ASIAN financial markets have been rattled again over the week as US Treasury yields continue to rise, bolstering demand for the US dollar, which has already risen to around three months high.
Concerns are growing in this region that the recent sharp increase in US bond yields –driven largely by higher inflation expectations which in a way suggest the eventual end to cheap money – could trigger a major sell-off in emerging-market assets.
It has also sparked debate over whether this could be reminiscent to the “taper tantrum” of 2013, whereby the surge in US Treasury yields then, resulting from the US Federal Reserve’s (Fed) announcement of future tapering of its quantitative-easing (QE) policy, caused massive outflow of capital from emerging-market assets and a subsequent decline in their currencies. The effects were felt across Asia, and Malaysia was not spared.
The yield on the benchmark 10-year US Treasury note has been marching up steadily, rising above 1.5% over the week from just 0.93% at the start of 2021. It hit a high of 1.614% on Feb 25.
There was no indication that the Fed would push back against the recent surge in bond yields, with its chairman Jerome Powell only saying he would be “concerned by disorderly conditions”, without any hint of intervention.
Goldman Sachs predicts the 10-year US Treasury yield could increase to as high as 1.9% by the end of 2021, driven by stronger economic data.
“While we think there will be some near-term consolidation, we believe strong economic data will lead yields to resume their upward trajectory in the coming quarters, and we therefore revise up our projections, ” the investment bank says in its latest economics research report.
Some major fund managers such as BlackRock Inc and Fidelity International have even warned about the deteriorating outlook facing emerging-market bonds as a result of rising US bond yields.
RHB Investment Bank, however, urges investors not to panic over the recent spike in US Treasury yields. The local investment bank says while the US Treasury yields will likely rise further through the first half of 2021, the trend could reverse in the second half of the year.
“We believe the 10-year US Treasury yield will rise to around 1.70%-1.75% by summer before declining to around 1.40% in the second half of 2021, ” RHB says.
“The silver lining is that some time in summer, we believe that the balance of risks is skewed towards the Fed announcing some measures to stabilise longer dated government bond yields if the upward momentum in yields is too rapid in the second quarter of 2021, ” it explains.
According to Rabobank, while increasing inflation expectations have contributed to the sharp increase in US bond yields, higher inflation in the future may not be a realistic scenario.
“Fundamentally, we do not believe that sustained higher inflation in the future is a realistic scenario because the current slack in the labour market should prevent a domestic wage-price spiral taking hold, ” the multinational banking and financial services group says in its recent report.
Irrespective of whether higher inflation actually materialises, it points out, the markets are testing the central banks’ willingness to act, or to comfort them.
“So the main question is: what are the central banks, the Fed in particular, going to do? If they react with strong verbal intervention and additional monetary policy measures, the market will probably shift back to risk-on mode, which would be beneficial to emerging-market currencies, ” Rabobank says.
“However, in a scenario (not our base case) in which the Fed does not act or even tightens monetary policy, we could see more capital flowing back to the United States, pushing up US yields and the dollar, depreciating most of the emerging-market currencies accordingly, ” it adds.
This would hurt many emerging markets, but probably commodity importers more than commodity exporters, Rabobank notes.
“Large depreciations in emerging-market currencies could force central banks in emerging markets to hike (interest) rates in some cases. This would undoubtedly hurt the economies, which are just crawling out of recession, ” it says.
Maybank Kim Eng notes that while Asean bond markets have also come under pressure as a result of rising US Treasury yields, the contagion to the region’s stocks and currencies so far have been rather limited.
“The Asean 10-year government bond yields are climbing in line with the 10-year US Treasury yield, with the biggest increase in the Philippines and Indonesia, followed by Thailand and Malaysia, ” the investment bank says.“Asean stock markets and currencies are, however, holding up much better compared to bonds, and US stock markets, ” it adds.
For comparison, year-to-date to March 3, the 10-year US Treasury yield has gained 57 basis points (bps), while the 10-year government bond yields for the Philippines was up 86 bps; Indonesia up 64 bps; Thailand, 60 bps; and Malaysia, 47 bps.
“Markets are pricing in QE tapering to start in the first quarter of 2022 and the Fed rate hikes to start in 2023, ” Maybank Kim Eng says, noting that the Fed is adopting a policy of “average inflation targeting”, allowing inflation to run “moderately” above 2% for “some time” before any tightening.
The bank argues that while Asean is not immune to another round of taper tantrums, the region is generally more resilient now compared to the situation in 2013.
“Stronger current account positions, larger foreign exchange reserves, lower inflation and limited foreign capital inflows over the past year suggest that any sell-off will be more modest and not be as severe as the 2013 tantrums, ” Maybank Kim Eng says.
Over the past year, foreign capital and QE money have flowed more to China and India, rather than Asean, South Korea or Taiwan.
“Foreign ownership in equity markets are near historical lows in markets including Indonesia, Malaysia and Thailand, while foreign ownership in government bonds have fallen significantly in Indonesia, ” Maybank Kim Eng says.
“Smaller current account deficits in Indonesia and improving current account balances also suggest lower dependence on foreign capital inflows. Asean central banks have built up their foreign reserves, which has risen to record highs in all the countries, except Malaysia, ” it adds.
However, there are weak spots, it acknowledges, pointing out that large Covid-19 relief packages have raised the external debt ratio for Indonesia relative to 2013, and the debt servicing ratios for Indonesia (19.9% of government revenue), Malaysia (15.3%) and the Philippines (13.3%). Higher bond rates will further increase these financing burdens, it explains.