Market Views: How will rising interest rates affect Asian capital markets?
The US Federal Reserve (Fed) raised interest rates by a half percent last Wednesday (May 4) – the biggest increase in 20 years and the second time this year after the quarter-percent hike on March 16 — sending stock markets rallying on the news but reversing sharply the next day, losing almost all of the previous day’s gains.
The S&P 500 closed down 3.6% last Thursday after having ended 3% up the day before, while the NASDAQ composite was down nearly 5% – its lowest level since November 2020 — after closing up 3.2% on Wednesday. Both indices recorded their worst single-day drop since 2020.
Analysts said the pendulum swing in the stock market last week reflected the confusion and uncertainty among investors with each new interest rate hike. Fed chairman Jerome Powell's comment that the Fed was not considering a bigger rate increase may have sparked last Wednesday's rally, which promptly fizzled out the next day as reality set in.
Most Asian markets — including Shanghai, Hong Kong, Seoul, Singapore, and Sydney — followed Wall Street’s cue and have been trading lower, as fears grew over the impact of US interest rate hikes pushing the economy into recession.
Investor concerns were compounded this week by weak Chinese trade data released on Monday (May 9) that signalled a possible slowdown of the world’s second-largest economy as well as Russian president Vladimir Putin’s call for his troops to persevere with the war in Ukraine at the Victory Day military parade in Moscow on Monday.
Volatility remains the key concern for global markets unused to fast-rising interest rates, inflation, and geopolitical instability, all happening at once. AsianInvestor reached out to experts for their views on how rising interest rates – with more increases to be expected this year — will impact Asian capital markets now and in the near future.
The responses have been edited for clarity and brevity.
Aninda Mitra, Head of Asia Macro & Investment Strategy
BNY Mellon Investment Management
Asian stocks and bonds could be hurt by further increases in US rates. However, the market has already priced in a more aggressive path of Fed rate hikes than reflected in the FOMC’s March “dot-plots”.
But the ongoing global volatility represents continuing market doubts about whether faster hikes will be sufficient. What is key for Asian risk assets is the behaviour of US real yields (for instance, the 10yr real yield), and especially the speed of further upward adjustment.
Rising real US yields are driving a strengthening trend in the US dollar and applying a larger discounting factor to high-duration risk assets (eg: high PE stocks) reliant on future earnings streams. Another factor to keep an eye on will be the behaviour of US inflation. We expect core inflation momentum to slow even as the headline rate stays elevated.
A peaking of real rates and slowing core momentum could be a turning point for risk assets. We are getting closer. But not there yet. Finally, the China growth outlook also matters, especially for the Asian USD credit outlook. The main risk is US inflation or wage growth or job vacancies surprise on the upside, setting up an even bigger clash between the market and the Fed.
Dong Chen, Head of Asia Macroeconomic Research
Pictet Wealth Management
The Fed’s rate hikes are pressing many Asian central banks to follow suit. Rising inflation also adds to the urge for regional central banks to tighten their monetary policy. The Reserve Bank of India’s recent surprise hike of 40bps of its policy rates is an example.
The tightening monetary conditions will likely weigh on the capital markets in Asia broadly, for both bonds and equities. On a relative basis, we believe equities markets in Japan and Asean may perform better as the Bank of Japan sticks to its ultra-loose monetary policy and some Asean economies may enjoy the benefits of economic reopening and strong industrial activities due to rising exports.
A hawkish Fed has also led to a surge in the US dollar, which weighs on the value of Asian currencies, especially the Japanese yen. While there could be further room for depreciation for many Asian currencies in the near term, we do not see any major financial risks, given Asian countries generally have seen significant improvement in their external positions over the past two decades.”
Jian Shi Cortesi, Investment Director, China and Asian equities
GAM Investments
US rate hikes are a headwind for global equity markets as the US market sets the tone for global markets. In particular, the rate hikes started when US stocks traded at relatively high valuations. In Asia, we see India as more vulnerable to inflation pressure and rate hikes, given its high valuations.
However, US stocks peaked in December 2021, while Asian stocks (MSCI Asia ex-Japan) have been falling for 15 months after peaking in February 2021. Some Asian stocks have already corrected dramatically. Some large caps are down 70% from the peak, and some mid-caps are down 90% from the peak.
Many Chinese stocks trade at multi-year low valuations, offering opportunities in my view. Chinese A-shares trade at cheap valuations, but not at deeply depressed valuations. Chinese stocks in Hong Kong offer more attractively priced opportunities after the large corrections. As we can allocate to both A-shares and Hong Kong-listed Chinese stocks, we are currently more interested in bottom fishing leaders in growth industries among Hong Kong listings, particularly in consumer, innovation, and renewables.
Michele Barlow, Head of Investment Strategy and Research
State Street Global Advisors
The global economic environment has become considerably more precarious following Russia’s invasion of Ukraine. This powerful stagflationary shock worsens the monetary policy trade-off for nearly every central bank, with the prospect of slower growth colliding with sharply higher inflation.
While the earlier pick-up in inflation was a combination of both supply and demand factors, this latest inflationary impulse is entirely supply-driven. And while central banks are rightly initiating or accelerating rate hikes in a quest to bring monetary policy into better alignment with employment and price indicators, we see a risk of policy missteps. We are concerned about a boom-bust scenario brought about by tightening that could prove to be too much, too late.
