Lower US interest rates will benefit EM assets, similar to what was experienced during the 2007/2008 global financial crisis

by MARK RAO / pic by MUHD AMIN NAHARUL

GLOBAL liquidity is expected to make its way back into emerging markets (EMs), including countries like Malaysia, if the US Federal Reserve (Fed) pushes for easing of rates.

EMs witnessed billions in funds scurrying out after challenging 12 months as growth prospects in the economies eased and the US equity markets hit new highs.

Bank Islam Malaysia Bhd chief economist Dr Mohd Afzanizam Abdul Rashid said lower US interest rates will benefit EM assets, similar to what was experienced during the 2007/2008 global financial crisis.

“It would boost stock and bond prices as global liquidity would be shifted from developed markets to high-yielding countries, especially in Asia and other emerging economies,” he told The Malaysian Reserve (TMR).

But the quantum of the US rate cut would determine the size of the fund flows, he said. The Fed will decide on the benchmark US lending rate today and anticipation is high that the US central bank will lower the rate to accommodate for growing growth and trade risks.

While markets differ on the quantum to be deployed, a rate cut in July leaves room for further monetary easing by the Fed which is scheduled to meet an additional three times this year.

Malaysia and other emerging and risk-based markets were victims of the hawkish Fed interest-rate increases. The US monetary authority had raised interest rates four times last year, triggering an exodus to US Treasuries and bonds.

Malaysia’s equity and bond markets registered total net outflows of RM11.7 billion and RM21.1 billion respectively last year, while the ringgit depreciated approximately 2.7% against the US dollar.

The Fed last deployed monetary easing during the global financial crisis when it lowered interest rates a total of 10 times between 2007 and 2008. The rate was effectively zero by December 2008, and remained at that level up to 2015.

However, Mohd Afzanizam said the resiliency of the US economy will influence just how aggressive the Fed will cut the interest rates.

“(A resilient US economy) could alter the Fed decision whether they would introduce aggressive monetary easing or just take preemptive measures by cutting rates only at a marginal pace.

“This will remain an open debate should the US economy continue to exhibit resilience,” he said.

The US-China tariff war has set alarm bells ringing as global trades are expected to take a dive. Worries of a slowing US economy would drag the global economy.

Recent economic data coming out of the US have largely been mixed with consumer spending up, at the same time, business investments declined. Meanwhile, exports plummeted though imports into the country grew.

Mohd Afzanizam said downside risks to global growth are still material, especially in the context of an ongoing US-China trade war, thus building the case for lower rates.

Vanguard Markets Pte Ltd managing partner Stephen Innes said lower US interest rates not only attract foreign inflows into Malaysia’s equity and bond markets, but allow Bank Negara Malaysia (BNM) greater monetary flexibility.

“A Fed cut offers (BNM) more policy wiggle room to lower interest rates, but it is also the fact that currency volatility remains low,” he told TMR.

“(It is this) that makes them feel even more comfortable as it’s unlikely the ringgit, for example, will weaken too much and weigh negatively on servicing foreign debt obligations,” Innes said.

But Innes said the markets have fully priced in a Fed rate cut in July, meaning there is limited upside for Malaysia’s capital markets following the decision.

“Unless the Fed delivers a 50-basis-point rate cut, it’s back to the trade war where the picture remains very uncertain,” he said, adding that the biggest factor to consider is the waning global growth arising from trade war conditions.

“If the Fed eases again, it could be viewed negatively for markets as manufacturing drag is starting to weigh on consumption, so it is important to keep tabs on the global economy.”

Investors typically flock to safety during a global recession, benefitting safe haven assets such as gold, the US dollar, Japanese yen, the euro and the Swiss franc at the expense of risk-based assets.