term, some predict more gains.

Rajeev De Mello, a global macro portfolio manager at GAMA Asset Management, said that the rally was so fast that he would expect some pullbacks. However, he added that more dovish Fed talk and policy actions in China do argue for a further rally.

Asian emerging-market equities outside of China attracted almost $10 billion in inflows from global funds in November, the biggest since 2020. However, the road ahead will be bumpy as traders navigate the risk of a US recession and potential policy whiplashes in China.

Frank Benzimra, head of Asia Equity Strategy at Societe Generale SA, believes that next year will be different from 2022. He cites several reasons for this, including the fact that many economies are expected to rebound from the pandemic and that there could be more clarity on trade relations between the US and China.

Asian central banks will need to take action before the Fed does, and valuations are currently low. However, "the Fed is not done hiking, and US financial conditions are still tight," he said.