Abacus | Be afraid, be very afraid as US readies to raise interest rates
On Wednesday the Federal Reserve is highly likely to raise US interest rates, resuming the cycle of tightening that was put on pause early in 2016 amid heightened financial market volatility. It is a nervous time for Asia. Not only are US interest rates rising, but the US currency is strong – the US dollar has risen 24 per cent against a basket of major currencies in the last two and a half years.
The precedents are hardly encouraging. The last time the US entered a tightening cycle, the result was the credit crunch of 2007 and the financial crisis that followed the year after. And the last time we had US interest rates and the US dollar going up at the same time, we got hammered by the Asian crisis of 1997. So how worried should Asia be this time around?
HSBC hits fresh one-year high as bank shares gain ahead of expected Fed rate rise
The answer depends on where in the region you are standing. A strong US dollar means US consumers have greater purchasing power. And if US interest rates are going up to mitigate the inflationary effects of strong US demand, that demand will tend to favour Asia’s exporters. On the other hand, a stronger US currency and higher US interest rates make it punishingly expensive for Asian companies that have borrowed in US dollars to service their debts.
The good news is that neither a 2008-style US financial meltdown, nor a 1997-style Asian currency crisis is on the cards. American consumers are much less indebted today than a decade ago, and the US financial system is more resilient. And Asian economies have largely abandoned the fixed exchange rate systems that shackled their currencies to a rising US dollar and made them such easy targets for speculative attack.
Nevertheless, with the yield on 10-year US Treasury bonds up from an all-time low of 1.3 per cent in June to a little over 2.3 per cent currently, it looks very much as if the long 35-year bull market in bonds is finally over. Such major turning points in financial markets do not occur without casualties. And if US dollar bond markets now enter a protracted bear phase, propelled by the inflationary effects of US president-elect Donald Trump’s proposed economic stimulus policies, the collateral damage could be severe.