In brief

• With US inflation finally trending downwards, the Federal Reserve (Fed) has pivoted to a more dovish bias, although the timing and extent of future rate cuts remains uncertain.
• Across the Asia-Pacific (APAC) region, inflation is also declining, raising the prospect of lower regional interest rates. However, the impact will likely be more variable due to market-specific nuances.
• In China, lower global yields will allow the People’s Bank of China (PBoC) to pursue a dovish monetary policy to stabilize economic growth.
• In Singapore and Australia, the Monetary Authority of Singapore (MAS) and Reserve Bank of Australia (RBA) remain hawkish, wary of sticky service inflation, although base rates have probably peaked.
• In Hong Kong, the HK dollar (HKD) peg should keep Hong Kong Interbank Offered Rates (HIBOR) aligned with US Secured Overnight Financing Rate (SOFR), but local liquidity conditions and equity market sentiment could magnify interest rate volatility.

Positive inflation trends

As part of its attempt to curb elevated inflation, the Fed has raised base rates to a 22-year high of 5.50%. Since the last rate hike in July 2023, US inflation has declined from a peak of 9.1% year on year (y/y) to 3.4% y/y at present.

Anticipating that inflation will continue its downward trajectory and that the Fed is likely to cut base rates (Exhibit 1 left) this year, US interest rates have fallen sharply and the yield curve has flattened. Although stronger-than-expected economic growth and robust employment make the exact timing and extent of Fed rate cuts uncertain, investors continue to predict multiple rate cuts in the coming months, encouraged by the Fed’s stated desire to achieve a soft landing.

Exhibit 1: The Fed hiked rates at the fastest pace on record to a peak of 5.50%; the majority of APAC central banks also hiked rates to multi-year highs.

Source: Bloomberg, J.P. Morgan Asset Management; data as of 20 January 2024.

In response to a strong uptick in regional inflation, many APAC central banks (Exhibit 1 right) also hiked their base rates during the past two years, some reacting to rising price pressures even earlier than the Fed. With inflation now trending downwards, investors are anticipating regional central banks will also start cutting rates in 2024.

Notably, the composition of inflation across the APAC region varies substantially from western countries impacting the pace of price declines. Local economic cycles and local currency considerations will also affect APAC central bank decisions. Therefore, the impetus for regional rate cuts will most likely be more variable.

Exhibit 2: APAC short-maturity interest rates have peaked; yield curves have inverted in anticipation of central bank rate cuts.

Source: Bloomberg, J.P. Morgan Asset Management; data as of 20 January 2024.

China

Over the past year, a weak post-Covid reopening combined with a sharp property downturn and export stagnation has negatively impacted Chinese growth. Uniquely and diametrically opposite to other APAC central banks, the PBoC has assumed a dovish bias, cutting interest rates and injecting liquidity to stabilize financial markets and support the economy. The latest PBoC announcement in late January of a Reserve Requirement Ratio cut of 50 basis points (bps) for large commercial banks surprised markets in terms of timing and size as the central bank sought to reinforce its dovish credentials and bolster market sentiment.

Exhibit 3: A dovish PBoC has put downward pressure on interest rates; the Chinese Shanghai Interbank Offered Rate (SHIBOR) is also impacted by market liquidity conditions.

Source: Bloomberg, J.P. Morgan Asset Management; as of 20 January 2024.

The Chinese government appears reluctant to unleash massive stimulus to offset weak consumer and business confidence. Nevertheless, additional, small supportive fiscal and monetary policy measures are likely, especially if the authorities confirm a 2024 growth target of “around 5%”. With major global central banks likely to cut rates in 2024, the PBoC will also have more monetary policy freedom to pursue additional steps based on China’s economic outlook rather than global trends. This suggests SHIBOR yields will continue their downward trend during the remainder of 2024.

Singapore

The MAS was the one of the earliest central banks to tighten monetary policy as inflation increased in 2021. However, following three slope increases and three upward re-centerings, the MAS has left its Singapore dollar nominal effective exchange rate (SGD NEER) policy unchanged since April 2023.

