Asia’s two biggest central banks are having to grapple with the fallout from the Federal Reserve’s hawkish pivot.
The interest rates China’s biggest banks charge their best customers were held steady on Wednesday, even as the economy slows under the weight of rolling lockdowns to curb Covid-19. That may slow the pace of capital outflows after investors sold government bonds at a record pace over February and March as the People’s Bank of China eased monetary policy, while the Fed tightened.
In Japan, the central bank was forced to ramp up its bond purchases again on Wednesday as investors continue to test its ability to keep yields low as their American equivalents climb. The yen has suffered a historic run of losses as a result, prompting Bank of Japan Governor Haruhiko Kuroda this week to amp up his warnings on the yen’s sharp moves, indicating there may be a limit to how long the BOJ can remain this dovish.
“The Fed’s tightening is having a clear impact on China and Japan,” said Tuuli McCully, head of Asia-Pacific economics at Scotiabank. “It is making their monetary policy conduct much more complicated.”
That divergence is expected to deepen. Fed officials have signaled a relatively rapid pace of rate increases over the rest of the year to get their benchmark rate to what they deem to be a “neutral” level of 2.25-2.5%, or higher. They lifted their benchmark rate by a quarter-percentage point in March after keeping it near zero for the previous two years.
Subtle Pivot
Analysts say both the Chinese and Japanese central banks will make a subtle pivot in order to plug the money flows.
The PBOC is holding off on broad-based interest rate cuts, and is instead using window guidance and other measures to ensure banks are lending to the parts of the economy that need it most. That reticence to lower rates comes as the yuan trading offshore weakened on Tuesday by the most since July, while U.S. Treasury yields surged and the greenback strengthened. The PBOC set its reference rate for the yuan at a weaker level on Wednesday.
Japan is also treading carefully as evidenced by Kuroda’s warnings on sharp yen moves while sticking with his commitment to keep stimulating a fragile economy. Japan last intervened to sell dollars and buy yen in June 1998 at the height of the Asian currency crisis.
The BOJ is likely to consider notable changes in its inflation and growth forecasts next week, according to people familiar with the matter. The bank will release the forecasts in its quarterly economic outlook report on April 28 after concluding a two-day meeting.
“I don’t think Japan or China can completely decouple their monetary policies with the Fed because doing so will further weaken their currencies and widen their yield gaps,” said Nobuyasu Atago, former head of the price statistics division at the BOJ and now Tokyo-based chief economist at Ichiyoshi Securities Co. Ltd.
It’s possible the BOJ gives up its policy of yield curve control, and that the PBOC moves further away from broad rate cuts and uses other channels to inject money into the economy, said Alicia Garcia Herrero, chief economist for Asia Pacific at Natixis SA.
“Nobody can hide from such a rapid tightening as the one the Fed is carrying out,” she said.
Other Factors
The Fed isn’t the only driver at play for either China or Japan. Russia’s invasion of Ukraine has sent jitters through global investors, as have the lockdowns in China. Japan has also been running trade deficits as energy import costs soar, further undermining the yen.
At the same time, China’s outflows have been modest relative to the big moves seen in the yen. Portfolio shifts are to be expected when the yield differential between nations moves in opposite directions, said Helge Berger, head of the International Monetary Fund’s China mission.
“It is the laws of international macroeconomics at work,” Berger said in an interview.
Still, the Fed’s expected emphasis on raising interest rates over the coming months will continue to be a factor.
Fed policymakers are reinforcing expectations they’ll raise interest rates by a half percentage-point next month, and interest-rate futures are almost fully priced for a half-point hike at the Fed’s May 3-4 meeting. That’s when officials could also announce a start date for beginning to shrink their almost $9 trillion balance sheet.
St. Louis Fed President James Bullard, speaking Monday, said the central bank shouldn’t rule out even larger hikes, invoking the 75 basis point move that former Fed Chair Alan Greenspan delivered in 1994.
Such an aggressive hiking cycle will inevitably lure foreign investors away from rival economies, according to Zhang Zhiwei, Hong Kong-based chief economist at Pinpoint Asset Management Ltd.
“It’s not just China, other emerging markets will also experience similar trends,” he said.
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