Asia CBs Urge Caution

With the global economy on an uncertain trajectory, China and the US on the cusp of a trade war and commodity prices recovering, Asian central banks are reassessing their monetary policies. After rate cuts in the last year, central banks are now adopting a "wait-and-see" attitude.

Last July, Bank Negara Malaysia surprised markets by cutting its benchmark interest rate for the first time in seven years. Fast forward six months and that cut seems a distant memory, Nikkei reported.

On Jan. 19, Malaysia's central bank kept its main rate on hold for a third consecutive time, stressing that "uncertainties in the global economy, the policy environment and geopolitical developments may result in bouts of volatility."

Malaysia has already experienced a sell-off. The ringgit has plunged 12.5% against the dollar since last July, with nearly half the decline occurring since Donald Trump was elected US president on Nov. 8. Malaysia's local currency government debt market, moreover, suffered outflows of nearly $6 billion in November and December, according to JPMorgan Chase, amid fears that Trump's reflationary economic policies would force the US Federal Reserve to tighten monetary policy aggressively.

Indonesia's central bank also left its benchmark rate unchanged in January for the third month in a row. It has warned of the need to remain vigilant of risks, including "the policy directions taken in the US and China." The rupiah has fallen nearly 3% against the dollar since the end of October, after having strengthened for most of last year.

Meanwhile, the Reserve Bank of India, which cut rates in October for the first time in six months, unexpectedly kept its main rate on hold in the face of a cash crunch stemming from the controversial demonetization initiative. The RBI cited the possibility of faster rate hikes in the US as a reason for its caution.

South Korea and Taiwan, both of which were trimming rates as recently as June, also stand pat.

JPMorgan expects monetary policy to remain firmly on hold in Malaysia, Thailand, Taiwan and the Philippines for the whole of 2017.

Reduction in Monetary Easing

Make no mistake, emerging Asian central banks' dovish stance over the past two years has run its course.

It is not just the tightening in global financial conditions—the yield on benchmark US 10-year Treasury bonds has shot up nearly 65 basis points since Trump's victory, to its highest level since September 2014—that has reduced the scope for further monetary easing in Asia. Since hitting a record low in January 2016, the Bloomberg Commodity Index has risen 20%.

This rebound is contributing to stronger economic data. Indonesia's exports rose 9% on a monthly basis in November, buoyed by sharp increases in the prices of coal and crude palm oil, while those of Malaysia—emerging Asia's sole net oil exporter—increased nearly 12%. Rising inflation rates across the region are still on an uptrend as the recovery in commodity prices takes hold.

This and higher core bond yields means that the scope for easier monetary policy across emerging Asia has narrowed further, JPMorgan noted.

Unsurprisingly, the more cautious stance by emerging Asia's central banks is weighing on the region's local currency bond markets, already strained by a significant reduction in foreign purchases. JPMorgan says foreigners only bought $12 billion of emerging Asian local bonds last year, compared with $86 billion in 2014 and $23 billion in 2015.

Another reason for prudence is the threat of a destructive trade war between America and China. Emerging Asia is vulnerable to an escalation in trade tensions because of the openness of regional economies and the importance of China's financial markets in shaping sentiment.

Still, the greenback has weakened this year and emerging market bond and equity mutual funds are once again enjoying inflows after several weeks of outflows following the US election.

The region's rate-cutting cycle may have just about run its course, but there is no pressure to tighten monetary policy just yet.