Dovishness catching up in Asia; rate cuts to create opportunities

The Fed’s policy U-turn this year opens the door for Emerging market central banks to cut policy rates, potentially more than what the market expects. This creates opportunities for investors in Indonesian local currency bonds and Indian equities.

Expectations regarding the outcome from the Federal Reserve (Fed) meeting later this month has been swinging between a 25 and a 50 basis point cut. This dovishness is inevitably spilling over to Emerging Market (EM) central banks.

Korea and Indonesia were among the first central banks in Asia to react ahead of the Fed meeting. Both central banks cut policy rates by 25 basis points1, with Indonesia leaving the door open for more rate cuts. Korea’s rate cut was a surprise against expectations that the central bank would wait until September to ease. Both the Bank of Korea and Bank Indonesia noted weaker domestic growth, low inflation and a dovish Fed as reasons for easing monetary policy. Both banks also signalled the intention to keep their monetary policy stance accommodative going forward. Outside of Asia, South Africa reversed last November’s hike by cutting policy rates by 25 basis points2 but kept its tone broadly neutral given concerns of rising inflation.

Thanks for subscribing!

Follow us :

Policy u-turn

When the Fed hiked aggressively last year, causing the USD to appreciate against most currencies and the DXY to rally nearly 10%, EM central bankers were pushed to hike policy rates, particularly to contain currency depreciation. This year, while Eastspring Singapore’s Multi Asset Solutions (MAS) team believes that the Fed will cut rates more gradually than what the market expects, the dovish shift in Developed Market monetary policy is likely to allow EM central banks to cut rates in the coming months.

What are some of these markets? We plot the change in real GDP growth over the past 2 quarters against the inflation gap (difference between the inflation target and the average 6-month inflation rate) for selected EM economies in Fig. 1. Economies in the bottom left quadrant display macroeconomic conditions (real GDP growth decelerating, and inflation is running below target), that make it more likely for them to ease monetary policy.

Fig 1: Slowing growth and low inflation suggest that economies in the bottom left quadrant have room to ease monetary policy


We further plot the change in policy rate for each of these economies since early 2017, the rate cuts year to date and market expectations regarding the change in the policy rate over the next one year. Fig. 2 clearly shows how monetary policy has reversed in some markets, from rate hikes last year to rate cuts this year. It also shows that in certain Asian economies such as Indonesia and the Philippines, their central banks may need to cut rates more than what is currently priced in, in order to reverse the rate hikes in 2017/18.

Fig 2: Markets may not be pricing in enough rate cuts in the Philippines and Indonesia


More easing all around

The MAS team sees rate cuts in Philippines, Indonesia, Thailand, Malaysia and India over the coming months.

The Philippines had hiked aggressively last year amid rising inflation and a weaker currency. With headline inflation plummeting from nearly 7% year-over-year in end-2018 to under 3% more recently, the central bank has room to ease monetary policy further. In Thailand, while financial stability concerns (particularly over high household debt) may make the central bank hesitant to cut rates initially, weaker growth, low inflation and a stronger Thai Bhat will probably trigger a 25 basis point cut in late Q3/early Q4, in our view. Meanwhile, China is likely to keep rates low and liquidity conditions accommodative as it aims to stabilise economic growth amid weak trade.

As for India, lower policy rates are likely given weaker than expected growth, below target inflation and a contained fiscal deficit. The Reserve Bank of India will also probably ease liquidity, especially to the non-bank financial institutions and public sector banks.

We expect the Monetary Authority of Singapore to reduce the slope of the Singapore Dollar Nominal Effective Exchange Rate — the exchange rate between the Singapore dollar and a basket of currencies of the country's major trading partners - at its October meeting, to support growth after Singapore’s Q2 GDP fell to 0.1% yoy, the lowest since the Global Financial Crisis.

Outside of Asia, Brazil, Chile, Mexico and Russia are all likely to cut rates this year.

Investment implications

With the Fed and EM central banks poised to cut rates further and keep monetary conditions accommodative, the MAS team sees opportunities in markets where rate cuts are currently under-priced. We favour Indonesian local bonds, in particular.

