'Asian banks to decouple from the Fed soon', says Nomura, cites 3 reasons

In India there could be a delay in the first rate cut because of the higher inflation point.

Indian banks, along with banks in Asia, could decouple from the Fed soon, according to Nomura’s latest report.

According to the brokerage’s economists Sonal Varma and Si Ying Toh, while Asian banks cutting rates ahead of the US Fed may seem counterintuitive, it has happened before. They cited six hiking cycles and said, except in one of the cycles, all the rest saw three out of eight Asian banks cutting first. “Most recently, during the Fed’s pause in H1 2019, India and the Philippines began cutting policy rates 2-5 months ahead of the Fed’s first cut to support domestic demand,” they wrote.

Fed's rate hike-and-pause cycle and Asian banks' response

“This runs counter to the widely held view that monetary policy in high yielding/current account (CA) deficit countries is aligned to the Fed due to FX concerns. On the contrary, CA surplus countries – China, Thailand, Korea – have historically moved more in sync with the Fed (but not always),” the economists noted.

This time around, the brokerage expects Korea, India and Indonesia to act before the US Fed due to “faster disinflation, weak demand and higher real rate”.

In India, there could be a delay in the first rate cut because of the higher inflation point. The economists have raised their CPI forecast for 2023 to 5.2 percent from 5 percent on rising vegetable prices.

Among Asian banks, India’s policy along with Indonesia’s was the second-most-decoupled from the Fed. In these two countries, they acted ahead of the Fed in three of the six instances, the economists cited. The most decoupled was the Philippines where the central bank did so four times out of the six.

The economists are basing their view on decoupling of banks based on the divergence the economies of Asia and the US.

For one, in Asia, the goods-led manufacturing downturn is hurting growth in Asia’s export-oriented economies and the recovery from the export-downcycle will be slow. For another, disflation is progressing faster than in Asia because food and energy have higher weightages in the CPI basket and higher wages are not a concern. In Asia, the near-term risks come from the supply-side and they are from El-Nino and the vegetable prices.

Thirdly, with faster fall in inflation, real-policy rates could become restrictive if nominal rates aren’t changed fast enough, according to the brokerage’s economists.

“For example, assuming unchanged policy rates, real policy rates will average ~1.5-1.8pp in India, Korea and Thailand, and 3.0-3.2pp in the Philippines and Indonesia over the next one year (Figure 4). As domestic demand cools and core inflation falls durably, this will call for moving rates to less restrictive settings, in our view,” they wrote.