Market Views: Will Asia gain as Fed nears end of rate hike cycle?
The US Federal Reserve raised interest rates on July 26 by a quarter of a percentage point, translating into 11 hikes after its last 12 meetings.
The new benchmark overnight interest rate in the 5.25%-5.50% range, a level last seen just before the global financial crisis of 2007-2008.
Fed chair Jerome Powell said the US economy still needed to slow and the labour market to weaken for inflation to "credibly" return to the US central bank's target of 2%.
Powell made no promises either way, with another rate increase considered possible at the next Fed meeting in September, according to several investment experts.
How will this affect Asia's prospects, especially in terms of capital flows and investor sentiment? AsianInvestor asked investment strategists, portfolio managers, CIOs and economists to find out.
The following contributions have been edited for clarity and brevity.
Gary Ng, senior economist for thematic research in Asia Pacific
Natixis
For Asia's markets, the Fed has not offered much certainty about the future trajectory, but Powell's comments at least limit the downside of rapid hikes, which is already marginally more dovish than before.
As investors price in the weaker greenback story, Asia's market sets to benefit from better sentiment and more capital inflows. Although no one is fully certain about the Fed's terminal rate, it is a consensus that we are almost there.
The market is now less sensitive to another one or two rate hikes, as shown by the stable VIX index.
It is also hard to expect most of Asia's central banks to hike further.
As such, Asia has a resilient growth story as investors turn on their risk-on mode.
Even for markets with possible changes, such as Japan and Australia, especially the latter with the high interest rates, there are also upsides to forex.
However, the positive medium-term sentiment does not mean there are no short-term headwinds.
The next Fed meeting will be two months away after the summer break, meaning any reversal of US CPI data can bring volatility.
There will be no rate cut this year and the quantitative tightening, meaning liquidity may still get tighter.
John Vail, chief global strategist
Nikko Asset Management
Likely to the Fed’s great relief, the markets seemed content with the consensus-like result of this meeting, with neither side of the debate exaggerating one side of the commentary.
Indeed, chair Powell’s ambiguity in the press conference was unmistakable.
Markets were, thus, stable today and likely to be so in the very near future, but clearly, there was no indication that the Fed is finished, and the odds seem slightly in favour for another hike.
Markets will obviously be very closely watching economic indicators and other factors such as wage settlements, announced price hikes and commodity prices, so market volatility will likely increase before too long.
The same should hold true for Asian markets, with the Japanese yen hopefully stabilising as the Bank of Japan will likely also announce a consensus-like result on July 28, although its guidance will be key to watch.
In this regard, the BOJ must have been greatly relieved that the services PPI data was much lower than expected on July 26.
As for China’s markets, much more depends on its internal decisions rather than outside factors, but the fact that the Fed staff no longer predict a recession should be positive for sentiment, not just for China but throughout the region.
Cecilia Chan, chief investment officer
HSBC Asset Management
The Fed hike has been fully priced in by the markets. Our central scenario for a recession emerging from late 2023 is consistent with “choppy waters” for DM equities over the next 12 months, and room for downside correction.
We remain positive on most EM asset classes given tailwinds from relatively low valuations, cautious investor positioning, more resilient growth, and the prospect of Fed cuts from late 2023 and further dollar weakness later in the year.
For fixed Income, we prefer Asian investment grade bonds as they are trading at a wider spread levels and lower duration versus US bonds, while issuers in this universe are of relatively high quality.
Within the high yield market, ASEAN bonds look compelling and are supported by improving fundamentals and loosening local credit conditions while we remain very selective on investments in China’s real estate market.
Asia equities in general will be in a better position with higher growth opportunities, lower inflation and lower valuations.
India will be a bright spot over the long term. The booming population as well as the growing affluent sector in the country, coupled with the structural reforms and good policy mix, provide a sizeable response to developed markets investors looking for idiosyncratic stories.
Sunny Jiang, senior portfolio manager
Haitong International
We are generally positive on the Fed meeting outcome. It indicates the rate hike cycle is near an end given the clear downward trend of US inflation.
