The impact of the Fed rate cut on the Asia-Pacific markets?

The financial markets are holding their breath for the upcoming interest rate decision by the Federal Reserve. Global funds are eager to seek new growth opportunities, and the outlook for the Asia-Pacific markets may be multi-tiered.

Yen "Rising Again" with Investor Sentiment Fluctuating

Some analysts believe that if the Federal Reserve cuts interest rates, it will trigger a rise in the yen, potentially causing concerns for investors in emerging markets, especially considering the collective sell-off on "Black Monday" in August is still fresh in memory.

Last month, the unwinding of yen carry trades caused by a rate hike in Japan briefly dominated market sentiment, leading to the Nikkei 225 index experiencing its most severe plunge since 1987. This was compounded by a significant drop in US non-farm payrolls and a sharp decline in US tech stocks.

Analysts point out that there may be similarities this time around. With the Federal Reserve's first rate cut cycle in years about to begin, the market is still divided on whether the rate cut will be by 25 basis points or 50 basis points:

On one hand, a 50 basis point cut may raise doubts about the health of the US economy, triggering a sell-off of emerging Asian assets. This could also strengthen the yen, prompting investors to unwind risk assets leveraged against the yen.

On the other hand, a 25 basis point cut may benefit the stock market, with Southeast Asian markets potentially being the major beneficiaries.

The yen's movement is closely related to expectations of a Federal Reserve rate cut. On Monday, as expectations of a "50 basis point cut" increased, the yen-to-dollar exchange rate broke through the 140 mark, reaching the highest level this year.

As of now, the yen is trading at 141.79 against the dollar, with the gains narrowing.

Data from the Commodity Futures Trading Commission (CFTC) shows that as of September 10th, asset management companies' bullish sentiment towards the yen has risen to the highest level since March 2021.

Some analysts point out that this has also caused anxiety among Japanese investors. If the Federal Reserve chooses a larger rate cut, the yen may further strengthen, putting pressure on Japanese companies that rely on exports.

Southeast Asian Markets Benefit, India Elected as "Mainstay"

Unlike Japan, Southeast Asian markets seem to be responding positively to the Federal Reserve's rate cut decision. Stocks in the region have easily outperformed other stocks in emerging markets. Four out of the top five performing Asian stock benchmarks this month come from the Southeast Asian region, with Thailand leading the pack.

The relatively smaller Southeast Asian markets have become the preferred choice for fund managers preparing for the Federal Reserve's policy shift. Over the past two months, fund managers have been increasing their holdings of sovereign bonds in Thailand, Indonesia, and Malaysia. For the past three months, they have been net buyers of stocks in Indonesia, Malaysia, and the Philippines. These inflows have helped Southeast Asian currencies become the best-performing currencies in the emerging markets this quarter.

India plays a "pillar" role in the emerging markets. Analysts believe that a Federal Reserve rate cut may prompt the Reserve Bank of India to cut rates, attracting a frenzy of foreign funds into the local stock market, pushing major stock indices to hit historic highs on Tuesday Singapore-based fund manager Sumeet Rohra from Smartsun Capital Pte. stated:

"The rate cut by the Federal Reserve will have a positive impact on its valuation and may potentially kickstart India's own rate-cut cycle with a lag, India's economic growth rate will help attract more fund inflows."

Analysis points out that after the Federal Reserve's rate cut, the increasing weight of India in the allocation of emerging markets may also receive a boost. With its strong economic growth, growing middle class, and thriving manufacturing sector, India has become a favorite among investors.

Challenges in the Australian Bond Market

However, not all Asian markets will benefit from the Federal Reserve's rate cut. Momentum indicators suggest that the upward momentum in the Australian bond market seems to have been excessively stretched. Earlier this week, yields on Australia's policy-sensitive three-year and ten-year government bonds briefly fell to their lowest levels since June.

National Australia Bank stated that due to the high correlation between Australian and U.S. government bonds, the continuation of the uptrend will depend on whether the Federal Reserve remains accommodative enough to meet the expected terminal rate of around 2.75%. Sydney-based senior fixed income strategist Kenneth Crompton commented:

"Australia's August employment data may also prompt the market to lower expectations of a rate cut by the Reserve Bank of Australia in the next six months. Short-term Australian government bonds appear too loose compared to expectations for the RBA, and I believe longer-dated Australian government bonds offer little value."