The latest word from the US Federal Reserve is that it remains confident it can undertake a rate cut in the coming months.  

While Fed chairman Jerome Powell admits there is a “lack of progress” in reaching the US central bank's inflation target of 2%, he says another rate hike in the current cycle is “unlikely”.

At the end of its two-day meeting on Wednesday (early Thursday in Hong Kong), the Federal Open Market Committee (FMOC) kept the federal funds target rate steady at 5.25% to 5.5%, the same level it has held since July 2023 and the highest in more than 20 years.  

Experts note that the FOMC statement kept its dovish language, a signal that the Fed is keeping inflation under control although it remains at elevated levels.

Preferred scenario

For Asian investors, this means a “higher for longer” interest rate environment with the US economy continuing to be strong. This dynamic is preferred in the region, compared to a scenario where rate cuts are implemented because US economic growth is faltering.

Tai Hui, chief market strategist at J.P. Morgan Asset Management, says: “We now expect the committee to reduce rates 1-2 times this year, with risks skewed to fewer cuts. Investors should take solace in that growth remains strong and consumption is solid. While inflation seems sticky, it’s not ‘sticking’ at a level that is causing a surge in wages, eroding consumption, or lifting inflation expectations, comfortably putting stagflation fears to rest.”

For investors, as long as the Fed remains biased towards cutting rates at some stage, risk assets will be supported, particularly if consumption growth remains strong, Hui says, noting that tight US labour markets and strong wage inflation support income.

“Asian market participants could heave a collective sigh of relief as the continued easing bias by the Fed is a welcomed development for Asian risk assets,” says David Chao, global market strategist, Asia Pacific (ex-Japan), at Invesco.

“Asian risk assets could continue to perform well. Global growth, led by the US, appears to be re-accelerating, which is positive for the Asian economies and markets.”

Chao, however, warns that in a “higher for longer” rate environment, Asian currencies would continue to struggle against a stronger US dollar, making the situation more challenging for central banks in the region.

Capital outflows

This warning is echoed by Nigel Greene, founder and chief executive officer of deVere Group, who says emerging market (EM) central banks are increasingly under pressure to increase rates as the Fed maintains rates at its current levels.

“This puts the squeeze on emerging-market central banks, including countries like South Africa, India and Mexico, to hike their own rates in order to address currency depreciation, inflationary pressures, capital flight risks, and external debt servicing concerns,” Green says.

But there’s a bright side to this scenario. As EM central banks raise rates, government bonds will deliver higher yields, which in turn would attract foreign investors, thus resulting in capital outflows from developed markets to EM economies.