US Fed ripples hardest hit in Asia as rate outlook changes
Central banks in emerging economies such as India and Indonesia may regret a limitation in their ability to relax their policies.
HONG KONG (June 17): New Federal Reserve (Fed) interest rate outlook ricocheted through Asian markets as dollar and Treasury yields surged, easing pressure on some of the biggest central banks the region and complicating the outlook for others.
Expectations of higher rates in the United States tend to divert capital from Asia, lowering local currencies and raising borrowing costs. This can be a boon for the People’s Bank of China (PBOC) and the Bank of Japan (BOJ) as it results in unwanted currency gains. But central banks in emerging economies such as India and Indonesia may regret a constraint on their ability to relax their policies.
“If the dollar continues to appreciate, it also puts pressure on Asian central banks,” said Teresa Kong, portfolio manager at Matthews International Capital Management LLC in San Francisco. “I consider that the Fed’s statement today leaves less political flexibility for emerging market central banks, shifting the odds towards higher rates to temper inflation even though their economies may benefit from lower rates for longer. “
The dollar rallied the most in a year following the Fed meeting, hitting Asian markets disproportionately, based on a gauge of risk-adjusted movements. The Philippine peso, Indonesian rupiah and South Korean won have been among the worst performers since the policy was announced, as measured by the three-month z-score, which tracks fluctuations relative to the average.
At the same time, a sharp drop in Treasuries weighed heavily on developed market bonds. New Zealand and Australia 10-year yields surged on bullish local data and are betting the Fed’s new turn will allow others to change their tone without risking too much monetary strength.
Markets see a good chance of a Fed rate hike by the end of 2022 – and overnight swap markets have risen to nearly 50 basis points of New Central Bank tightening. Zealand by the end of 2022, up from around 32 basis points on Tuesday.
“We are looking at regional central banks here in Asia and debating which ones may come in earlier than projections and some of which may get ahead of the Fed,” Stephen Chang, Hong Kong-based portfolio manager at Pacific Investment Management Co, told Bloomberg. Television. He cited the Bank of Korea and Australia as possible candidates for an earlier-than-expected decision.
In a speech on Thursday, Reserve Bank of Australia (RBA) Governor Philip Lowe said requirements to raise the benchmark interest rate could be met in 2024 under some of the scenarios the bank looked at, but not in others. The RBA will review the scenarios again at its meeting next month. Shortly after its conclusion, data for May on the labor force showed a surprising drop in the unemployment rate to 5.1%.
Bank of Indonesia Governor Perry Warjiyo, who held rates stable Thursday for a fourth consecutive month, said the reaction to the Fed’s move so far appears relatively stable, although he added that the bank remains under surveillance.
“We will continue to be vigilant and ensure the stability of exchange rates and financial markets,” he told reporters after announcing the bank’s policy decision.
Big tail wind
For the BOJ, which meets on Friday, the Fed’s decision could offer some respite, said Tomo Kinoshita, global markets strategist at Invesco Asset Management in Tokyo.
“The Fed is sending a big tailwind to the BOJ by adding pressure for the yen to weaken,” Kinoshita said. “All the BoJ has to do is stick to what it did for a distant inflation target.”
As for the PBOC, it will also likely welcome the Fed’s change as it grapples with the strength of the yuan, the influx of capital and very high commodity prices. The central bank has warned against expectations of continued appreciation of the yuan.
China’s benchmark CSI 300 equity index rose 0.8%, the best performance among major Asian equity gauges.
Fed officials ramped up their expected pace of policy tightening amid optimism about the job market and heightened concerns about inflation, and released forecasts showing they were anticipating two rate hikes interest by the end of 2023 – sooner than many expected.
Fed Chairman Jerome Powell told a news conference officials will begin a discussion on reducing bond purchases used to support financial markets and the economy during the pandemic.
This will have ramifications for Asia and other regions, said Marc Chandler, chief market strategist at Bannockburn Global Forex.
“If US rates really rise steadily and the dollar rises, many emerging countries will be squeezed, especially where interest rate differentials have been a big support,” he said.