At its recent monetary policy meeting, the MAS forecast that Singapore’s economic growth will be stronger in 2024 while inflation would be sticker than expected, noting that the core Consumer Price Index (CPI) is “likely to remain elevated in the earlier part of the year”. This suggests the central bank is likely to retain its hawkish bias, hoping that a sustained appreciation of the policy band will “continue to dampen imported inflation and curb domestic price pressures”.

Exhibit 4: SGD NEER remains in the upper half of trading range; Singapore Overnight Rate Average (SORA) rates have declined and the curve has inverted.

Source: Goldman Sachs, Bloomberg, J.P. Morgan Asset Management; data as of 29 January 2024.

We believe the MAS policy will remain unchanged this year, with the SGD NEER staying in the upper part of its trading range and SGD outperforming. This hawkish bias will help offset the drag of lower US rates and, although SORA yields have likely already peaked, they continue to present relatively attractive opportunities. Notably, while Singapore yields have declined in sympathy with US dollar yields, the SORA curve has not flattened to the same extent as the US SOFR curve.

Australia

Despite inflation spiking to a 32-year peak in late 2022, the RBA exhibited a reluctance to raise interest rates too aggressively. It started hiking later than other major central banks, paused on three occasions and hiked by a lower quantum as it attempted to engineer a soft landing by curbing inflation while avoiding unnecessarily triggering a recession.

Exhibit 5: The RBA has hiked rates by a total of 425bps to an 11-year high of 4.35%; the bank bill swap rate (BBSW) yield curve has recently flattened.

Source: Bloomberg, J.P. Morgan Asset Management; data as of 31 January 2024.

Fortunately, the latest slowdown in growth and inflation data suggests the RBA is on track to achieve its objectives. Nevertheless, with inflation still well above the mid-point of the central bank’s target range, the monetary policy board has a “low tolerance for a slower return of inflation to target than currently expected” and reaffirmed its hawkish stance at its February meeting.

We believe the RBA will keep base rates unchanged in 2024. While eventual Fed rate cuts will increase speculation of a dovish RBA pivot, we think this is unlikely until the RBA has more evidence that inflation is on a sustainable path to its target. The BBSW yield curve has flattened but yields have not fallen to the same extent as US SORA yields and the curve is still upward sloping. Although BBSW yields have likely peaked, they still offer attractive opportunities to lock in longer-tenor yields.

Hong Kong

In theory, Hong Kong’s HIBOR rates should closely echo US SOFR rates due to the Linked Exchange Rate System (LERS). However, variable local liquidity conditions, negative Chinese sentiment and divergent economic cycles have increased the volatility of the HIBOR/SOFR spread. Despite these challenges, we believe the peg will remain for the foreseeable future.

Hong Kong yields remained below US yields for the majority of 2023, but the spread trend reversed in the final quarter of 2023 as SOFR yields rallied sharply in anticipation of Fed rate cuts. Recently, however, weak Chinese and Hong Kong economic data and declining stock market sentiment has boosted HKD liquidity, pushing HIBOR rates sharply lower.

Exhibit 6: HIBOR yields have declined from recent highs; the HIBOR/SOFR spread has turned negative as excess liquidity floods the local market.

Source: Bloomberg, J.P. Morgan Asset Management; data as of 31 January 2024.

With the Hong Kong Monetary Authority (HKMA) aggregate balance at 16-year lows, we believe HIBOR rates will remain volatile in 2024, although they should narrow as investors arbitrage the yield differential and Chinese economic sentiment stabilizes. In addition, once the Fed eventually begins its rate-cutting cycle the HIBOR/SOFR spread should normalize, allowing HKD cash investors to enjoy higher rates for longer.

Conclusion

While regional central banks are unlikely to hike rates further – especially with the Fed pivoting to a more dovish policy stance – variable local inflation conditions, economic differences and concerns about a strong US dollar are likely to prevent APAC central bank from significantly preempting the Fed as the first to cut interest rates.

For APAC cash investors, while money market yields have likely peaked, they remain attractive with upward sloping yield curves in several countries. Balancing the need to lock in longer-tenor yields relative to the requirement for liquidity while considering market volatility concerns will remain a key investment consideration. In the current economic environment, we believe a laddered and diversified approach to investing cash across different currencies, maturities and instruments is warranted.

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