US Fed rate hike will intensify market risks for Asia's central banks

The expected 75-basis-points interest rate increase from the Federal Reserve this week will heap pressure on its Asian counterparts to speed up monetary tightening -- or risk further fund outflows and weaker currencies.
 

An analysis of policy rates in Asia Pacific versus their five-year averages shows a high degree of vulnerability across the region, as does an examination of interest rates adjusted for inflation, and yield spreads versus US Treasuries.

The level of threat varies considerably, with the most danger for markets like Thailand, where the central bank has kept rates at a record low. South Korea and New Zealand, which moved early to front load hikes, are better placed but not immune to trouble.

Recent tightening announcements from unscheduled meetings of the Monetary Authority of Singapore and the Bangko Sentral ng Pilipinas indicate that Asia’s central banks are susceptible to making rapid readjustments as inflation bites harder than expected. 

Here are three charts showing how the pressure is building on the region’s policy makers to normalize their benchmark rates. 

1. Smaller Cushion 

A 75-basis-points hike by the Fed would narrow Indonesia’s policy-rate buffer versus the US to just one percentage point, which is more than five standard deviations below the five-year average gap of 3.3 percentage points. The same gauge for Thailand stands at 4 standard deviations. Narrowing rate differentials with the US have fueled net bond outflows from Thailand, Indonesia and Malaysia since early June. 

Central banks such as in Australia and South Korea, which have been quicker to increase rates, have buffers that are closer to their five-year averages. New Zealand is the only country in the region where the buffer will still be bigger than the five-year average after a 75-basis-points Fed move. 

2. Inflation Impact

While some Asian central banks have been aggressive in trying to head off price gains, policy rates adjusted for most recent monthly inflation figures are still below the five-year averages and in negative territory for many markets in the region.

Inflation has risen to the highest in 23 years in South Korea, 21 years in Australia and 14 years in Thailand. And the worst may not be over as elevated commodity prices and supply-chain disruptions continue to drive up import costs.  

3. Bond Blues

The allure of Southeast Asian bonds is at a low ebb as measured in the spread their yields offer over Treasuries. Malaysia’s 10-year government bonds are more than one standard deviation below the five-year average gap. 

The spread is also tighter in Thai, Indian and Indonesian bonds. As such, central banks in these countries may need to accelerate the pace of policy tightening to push up yields to curb outflows and headwinds for their currencies. 

More rapid rate hikes from South Korea, New Zealand and Australia have supported yields, resulting in a more attractive spread to the US.  

The analysis excludes the central banks of Japan and China. The Bank of Japan is committed to its negative rate and yield-curve control policy, while the People’s Bank of China is providing ample liquidity as the economy struggles with a Covid-zero policy.