Yen, emerging markets to see biggest impact of Fed cut in Asia

The Federal Reserve’s widely anticipated pivot to interest-rate cuts this week is likely to bolster emerging Asian market assets, further extending their recent lead over global favorites such as Japan and chip stocks.

Smaller Southeast Asian markets may continue to do better than larger ones, while a significant rise in the yen might cause volatility in the Japanese market and high-performing chip stocks. Fear of an unwind in the yen carry trade has the potential to hit markets globally.

Investors are split on whether the Fed will kick off its easing campaign with a standard 25 basis point cut or a larger one. A half-point reduction may raise doubts about the health of the US economy, outweighing any enthusiasm about a stimulatory effect from the cut.

Here’s a look at what market participants are expecting.

Watching Yen

The yen’s trajectory is closely tied to expectations around Fed rate cuts. The currency surged past the 140 per dollar mark on Monday, reaching its strongest level this year, as speculation grew about a half-point cut.

This has spooked Japanese investors, as a bigger Fed cut could boost the yen further, hurting the earnings of the nation’s exporters. Traders, hedge funds and institutions still have fresh memories of last month’s sharp rally in the currency following the Bank of Japan’s rate hike, which fueled a wave of selling across global markets.

After the Fed’s rate decision, attention will turn to the BOJ meeting on Friday. While most economists anticipate no changes in policy, investors will be looking for any signals hinting at another possible hike in December.

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Bets on Smaller Markets

The smaller Southeast Asian markets have become a top choice for money managers positioning for the shift in Fed’s policy. Four of the five best-performing Asian equity benchmarks this month are from the region, with Thailand leading.

For the past two months, fund managers have boosted positions in sovereign bonds in Thailand, Indonesia and Malaysia. They’ve been net buyers of Indonesian, Malaysian and Philippine equities for three months. These inflows have made Southeast Asian currencies the best performers in emerging markets this quarter.

India as EM Anchor

Lower rates in the US may prompt the Reserve Bank of India to reduce borrowing costs. This prospect has attracted foreign investors to local shares, pushing up the main equity indexes to a record on Tuesday.

“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, a fund manager at Smartsun Capital Pte. in Singapore. India’s economic growth rate will help attract more flows, he added.

India’s rising heft in emerging market allocation may also get a boost following a Fed rate cut. The country — long touted as “the next China” — has emerged as a favorite among investors, driven by its robust economic growth, a growing middle class and burgeoning manufacturing sector.

Mixed Mood on China

Yuan strength could gather pace if the Fed rate cut shrinks the yield gap between US and Chinese government bonds.

Still, the mood is cautious as investors wait to see whether weak economic data over the weekend will prompt authorities to ramp up fiscal and monetary stimulus. The CSI 300 Index closed at its lowest level since 2019 last week.

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A rate cut by the Fed may mean China has more room to ease without currency worries, but “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,” said Vey-Sern Ling, a managing director at Union Bancaire Privee.