How the Fed Could Give Asian Markets Room to Move

As we enter the easing phase of the United States (US) interest-rate cycle, we explore the longer-term effect of lower borrowing costs on Asian markets.

The US Federal Reserve (Fed) announced in September 2024 that it would reduce the benchmark federal funds rate by 50 basis points to a range between 4.75%-5%. The US central bank also said it would likely trim rates again later this year and in 2025/ 2026 if inflation remained sufficiently contained. ¹ This lowering of borrowing costs offers most Asian markets an opportunity to reduce interest rates, which could provide a boost to their economies. And in such a diverse region, it is no surprise that rate pathways vary considerably.

High Real Interest Rates Across the Region

Analysis by Bloomberg shows that, from a historical perspective, real interest rates (the interest rate minus inflation) in Asia are generally elevated. ² A high real interest rate allows central banks to lower borrowing costs without overly stoking inflation. What’s more, falling interest rates are supportive of bond prices. Indeed, foreign investor inflows into sovereign debt have risen in recent months, notably in Thailand, Indonesia and Malaysia. ³ This development has also helped boost these markets’ currencies. ⁴

Yet…A Stronger Currency is Not Always Better

Economies that are dependent on exports like textiles and manufactured goods, which compete on price, may experience a decline in exports if their currency strengthens too much. They may also see an uptick in cheaper imports – a move that could negatively affect their current accounts. ⁵ Central banks in such territories can choose to intervene in foreign exchange markets to reduce this appreciation and boost reserves, providing a buffer for the future while also reducing exchange-rate volatility. ⁶

China Introduces Further Stimulus Measures

The Fed cut also gives China room to reduce its interest rate with less risk of capital outflows. ⁷ Policymakers have made several moves to stimulate the economy and support the property market. For instance, in September 2024, the People’s Bank of China (PBoC) lowered the reserve requirement ratio (RRR) by 0.5% to an average of 6.6%. ⁸  This should create additional long-term liquidity in the financial system of 1 trillion yuan or around US $143 billion, allowing banks to lend more or invest in government bonds. Mortgage interest rates will also be trimmed by an average of about 50 basis points by the end of October 2024 as the authorities attempt to avoid a deflationary spiral. ⁹

Reflation Remains a Risk

While not an immediate concern as price rises in the US appear to be under control, there remains the possibility that inflation could reignite, which would leave the Fed with less room to continue with rate cuts. ¹⁰ This is known as the ‘no landing’ scenario rather than a ‘hard’ or ‘soft landing’. ¹¹ A hard landing in the US could cause demand for exports from Asia to drop and trigger a potential flight to safety – historically, the US dollar and US government bonds. This outcome would see foreign capital flow out of Asia negatively impact currencies and other asset prices.

Asian Central Banks Have a Crucial Role to Play

Central banks will need to anchor inflationary expectations by effectively communicating their interest rate policies. They must also ensure that borrowing costs are not so high that they attract excessive foreign capital inflows, as this could lead to an overvalued currency. This is especially important for export-reliant economies like South Korea. ¹²

Domestic inflationary pressures should remain the priority for policymakers rather than simply following the Fed. ¹³ The actions of most Asian central banks during the Fed’s recent tightening cycle have demonstrated their maturity and independence from political pressure. They will need to maintain this discipline in a rate-cutting cycle as they potentially face currency appreciation and the return of inflationary pressures.