After the Fed raised interest rates last week in a move widely expected to be its last in its fight to bring inflation down, currencies in the Asia-Pacific cheered a potential pivot ahead as the dollar index declined.
As of Monday morning in Asia, market pricing showed a more than 90% probability of a pause in the Fed’s June meeting, according to the CME’s FedWatch Tool which uses Fed funds futures contracts as a guide. Traders priced in less than a 10% chance of a quarter-point increase.
A Fed pause could boost U.S. stocks, but its effect on regional growth in Asia may not be as straightforward.
“The Fed may be ‘done’ for now but all the DM [developed market] central banks are not,” Manishi Raychaudhuri, BNP Paribas’ Asia-Pacific head of equity research, said in a Saturday note.
“While Asian currency stabilization is potentially good news for foreign flows into Asian equities, in the near term, shifting sands in the Chinese economic landscape could be the stronger driver of Asian equities, we think,” he wrote. He pointed to a disappointing earnings season in Asia, with every sector except consumer discretionary and technology missing consensus estimates.
Nomura’s equity strategists kept their views for Asia-Pacific stocks unchanged despite the likelihood of a potential Fed pause, maintaining its year-end target for MSCI Asia ex-Japan. Strategist Chetan Seth of Nomura added the risk of a recession in the U.S. looms, but the exact timing of a slowdown is hard to predict.
“Nonetheless, in our base case, we do not expect a meaningful decline in Asian stocks. Ultimately, we think any weakness in Asian stocks due to U.S. recession concerns will be an opportunity for investors to raise exposure to Asian stocks due to still-supportive local factors,” Nomura strategists wrote in a Sunday note.
UBS Global Wealth Management meanwhile pointed to central banks in Asia finally seeing relief from pressure to keep up with the Federal Reserve’s rate hikes.
“The peaking of U.S. interest rates is a key turning point that should open the door for Asia to begin easing, with scope for rate cuts of 25–50bps already in place in certain economies,” UBS said in its May monthly outlook report, naming the central banks of South Korea, Indonesia and India as likely candidates to pivot into an easing cycle.
BNP Paribas’ Raychaudhuri added that investors in Asia are now focused on China’s “patchy” recovery path after lifting its stringent Covid restrictions.
“Asian investors’ big worry surrounds China,” he said, pointing to the “unsustainability of consumption rebound, especially against the backdrop of persistently high youth unemployment levels.”
He noted that disappointing economic data are outweighing the numbers that suggest the economy is returning to normal.
“The sharp drop in China’s April manufacturing PMI, spike in Local Government Financing Vehicles (LGFV) debt, persistent youth unemployment, declining investments in property and ongoing geopolitical strains are eclipsing the good news from China: robust services PMI and record Golden Week tourist activity,” he said.
HSBC added that it believes Asian currencies are underperforming partially due to low confidence in China.
“Sentiment on mainland China remains weak – probably reflecting a lack of confidence about growth and geopolitical questions,” HSBC wrote in its May outlook note.
Societe Generale added that historically, not all markets in the region gained after the Fed pivoted from its rate-hiking cycles.
“The picture is a bit different for Japan, where the Topix declined on average by 1% in this last Fed hike-first rate cut interval,” a team of strategists led by Makhdoom Muteeb Raina wrote in a May 5 note.
“Market by market in the region, we observe that markets tied to global growth — Japan, but also Korea and Taiwan — underperform more domestic markets — South Asia and China,” they wrote.