We remain positive on US and Asian High Yield bonds, as well as on duration. We see rates drifting lower in China as liquidity remains easy.

Over in India, the team expects the liquidity impulse from the central bank to be more powerful than rate cuts, leading us to favour Indian equities over Indian bonds, a somewhat contrarian view given the prevailing negative sentiment towards the former.

We are also positive on the Russian ruble and Australian rates.

For Use with Professional Clients / Qualified Investors Only. Not Approved for Further Distribution or Use with the General Public.

The information and views expressed herein do not constitute an offer or solicitation to deal in shares of any securities or financial instruments and it is not intended for distribution or use by anyone or entity located in any jurisdiction where such distribution would be unlawful or prohibited. The information does not constitute investment advice or an offer to provide investment advisory or investment management service or the solicitation of an offer to provide investment advisory or investment management services in any jurisdiction in which an offer or solicitation would be unlawful under the securities laws of that jurisdiction.

Past performance and the predictions, projections, or forecasts on the economy, securities markets or the economic trends of the markets are not necessarily indicative of the future or likely performance of Eastspring Investments or any of the strategies managed by Eastspring Investments. An investment is subject to investment risks, including the possible loss of the principal amount invested. Where an investment is denominated in another currency, exchange rates may have an adverse effect on the value price or income of that investment. Furthermore, exposure to a single country market, specific portfolio composition or management techniques may potentially increase volatility.

Any securities mentioned are included for illustration purposes only. It should not be considered a recommendation to purchase or sell such securities. There is no assurance that any security discussed herein will remain in the portfolio at the time you receive this document or that security sold has not been repurchased.

The information provided herein is believed to be reliable at time of publication and based on matters as they exist as of the date of preparation of this report and not as of any future date. Eastspring Investments undertakes no (and disclaims any) obligation to update, modify or amend this document or to otherwise notify you in the event that any matter stated in the materials, or any opinion, projection, forecast or estimate set forth in the document, changes or subsequently becomes inaccurate. Eastspring Investments personnel may develop views and opinions that are not stated in the materials or that are contrary to the views and opinions stated in the materials at any time and from time to time as the result of a negative factor that comes to its attention in respect to an investment or for any other reason or for no reason. Eastspring Investments shall not and shall have no duty to notify you of any such views and opinions. This document is solely for information and does not have any regard to the specific investment objectives, financial or tax situation and the particular needs of any specific person who may receive this document.

Eastspring Investments Inc. (Eastspring US) primary activity is to provide certain marketing, sales servicing, and client support in the US on behalf of Eastspring Investment (Singapore) Limited (“Eastspring Singapore”). Eastspring Singapore is an affiliated investment management entity that is domiciled and registered under, among other regulatory bodies, the Monetary Authority of Singapore (MAS). Eastspring Singapore and Eastspring US are both registered with the US Securities and Exchange Commission as a registered investment adviser. Registration as an adviser does not imply a level of skill or training. Eastspring US seeks to identify and introduce to Eastspring Singapore potential institutional client prospects. Such prospects, once introduced, would contract directly with Eastspring Singapore for any investment management or advisory services. Additional information about Eastspring Singapore and Eastspring US is also is available on the SEC’s website at www.adviserinfo.sec. gov.

Certain information contained herein constitutes "forward-looking statements", which can be identified by the use of forward-looking terminology such as "may", "will", "should", "expect", "anticipate", "project", "estimate", "intend", "continue" or "believe" or the negatives thereof, other variations thereof or comparable terminology. Such information is based on expectations, estimates and projections (and assumptions underlying such information) and cannot be relied upon as a guarantee of future performance. Due to various risks and uncertainties, actual events or results, or the actual performance of any fund may differ materially from those reflected or contemplated in such forward-looking statements.

Eastspring Investments companies (excluding JV companies) are ultimately wholly-owned / indirect subsidiaries / associate of Prudential plc of the United Kingdom. Eastspring Investments companies (including JV’s) and Prudential plc are not affiliated in any manner with Prudential Financial, Inc., a company whose principal place of business is in the United States of America.