On the Minds of Investors
More room for rate cuts in Asia?
Central banks in the Asian Pacific region have been cutting interest rates since early 2019. In August alone, India (-35bps), New Zealand (-50bps), the Philippines (-25bps) and Thailand (-25bps) decided to cut rates. With the exception of the Philippines, the other three central banks’ actions were unexpected or more aggressive than the market forecast.
The move to lower interest rates is facilitated by two developments. First, Asia’s growth momentum has weakened in recent months. July Purchasing Managers Indices are showing some signs of stabilization, however, the ongoing trade tension between the U.S. and China continues to weigh on corporate sentiment. Hence, a combination of weak export growth and downbeat corporate sentiment weighing on capital expenditure is threatening growth momentum as we progress towards the end of 2019. Sluggish growth also means that inflation is running below central banks’ targets in most of these Asian economies.
Second, the U.S. Federal Reserve has changed its position significantly since the start of the year. In December 2018, it was forecasting more rate rises in 2019. However, it delivered its first rate cut since the global financial crisis at its July Federal Open Market Committee meeting. This effectively drew the U.S rate hike cycle to an end and this provides more room for Asian central banks to cut rates. Furthermore, the relative stability of the U.S. dollar (USD) in the first half of the year provided additional support to these central banks. Since they no longer need to focus their monetary policy on maintaining currency stability, and provide greater support to domestic growth.
We believe selected Asian and emerging market central banks still have room to cut rates in months ahead. This is because many of them still have positive real yields, such as India, Indonesia, Philippines, South Korea and Thailand.
However, some of these markets may face fresh constraints from stemming from currency markets. The renewed U.S.-China trade tension is fueling risk aversion and investors are moving into traditional safehaven’s of the USD, Japanese yen and Swiss franc, bolstering these currencies. The depreciation of the Chinese yuan against the USD past the psychological level of 7 is also dampening sentiment towards broader emerging market assets. Meanwhile, the political developments in Argentina are causing disruptions to its domestic market that could also shake investor confidence in the near term, despite limited direct contagion risk to Asia. Balancing between the need to support growth and currency stabilization, we see another 50-75bps in rate cuts amongst Asian central banks over the next 6-12 months.
EXHIBIT 1: Real and nominal yields
A more dovish stance by Asian central banks, combined with lower rates from major central banks, should continue to support Asian fixed income in the medium term. However, growth fears could put pressure on corporate bonds and lead to widening spreads, requiring active research to differentiate the issuers’ balance sheets and cash flow. This should be less of a concern for Asian government debt or high quality corporate credits.
This also implies that Asian investors’ cash returns will continue to remain poor. To meet their investment objectives, they would need to consider increase risk exposure to generate income. This could be through taking more credit risk by investing in corporate credit with lower credit ratings. While growth is soft, the risk of default remains relatively low at this stage. Or they can accept to have their capital locked up for a longer period of time, and generate liquidity premium by investing in assets that need more time to accumulate return. A time deposit is a traditional way to generate such premium, but that is also being undermined by low risk free rates. We note that a number of alternative strategies, such as real estate and other real assets, would also fit into this profile while providing long-term price return as well as income return.