Asian markets and currencies will likely be more resilient this time around, but the policy outlook of individual economies diverges from here.
The Fed surprised markets with a hawkish pivot. The big news out of the June FOMC meeting was that the “dot plot” (an output from the meeting that shows where Federal Open Market Committee members think policy rates will be) showed that the median FOMC member expects policy rates to be 50 basis points (bps) higher by the end of 2023. That marked a big change from its last meeting, when the median member did not expect any changes in policy through the end of 2023. While Fed Chair Jerome Powell tried to downplay the significance of the dot plot, it does suggest that the Fed is thinking about moving toward a more restrictive stance.
How did markets react?
The Fed's hawkish turn hasn't been that disruptive, as it didn't trigger a lasting increase in US yields. Real yields jumped up about 15bps, and nominal yields by 8bps, but both have since retraced. Equities sold off but soon recovered. Bringing forward rate hikes seems to have heightened concerns about growth prospects in a higher interest rate environment, which has also caused inflation expectations to fall. Asian currencies are about 1% weaker against the dollar since before the FOMC, with the MYR, PHP and THB at their lowest for the year. But most others reversed only a few weeks' appreciation.
How does this compare to the 2013 Taper Tantrum?
In 2013, talk of Fed tapering triggered a sell-off in emerging market assets and currencies. So how great is the risk of a similar rout this time around, particularly in Asia?
There is both good news and bad. In general, external positions are stronger and reserve cushions are greater, but some fiscal balances are weaker. It’s also important to note that the backdrop is substantially different: the general trajectory of the USD is for it to head lower, and commodities are on an upswing. Furthermore, Asia has become a more heterogeneous group – with growth drivers varying widely across the region and more regional interdependence.
There are other reasons to suggest this time will be different. The Fed learned their lesson, so to speak, and they are far more sensitive to global conditions. They are anxious to avoid a panic.
Does this shift impact Asia?
This move by the Fed comes just as Asia is slowly emerging from its recent Covid-19 outbreaks. In Q2, Asia’s mobility declined sharply amid tightened social distancing measures, weighing on a recovery in domestic demand. Nonetheless, the region continued to benefit from a strong growth impulse from abroad and see an improvement in economic fundamentals. Since the Fed move hasn’t sparked a tightening of financial conditions, much will depend on whether the growth trajectory is affected by the Fed’s tilt. As such, the policy shift is unlikely to materially impact the trajectory of policy in Asia. However, even before the Fed surprise, policy normalization has emerged as a key theme for the region, albeit with significant divergence between individual economies.
While most Asian economies carried out monetary and fiscal stimulus in order to cushion the economic fallout in the early stage of the pandemic, the policy outlook from here diverges depending on progress in managing the pandemic and the pace of recovery. Economies that managed to keep the virus in control are scaling back policy support, while the ones that are still suffering from a virus resurgence and intermittent lockdowns are stepping up policy easing to fuel the economy. Major Asian economies can largely be divided into four groups based on their policy stances:
- China, South Korea and Singapore. This group is characterized by a tightening policy stance both in terms of monetary and fiscal policies. China is in the lead; being “first in, first out” of the pandemic, the country started policy tightening early this year, and credit growth will likely continue to decline. The Bank of Korea looks set to spearhead Asia’s first interest rate hike later this year as the central bank sees strong growth and inflation momentum ahead. The Singapore government is scaling back its largest deficit since independence, and monetary normalization is expected to start in Q2 next year.
- Japan, Indonesia and India. This group is keeping monetary policies accommodative as virus concern still lingers, but they are on track for policy normalization due to limited policy space and financial stability concerns. Japan is cutting back support after the largest single year increase in fiscal deficit last year, and is on track to set a multi-year blueprint of fiscal reform, targeting a primary balance surplus by fiscal year 2025. India’s fiscal budget this year was decided before it was hit by the second wave, indicating a smaller deficit; and consensus expects the Reserve Bank of India to begin raising rates as early as Q2 2022, though the path of inflation and the virus create a high degree of uncertainty.
- Malaysia, Philippines and Thailand. This group is stepping up policy easing measures to combat virus resurgence, with normalization unlikely before Q4 2022. Malaysia and Thailand both unveiled another round of fiscal stimulus in Q2 in light of the virus resurgence and slow reopening. The Philippines is also expecting another year of widening deficits as the government ramps up expenditure.
- Taiwan is an exception due to its unique COVID situation. The island managed to prevent an outbreak allowing its economy to see a high rate of growth without a policy stimulus until May this year, when it was hit by its first wave. On the fiscal side, the Taiwanese government has put a moderate-sized relief package in place. However, gradual monetary tightening will still likely be considered, starting 2H 2022, provided the virus situation stabilizes in the coming months.
What does it mean for investors?
While many compare our current environment with the 2013 taper tantrum, we believe there are differences. The Federal Reserve has stated that it wants to avoid premature tightening in order to allow a fuller recovery. The USD is also not on a structural uptrend as it was in 2013 – and instead started this cycle on the more expensive side of its historical valuation. So the global backdrop is benign, and will remain for some time, in our view.
In Asia, although many economies are still recovering slowly from COVID disruptions, broadly the region’s external balances are in better shape, and their policymakers are well-prepared. Therefore, Asian markets and currencies will likely be more resilient this time around. More specifically, there are divergences within Asia.
On the one hand, China has been normalizing policies since 2H 2020. Singapore and Korea are on track to tighten as well. Being ahead of the Fed in this cycle will help to give these economies a buffer against a surprise turn from the Fed. On the other hand, Malaysia, the Philippines, Indonesia and India are still running fairly loose policies – which are good for markets now but are potentially vulnerable if the Fed does surprise everyone by turning hawkish.
All market and economic data as of June 28, 2021 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
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