Asia Economics Focus : After liftoff – the uncertainty starts now

For the first time in nearly 10 years, the US Federal Reserve has raised the policy rate. A “gradual” glide path is expected, and “gradual” probably describes Asia’s short-term reaction.

As capital inflows slow, we expect weaker Asian currencies pretty much across the board. Except HKMA, no central bank should raise rates. The PBOC and RBI could cut, as could BI. The CBC has already cut. Long-term bond yields should be firmer as risk aversion rises. But, in general, reactions should be mild for now.

But does the Fed move mean that uncertainty is over? On the contrary, we are entering some uncharted territory.

First, there is policy divergence globally as the ECB, BOJ and PBOC are all in easing mode and likely to stay that way. Consequently, markets are likely to vacillate on the direction of global trends, depending on where they look.

Second, history is not a very good guide on what to expect. The last time the Fed raised rates was from June 2004 to June 2006. In the US, the main concern was a housing bubble. China was booming, with GDP growing at a double-digit clip. Commodity prices were smack in the middle of the 2001-2011 supercycle. The RMB had been adjusted to a stronger level in 2005, and small rallies aside, the USD was on a several year weakening trend. Things are very different now.

Besides these, there is the possibility of a rate shock. While the Futures market expects the Fed Funds rate to increase by 50 basis points in both 2016 and 2017, the Fed’s own projection is for increases of double that magnitude in both years. Only one of them can be right.

To this, add the change in anchor for the RMB and continued gyrations of the price of oil. Market volatility is probably the only certainty. (Read Report)

Read Related Report
1) Fed hikes. What now? - Implications for EM equities by Macquarie Equities Research, published on 17 December 2015

Source : CIMB Research