Tim Graf (TG): This is Street Signals, a weekly conversation about markets and macro brought to you by State Street Global Markets. I'm your host, Tim Graf, European Head of Macro Strategy.

Each week, we bring you the latest insights and thought leadership from our award-winning suite of research, as well as the current thinking from our strategists, our traders, our business leaders, and a wide array of external experts in the markets. If you listen to us and like what you're hearing, please do subscribe, leave us a good review, get in touch with us. It all helps us improve what we hope to bring to you.

With that, here's what's on our minds this week.

TG: While US trade and fiscal policies dominate the discourse, recent developments across Asia have the potential to be every bit as consequential for currency and equity market returns this year. Newly announced Chinese stimulus measures and adjustments to their growth and inflation targets following the recent National People's Congress, have contributed to a more positive outlook for regional equity markets.

The emergence of DeepSeek, which we talked about on the podcast a couple of months ago, as well as the strong performance of Chinese EV makers like BYD, suggest more competition in tech and AI adjacencies than US companies may have appreciated. And as my guest this week notes, while US tariffs are certainly a threat to regional exporters and the alliances that many countries have built with the US remain of utmost importance, intra-regional dynamics are every bit as important to Asia's future.

We pick up a lot of these threads with Ben Luk, a senior strategist on our team in Hong Kong.

Ben Luk (BL): Hey, Tim.

TG: Hey, how's it going, Ben?

BL: I'm good. I'm good. How was your weekend?

TG: It was good, actually. Yeah. It was very chilled out. How about you guys?

BL: Well, I mean, it's getting very warm now on our side. I mean, I think over the week, I went to Disney with the kids just for like a day. I mean, because the thing is, when you buy these annual passes that I do, you got to max it out.

TG: 100 percent. So you're all ready to go?

BL: Yeah, I'm good.

TG: Pretty obvious trade wars and tariffs. I mean, the Western press and markets in London, in the States, it's all about this. And yet, we kind of don't get the perspective from a lot of the perspective targets.

We'll talk a lot about data, but actually, I was curious if there's anything anecdotal you thought was interesting you're hearing from clients or in the media, just the reaction to all of this. Is it as hot a topic there as it is in the West?

BL: Yeah, I think the general theme that I'm at least seeing from the clients I'm seeing here as well as the media is, it's a well-known risk, Tim, but there's far more things that impact Asian markets now than the trade war itself. The DeepSeek stuff obviously being the biggest theme in China. But outside of that, right, we just had the impeachment in Korea, right? That's another thing that have just popped up again over the weekend. Then basically, you have continual concerns over certain places like India. You have massive equity outflows there.

There's idiosyncratic stories that the media is picking up here as well on top of the trade war stuff. I think at the end of the day, it's also impacting the dollar move, because the dollar at the end of the day is our biggest risk. It's not really the trade war stuff. It's whether or not the dollar can weaken further, and you basically have capital flows coming back into the region. So that, to me, is more of a bigger risk than just the Trump stuff.

TG: I mean, the dollar has been weak to start the year. Would you then almost characterize it as a more positive environment? I mean, you mentioned some negative flow stories, and we'll get to that.

But is the dollar weakness actually, it's obviously a boost for the currency, and is it seen as almost a positive at the moment?

BL: It is, it is. I think what we are seeing at least is, for Asia, we don't tend to appreciate much. The more important thing is we don't need to depreciate, because once we depreciate, then we defend. That's how Asian Central Banks work. So as long as they don't need to defend, then they're happy with the reserves that they have, and things can go as market driven. Once you see it go the reverse where they have to defend, then they have to care about the liquidity, but when they care about the liquidity side, then they're tightening the actual growth of the economy. So that's always an issue.

So there's much more of a, I think a defensive mindset in Asia. They don't need to see strong or high growth, but they don't want to see like massive capital outflows. That's the thing for us.

TG: On the flow side then, whether it's using our data or just what you're talking to clients about, how are they reallocating, just very broadly speaking within the region in response to the more general risks, the dollar risk you talked about as well as the idiosyncratic risks.

What are the big themes you're seeing?

