Asia Prepares for Fed's Imminent Rate Cuts

The Federal Reserve's anticipated shift to interest-rate cuts this week is expected to bolster emerging Asian market assets, potentially extending their recent lead over global favorites like Japan and chip stocks.

Smaller Southeast Asian markets are likely to continue outperforming their larger counterparts, although a significant rise in the yen could introduce volatility into the Japanese market and high-performing chip stocks. The fear of an unwind in the yen carry trade could have global repercussions.

Investors remain divided on whether the Fed will initiate its easing cycle with a standard 25 basis point cut or opt for a larger half-point reduction. A more substantial cut could raise concerns about the US economy's health, outweighing any positive stimulus effects.

Key Market Expectations

Watching the Yen

The yen's trajectory is closely linked to expectations around Fed rate cuts. The currency surged past the 140 per dollar mark on Monday, reaching its strongest level this year amid growing speculation about a half-point cut. A bigger Fed cut could strengthen the yen further, impacting Japanese exporters' earnings and potentially causing market volatility.

Following the Fed’s decision, attention will shift to the Bank of Japan's (BOJ) meeting on Friday. While most economists expect no changes, investors will look for any hints of another possible rate hike in December.

Bets on Smaller Markets

Money managers are increasingly favoring smaller Southeast Asian markets in anticipation of the Fed's policy shift. Four of the five best-performing Asian equity benchmarks this month are from this region, led by Thailand. Fund managers have been increasing their positions in sovereign bonds from Thailand, Indonesia, and Malaysia, and have been net buyers of Indonesian, Malaysian, and Philippine equities for three consecutive months. These inflows have helped make Southeast Asian currencies the top performers among emerging markets this quarter.

India as the EM Anchor

Lower US rates could prompt the Reserve Bank of India to reduce borrowing costs, attracting foreign investors to Indian shares and pushing equity indexes to new records. "A rate cut by the Fed will be positive for valuations and can begin India’s own cycle of interest rate cuts with a lag," said Sumeet Rohra, fund manager at Smartsun Capital. India's economic growth is expected to continue attracting investment flows, further strengthening its position in emerging market allocations.

Mixed Mood on China

A Fed rate cut could narrow the yield gap between US and Chinese government bonds, potentially strengthening the yuan. However, investor sentiment remains cautious amid weak economic data, which may prompt Chinese authorities to increase fiscal and monetary stimulus. The CSI 300 Index recently closed at its lowest level since 2019.

While a Fed rate cut could give China more room to ease without currency concerns, "given the host of issues that China is facing — from domestic economic weakness to external tariffs — a rate cut cycle may not be as beneficial as before," warned Vey-Sern Ling, managing director at Union Bancaire Privee.

Overall Outlook

With the Fed's decision looming, the impact on Asian markets will depend largely on the size of the rate cut and subsequent policy signals. Smaller Southeast Asian markets, India, and potentially China could see significant moves in response to the Fed's actions, while the yen's strength may continue to introduce volatility into Japanese stocks.