By Rajiv Biswas, Asia-Pacific Chief Economist, IHS Global Insight
Key Points:
- With the US Federal Reserve having hiked the US policy rate by 25 basis points at the Federal Open Market Committee (FOMC) meeting on 14 December as anticipated by financial markets, further Fed monetary policy tightening is expected to follow in 2017. Expected further US Fed rate hikes need to be seen in the context of strengthening US economic growth in 2017. IHS Markit forecasts that global GDP growth will rise from 2.5% in 2016 to 2.8% in 2017, with the US economy forecast to strengthen in 2017.
- IHS Markit expects three more Fed rate hikes in 2017. Further tightening of US monetary policy during 2017 was also reflected in the latest Fed Funds rate projections by the Federal Reserve Board members and US Fed Presidents released at the December FOMC meeting. Furthermore, their policy rate projections indicate further tightening steps in 2018 and 2019. This is expected to result in further bouts of volatility for Asian financial markets during 2017 as US short-term interest rates move higher.
IHS Global Insight Views:
A key risk is for further capital outflows from Asian emerging markets’ assets as investors rebalance portfolios towards the strengthening US dollar and higher US interest rates at both the short- and long-end of the yield curve. US monetary policy tightening has pushed up short-term US interest rates and yields on shorter-dated US Treasuries, with the yield on two-year US Treasuries spiking to the highest level since August 2009, following the Fed’s 14 December rate hike. Meanwhile, longer-dated Treasury yields reached their highest levels for 18 months in early December on rising inflation expectations.
Further capital outflows from Asian emerging equity and bond markets in 2017 could create volatile conditions in the more vulnerable global emerging markets with significant external account and domestic macroeconomic imbalances. An investment climate of increasing risk aversion towards emerging markets’ assets could result in further capital outflows from Asian emerging equity and debt markets, particularly if investors fear that a further slowdown in Chinese growth will have negative transmission effects on Asian exports and investment flows.
Due to the Hong Kong dollar peg to the US dollar, HK property prices are particularly vulnerable to further Fed tightening since the Hong Kong Monetary Authority will be forced to follow US Fed tightening steps.
With more US Fed rate hikes expected in 2017, this is expected to support the further appreciation of the US dollar against many Asian currencies.
The Chinese yuan is expected to gradually decline further against the US dollar, falling through 7 against the dollar during 2017. Chinese FX reserves have fallen by a massive USD939 billion from their peak in June 2014 until November 2016. Further yuan weakness could contribute to more turbulence in Asian currency markets.
The Japanese yen has already depreciated significantly against the US dollar during 2016 and IHS Markit forecasts that by the fourth quarter of 2017, the yen will fall to around 120 per dollar as the Fed tightens further in 2017 while the Bank of Japan maintains its quantitative easing (QE) policies to try to boost weak Japanese economic growth. This will help boost Japanese corporate profits, as well as boosting Japanese exports. A key beneficiary of the weak yen has been the Japanese tourism industry, which has shown strong growth in the last two years.
Global investors will continue to differentiate among the Asian emerging market currencies, based on external account vulnerabilities and domestic macroeconomic imbalances, with the Indonesian rupiah, Philippines peso and Malaysian ringgit having hit their lowest levels since the East Asian crisis during 2015-2016, with the risk of further depreciation during 2017 in an environment of capital outflows from emerging markets towards the US dollar and the dollar assets.
Even the Philippines peso, which is supported by current account surpluses and large inflows of worker remittances, has depreciated significantly against the US dollar since September, from around 46.6 in late August to 49.8 by mid-December.
The high level of foreign ownership in the local equities and debt markets of Malaysia and Indonesia make the rupiah and ringgit vulnerable to a rebalancing of global investment portfolios towards USD-denominated assets. While higher world oil prices following OPEC’s decision to cut oil output is supportive for the ringgit and the Malaysian economic outlook, the ringgit, like many other Asian currencies, still faces downside risks against the US dollar in 2017 due to rising US interest rates and expected strengthening in US economic growth, which support a stronger US dollar.