On March 23, US Federal Reserve policymakers said they were prepared to act aggressively to bring down unacceptable inflation, including a possible hike in interest rates by half a percentage point or even more, at its next meeting in May. The Fed had previously forecast that rates could rise to 1.9% or more by the end of the year.
The message came barely a week after the Fed’s decision to raise interest rates by 25 basis points on March 16 – the first since 2018, when the United States posted the highest inflation since decades.
Investors predict up to seven interest rate hikes for 2022, but how will these rate hikes affect Asian financial markets? Fixed income and equity experts in Asia spoke with Asian investor this week on what these structural changes may mean for investors in the region.
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Responses have been edited for clarity and conciseness.
Brian Nick, Chief Investment Strategist
As the central bank of the world’s largest economy – and its biggest importer – the Fed’s monetary policy has global implications. His expectations of a more aggressive path of rising interest rates helped push the US dollar higher against most other currencies while tightening financial conditions in the US and around the world. This will lead to slower US domestic growth via weaker US consumer and corporate sectors, which will affect export-sensitive capital markets in Asia.
Several Asian central banks – China is a notable exception – have also started raising interest rates, but the Fed’s predicted upward path comes earlier and is expected to be steeper, meaning virtually all Asian currencies have been falling since the beginning of the year against the dollar.
Expectations of monetary policy tightening hit high-growth companies more than others, driving underperformance in tech stocks and contributing to similar underperformance in Asian markets with large tech sectors.
Finally, as U.S. interest rates rise and the U.S. dollar strengthens, debt issued in U.S. dollars will become more expensive to fund, which could harm Asian economies that issue large amounts of dollar debt.
Andrew Zurawski, Associate Director, Asia Investments
Willis Towers Watson
The Fed is planning major increases in its key rate over the next two years. Interest rates in Asian economies are unlikely to rise as quickly – in fact, in China we expect further policy rate easing in the coming months. These conditions are generally supportive of US dollar strength, and the higher rates could also lead to a return from US government bonds to Asian and Chinese bonds as spreads narrow.
Past tightening cycles in the United States have sometimes been associated with tensions in Asian financial markets. In this cycle, we generally consider the risks for Asian economies to be lower than previous episodes due to several mitigating factors such as strong economic fundamentals and a lower share of US dollar-denominated debt, although higher rates could mean pockets of stress for some of that debt. . Inflation has also been much lower in Asian economies than in the United States and the Eurozone, giving central banks in the region more room to support growth. The cut in key rates should support risky assets such as equities, as should the recent U-turn by the Chinese authorities to further support financial markets.
Mary Nicola, global multi-asset portfolio manager
For Asia, economic growth should be robust enough to withstand tighter financial conditions, but quantitative tightening can be a significant headwind for markets. Asia and other markets benefited from the ultra-loose monetary policy of global central banks.
On the other hand, Chinese policymakers appear to be reacting to their growth underreaction by easing policy, albeit in small steps. We expect this stimulus to target higher value manufacturing and climate priorities. That said, we believe that emerging markets (EM) equity markets will benefit from this policy stimulus. As the US tightens, China’s easing policy should support emerging markets. During this time, the focus will be on inflation and the impact of rising commodity prices over the next 9-18 months. In Asia, higher oil prices could lead major commodity importers like India to battle higher inflation, while commodity exporters like Indonesia could benefit from improving lending terms. ‘exchange.
Brad Gibson, Co-Head – Asia-Pacific Fixed Income
Asian bond and money markets will not be completely immune to US rate hikes and the withdrawal of emergency levels of USD liquidity splashed to cushion the blow from the Covid lockdowns. Although each market is different in terms of precise timing, we can expect most central banks in the region to follow the Fed’s decision, if they haven’t already.
Given the softer overall inflationary backdrop in Asia relative to the US and the ongoing battle to combat Covid surges, we see a mild tightening cycle beginning in Asia. This should allow Asian bond markets to continue to outperform other developed or emerging regions. The economic diversity within the region in terms of exposure to commodities, trade, tourism, global supply chains, etc. creates opportunities for investors to position themselves in Asia to capture a range of potential market outcomes.
A glaring exception to this monetary tightening theme in 2022 will be China, where the potential for further monetary easing will dominate this market. We have already seen Chinese government bonds strongly outperform US and European bond markets in recent months and there are good reasons to expect this trend to continue. Inflation-adjusted yields remain relatively attractive.
Carol Lye, Associate Portfolio Manager and Principal Research Analyst
As the Fed’s first rate hike approached in March, Asian fixed income markets diverged, with inflation less entrenched here and China’s easing providing support. Additionally, the Asian high yield market continues to focus on China’s somewhat underperforming real estate sector. Going forward, the divergence between Chinese and US rates will continue as China eases. This will result in a lower rate differential between the United States and China.
Given the strength of the CFETS (China Foreign Exchange Trade System) basket, it would not be surprising if the Chinese RMB weakens somewhat from here. Low-yielding Asian countries such as South Korea, Singapore and Thailand should continue to see their yields rise in line with global yields as the Fed raises rates. In contrast, high-yielding countries such as Indonesia and India may need to start raising rates alongside the Fed to keep their rate differentials buffered and avoid currency weakness.
Silvia Dall Angelo, Principal Economist
The Fed tightening cycle – which could be quite aggressive this year, judging by recent Fed communications – poses challenges for Asian capital markets in an already challenging environment for Asian economies this year. The Fed’s accommodative policies meant that financial conditions were easy for emerging economies in 2020 and most of 2021, as international capital markets were particularly accessible to emerging market borrowers. A tightening of the Fed would lead to risk aversion and potential capital outflows from emerging markets. Higher US rates and a growing gap with local rates – Asian central banks should raise their policy rates more gradually given the more favorable inflation situation they face, as they risk fueling weak local Asian currencies and broader financial market volatility.
The stronger US dollar that is expected to accompany Fed tightening will translate into tighter financial conditions for developing Asian economies that rely on dollar financing. In general, the environment for Asian economies appears challenging given weaker global demand and declining trade growth, a continued slowdown in China, the withdrawal of stimulus in the United States, and more recently , the escalation of geopolitical risk. Ultimately, a slowdown in domestic economic growth would be detrimental to Asian capital markets.