What do Fed rate cuts mean for Asian markets?

Key Takeaways

• The investment backdrop has improved and calls for an active Emerging Market (EM) allocation. Specifically, EM Asian assets are likely to outperform in the coming year because of a rosier global backdrop and monetary policy pricing relative to the Federal Reserve (Fed).
• Asia is set to drive the next phase of EM monetary easing and so we particularly like EM Asia currencies, local currency government bonds and equities for 2025.
• Historically, EM and EM Asian risk assets have tended to outperform during the start of easing cycles in non-recessionary environments. Throw in a softening dollar and stable oil prices and a clearer picture for active EM investing has unfolded.
• Still, the biggest risk and unknown for EM markets continues to be who will occupy the White House next year – a Trump 2.0 presidency brings more tariff risks and protectionist policies that could stay the hand for EM central banks. 

The Fed cut rates by an outsized 50 bps in September and stocks in the US have continued to rally.

Furthermore, inflation concerns have largely been put to bed, making it clear to us that we are now staunchly in a rate cutting environment.

While some labour market data such as a more robust nonfarm payrolls figure could give the Fed some pause, the directional path for US rates is downwards.

First, the Fed kickstarting an easing cycle comes as a welcome relief for global central banks. The door has been opened to follow in the Fed’s footsteps.

A host of EM central banks from Central and Eastern Europe to Latin America have long ago started to cut rates are now starting to slow or even pause their easing. Brazil may even hike rates due to fiscal challenges.

The monetary easing baton has recently been passed to the Asia region. What does such a backdrop portend for Asian economies and markets?

Most EM Asian central banks that have been keeping rates higher in a bid to defend their currencies, despite what domestic fundamentals and inflationary dynamics would otherwise have justified. EM Asia has largely been spared from high levels of inflation because of prudent fiscal policies during the pandemic. 

Already, we’re starting to see encouraging signs of easing across the region – first led by Bank Indonesia in September and then followed in October by the Bank of Thailand, Bank of Korea and the Bangko Sentral ng Pilipinas.

China’s People's Bank of China (PBOC) also cut a slew of key policy rates in a pro-growth pivot starting in September followed by fiscal stimulus measures to boost local government’s balance sheets and recapitalize banks.

As the world’s most populous consumer class, a positive turnaround in China is likely to have spillover effects on other Asian economies. Korea, Taiwan and Malaysia economies are the most sensitive to Chinese growth, along with commodity rich markets such as Australia and Indonesia.

We also expect a rate cut in India in the coming months. Overall, the path to normalization has begun in earnest in Asia - a welcome sign of relief after years of restrictive monetary policy.

Asian currencies

Despite the significant - once in a generation - hike in policy rates by the Fed and other major central banks, EM currencies and risk assets have been remarkably resilient over the past couple of years.

As it relates to FX, Asian currencies have seen 2 major inflection points this year (Figure 1).

In July, markets began pricing for faster Fed rate cuts on the back of softer activity data, causing Asian currencies to generally appreciate against the US dollar.

More recently, this balance was reset following indications of a tighter US labour market and elevated wage growth which pushed back expectations for Fed rate cuts and caused Asian currencies to give back some gains.

Foreign exchange volatility could endure for the rest of the year because economic data emerging from the US continues to surprise and the Fed has promised to be data dependent when weighing the size and pace of rate cuts.

Thus, US rates volatility is likely to remain high and hence, the challenge remains for investors to plot out a clear direction for Asian currencies in the near-term.

That said, the dollar looks expensive and very strong relative to history, especially in a landscape marked by low recessionary risks, making it seem to us that Asian currencies have much room to climb against the dollar in the coming year.

Asian equities

Conventional wisdom suggests that Asian equities, especially emerging ones, tend to perform relatively well in a non-recessionary Fed cutting cycle.

This makes sense from the perspective that risk assets would be boosted by a combination of lower rates and robust growth.

Examining the historical performance of Asian equities over previous Fed easing cycles, we find something more mixed (Figure 2).

Importantly, the precedence of the Global Financial Crisis (GFC) in 2008 and tech bubble in 2001 demonstrates that the state of the global economy matters.

Returns for Asian equities are negative in a recessionary environment, which hopefully is not reflective of the current outlook. 

A unique feature of the current cycle is that valuations of Asian equities look relatively cheap, with notable exceptions (Figure 3).

The allure of US exceptionalism has sucked in global funds and overlooked pockets of opportunity in Asia, in our view.

Many stock indices across the region are trading below their 10 year historical average, and well below the US at 27x.¹

Exceptions include Taiwan, which has a semiconductor heavy stock index exposed to AI trends and thus strong earnings growth, and India with high economic growth potential alongside a vigorous retail investor base.

Outlook

Going forward, we believe that the path ahead for Asia is one of idiosyncrasies and domestic factors will matter more.

Japan is moving in the opposite direction to major central banks, raising rates cautiously from a low base whilst keeping an eye out for structural reflation.

Market is still watching whether incoming Chinese stimulus will meet high expectations. Overall though, growth is expected to pick up across most Asian economies. International Monetary Fund (IMF) forecasts suggest Asia is expected to contribute 60% of global growth this year, led by India.²

There are sources of caution. The US elections could pose a challenge for many Asian countries. While a Harris white house represents more continuity to the current approach towards the Asia, a Trump win could mean significant tariff implementation.

A Trump 2.0 White House is likely to immediately strengthen the dollar and it’s likely that Asian central banks may hold their rates higher than what we currently forecast for next year. 

Investment risks

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.