Markets cower under shadow of hawkish Fed

[SINGAPORE] Financial markets around the world retreated yesterday as they digested subtle changes to the US Federal Reserve's latest policy statement, while analysts warned of greater unpredictability and the possibility of a more hawkish stance in coming months.

Markets latched onto three key aspects of the Fed's March 19 statement, which was issued before yesterday's opening bell in Asia. First, the Fed departed from its previous target of 6.5 per cent unemployment as a pre-condition for raising short-term rates; it switched instead to a more qualitative assessment of labour market conditions, inflation and financial developments.

Pressed to define how long the Fed might maintain its current low-rates policy after the end of quantitative easing, Fed Chair Janet Yellen said at her first news conference since stepping into her current role that "it probably means something on the order of around six months or that kind of thing".

The third key piece of data came from the Fed policymakers' quarterly projections of interest rates and policy firming, which suggested stronger expectations of higher rates in 2015 and 2016 and tightening in 2015 rather than in December.

Stock markets perceived a more hawkish stance. The Straits Times Index slipped 0.8 per cent, or 23.55 points, to close at 3,057.2, with most major industrial indices lower on the day. The Thomson Reuters South East Asia Index eased 0.05 per cent to close at 406.84.

Real estate investment trusts (Reits), which took a hit last year in the run-up to the tapering of quantitative easing, were relatively resilient, said CIMB analyst Donald Chua.

"Reits have not fallen as much as the other property companies," Mr Chua said. "The greater worry is the ones that are exposed to China, like CapitaMalls Asia, Global Logistics Properties, CapitaLand. . . That's not to say that Reits are very compelling instruments at the moment, but the anticipation of high interest rates is already there."

OCBC analyst Eli Lee said the impact on developers - which could see a drop in demand if interest rates rise - was slightly more complex.

"The looming spectre of rate hikes certainly poses incremental headwinds to an already slowing housing market," Mr Lee said. "That said, we believe the key driver for the slowdown over the last two quarters were government measures (primarily the total debt servicing ratio limit) aimed at averting a housing bubble, and we could see authorities reviewing them should prices accelerate to the downside due to external macro forces."

ING economist Tim Condon said the current round of concerns affect equities because a tightening interest rate policy would raise short-term borrowing costs. Hong Kong and Singapore are particularly vulnerable to changes in short-term rates, he reckoned.

"In Singapore it will be hit quite hard when Libor goes up because people think that tightening is imminent. That will be felt directly in Singapore, and there won't be any cushion," Mr Condon said.

While tapering raised bond yields at the long end of the curve, the current discussion about the Fed's rates policy affects short-term yields, Mr Condon noted.

In the wake of Ms Yellen's comments, the benchmark two-year US Treasury yield rose seven basis points, the steepest increase since 2011.

"We're not looking at a 150 basis-point increase in 10-year Treasury yields like we saw last year with tapering," Mr Condon said. "The impact will be in the front end, which is what we're going to see in Asia. The impact will be felt the most where money-market interest rates are most tied to the US, which is Hong Kong and Singapore. Singapore historically will go up something like two-thirds of what Libor goes up in the US."

Mr Condon also noted that regional economies such as Indonesia and Malaysia, which were hit by concerns over their current account deficits amid the tapering talk in 2013, are unlikely to face the same problems this time because the market's reaction will not be as abrupt. "It won't be so bad for countries like Indonesia," Mr Condon said. "It will be more adverse for equity markets."

DBS economist Irvin Seah also noted that Sibor has inched up recently.

"Investors, home owners, consumers and businesses will have to price in higher rates in their loans to ensure that they get themselves covered, that they don't get themselves over-extended," Mr Seah said.

Bank of Singapore economist Richard Jerram wrote in a note that the Fed's assessment of the US economy did not seem to have changed. But the move away from a firm unemployment target suggested a return to "the more traditional way of setting policy".

"A shift to qualitative guidance implies a rise in financial market volatility, for two reasons," Mr Jerram wrote. "First is that the Fed will find it more difficult to convince the markets about its policy intentions, so verbal guidance will have a stronger effect on markets. Second is that fluctuations in the economic data will lead to volatility in interest rate expectations. We need to watch for a similar rise in rate expectations to that which accompanied the move towards tapering in mid-2013."

But Mr Jerram felt there was a need to differentiate between the various markets in the region.

"The past six months have shown that we need to be careful in discriminating within the emerging market universe," he wrote.

"Countries with a moderate deficit and with a credible policy response are able to stem and reverse a currency decline. Others with wider deficits and poor policy management will struggle."