BL: Yeah, so I think the biggest theme is really trying to long duration back into sovereign bonds. The thing that I'm seeing right now is unlike other parts of emerging markets (EM), Asia is set to cut rates much more. So we have a low inflationary regime, so that's not going to change. So that's a good thing for us, right?

The second thing is we rely oftentimes for exports to drive growth, and that's going to soon become a headwind, which it was basically a tailwind last year with the rebound of the semis, or basically Chinese exports doing relatively okay. But this year is going to be a drag. So the only way for them to offset that drag is from consumption, and that needs to come from lower rates. And because inflation is not a risk for us, we can lower rates. So I think that's why long duration helps the story for spreads and yields to compress in our region.

The equity story is much more complicated. And it's even really in our flows where China benefits, but other than that, nobody benefits from the spillover for now.

TG: Okay, well, let's talk China, because I was going to ask what the equity effects were outside of China and then get to China, but we're going to get to China now. The stimulus efforts, this for me has not been nearly as covered as it might be. And again, I think this is maybe a Western bias thing where, and look, it's significant what the Europeans and particularly the Germans have done on the fiscal front and are doing and likely will do.

But at the same time, as part of this broader, I think, long-term reorientation of growth towards domestic demand in China, it does seem as though we're getting more and more stimulus efforts from China. And I wanted to see if you could walk through what recently has happened and maybe compare it to what we're seeing in Europe.

BL: So we’ve just gone through the NPC, right Tim? So we often go through this very high optimism that Chinese stimulus is going to be very supportive. And often times, the expectation is that they're going to do more, but that it lacks details.

But the numbers that they have sent out post-the NPC is supportive of that. I think first of all, setting the GDP target back at 5 percent was a signal that they're not giving up on growth this year. The second thing is they have for once finally lowered inflation target from 3 percent to 2 percent. And I think it's a signal that they are recognizing that there is deflationary risks and that they need to do something about that risk, which is why in conjunction with the lowering of the inflation target, they've also boosted fiscal deficit for the first time from 3 percent to 4 percent.

And they're lifting all of the quota issuance for central government policy bonds, from local government policy bonds, they're all lifting those quotas to really try to get more money for the local governments and really try to improve that domestic demand story. And I think if there's like really one line to focus on, what they're trying to do this year is they want to use domestic consumption as a way to fight through the drag in exports.

And there's a lot of mini things that they're doing, I think, that's not really covered by international press. The first thing is they're doing this consumer goods trade in program. A Chinese citizen, they can buy a digital product like a phone or even an electric vehicle. All of that was actually boost. Last year, the program was only capped at 150 billion renminbi. And this year, they've doubled that program to 300 billion. They've also done equipment upgrade schemes. That's a little bit higher from 150 to 200 billion in terms of the overall upgrades.

And last but not least, they've also upgraded the total number of new jobs that they expect to create this year at 12 million. And really lowering that unemployment rate to 5.5 percent. So there is these tiny details that we're seeing from it that's moving in the right direction. And because of the way that China works, where these policies are not independent with each other, I do believe that they can use a mixture of policies to achieve those goals.

TG: Thinking about it longer term then, I think it was around this time last year, we did a podcast on the Japanification process and whether China could avoid it. There were some glimmers of hope that they might be able to. How would you assess the progress given it's about a year later and we still are seeing these rollouts of fiscal programs.

Are there enough markers of success so far for you to think that yes, we can avoid the scenario that Japan went through from say the early 1990s onwards up until just a few years ago?

BL: I would say half and half for now, Tim. The first step was recognizing this deflation risk. And we finally see it with the downgrade of the inflation target to 2 percent. So, this is actually the first time we have seen them downgrade since 2003. So, that's really 22 years that it takes them to recognize that.

The second step, I think, was realizing that in order for them to grow out of the situation you mentioned is they can't rely on just public investments. They have to use the help of private investments and private enterprises to drive them out of the situation. The high-frequency data, in terms of what we measured, I would say, throughout the last 12 months that you mentioned, is nowhere close to getting there, I think.

