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The growing likelihood of a US interest rate hike in December – with several others likely to come in 2018 – will put more heat on Asian central banks as divergent monetary policies heighten the risks of capital outflows and currency upheaval.
As expected, the US Federal Reserve left its benchmark rate unchanged at 1.0% to 1.25% on November 1, but board members indicated they were ready to launch a preemptive strike on rising wage pressures which could eventually feed into higher prices.
Wages grew by 2.9% in the US between January and September, the biggest gain since December 2016; job markets are soft, but the unemployment rate dropped to 4.2% in September, which was the lowest level since February 2001.
US rates were lifted in March and June, and odds have tightened on a further rise at the board’s mid-December meeting. Outgoing Fed chairwoman Janet Yellen has said three hikes are likely in 2018; all will probably be of 25 basis points.
Her successor, Jerome Powell, appointed on Thursday by US President Donald Trump, is widely expected to adopt a similar approach. Already a Federal Reserve board member, he has consistently backed Yellen’s strategy of tightening monetary policies through gradual interest rate hikes.
Powell has indicated his view that the American economy is at full employment and that inflation is a “kind of a mystery” that he expects to start to rise. Investment analysts expect him to apply a softer touch to certain financial regulation, including the ‘Volcker rule” on banks making speculative investments and supplementary leverage ratios.
European monetary policies have also become less expansionary, in a clear break with the neutral interest rates stance of the European Central Bank.
Prime rates have already risen in the Czech Republic and on Thursday the Bank of England lifted its signature rate from 0.25% to 0.5%. It said two more increases were likely in the next three years. Poland and Hungary are also expected to hike their rates.
This could be bad news for many Asian nations which have prospered for years from a flood of cheap offshore funding and could see much of it flow back out as investors chase higher returns from higher interest rates in the US and Europe. Most Asian rates are still in touch, but the differential with US rates is expected to widen during 2018.
Japan, which maintains a negative rate of 0.10%, and Singapore (0.60%) are most out of step with the global trend. But as regional hubs they should have adequate liquidity available.
So should Hong Kong (1.50%), but South Korea (1.25%), Taiwan (1.38%), Macau and Thailand (both 1.50%) and Cambodia (1.55%) are more vulnerable. All rely heavily on US and European financing.
In October, the World Bank warned that interest rates might need to rise in Malaysia and the Philippines (both now 3%) to keep investors onshore and protect their currencies. The Philippines is expected to raise its prime rate in December.
Policies in other Asian countries are still moving in a contrary direction. India’s central bank reduced the official rate by 25 basis points to 6% in August, pointing to lower inflation risks. Indonesia trimmed its rate by a combined 50 basis points to 4.25% in August and September in response to slowing economic growth.
Vietnam’s refinancing rate was reduced by 25 basis points to 6.25% in July and its central bank said in October it would advise commercial banks to make additional cuts if possible in the final quarter to support lending activity.
Widening interest rate differentials will boost repayment costs on loans, putting pressure on the currencies of China, Malaysia, Indonesia, Hong Kong, South Korea and India, which all have big debt exposure. Recognizing the risks, China has allowed its interest rate to climb to 4.35% in a bid to curb speculative consumer spending.
China’s US$3.1 trillion of international reserves should give it an adequate buffer against any short-lived exchange stresses, and Hong Kong (US$419.2 billion), India (US$361.7 billion) and South Korea (US$384.4 billion) are also well protected.
Yet China still lost US$100 billion a month after the Fed lifted its rates and cut back on bond purchases in 2015, leading to a global stock market and commodities slump.
Investors will mostly be looking at Malaysia and Indonesia, which have some of Asia’s biggest offshore borrowings on a per capita basis. The countries’ respective foreign reserves of US$101.1 billion and US$129.4 billion offer monetary chiefs only a limited ability to intervene in support of their currencies.
Liquidity will not be drained overnight, but the Fed’s other big monetary shift could speed up the process. In October, the Fed began unwinding a US$4.5 trillion stimulus war chest it compiled at the onset of the 2008 global financial crisis to stabilize markets. About US$10 billion will leave the financial system each month.
The European Central Bank has also started a cautious quantitative easing by reducing its bond purchases from 60 billion euros (US$70 billion) a month to 30 billion, which will mean less economic stimulus and thus reduced liquidity.
Don’t expect a re-run of the 1997-98 Asian financial crisis, when investors attacked the currencies of Indonesia, Thailand, Malaysia and South Korea amid concerns over their debt levels. But there could still be a bumpy financial ride ahead for several Asian countries.