Asia finds itself at a 'negative intersection' in an unpredictable world

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There’s a lot at stake for Asia in 2017.

The region “stands in 2017 at the negative intersection of many of the factors most of concern in this increasingly unpredictable world,” according to a note from Deutsche Bank strategists led by Sameer Goel.

Asia is especially vulnerable to a whole host of geopolitical and macro risks, ranging from a stronger dollar to the policies of US president-elect Donald Trump.

The Deutsche Bank note focuses on what it calls “fatter tails,” which is to say that there are higher risks.

“The tail comes first and foremost from the exceptionally large amount of uncertainty around the shape and form of the political and economic world order that lies ahead, and particularly given the preference for de-globalization implicit in the support expressed for nationalist governments around the world in recent months,” the note said.

Let’s take a look:

1. A stronger US dollar

The US dollar has been on a tear since Donald Trump's victory in early November, with markets reacting to his proposed fiscal policy initiatives. It pushed even higher after the Federal Reserve decided to raise interest rates for the second time this decade.

While a stronger currency is typically considered a sign of economic strength, the dollar move could have negative consequences for the rest of the world, given the its status as a global reserve currency. For starters, it spells bad news for emerging markets companies that have borrowed in dollars.

'Rising USD funding costs, especially when combined with a 'USD shortage', will ultimately undermine economic prosperity globally,' Morgan Stanley strategist Hans Redeker said in November.

2. The threat of capital flight

Money has been leaving a number of Asian countries at a faster clip since early last year, forcing authorities to respond.

In China, the government has instituted even stricter capital controls to prevent citizens and corporations from taking the yuan out of the country, according to a note circulated by Wells Fargo's Cameron McKnight and Robert J. Shore on Friday, January 6.

This 'capital flight' is the result of a number of factors including a decline in the value of the yuan and other Asian currencies against the dollar, which incentivizes savers to move their money into alternative currencies to protect against the devaluation of their home currency.

The potential for two or three interest rate hikes by the Federal Reserve in 2017 would exacerbate capital flight from Asia, as attractive returns in the US could see investors pull their money out of Asia and put it to work elsewhere.

3. External demand shocks

If protectionism triumphs over free trade in 2017, then it could result in a number of demand shocks, which are dramatic changes in the demand of a good or service. That could hurt Asia.

'Simply put, Asia is the most export dependent region in the world with exports averaging 50% of GDP, although there is large variation,' the Deutsche Bank note said. 'Five out of the top ten contributors to the US trade deficit are in Asia -- China, Japan, Korea, Malaysia and Thailand. China is the real elephant in the room, making up nearly 50% of the deficit or $348bn over the past year.'

4. The new Trump administration

Dominick Reuter/AFP/Getty Images

Donald Trump started characterizing China as an economic rival as soon as he announced his plan to seek the Republican presidential nomination. He has since referred to China as a currency manipulator and accused it of draining the US of its manufacturing jobs.

The question now is whether Trump will follow through on his promises to radically change the way the US engages economically with China and the rest of Asia. His website says he supports implementing tariffs, withdrawing from the Trans-Pacific Partnership, and appointing 'tough and smart trade negotiators to fight on behalf of American workers.'

According to Deutsche Bank, it is unlikely that the president-elect will welch on those promises.

'The risk of a more strident approach to trade from Trump has risen, with Cabinet appointments suggesting the President-elect could follow through on threats made on his campaign trail,' the bank said.

'Asia stands out as having the most to lose,' the bank added.

5. Domestic uncertainty in China

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2017 is a critical year for China, as 11 seats of the 25-member Politburo will open up at the 19th National Congress. That includes five seats from the seven-member Politburo Standing Committee, which contains the main leadership of the Communist Party of China.

According to a team of Credit Suisse analysts led by Vincent Chan, the National Congress 'goes a long way in deciding the top leadership around President Xi Jinping and how far he could consolidate his power, and potentially creates conditions for him to extend his rule in China beyond 2022.'

'This meeting could decide China's political landscape during the next decade,' the team added.

In addition, the Chinese government will also attempt to implement measures in 2017 geared toward transitioning the export-dependent economy to one that is based on consumers.

According to BMI Research, the Chinese government will have to decide the manner in which it will overcome numerous 'structural obstacles' that stand in the way of this transition. They said in a note to investors that the necessary changes to diminish the dominance of state-owned enterprises would be a slow and politically sensitive process.

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