I think going forward, what they need to do is basically consider things like partnerships, deregulation, something maybe even the US would consider, deregulations, in order to really encourage that what they're doing in the private space can soon become the norm for public as well.

TG: That was actually the next question I wanted to ask you about because of course, you did have this outreach from Xi to various tech leaders. Jack Ma has even come in from the cold, it would seem. I'm assuming this is all part of what you're talking about.

Does it speak though to any sense that the central government just wants more control over that sector as part of pushing the levers of growth? How significant is it in letting the private sector take the lead? And does this truly represent a significant moment in that process?

BL: I do think the sentiment was definitely a game changer from that perspective, because we have really hardly seen China trying to push so much on private to lead public. It's always been the other way around. Even in the 15th five-year plan that was announced previously, they had mentioned about stay-on enterprises to prioritize AI development. But they never really mentioned about doing this on a parallel conjunction with private.

But I think, to your earlier point, Tim, the fact that she did reach out to the private side and really going for more joint partnership from that perspective, that will facilitate more investments. And there's a lot of things that China wants to dominate in, which is something that the public side cannot really control in the longer term. I mean, it's not just on AI. They want to focus on the chips production. They want to focus on dominating EVs. They want to focus on dominating robotics, drugs, automations. All of those things are something that I think only the private side can help them on.

Most recently, they have actually assigned a new law called a Private Economy Promotion Law, really trying to remove some of the autocratic barriers with respect to maybe getting the businesses up and running or basically trying to minimize the admin procedures per se to help with this dominance. But I think it does take time.

TG: This is interesting because it speaks to the long-known need to reorient the economy to domestic consumption. This is something that is also not to make it all about Europe, but this is of course something that is also happening in Europe with respect to defense and infrastructure.

Is there any sense of this in the region and particularly in China that this is also a reaction to the US's efforts to maybe redress imbalances that have built up over decades and both on the defense side when it comes to the US vis-a-vis Europe, but also on the external balance side in the US versus Europe, the US versus China.

Does that motivate some of the thinking in China?

BL: I mean, I'm obviously no means a political expert, but I think it's very hard for Asia right now, because although Asia does not want pure China dominance going forward, the simple answer is Asia relies heavily on China just as much as they do on the US. So picking sides is often very, very difficult for any Asian economies. The US cannot just give up on it, just like how they're doing it for the Ukraine situation, especially for places like Taiwan.

Taiwan is basically the heart of the global trade. Every container ship, let's just say, uses Taiwan's Strait for trade. And if you look at the geographical location of it, it basically forces Taiwan to be in the middle because of how the location forces China to have this direct access to China's coastline and in the Pacific Ocean.

Given this situation, and given really how at the end of the day, it's not a war of guns anymore in terms of Asia. It's really a tech world that we need to control. It's very difficult for US just to give up on Taiwan because that will simply mean that they are basically going to give up all the power and resources once that becomes the case. And that will actually speed up China to become the global dominance of the world is what we can see.

TG: Do you think this is a situation where it's a continuation of a reorientation, but that there's no acceleration of commitment? Or do you think this actually does represent an acceleration of the US's commitment to the region for all the reasons you elucidated in your last answer?

BL: I think it's actually more of the latter, Tim, where the US has no choice but to further commit to our region. Because if they don't do that, then it basically gives the opportunity for China to do more and actually build more allies against the US going forward. When you look at the breakdown of exports as a percentage of GDP in Asia, 10 years ago, we would still say that US is the biggest trading partner for many, many of the Asian economies.

But when you then look at it today, basically, even for the likes of Taiwan, Korea, Japan, the biggest export partner for these big countries is China. And actually, the second is the US. That becomes a very difficult situation at the end of the day when your growth is basically reliant on the growth of Chinese demand. And if the US continues to pull out, then you're basically forcing the rest of the smaller economies in the region to have no choice but to actually work with China even more.

TG: Very, very interesting. And you mentioned Japan. And I wanted to see if you could talk a little bit about where they sit here. Because they're of course watching this from the perspective of as being a US ally, but they also run a significant trade surplus still with the US. And so they're a potential target for tariffs. And what are they hoping to accomplish vis-a-vis the US in any trade negotiations?

