Markets around the world are waking up to the reality of rising interest rates. That is a far cry from the fantasy world that the Trump administration lives in. The US administration believes that interest rates should be lowered because the economy is growing strongly. That is just preposterous.
However, the rate-tightening cycle that is happening in the US could prompt central banks in Asia to hike rates, too. In the case of the US, it is unlikely to be one-and-done. The Fed could continue to raise rates until the spectre of entrenched inflation is put to rest.
That could be a tall order, given that the causes of inflation have been self-inflicted by the Trump administration. For instance, the US-Iran war that has caused energy prices to surge shows no signs of abating. It is unclear if America has even found a way to end the conflict.
The shift in US monetary policy could have an impact on many economies here in Asia. Firstly, the more attractive interest rate on US dollars could encourage a flow of capital into the greenback. Secondly, weakening Asian currencies could stoke inflationary pressures. Thirdly, softer Asian currencies could prompt central banks in the region to raise interest rates in response to higher US interest rates.
The impact of higher US interest rates could cause problems in many ways. Particularly vulnerable are Asian economies that are running large deficits. Additionally, depreciating Asian currencies could exacerbate economic conditions as imports become more expensive. The upshot is that stock markets in the region could come under pressure, if they haven’t already done so.
A drawdown of regional equities is a natural response to what is happening. After all, a risk-free return of 5% on 10-year Treasuries can be too tempting to ignore. But 10 years is a long time to be out of equities. Additionally, higher interest rates are not necessarily bad for all sectors of the stock market.
Banks, for instance, thrive on high interest rates. It can help to boost their net interest income by widening the difference between the interest that they pay savers and the interest they charge borrowers.
Insurance companies can benefit from higher interest rates, too. It can be a good way to generate a high return on their float, as they invest in higher-yielding bonds. But high interest rates can be bad news for heavily indebted companies.
The upshot is that rising interest rates can have a mixed impact on the stock market, even though some investors may see equities as a homogenous unit. That can create good buying opportunities for investors who are prepared to look through the current interest-rate cycle.
It is important that we don’t lose sight of our long-term goal just because interest rates are rising. A 5% yield on a risk-free bond might seem appealing at the moment. But bear in mind that it will be 5% a year for a decade. We want to do better than that. And that 10-year Treasury is just not going to cut it.
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David Kuo does not own any of the shares mentioned.