Consequently, we think near-term uncertainty and market volatility are likely to remain high. With the US monetary policy tightening ahead of most Asian countries, Asian FX could continue to come under pressure while regional bond and equity markets will not be immune.
Valuations do appear to be pricing in some risk, but we believe that caution is still warranted. China is less impacted by global rate moves but its “zero-Covid” policy and lockdown strategy remain a headwind to economic growth and markets.
Michael Kelly, Global Head of Multi-Asset
PineBridge Investments
Today’s heightened volatility reflects continued uncertainty over two potential paths. On the one hand, the bullish path will manifest if inflation and the hawkishness of the Fed peaks, allowing a resumption of Asian capital markets to reflect the region’s growth trajectory. On the other hand, the frustratingly slow decline in inflation could keep central banks draining liquidity for years.
Over the past 40 years, we’ve seen real interest rates fall secularly from +6% in 1980 to -7% now, with the global savings rate rising, driven by debt/demographics/technology. This growing structural imbalance between capital and cash flows to invest in was compounded by a second driver: central banks including the Fed, ECB, and BOJ becoming increasingly concerned with the sluggishness of the post-GFC era, and as a result, surging their balance sheets.
These factors have led the markets to appreciate faster than fundamentals over the last decade. While markets have done a decent job discounting rising policy rates, it’s tougher to discount the impact of shrinking balance sheets on capitalisation rates.
Nonetheless, today’s supersized central bank balance sheets are scheduled to be dialled back by one-third over the next three years. Keep your eye on quantitative tightening, not policy rate noise. During this stretch, we believe markets in Asia and elsewhere will rise, yet, this time around, should underperform fundamentals.
Matt Simpson, Market Analyst
City Index
If you look back over recent history, rising interest rates haven’t been negative for equity markets overall as the Fed hiked during economic expansions. But the dynamics today differ from those of the previous two hiking cycles; central banks are being forced to raise rates to fight historically high inflation, at the risk of triggering a global recession.
At the same time, the Ukraine crisis and recent lockdowns across China have only exacerbated fears of stagflation. Ultimately, sentiment remains fragile for Asian investors with China in lockdown. Moreover, the rate of the Fed’s hiking cycle really depends on whether inflation can recede from its 40-year highs. This backdrop has been beneficial for the US dollar as yield differentials and risk-off flows have sent it soaring higher.
The PBOC is being forced to devalue its currency at its fastest rate since 2015, and that now places pressure on China’s Asian trade partners to guide their currencies lower to compete in trade. (It’s no coincidence that the Singapore dollar and Korean Won have fallen to multi-month lows).
The BOJ can’t support the yen whilst they defend yield curve control (YCC), so USD/JPY is likely to break convincingly above 130 as the Fed continues to hike. To see a reversal lower on USD/JPY we would need US inflation to peak, the Fed to hint at a lower trajectory, and the BOJ to abandon YCC. Right now, this appears unlikely.
As for China’s equity markets, they have been in an established downtrend since the “common prosperity” initiative saw Beijing crack down on key sectors. So even if the Fed were to tighten at a slower pace and send Wall Street higher, we doubt China’s markets would outperform given a key pillar of support has been removed and lockdowns are likely to persist.
Sat Duhra, Co-portfolio manager, Asian Dividend Income Strategy
Janus Henderson Investors
With the Fed hike well flagged, it did not create the shock that Asian investors feared. In fact, Asian markets had already begun tightening, as seen in Korea, Singapore, Taiwan, and New Zealand, and latterly Australia and India. These moves largely passed by without significant disruption. It is indeed the impact of other factors that have created the shock.
Looking ahead, growth is still a key feature of our markets. Asean, for example, is still witnessing a domestic demand recovery from re-opening efforts, and markets such as Indonesia and Malaysia are beneficiaries of commodity inflation. Meanwhile, inflation is currently less pronounced in Asia with real GDP growth resilient and real rate differential versus the Fed attractive, though the recent hike in Australia and India did expose some central banks behind the curve.
In the short-term, China is key for performance in Asia; the zero-Covid policy and the ensuing weak macroeconomic data have spooked global investors but more so in Asia given the significant share of exports to China. In addition, the behavioural change in the Asian consumer from sharply rising household costs and the likely negative impact on corporate earnings are likely to keep volatility elevated for a while yet.
Ankit Khandelwal, Chief Investment Officer
Maitri Asset Management
Historically, a Fed rate hike has always impacted markets globally, including Asia. While this time will unlikely be any different, one point to note is that most Asian economies appear to be better positioned financially than before.
Overall, capital markets globally and in Asia are seeing significant drawdowns in risk assets, in face of the triple threats of hawkish central banks led by the Fed; Covid lockdown-induced slowdown in production and consumer activities in China; and the Russia-Ukraine conflict’s impact on the supply of critical soft and hard commodities.
One major driver we see is portfolio outflows leading to weaker currencies against the US dollar, which affects importer economies. Exporter economies won’t be immune either, as they could be impacted by expected demand slowdown due to rising interest rates. Given that the Fed is also embarking on quantitative tightening, the withdrawal of liquidity will also be a pressure point for Asian capital markets.
However, there’s always a silver lining if one adopts a medium to longer-term view. Asia is poised to benefit from secular growth opportunities tied to a growing young middle class in areas such as Southeast Asia and South Asia. [Given] the rising prominence of decarbonisation, with Asian governments setting net-zero targets, as well as the continued digitalisation of economies, the Asian capital markets to us still present a bright outlook in the medium to long term.