And then also, any sort of triangulation with China or against China on working with the US as being a potential competitor with China. Where do they sit here?

And can you talk a little bit about some of the things you're hearing from clients or that your own personal thinking on what Japan's stance right now would be?

BL: From a high level perspective, Japan will always be seen as a true ally for the US. But like what I've said earlier, numbers are the numbers. The exports to the US has now dropped to 17 percent in terms of Japanese exports. But the numbers for China, including even Hong Kong, as a re-exporting center, that has now jumped to 27 percent.

And more importantly, it's not just direct exports, because at the end of the day, both China and Japan have used, actually, the rest of Asia as actually a smaller manufacturing powerhouse using the likes of Thailand, Indonesia, Malaysia, all of these smaller ASEAN economies as a way to continue to build a very, very strong export hub for the rest of the world. So I think that in of itself puts them in a very difficult position that yes, they respect the ally or the relationship with the US, but at the end of the day, they need to protect themselves. And that's really competitive landscape that they need to deal with in Asia.

From a client's perspective, there is definitely more interest in terms of investors considering Japan more as a longer term, I would say, asset allocation. The yen, I mean, according to our metrics, right, Tim, we see that basically real money investors continue to buy, and it's already an overweight in terms of the positioning data that we have. But the equity story, not so much.

But what we're seeing at least from an earnings perspective, from a valuation perspective, it's also looking quite attractive, which is why for investors that may not just jump straight into buying yen, Japan is also a very good value play that is still under owned, under value, and it does have that earnings potential that investors are considering.

TG: That's a perfect segue into talking about views on the region. And at the very beginning, you talked about DeepSeek. It's my pet theory that a lot of the equity market weakness we've seen in the US was maybe related to uncertainty over trade. It's hard to ignore that.

But I think the release of DeepSeek was underrated as a factor. And it has really led to a renaissance in valuation in the region.

How much further positivity do you think we can get from the AI story in China specifically? And particularly, how positioned are investors for this to continue? Is there room for further strength? Or is this something that now you see as fully priced?

BL: Since last year, China has no longer decided to release daily northbound flows into the Chinese onshore market. So it's very much a big, I would say, uncertainty in terms of nobody really knowing how much money is going into Chinese equities or going out of Chinese equities. But with our data, we can still track daily flows in and out of Chinese equities. And really, the first initial spike of inflows that we saw was late Q3, early Q4 last year, when we first heard about the stimulus announcements and really the further support from Beijing to, I would say, push for that private or domestic consumption story.

That initial spike lasted for, I would say, a little more than two months. And then things started to fade again with the fact that we had the US election and certainly over the trade war, the tariffs. And really, we continue to see inflows from real money investors, but that magnitude has had, I would say, haft in terms of people buying back into the region. It even actually went back into negative slightly at the very early part of 2025.

But since the DeepSeek announcements, we basically saw a resurgence of flows back into Chinese equities. But all of that resurgence is still not enough to close the underweight that we have seen according to our positioning data. So Chinese equities is still the biggest underweight that we're seeing across all of the equity markets that we're tracking. So if you ask me, Tim, whether or not this is just the end or the beginning, I would lean more towards that there's further room to go in terms of this underweight story and really trying to just close the short positions that they have built for many, many years already.

And I think at the end of the day, what is valuable in understanding the DeepSeek, at least for now, is this is still a free software that is allowing everybody to try it out. And this is just, DeepSeek is just one example, I think, of what China can do. And that's why I think the optimism has really shifted in terms of if I can get similar potential from these Chinese tech companies, but at closer towards a 50 percent valuation discount relative to US tech, then it's a much better proposition to at least consider owning some of it, or at least just clothing the underweights that they have built. So I do believe that there's a lot more room to go in terms of just closing that, that underweight position.

Whether or not we can go into an overweight position, like what we're seeing in US tech, that's still something I think the earnings needs to come through. But just the initial phase of it seems to be sustainable, at least from the flows that we're seeing.

