# Shift in Fed Policy Expectations: ASEAN Central Banks Face Different Challenges

- Link: https://www.thailand-business-news.com/set/139387-shift-in-fed-policy-expectations-asean-central-banks-face-different-challenges
- Published: 2024-05-07T15:26:41+07:00
- Author: SET News

**Financial markets have shifted their expectations of Fed policy conduct in 2024,
while bond investors pressured the Fed for dovish policy. ASEAN countries face challenges
due to the Fed’s policy changes.**

---

Financial markets have dramatically revised their expectations of Fed policy conduct
in 2024. After the global financial crisis (GFC), bond investors embraced a secular
stagnation thesis for the US economic outlook, requiring permanently easy monetary
policy. Consequently, they played an almighty game of chicken to force the Fed to
accept their dovish policy prescription.

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The secular stagnation thesis still prevailed during the period of rising inflation
after the pandemic. Once the Federal Open Market Committee (FOMC) changed their 
policy rate outlook in December to three reductions in 2024, the game of chicken
quickly returned in January. Investors discounted seven rate cuts. Courtesy of strong
economic data, however, their assessment fell from seven to its current two (due
in September and December).

Hence, bond investors have become more hawkish than the FOMC for the first time 
since the infamous taper tantrum in 2013. Consequently, this could herald a new 
era of more realistic Fed policy expectations being formulated after years of dovishness.

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## June’s FOMC Meeting: Critical for Policy Expectations

Adjustments to the FOMC’s forward guidance are conveyed in their Summary of Economic
Projections, the next due after June’s policy meeting. Fed policy conduct remains
firmly data dependent. Incoming information before the next FOMC meeting will, therefore,
shape potential forward guidance changes for 2024 H2 and 2025 H1. Investors could
easily change their expectations in either direction, depending on incoming data.
Meanwhile, the Fed’s preferred inflation gauge, the personal consumption expenditure(
PCE) deflator, is still displaying a disinflationary trend, unlike the consumer 
price index.

Crucially, the continuation of disinflationary PCE trends creates leeway for the
FOMC to enact their current forward guidance in H2. Meanwhile, the FOMC has reverted
to an asymmetric approach to strong employment gains, relying on immigration to 
quell wage inflation pressures, as opposed to higher unemployment. Hence, policy
rate reductions and strong job growth are currently viewed as being completely compatible.

## The Looming End of Quantitative Tightening: Benefits for ASEAN Borrowers?

Interest rate reductions form one pillar of Fed policy easing: the other is reduced
quantitative tightening (QT). Slowing the shrinkage of the Fed’s balance sheet via
tapering should help reduce pressure on US long-term interest rates. The timing 
of the start of tapering remains, however, somewhat uncertain, but it should start
the eventual closure of QT. Ending QT should impart benefits to ASEAN credit markets,
particularly those where there are significant numbers of corporations borrowing
in US dollars.

Meanwhile, the overall impact of QT tapering could depend heavily on the reaction
of the term premium embedded in long-term interest rates to future Fed policy rate
cuts. If bond investors’ view Fed rate cuts as being risky, then long-term interest
rates could rise due to term premium pressures, which would ironically tighten financial
conditions. This outcome would, therefore, be perverse for US dollar borrowers in
the ASEAN region who seek to refinance debt in 2024 and 2025. Meanwhile, ASEAN central
banks are unlikely to be slaves to the Fed’s conduct due to past policy measures,
as well as ongoing currency weakness.

## ASEAN Central Banks Face Different Challenges

The Fed led the charge towards higher policy rates in early-2022. ASEAN central 
banks duly followed, but only Vietnam, Indonesia, and the Philippines exceeded the
Fed’s peak level. Meanwhile, more hawkish expectations about the path of Fed policy
have significantly complicated the ASEAN monetary policy outlook due to downward
pressure on local currencies. Varying domestic economic conditions and currency 
pressures imply that a “one size fits all” regional monetary response is impossible.

The scope for monetary easing when the Fed eventually cuts its policy rate is more
restricted in Indonesia and the Philippines due to higher inflation and currency
weakness. **Meanwhile, Malaysia and Thailand have their respective central bank 
policy rates below the Fed’s current level.**

Both countries are experiencing weak external demand and soft currencies. Given 
that ASEAN central banks face limited scope to ease policy rates, local currency
bonds and equities face stiffer headwinds than envisaged at the start of the year.
Ultimately, local currency bonds and equities will benefit once central banks begin
reducing their policy rates.

Arguably, currency depreciations have already effectively eased local financial 
conditions ahead of ASEAN central bank actions. Countries with weakening currencies
will import both growth and inflation. Thailand and Malaysia should have less concern
about currency weakness compared to Indonesia and the Philippines due to their lower
inflation rates.

## Better Economic Backdrop for ASEAN Risky Assets in 2024

Unfolding events in China and the US will have strong influences on the economic
outcomes of ASEAN countries reliant on external demand. China and the US remain 
the main drivers of global growth. Meanwhile, the economic outlook for the ASEAN
region has been revised upward since the start of the year due to resilient domestic
demand and modest improvements in net exports, thereby providing a better backdrop
for risky assets. Crucially, ASEAN capital markets have become less hostage to foreign
capital flow disruptions since the Asian Financial Crisis. Except for Indonesia,
duration equivalent sovereign bond yields in the ASEAN region are below the 10-year
US Treasury note without any semblance of local market disruptions. 

ASEAN equity valuation risks seem more limited compared to the US, particularly 
in Indonesia, Philippines, and Singapore. These markets trade on a P/E multiple 
of 11-12. Relative to history, current valuations are cheap. Malaysia, Vietnam, 
and Thailand are trading on higher P/E multiples, ranging from 15 to 17, and, consequently,
appear more fairly valued to historic norms.

The importance of overseas portfolio inflows is often over-hyped in terms of gauging
economic optimism for a region. Foreign direct investment (FDI) flows are far more
important in terms of magnitude. The outlook for FDI into the ASEAN region is bullish,
underpinned by favourable demographics and the diversification of supply chains 
by multinationals. Crucially, rising FDI is beneficial for boosting productivity
and reducing inflation in host countries. Hence, higher secular regional equity 
valuations are both potentially achievable and sustainable, even without major help
from the Fed and regional central banks.

Author: Said Desaque | Said is a professional economist with over 35 years of experience
covering the global economy, with significant expertise in the US, China, Japan 
and emerging markets. He has worked with US investment banks for over 25 years covering
institutional investors in Europe, Middle East, Far East and Australia.

**Source** : [Significant Shift in Fed Policy Expectations](https://www.aseanexchanges.org/content/significant-shift-in-fed-policy-expectations/?rand=138677)