A weaker and more protectionist US economy will mean less export demand for the region
Our primary concern is the health of the American economy. Nine months into the Trump administration, and the US economy appears to be holding steady. The Atlanta Fed’s “nowcast” estimate is that the economy grew 3.9% in the third quarter of the year, and other agencies’ estimates are not far below that. The stock market is booming, with excitement over AI unleashing a tidal wave of capital spending that is boosting the earnings expectations of key companies.
Many analysts justify the upbeat mood by pointing to the tax refunds that will be paid out to households early next year, which should spur consumer spending. In addition, capital spending is expected to continue growing because revised depreciation rules for capital equipment purchases will encourage further investment. The deregulation that the new administration is pushing in many areas should also help capital spending. And the good news doesn’t end there. The consensus view is that oil prices are set to fall further than they have already this year, which would give global demand yet another fillip.
Still, it will be a stretch to predict that such benign conditions will last. The broadly held view is that any US slowdown in 2026 will be moderate, with the economy growing roughly at its long-term trend rate, just above 2%. Questioned about the risks, these analysts comfort themselves by insisting that the Federal Reserve will be quick to cut policy rates to give the economy downside protection.
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Nevertheless, it all seems too good to be true for us. The areas of strength in the US economy are not to be gainsaid, but is it really possible that there is little cost to the huge dislocations in trade, immigration, government services, foreign policy and institutional quality that the new administration has brought in? We are firmly in the pessimists’ camp.
First, we believe that several of the forces supporting the US economy will not last, while the lagged effects of Trump’s economic and other actions will hurt economic activity as we move further into 2026.
The economy is still enjoying the lingering effects of the previous administration’s infrastructure and industrial policies. However, as the current administration is already reducing or eliminating those policies, the uplift will give way to a decline.
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The capital spending boom has been extraordinary. One estimate is that investment accounted for a stunning 92% of economic expansion in the first half of this year. Investment in information processing equipment and software grew 14.5% on year in the second quarter, a sizzling pace not seen since the height of the dot com bubble in late 2000. To continue contributing strongly to economic growth, this investment category needs to sustain extraordinary rates of growth, which is possible but not likely.
If we exclude investment in information processing equipment and software, the economy barely grew, registering just 0.1% annualised growth in the same period. That’s because there is substantial uncertainty in the business sector, stemming from the policy shocks the new administration has unleashed on the economy. This uncertainty is likely to persist and may even worsen as we explain below.
Second, the full impact of tariffs and other policy changes has yet to be felt because they have only recently fully taken effect. Even with the likely trade deal with China, the average tariff rate in the US will rise from just below 3% to somewhere in the region of 15%-18%. That is a sizeable shock to the system, with its effects percolating into the broad economy over the coming months:
For now, many companies are absorbing the tariff costs and not passing them on to consumers. But the surveys suggest that this will not last, and that firms will eventually pass most of the higher costs to their buyers. As prices rise, consumers will become more wary, and consumer spending will slow. The early signs indicate that trade-sensitive consumer goods prices are accelerating.
Such a large tariff increase will cause dislocation in supply chains, with many small firms likely to downsize as they struggle to cope with the added burden and compliance costs.
The combination of rising prices and a slowing economy will place the US Federal Reserve in a dilemma — cut rates to support the economy, and inflation could spike further.
However, if rates are not cut, then the economy could go into a tailspin. If the Fed still cuts, then bond yields could well remain higher than desired, reflecting the higher inflation risk.
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Remember also that the economy is suffering a huge and unprecedented labour supply shock as the new administration’s harsh crackdown on illegal immigration causes the net inflow of migrants to turn negative for the first time in almost a hundred years. Sectors that rely on migrant workers — construction, agriculture, restaurants, home health and personal care aides, and accommodation services — are certain to suffer.
The US fiscal position is also on a tricky trajectory. The IMF projects the US budget deficit to exceed 7% of GDP each year through 2030, higher than in most OECD nations. Tellingly, the IMF sees the US performing worse than Italy — unlike the US case, the IMF expects Italy’s net debt burden to be falling from 2028 onwards. If the American political class is not prepared to address this ticking time bomb — and there is no sign of such political will — then there will be a financial shock at some point in time.
