Whether Janet Yellen initiates lift off in September or December is mere semantics - the ‘data-dependant’ Fed has split both the market and economists evenly between these two months. Either way, preparation for the main event of 2015 needs to be front and centre of thought. Clearly this isn’t the case in Asia.
An Asian history lesson
Historically, Asia has rallied into a Fed rate hike before fading and even heading into bear markets following the rate change.
However, the fact is the US’s last increase to the Fed funds rate was in July 2006 after raising the target rate steadily over the previous two-year period. History may not be the best measure of future reactions but:
The likely reaction in the Asian regions will likely follow the historical trend
Clearly northern Asia (China, Japan and South Korea) is heavily linked to the growth recovery in the US and China. Tightening will slow this relationship but it should be able to withstand this event.
ASEAN nations are more exposed to the risk of rate rises as US-denominated debt is heavily used in this region. I have mentioned this before: the likes of Indonesia, Thailand, Vietnam, the Philippines and India (not part of ASEAN but is clearly affected) could see a run as external liquidity conditions move against these nations.
Southern Asia is clearly effected by the sentiment of North Asia and ASEAN – if we see disorder, the commodity-dependent south will get caught up in the market changes from the north with or without preparation for a September or December lift-off date.
What is also clear in current trade is ASEAN, North and South Asia are ignoring the preparation the Fed is undertaking for its first movement in the Fed funds rate in nine years – this is a huge concern. Asia is more transfixed on market and economic growth (understandable but the instruments it is using to do this are the main risk to possible disorderly exits) rather than shielding themselves from the tightening movements of the liquidity markets.
The possibility of underperformance for Asia in the run home to year-end is building and if Asia doesn’t start to prepare for what I believe is the biggest macro divergence of 2015 (and likely 2016 also), the expectations of underperformance could become highly disordered.
The reaction in monetary policy is likely to be muted mainly because monetary accommodation in Asia is close enough to fully open. I wrote about the G10 commodity currencies and the massive underperformance of the USD yesterday - two of these fall inside Asia with the AUD and NZD. However, on the exotic side, KRW, IDH and IDR have just as much downside as their G10 Asian compatriots.
Our strategy as Fed prep begins is to remain long USD and short Asian currencies. We prefer using AUD/USD and NZD/USD in the current period for this strategy as USD/JPY is reaching heights that limit this movement and increase in risk will create JPY strength. The slides we expect in the exotics will come closer to the actual US lift off event. When this happens, IDR is likely to have the biggest downside risk.
Commodities continue to plummet
Copper, nickel, zinc and aluminium have been under sustained pressure for days and last night was no different.
The fear that longer-dated demand estimates have been severely overstated are growing stronger every day and top-bottom and bottom-up data is telling us this. The risk there will be lower-for-longer demand from the likes of China and other developing nations is causing a rethink for industrial metals and they are feeling the pinch on this sentiment change.
The schedule move from the Fed will only add to the risk as China grapples with its biggest trading partner tightening its purse strings.
I am still confident the ASX will have a good July and early August. However, come September the risks to the ASX puts it on a course for underperformance as the market prepares of a new dimension in the central bank divergences.
Ahead of the open, the ASX is pointing down 17 points to 5572.