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The steep rate hikes by the US Federal Reserve to curb inflation have evoked fears of a repetition of the Asian financial crisis of the late 90s. However, market experts are of the view that the Fed’s actions will not have as much impact on the region as they did in the late 1990s. Currently, many Asian economies are stronger and more durable – for a meltdown like the one in 1997 to reoccur.
The crisis in 1997 was primarily due to macroeconomic imbalances and sharp capital flow reversals, prompted by hypothetical attacks on the Thai baht and other regional currencies. In fact, the Fed policy is likely to give risk assets in Asia a bounce this time, but investors should still maintain a defensive perspective as further policy tightening and capital outflows are likely.
Analysts also warn investors not to anticipate an inflexion point for the dollar because any pullback in the US currency will possibly be more of a pause. They reiterated that while Chinese assets are less exposed to US rate hikes, Indian and Southeast Asian assets are more vulnerable.
US policymakers hiked key interest rates by another 75 basis points recently and anticipated “ongoing increases” but refrained from offering specific guidance regarding how far the policy tightening may go.
According to Marvin Loh, a senior macro strategist at Boston-based State Street Global Markets, it is very early to signal an all-clear. He suggested, “Expect that volatility will return, possibly in the fall, when inflation comparables would expect a rapid decline in prices.”
Asian financial crisis on the cards?
Several analysts have expressed their views on what is next for Asian markets after the Fed policy decision, potentially giving a direction on whether an Asian financial crisis is on the cards. Dwyford Evans, head of Asia-Pacific macro strategy at Hong Kong-based State Street Global Markets, suggests that investors need to remain defensive. “Within Asia, investors are still in defensive mode, partially on policy tightening, but also in the backdrop of negative capital flows,” he said, adding, “As for equities, we have growth concerns on South Korea, and we favour Taiwan on strong earnings.”
Hartmut Issel, head of Asia-Pacific equities and credit at Singapore-based UBS Wealth Management, suggests that for the next six months investors need to be somewhat defensive throughout Asia as the region is likely to follow what the US does vis-à-vis more tightening.
According to Jian Shi Cortesi, investment director at GAM Investment Management in Zurich, “China is less vulnerable to U.S. rate hikes.” She adds, “For China, we see domestic policies as a much more important driving force than the U.S. rates. On the other hand, India is vulnerable to higher U.S. interest rates, and this could result in capital outflow, weaken the Indian rupee further, extend imported inflation and trigger further domestic rate hikes”. Cortesi says that there is a tendency for Southeast Asian markets to underachieve in the rate-hike cycles.
Market analysts Oscar Munoz and Priya Misra from TD Securities say that the USD/JPY pair is already in a comfort zone between 135-140. They say that the yen remains sensitive to Fed terminal rate pricing, but it is still not clear where it might finally land. “We do not think that there is significant downside risk yet considering the rate differential backdrop remains strongly in favour of the USD,” the strategists said, adding, “For the dollar, we think it is proper to embrace a neutral perspective as of now because this is more of a dollar on pause than an inflection point.”
While India’s foreign reserves are down from a lifetime high of $632 bn to $580-590 bn, its capital flow woes are likely to continue. Following the hike in the Fed rate, foreign capital flows into India could be further impacted putting more pressure on the already depreciating rupee. High commodity prices in the first half of the year have further deteriorated the foreign currency situation of the country. Meanwhile, consumers and corporates are reeling under high inflation rates which are above RBI’s comfort band of 4-6%. Any rupee depreciation from current levels could further impact inflation levels as the cost of essential imported items like crude oil could rise.
Pil-Seok Heo, chief executive at Seoul-based Midas International Asset Management, believes that there may be a marginal improvement in investor sentiment and any rebound in the South Korean won will not be viable in the long term. Heo is of the view that at the best there will be a short rebound because the second quarter did not have great corporate earnings results and it could be worse in the third quarter with macroeconomic data likely to deteriorate further.
Chief market strategist for the Asia Pacific at Hong Kong-based J.P. Morgan, Tai Hui, is of the view that investors could begin to witness the end of the rate hiking cycle, providing some optimism. “This was reflected by growth stocks outperforming value stocks overnight, Hui said, adding, “Bond yields have also declined with curve flattened.” He expects this would also be encouraging for Asian assets considering the potential improvement in risk appetite in the short term. He is positive about the domestic recovery story in Asia, especially in ASEAN countries.
Rodrigo Catril, a Sydney-based strategist at National Australia Bank, says, “The world still sees Australia in a range near term, and risk assets need to steer a complicated path with more Fed hikes and a slowing global economy coupled with geopolitical tensions not going away either.”