Third, even without a fiscal shock, there are emerging signs of stress in financial markets. A correction of some kind — not necessarily a crash like in 2008 or 2001 — is a reasonable expectation. This is especially the case as the signs of financial indiscipline typical of the late stage of a financial cycle have started to appear:
The bankruptcies in quick succession of companies involved in the automobile supply chain — Tricolor, First Brands and PrimaLend — have raised questions about how rigorously banks extended credit.
Private credit funds have been reported to be lending to their own subsidiaries or affiliated private equity firms.
Over the past year, US banks have loaned US$600 billion ($777 billion) or so to non-bank financial institutions, which have gone on to provide multi-fold leverage to their clients.
This kind of leverage on leverage behaviour is often seen before a financial accident.
Investor margin debt is now much higher than revolving credit card debt.
The Bank for International Settlements has warned that credit ratings on private loans held by US insurers may have been systematically inflated.
We could go on, but the picture is clear: as financial indiscipline worsens, it is a matter of time before there is a sharp correction. Note that, as the proportion of Americans playing the stock market is now much higher than 20 years ago, the damage from a sharp correction in equities will be significantly higher than before. Such financial shocks would be transmitted swiftly to Asean equity and currency markets as well.
One-sided trade deals for Asean could lead to trouble later
Another channel through which the US will impact our region is the trade shocks, which will not go away just because a few trade deals were signed recently at the Asean Summit, which Trump attended.
The agreements are greatly one-sided. Asean countries agreed to onerous conditions imposed by the US. When it comes to the crunch, countries will struggle to fulfil them. For instance, some clauses in the deals could be interpreted as requiring regional countries to help the US contain China. An article in the Malaysian deal obliges it to adopt measures with “equivalent restrictive effect” as the US measures directed at a third country. Malaysia has to consult with the US before entering into a new digital trade agreement with another country. The Asean countries had little choice but to accede to US demands, given their reliance on the American market. But if the US sees these agreements as pressuring regional countries to adopt restrictions on China, there will be pushback from the region, and the trade deals could unravel.
The region must step up de-risking from the US
The US economy poses downside risks to Southeast Asia over the medium to long term. The risk of economic, trade, and financial shocks is high. The region must therefore create strategies to reduce its reliance on the US and to build resilience against these shocks.
First, since a unified approach to the US on trade matters is not politically feasible, Asean nations should at least agree on a few common positions on future concessions when they negotiate bilaterally with the US. Otherwise, there will be a race to the bottom on such concessions, and everyone will be the loser.
Second, Asean can benefit from its position at the centre of the Regional Comprehensive Economic Partnership (RCEP), which brings together the Asean members with China, Japan, South Korea, Australia and New Zealand. Hong Kong, Sri Lanka, Chile, and Bangladesh are applying to join the RCEP. Asean should work to bring in even more countries and make RCEP the world’s largest trading bloc. Expanding RCEP will help maintain some momentum in trade opening despite the ill-effects of American protectionism and improve access to other markets besides the US. It will also give Asean better bargaining clout in trade negotiations.
Third, Asean needs to go further than it has in strengthening regional integration. At the recent summit, the member states upgraded their Asean Trade in Goods Agreement (ATIGA) to ease the non-tariff barriers (such as customs procedures) which have impeded intra-regional trade. They now need to resolve the differences that are holding back the Asean Digital Economy Framework Agreement and the Asean Power Grid proposal as well.
Fourth, Asean should quickly implement practical proposals made by the Asean Business Advisory Council (Asean-BAC). One idea is the Asean Business Entity concept, which would create a new category of companies that would more seamlessly operate throughout the region. The result would be to spur intra-Asean trade and investment.
The next few years will be troubled ones, but the region can proactively take the steps necessary to protect itself from the downsides.
Manu Bhaskaran is CEO of Centennial Asia Advisors
