Impact of Federal Reserve Rate Cut on APAC Markets

The financial markets are currently brimming with anticipation as investors await important decisions from the Federal Reserve regarding interest rates.This uncertainty is causing a ripple effect across global capital flow,as investors in various regions seek new opportunities for growth,leading to an expected bifurcation in the outlook for the Asia-Pacific markets.One area of notable interest is the Japanese yen,as market analysts speculate on its potential reaction to the Federal Reserve’s next move.If interest rates are indeed lowered,it could trigger a surge in the yen's value.This scenario,while beneficial for the yen,might raise alarm bells among investors in emerging markets,especially considering the fallout from the collective sell-off witnessed in August,dubbed "Black Monday." This sell-off was largely influenced by the recent interest rate hike in Japan,which dominated market sentiment and led to a dramatic plunge in the Nikkei 225 index—the worst drop since 1987.Superimposed on that was a significant decline in non-farm payrolls in the United States,which contributed to the fall of key tech stocks.The current climate appears to draw parallels to those tumultuous times.With the onset of what is anticipated to be the Federal Reserve’s first rate-cutting cycle in years,the market remains divided on the magnitude of potential cuts—whether it’s a 25 basis point cut or a more aggressive reduction of 50 basis points.On one hand,a hefty 50 basis point cut could instigate skepticism about the health of the U.S.economy,potentially sparking a sell-off of emerging Asian assets,in turn strengthening the yen further as investors look to unwind their riskier positions financed in yen.Conversely,a more modest 25 basis point cut might provide a favorable environment for stock markets,especially those in Southeast Asia,which are expected to be significant beneficiaries of such a decision.Hence,the trajectory of the yen is intrinsically tied to expectations surrounding the Federal Reserve’s interest rate decisions.On recent developments,as the expectations for a 50 basis point cut became more pronounced,the yen crossed the 140 mark against the dollar,reaching its highest level this year.As of the latest updates,the exchange rate stands at approximately 141.79,with some tightening observed.Data from the Commodity Futures Trading Commission (CFTC) indicates that,as of September 10,asset management firms have expressed their most bullish sentiment towards the yen since March 2021,highlighting a growing appetite for the currency.However,this bullish trend is also fostering a sense of anxiety among Japanese investors,as the prospects of a more substantial rate cut from the Federal Reserve might propel the yen even higher,thus extracting pressure on export-dependent Japanese corporations.In stark contrast to Japan’s situation,the Southeast Asian markets seem to be responding favorably to the anticipated actions of the Federal Reserve.Stocks in this region are outperforming their counterparts in other emerging markets,marked by four out of the five best-performing Asian stock benchmarks being from Southeast Asia,with Thailand leading the pack.The smaller-sized Southeast Asian markets have increasingly become the go-to choice for fund managers preparing for a strategic pivot in Federal Reserve policies.Over the previous two months,fund managers have been steadily increasing their holdings in government bonds from Thailand,Indonesia,and Malaysia,cementing their status as net buyers of Indonesian,Malaysian,and Philippine stocks over the last three months.This influx of capital has bolstered Southeast Asian currencies,making them the best performers in the emerging market sector this quarter.India is also carving out a pivotal role as a "pillar" within the emerging markets.Analysts opine that a rate cut from the Federal Reserve could lead India’s central bank to reassess its own interest rates,consequently attracting significant foreign investment into local equities and pushing major indices to reach historic highs this past Tuesday.According to Sumeet Rohra,fund manager at Singapore’s Smartsun Capital Pte.,“A Federal Reserve rate cut will positively impact valuations and may prompt a lagging Indian rate-cutting cycle,with India’s economic growth attracting more capital inflows.” Furthermore,as the Federal Reserve cuts rates,India’s increasing weighting in emerging market allocations is expected to be further enhanced.With robust economic growth,a burgeoning middle class,and an expanding manufacturing sector,India has emerged as a favored destination for investors looking to tap into Asia’s dynamic growth story.On the other hand,not every Asian market stands to gain from the Federal Reserve's anticipated easing policy.In Australia,the bond market appears to be facing its own set of challenges.Momentum indicators suggest that the upward trajectory in Australian bond yields may be overstretched.Earlier this week,yields on three-year and ten-year government bonds—sensitive to policy shifts—plummeted to their lowest levels since June.The National Australia Bank has pointed out that given the high correlation between Australian and U.S.Treasury bonds,the sustainability of this upward momentum will hinge on whether the Federal Reserve adopts a sufficiently dovish stance,aligning with expectations for a terminal rate around 2.75%.Kenneth Crompton,a senior fixed-income strategist from Sydney,commented,“The employment data for Australia in August might also compel the market to adjust expectations regarding rate cuts by the Reserve Bank of Australia over the next six months.Compared to the RBA’s outlook,the short end of the Australian sovereign bond market seems excessively loose,and I doubt there's much value left in longer-dated Australian bonds.”