Jerome Powell’s rate hikes are the last thing Asia needs this year.
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As economists debate the significance of the latest US jobs data, Asia has no worries that the Fed’s tightening cycle will continue.
After falling behind the inflation curve in 2021, Fed Chair Jerome Powell’s team has been catching up in 2022 and earlier this year. Chances are the US added another 236,000 nonfarm payrolls in March – despite Fed rate hikes – means the monetary brakes will be tightened further.
That’s the last thing Asia needs in 2023.
This region tends to be hit hardest by Fed tightening cycles. The late period when the Fed raised rates so abruptly — in 1994 and 1995 — set the 1997 Asian financial crisis in motion.
As the dollar soared, it made it impossible to maintain currency pegs across Asia. First, Thailand was devalued in July 1997. Then Indonesia, followed by South Korea. The shockwaves boomeranged back to America and hit Wall Street’s shoulder.
In 2013, Asia had a bit of a panic at mere hints that the Fed might taper quantitative easing. This “taper tantrum” reminded the region that many of its 1997 vulnerabilities remained.
This time Asia is holding up better than those earlier episodes. So far at least. The problem is that the cumulative impact of nearly 500 basis points of monetary tightening is catching up to Asia.
The collapse of the Silicon Valley bank bears the fingerprints of the Fed. The domino effect of SVB – and other casualties like Signature Bank – sent shockwaves across Asia. The fact that Credit Suisse had to be rescued by the UBS Group hardly helped.
These disruptions could have a direct impact on the availability of credit for small and medium-sized businesses and increase US inflationary risks. They have also changed the calculus for Asia’s largest economies.
China, for example, is pumping fresh liquidity into Asia’s largest economy. Last month, the People’s Bank of China announced a 25 basis point cut in bank reserve ratios.
Kazuo Ueda, the new governor of the Bank of Japan, has faced a bewildering array of challenges from the outset in Tokyo. A large one bridges the wide gap between US and Japanese interest rates.
Japan’s economy may not be resilient enough for BOJ tapering, let alone rate hikes. But as the Fed continues to hike rates, the yen is under downward pressure. This could exacerbate the worst Japanese inflation in 40 years.
Japan’s wholesale and consumer prices have risen to a decade high on rising global commodity and fuel costs.
RICHARD A. BROOKS/AFP via Getty Images
Talk about Catch 22. Japan’s inflation is largely out of the BOJ’s control. It seeps in via elevated global energy and food prices, not strong domestic demand. The more the Fed tightens, the softer the yen becomes and the greater the risk that Japan will import more inflation.
But the Powell era, which began in February 2018, may be remembered for causing severe damage to the Fed’s hard-won credibility. In 2019, Powell bowed to pressure from then-President Donald Trump to add stimulus the world’s largest economy didn’t need.
With Trump effectively threatening to fire him, Powell led the Fed down a dangerous path by cutting interest rates to appease the White House. In 2020, when Covid-19 hit, the Fed had less ammunition to defend growth.
After selling his money soul to Trump, Powell tries to buy it back. His arguments in 2021 that rising inflation would prove temporary proved dead wrong. As he struggles to make up for lost time — and repair his legacy — Powell risks inflicting a series of collateral damages in his wake.
Gavekal Research economist Tan Kai Xian still believes that the “Fed’s actions to contain inflation will fuel a deepening of the banking crisis that has probably only just begun.”
The panic surrounding the SVB seems to have subsided for the time being. However, there is a lag between the Fed raising interest rates and the impact on the financial system. Capital Economics’ Neil Shearing warns that there is still a risk of a “doom loop” developing if the Fed unleashes a series of chain reactions.
A major concern is the many U.S. office buildings that are essentially half empty in the wake of the pandemic. That’s a gaping vulnerability. CNN reports that analysts at Goldman Sachs believe banks currently have 55% of US office loans on their balance sheets. The more the Fed raises the cost of borrowing, the weaker things get.
The shock waves would hit Asia all too quickly. Hence the paranoia in Asian markets that the Powell Fed is missing the bigger picture over 2023.
Here, the debates at the Bank of Korea’s headquarters in Seoul are very revealing. In August 2021, the BOK became the first major monetary authority to hike interest rates after the pandemic. Now, however, this global weathervane is pausing on rate hikes pending more clarity from the Fed.
The problem is that Asia has limited insight into whether the Powell Fed really knows what it is doing. Even the most superficial look at the Powell era does not inspire confidence.
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