The Federal Reserve's interest rate cut expectations have been lowered again and again, coupled with the surge in demand for safe-haven assets due to changes in the Middle East situation. As the US dollar continues to rise for the fifth consecutive day, emerging markets have once again launched a "currency defense war," and the greater risks seem not to have passed yet.
On April 15, a team led by Chetan Ahya, the Chief Economist for Asia at Morgan Stanley, released a report stating that the decline in inflation in most Asian economies has created conditions for central banks to cut interest rates. However, due to the pressure of currency depreciation, emerging market central banks dare not "act rashly."
If most Asian countries keep interest rates high for a long time, it will put greater pressure on the economy. Morgan Stanley emphasized that if the Federal Reserve postpones interest rate cuts until 2025, or if oil prices rise sharply to $110-120 per barrel, Asian countries will be "forced" to postpone interest rate cuts, putting economic growth under pressure.
Since April 10, the US dollar index has noticeably accelerated its rise, successively breaking through the 105 and 106 thresholds. Yesterday, the US retail data for March exceeded expectations, showing that the economy still has resilience and once again boosting the dollar. As of press time, the dollar has slightly risen to 106.31.
Advertisement
The recent continuous rise in the dollar has also led to a "currency defense war" in emerging markets, putting tremendous pressure on an increasing number of emerging economies to take interventionist actions. Data shows that the MSCI Emerging Market Currency Index has fallen for the fifth consecutive day, approaching its lowest level of the year.
Due to the pressure of currency depreciation, Asian central banks dare not "act rashly."
Morgan Stanley believes that the inflation rate of about 80% of Asian economies is already at or below the target range of each central bank, and the gap between the inflation levels of the remaining Asian economies and the central bank's target range is also narrowing, indicating that achieving the central bank's CPI target is imminent:
Core goods and services inflation are both slowing down, which helps to slow down overall inflation. Asian core inflation is more driven by the goods part (which in turn reflects higher input costs), and it has now fallen back to the level before the COVID-19 pandemic.
For service inflation, labor market trends are key, and except for Australia, the labor markets in Asia seem to be basically balanced.
The report points out that as Asia returns to the low inflation environment before the COVID-19 pandemic, the real interest rates in the Asian region have risen to a five-year high. The real interest rate based on the 12-month forward CPI has reached 1.7%, slightly higher than the five-year average before the COVID-19 pandemic, which was 1.5%.As the market gradually reduces expectations for Federal Reserve rate cuts, the US dollar strengthens, while Asian currencies remain weak. Morgan Stanley believes that central banks may exercise caution on rate cuts, following the Federal Reserve's lead. If currencies depreciate further, it could put upward pressure on inflation, making it difficult to maintain within the target range. Consequently, Asian central banks will wait for the Federal Reserve to begin cutting rates in June (the base case scenario of the US economic team) before taking action.
Morgan Stanley anticipates that against the backdrop of the Federal Reserve's first rate cut in June, the situation where real interest rates in Asian countries rise will not last long. However, if nominal policy interest rates remain high for a longer period, it could exert pressure on Asian economies.
Economic Downturn Pressure in Asian Countries
Morgan Stanley points out that if central banks in Asian countries could start cutting rates from June or May, improvements in exports and capital expenditure are expected to alleviate the risks of economic slowdown. The current key risk lies in the possibility that the Federal Reserve may postpone rate cuts to 2025, driven by supply concerns that push oil prices to $110-120 per barrel.
Morgan Stanley states that the policy stance of central banks in Asian countries will largely depend on the actions of the Federal Reserve. If the Federal Reserve delays rate cuts, the rate cut cycle in Asian countries will also be correspondingly postponed, which implies a slight slowdown in Asian economic growth. It is crucial to understand the motives behind the Federal Reserve's delay in rate cuts. If the delay is due to supply tensions leading to upward risks in inflation, this would have a clear negative impact on Asian economies:
If the Federal Reserve delays rate cuts because the US economy continues to maintain strong GDP and employment growth against the backdrop of supply improvements (such as increased labor supply), Asian economies may also benefit. A stronger US economy could lead to more exports from Asia and have a positive spillover effect on investment. Overall, there is still a slight downside risk to the growth outlook.
If the Federal Reserve delays rate cuts due to supply tensions leading to upward risks in inflation, this would clearly have a negative impact on Asian economies. In this scenario, Asian economic growth would face greater downward pressure. Central banks in countries such as India, Indonesia, South Korea, the Philippines, and Thailand may have to postpone rate cuts.
The report notes that if supply or geopolitical concerns lead to a sustained increase in oil prices to $110-120 per barrel over the next 3-4 months, this would raise concerns about the inflation outlook. Rising energy prices would lead to increased overall inflationary pressures and could pose upward risks to the inflation outlook. In this context, Asian central banks may postpone rate cuts:
Historically, Asian central banks have been more concerned about the impact of rising energy prices on inflation rather than their destructive effect on demand. In this context, Asian central banks may postpone rate cuts. Supply shocks and the inability of central banks to cut rates further would suppress total demand.
Most Asian economies are net importers of oil, so they will be affected by rising oil prices. Among them, Thailand, South Korea, the Philippines, and India are more sensitive to oil price increases in their CPI, and they also have larger oil trade deficits, so these economies will be more significantly impacted.
Leave A Reply