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Fed's quantitative tightening looms over Asia as yields the key

[SINGAPORE] Asian emerging markets were among the biggest beneficiaries of the Federal Reserve's massive balance-sheet build-up over the past decade. So it's tempting to conclude the Fed's coming asset wind-down bodes ill for bonds and equities from South Korea to Taiwan.

The key gauge to watch may not be the pace at which the US central bank's balance-sheet contracts as what happens to 10-year US Treasury yields. If those benchmark rates remain contained below 3 per cent, investors may still have a twinkle in their eyes for the higher returns available outside the US.

There's little precedent to rely on, as Fed policy makers embark again for uncharted waters, after unprecedented rounds of quantitative easing that began in 2008 and continued through 2014. For now, emerging markets continue to enjoy strong capital flows - for Thailand, the influx is so strong that officials are dusting off the toolkit to potentially limit gains in the baht.

"The US yield curve could steepen further, which would also impact local yield curves," said Rajeev De Mello, who oversees about US$11.7 billion as head of Asian fixed income in Singapore at Schroder Investment Management Ltd.

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"We don't believe this announcement by itself would lead to a period of market turmoil. Investor interest in emerging markets has been strong as we would expect it to continue." The US 10-year yield could gravitate toward 2.75 per cent, he said.

If Mr De Mello's view is accurate, Thursday's retreat in Asian stocks and currencies won't be part of a longer trend. The MSCI EM Asia index slid 0.8 per cent by 2:52pm in Tokyo, while South Korea's declined 0.6 per cent.

Emerging Asia's bonds and equities lured more than US$40 billion this year as the US 10-year yield rose as high as 2.63 per cent last month. The last time the US 10-year yield reached 3 per cent was in early 2014, months after then Fed chair Ben Bernanke signalled he will stop quantitative easing.

The region's improved economic outlook, helped by a more stable Chinese economy and an accelerating US economy, pushed a gauge of regional equities to its best performance last quarter since September 2010. All Asian emerging-market currencies advanced this year, except for the Philippine peso. Local bonds also mostly gained, with China and India the only losers.

For Fidelity International and BNP Paribas Investment Partners, the removal of market-supportive measures is a positive indicator for both US and global growth.

Manufacturing gauges for Asia and emerging markets in general are "encouraging," said Bryan Collins, a fund manager at Fidelity in Hong Kong. He said the impact from a reduction of the Fed's balance sheet would be minimal as monetary policy remains accommodative.

"For Asia, we are not that concerned," said Hue Lu, a senior investment specialist at BNP in Hong Kong.

"Following the recent December rate hike, investors barely blinked. We believe even those economies viewed as 'fragile' within Asia are in a better situation today as a result of reforms which have been implemented in recent years."