TG: Would you favor equities over bonds? Because I wanted to talk about Chinese rates, and you mentioned the significance of lowering the inflation target. But we've also, of course, seen a big rally in Chinese fixed income because of low inflation.

But the recognition that inflation is low that you've discussed, I do wonder if that marks a bottom for rates. I mean, do you think that's the case?

BL: I do think so. I think there's a lot more potential for equities to outperform rates. At the very beginning, when we talked about the Chinese policies, we mentioned about supply versus demand and balance. What we're seeing, at least from this year, is there is a very strong push to issue more bonds, regardless if it's central government or local governments or basically state bank recapitalization plans. And that's really the supply side trying its best to allow for more liquidity to come into the system And I think with that being, the supply side being so strong this year, it is going to put a floor on whether or not yields can go any lower from what we're seeing already.

And the other flip side of that is, when you look at the overall situation also in the currency, the currency right now is still overvalued when we look at it from a basket perspective. So I think from a fixed income investor, if they do need to be concerned about further depreciation, then they need to consider hedging. But because rates are so low already, when you hedge out that currency risk, you may actually get a total return that's actually negative if the spreads actually don't compress from here.

So I do see that there's more potential with the flows that we're seeing especially that equities do have a much better upside versus what we're seeing in the rate story.

TG: I wanted to finish with a question on currencies because as you were going through that and talking about the renminbi in particular, I pulled up WCRS on the Bloomberg. Looking at year-to-date spot returns, the bottom 10 or 12 currencies, you have the Turkish lira at the bottom, which okay, we can throw that out because of all the political volatility that we've seen over the last few days. The Canadian dollar is also there, which is understandable given all the tariff-related discussion. Every single other currency is an Asian or Australasian currency.

The Aussie dollar is in there. Is there anything to finish with that you would pick as something that's now cheap and is worth buying?

BL: I think most of Asian currencies are going to underperform. We're often in a region that is, as I mentioned, more defensive, we have high FX reserves, so we're a low carry region. So if the dollar weakens or have, let's say, a more trajectory of more downside to see, then carry or basically ex-Asian currencies are going to benefit more. We're also at the heart of basically the trade war, if things escalate from here.

I think the one currency that we would slightly be more positive on would be something like the Singapore dollar. The SGD is a very managed currency, but the Sing has the highest correlation to places like Euro and Aussie as a way of how they manage the index or the SGD NEER basket. And I think if there is obviously a potential for G10 to rally against the USD, then the Sing naturally benefits simply from a correlation perspective.

Also, Singapore is much more of a pharmaceutical export powerhouse as opposed to being a tech powerhouse. So the pharmaceutical world is slightly more, I would say, dependent on the European story as opposed to US import story. The correlation would be less impacted just simply from a tech universe that we're seeing in most of Asia, where Singapore is slightly more dependent on the European side. So, outside of that, I think most of what Asia can provide is using Asia as a funder.

The likes of Taiwan, the likes of Korea, Thai baht, CNY, CNH are all basically very good funding currencies to long any of the more exotic high beta currencies in EM, where you can get a lot more carry than shorting simply the dollar, at least in our world. So that would be one area that I would prefer more of as opposed to betting long Asia given the uncertainty that we have in the region.

TG: Very good. Ben, you've mentioned a bunch of things that are very chartable and that is just to finish. As we did last week, I'm going to definitely throw some charts together for this, publish them in the show notes, which will come out with the podcast. You've shown us the way, Ben. There's lots that I can do with that. So thank you very much for doing my job for me in a way. And thanks as always for joining the podcast. It's been great to catch up with you.

BL: Thank you. Take care.

TG: Thanks for listening to this week's edition of Street Signals from the research team at State Street Global Markets. This podcast and all of our research can be found at our web portal Insights. There you'll be able to find all of our latest thinking on macroeconomics and markets where we leverage our deep experience in research on investor behavior, inflation, risk and media sentiment. All of which goes into building an award-winning strategy product.

If you're a client of State Street, hit us up there at globalmarkets.statestreet.com. And again, if you like what you've heard, subscribe and leave a review. We'll see you next time.