Asia credit to survive Fed taper

The Fed has decided to reduce its monthly asset purchases, potentially triggering outflows from Asia once again but the region is much better prepared to withstand the turmoil this time round.
Ben Bernanke: The Fed chairman is cutting $10 billion from its monthly QE programme
Ben Bernanke: The Fed chairman is cutting $10 billion from its monthly QE programme

The US Federal Reserve has announced its decision to cut its monthly bond purchases to $75 billion from $85 billion, suggesting that the world’s largest country is on road to recovery. But fund outflows from Asia could materialise once again — although the magnitude is likely to be more subdued compared to the summer.

The $10 billion reduction comes from two areas: the Fed will reduce its US Treasury purchases from $45 billion to $40 billion a month as well as its buying of mortgage-backed securities (MBS) from $40 billion to $35 billion a month.

The US central bank’s announcement could cause a stir in Asian markets, potentially leading to adverse fund flows as was witnessed back in the summer months. This is especially true for the Asian dollar high-yield space as investors look to move up the credit curve and minimise duration.

“Tapering itself seems increasingly well internalised by the markets, and if accompanied by a significant softening of threshold guidance [by global central banks], can prove to be a near term inflection point for growth or carry flows into Asian assets,” said Sameer Goel, head of Asia FX and interest rate research at Deutsche Bank. “The hurdle for Asian or EM local markets to attract sustained flows has gone up as the outlook for relative returns improves in developed markets.”

To counter this, the burden on policymaking in Asia should broaden out from merely fighting portfolio outflows to more fundamental structural reforms, such as energy pricing and foreign direct investment (FDI) regulations to attract stable long term capital, adds Deutsche.

Despite mounting concerns of fund outflows from the region, bankers believe that the Fed tapering will be executed very carefully, and potentially, supplemented by counter-measures such as cuts in interest rates on excess reserves with the US central bank, for example.

The Federal Open Market Committee states that the funds rate will be kept near zero “well past” the time when unemployment reaches 6.5%, especially if projected inflation continues to run below the committee’s 2% longer-run goal.

“This constitutes a much more dovish outcome than feared over the summer when angst was at its highest,” said Leif Eskesen, chief economist for India and Asean at HSBC. “In turn, this also implies that the spillovers to emerging markets from Fed tapering may be smaller this time around, although a knee-jerk reaction cannot be ruled out.”

Some rebalancing has already taken place between advanced and emerging markets, highlight other experts. This means that the effects of tapering have to some degree been priced in and that the capital flow effect may not be as large this time round.

Credit markets undeterred
Two big risk factors have been resolved, relieving credit markets of some uncertainty, say syndicate bankers. This could prove to be favourable for bond issuers that have funding plans in 2014.

The first being the US budget talk, which was finally resolved on Wednesday. The two-year deal seeks to restore overall fiscal 2014 spending levels for government agencies to $1.012 trillion, trimming the across-the-board budget cuts that were set to begin next month by about $63 billion over two years.

The second is Fed tapering. “Tapering has been resolved at least for now,” said a Hong Kong-based syndicate banker. “We should have a very good window for bond issuance next year, particularly in January.”

The cost of insuring corporate and sovereign bonds in Asia against non-payment held at the lowest level in almost three months after the policy decision by the US central bank. The Markit iTraxx ex-Japan opened at around 124bp Asian time, which was 4bp lower than Wednesday.

The Fed has been signalling a reduction in its stimulus programme for months, but has held off until the economy showed sustained momentum. Stronger job growth prompted the decision to begin winding down the bond-buying programme, cited the US central bank’s governing committee on Wednesday.

Households saw their purchasing power boosted in September by the biggest year-over-year jump in home prices since February 2006, as well as by the rising stock market and continued job growth. Payroll gains have averaged more than 200,000 a month since August, while unemployment fell to 7% in November, the lowest in five years, based on Labor Department data.

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