We might start to increase our duration for fixed income investment from underweight to equal or slight overweight, but we would not expect a quick downturn on US treasury yields.
In Asia, the effect to Asian market may not be significant in the short run, since the US economy and labour market is still robust, and the Fed could maintain the current rate level for a long period.
Emerging markets including Asian fund flows could only see large inflows after the market yield turns lower further. Still, we might see it improve after further weakening of the US dollar.
Lorraine Tan, director of Asia equity research
Morningstar
The Fed’s July hike was well expected, and this can be seen by the lack of reaction to the news.
The US dollar fell while equity markets gained. This implies that investors believe that the interest rate cycle is at a turning point and more likely to decline going forward.
Morningstar expects the Fed to hold interest rates steady until February 2024 when a cut may occur.
We believe that the next few quarters of US GDP growth will be weaker. We’re looking at US real GDP growth of 1.1% in 2024. This implies that earnings growth may slide through 2024 for the broad market.
We think that this softer US outlook at a time that our US market strategist sees more limited upside to our fair value estimates implies greater risk of disappointment.
On this note, we would not be surprised to see Asian investors shift out of the higher priced US equities into other markets that have lagged the US in performance so far this year.
Kerry Craig, global market strategist
J.P. Morgan Asset Management
With the market almost fully pricing the expected rate hike, the reaction across equities and bonds was muted.
But there is still plenty of scope for a higher reaction given the Fed’s renewed data dependent stance.
We recognise that recession risks in the near term for the US economy have faded but are still above the average level.
This keeps us of the view that investors should maintain a degree of caution when it comes to risk allocation and focus on broader diversification in portfolios.
The end of the US rate hiking cycle and case for rate cuts in 2024 may see the rate differentials to other economies start to narrow and the US dollar resume its downward trend, especially if recession risks continue to abate and the US currency is not supported by a flight to safety.
This may support the outlook for Asian equity markets and rates as import inflation is reduced.
As Asian currencies strengthen, reducing imported inflation, central banks across the region may start to contemplate their own path for rate cuts to support economic activity and domestic demand.
Jon Maier, chief investment officer
Global X ETFs
While the Fed hike was expected and GDP growth is slowing in the US, growth is broadly picking up in emerging markets (EM).
China’s reopening and its potential new stimulus package could allow more trade deals to occur in the region. That is positive for Chinese manufacturers.
EM central banks are ahead of the Fed in the tightening cycle. Inflation is decreasing faster in certain emerging markets than the US.
Some EMs have positive roll rates, which could lead to a weaker dollar, meaning it helps emerging markets.
EM economies should have a positive story over the next 6 to 12 months. This hasn’t all come together yet, but it does seem that the stars are more aligned.
EMs are cognisant about inflation as they have a history of managing it.
China is the main driver on many thematic stories. The Chinese government is concerned about domestic spending. The government needs to keep up growth. To keep the population content, the government must deliver strong per capital growth.
This means that the government could continue spending for some time.
David Chao, global market strategist, Asia Pacific ex-Japan
Invesco
Even though the Fed has left the door open for an additional rate hike before the end of the year, we believe that the Fed tightening cycle is done and expect policy rates to be reduced throughout 2024.
There continues to be signs of disinflationary forces at play, and we continue to expect core CPI to ease before the next Fed meeting in September.
We’re likely to see increasing global risk appetite as markets continue to positively re-price recession risks, and ultimately look forward to and discount an economic recovery that could begin to unfold late this year.
Regarding Asia Pacific assets, this increase in global risk appetite should be positive for emerging markets/Asia, but ultimately it is the local dynamics in these markets that will likely matter more going forward.
Since the US yield curve tends to flatten (that is, invert) while the Fed is raising rates and to steepen when it stops, we thus expect the yield curve to begin steepening over the coming months and into 2024.
In the early stages of steepening, we believe that yields could fall along the curve but that the effect of duration will give better returns at the longer end of the curve.
Equity markets have perhaps prematurely anticipated the move to Fed easing, and we wouldn’t be surprised to see a surrender of recent gains over the coming months before indices eventually move higher.