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Fed Hikes: Asia’s Winners and Losers

 
 

The U.S. Federal Reserve has again pulled the trigger, raising official interest rates and threatening more hikes in 2017. With Asia’s markets feeling the effects, who are the winners and losers from tighter money in the world’s biggest economy?

In its statement Wednesday, the Fed’s policy-setting Federal Open Market Committee (FOMC) announced it would raise the target range for the official federal funds rate to 0.5 to 0.75 percent, up from 0.25 percent previously and the first increase since last December.

Explaining its move, the FOMC said the U.S. labor market had continued to strengthen, with economic activity expanding at a “moderate pace,” although business investment remained soft and inflation was still below the Fed’s 2 percent goal.

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While the rate hike had been forecast by all 120 economists in a recent Reuters poll, what surprised markets was the change in the Fed’s median outlook for rate hikes. It now expects three 25 basis point rises in 2017 from two as of September, followed by another three increases in 2018 and 2019 before leveling off at the “normal” 3 percent.

The move sent the U.S. dollar sharply higher, putting downward pressure on Asian currencies, hitting bond prices and threatening to suck capital from emerging markets back into dollar-denominated assets.

“Let’s not confuse this move with a modest shift in language, this is flat out hawkish, and the U.S. dollar is reacting accordingly,” OANDA Australia currency trader Stephen Innes told the Australian Financial Review.

Asian Stocks Suffer

Stocks in China, Hong Kong, Singapore, and Australia all fell, with Hong Kong showing the worst fall of nearly 1.8 percent due to the peg between the Hong Kong dollar and its U.S. counterpart.

On Thursday, the Hong Kong Monetary Authority responded by raising its base rate by 0.25 percentage point to 1 percent, matching the Fed’s hike and hitting property stocks on the local bourse.

Citi told clients that the Fed rate rise “should trigger the start of a Hong Kong home-price downtrend,” as the cost of mortgages increased in the Chinese territory.

In contrast, Indonesia’s central bank decided Thursday to hold the line on rates, sticking to its seven-day reverse repo rate of 4.75 percent as expected by analysts, despite a slide in the Indonesian rupiah.

South Korean stocks closed virtually flat, with the nation’s central bank deciding to keep its benchmark rate at 1.25 percent. However, Bank of Korea Governor Lee Ju-yeol warned of the risks from both its domestic political crisis and the potential impacts from the new U.S. administration.

In China, the Shanghai Composite Index slumped to a six-week low, while the yuan dropped 0.4 percent to its lowest level against the dollar since 2008. China’s 10-year bond yield also climbed to 3.45 percent, further curbing demand in the world’s second-biggest economy.

“There are a few problems occurring together,” James Yip, a Hong Kong-based money manager, told Bloomberg News. “The People’s Bank of China is tightening marginally, the market’s leverage has been very severe, inflation data is pointing to a reflationary story, the U.S. is raising rates and the currency is depreciating. Everything put together has driven sentiment to this stage.”

Other Asian currencies also fell, with the Indonesian rupiah down 0.7 percent and the Malaysian ringgit 0.4 percent lower. The Australian dollar plunged by 1.4 percent in the immediate aftermath, but bounced back after stronger local employment data.

Japan Gains

However, not all of Asia suffered negative effects from the Fed’s more hawkish tone. Japan’s benchmark Nikkei 225 Stock Average gained 0.1 percent to reach 19,273, with the broader Topix index rising by 0.26 percent as traders eyed the beneficial effects of a cheaper yen on exporters’ profits.

According to Goldman Sachs’ Kathy Matsui, domestic consumer spending should also provide a tailwind for Japanese stocks in 2017, helped by higher wages, with land and other asset prices seen rising.

“Japanese equities have always been extremely correlated to the currency, with yen appreciation forcing negative stock performance and yen depreciation forcing Japan outperformance, and in recent weeks, that relationship has been holding stronger than ever. Japanese stocks have become a top global markets performer, moving in lock-step with the accelerating depreciation of the yen,” WisdomTree Japan’s Jesper Koll said.

Koll said yen depreciation toward new decade lows of around 130 to 140 against the dollar “has become possible, which in turn suggests at least 20 to 30 percent upside to Japanese equities.”

On Thursday, the dollar was trading above 117 yen, having topped the 117 level overnight for the first time in 10 months.

According to Koll, tightness in the Japanese labor market has driven wages and incomes higher, resulting in a lower risk of a domestic political backlash against higher import costs. He also noted the further “insurance” policy of the Abe administration, in that companies that raise employment will gain tax cuts in 2017.

However, the rest of the region may be less comforted by warnings of a capital flight from Asia’s emerging markets back to U.S. assets.

In its latest “Asia Bond Monitor,” the Asian Development Bank (ADB) warned that bond yields in most emerging East Asian markets were rising due to concerns over U.S. economic policy. Risks identified included uncertainty over the Trump administration’s policies, global risk aversion toward emerging markets, the threat of rising protectionism, and a “hard Brexit” due to the region’s financial links with Europe.

According to ratings agency Standard & Poor’s, Asia-Pacific companies will have to repay almost $1 trillion of debt over the next four years, with more than half of it priced in U.S. dollars. Some 80 percent of outstanding bonds from emerging market borrowers are denominated in dollars, compared to just over half in Australia, New Zealand, and Japan.

Further weakness in Asian emerging market currencies threatens to cause a surge in debt costs for the region’s borrowers, potentially crimping business investment, while central banks are potentially forced to hike rates to keep their currencies from sliding further.

One bright light for the region’s commodity exporters such as Australia, Indonesia, and Malaysia is recent gains in commodity prices, including oil, coal, copper, and iron ore, which will lift export revenues, particularly for contracts priced in dollars.

Fortunately for Asia, U.S. consumer confidence hit a nine-year high in November, in surveys conducted before the U.S. presidential poll and the Fed’s latest hike. Should U.S. consumers continue opening their wallets, Asia suddenly has a bigger market for its cheaper exports – providing the Trump administration does not follow through on threatened tariff hikes against China.

Suddenly, the risks of changed policy in the world’s biggest economy just got very real for Asia.

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