For years, it’s been a somewhat predictable reaction: The Federal Reserve moves interest rates, and great volatility ensues in Asian stock, bond and foreign exchange markets. Rising U.S. rates have tended to lure investors away from Asia, while falling rates have fueled destabilizing flows of hot money into its higher-yielding assets. The consequence: Asian central banks got in the habit of moving interest rates in parallel with the Fed. But there’s some evidence that the correlation is breaking down, with several economists even suggesting that Asia’s central banks are decoupling from the U.S. -- at least for the time being.
1. Where’s the evidence of decoupling?
Asia has taken in stride four U.S. rate increases since late 2015. Anticipation that the Fed will begin shrinking its humongous balance sheet (offloading some of the $4.5 trillion of securities it purchased after the global financial crisis) has also caused minimal disruption. Even with further U.S. tightening expected, some Asian monetary authorities have moved the opposite way: India, Vietnam and Indonesia all recently cut their key rates, and Thailand may follow suit. Japan is nowhere close to tightening monetary policy. China’s benchmark rates remain at record lows, as are those in Australia and South Korea. Only the Philippines, buffeted by a weakening currency, may need to hike rates.
2. How is this different from past practice?
It’s a far cry from when the Fed was raising interest rates between 2004 and 2006. Then, most of Asia’s biggest central banks lifted their rates within a year of the Fed’s first move and the others swiftly followed, according to analysis by Oxford Economics. And just four years ago, the so-called taper tantrum prompted tears in Asian markets when the Fed signaled it would begin winding down its purchases of government bonds and other securities.
3. Why are Asia’s central banks going their own way?
The Fed’s cautious (and well-flagged) approach to lifting rates has maintained calm, so Asian central bankers haven’t had to deal with volatile flows or whipsawing currencies. Another reason: The growing importance of Europe. In Indonesia, for example, yield-hungry Europeans have become the biggest foreign investors in the nation’s bonds and have driven inflows toward a record this year. Who’s worried about the Fed if the European funds are buying?
4. What’s attracting those investors?
Asia hosts many of the world’s fastest-growing economies, and the International Monetary Fund projects robust growth in 2017, led by China. Crucially, though, inflation is contained and yields remain attractive when compared with the Euro zone, U.S. and Japan -- home to many of the world’s biggest investors.
5. Is it all rosy in Asia?
Hardly; there are plenty of risks. Debt has soared since the financial crisis and faster growth and infrastructure spending have boosted imports, making some governments heavily reliant on foreign cash that could quickly evaporate. Sentiment can swiftly change. A better-than-expected pick-up in Asian exports this year could fizzle out. Trade tensions linger between the U.S. and big economies such as China and South Korea. And if Janet Yellen announces a faster-than-expected winding down of the Fed’s balance sheet, Asia is likely to feel the pain.
6. And if the climate does suddenly worsen?
Swelling foreign currency reserves could be used, at least for a time, to defend local currencies. Some central banks may allow their currencies to weaken, which would boost export competitiveness. Others may feel pressure to raise interest rates, especially if currencies were to weaken to such an extent that companies’ overseas debt obligations became tough to service.
7. What about that decoupling?
Talk of decoupling from the U.S. has been floated in the past, only for Asia to quickly get back in line. Besides, if inflation accelerates, all bets are off: Interest rates will need to rise. The good news for now is that tame inflation, low interest rates and robust growth give Asia’s central banks plenty of options to cope with the Fed’s next moves.
The Reference Shelf
- A QuickTake Q&A on the Fed’s big unwind.
- Bloomberg Intelligence explains why financial conditions may trip up the Fed.
- Oxford Economics analysis on Asia’s divergence from the Fed.
- Bloomberg News wrote about the the monetary policy gulf.
- The Brookings Institution explains the Fed’s balance sheet.
- A QuickTake explainer on why measuring inflation is so difficult.