Several Asian central banks have started cutting interest rates, driving down bond yields in Asia. In contrast, the US Federal Reserve is still caught between a rock (slowing growth) and a hard place (higher inflation). The 10-year US Treasury yield has been trapped in a 4%-5% range for over a year, though more recent moves have been toward the lower end of the range.
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Bank of Thailand, Bank of Korea, Banko Sentral ng Pilipinas (BSP) and Bank Indonesia have cut rates in recent weeks, sustaining the downtrend in Asian government bond yields since early this year (see Exhibit 1) and validating our constructive view on emerging Asia assets.
More Asian rate cuts to come
Further rate cuts by the region’s central banks appear on the cards. The catalysts include a benign outlook for inflation, headwinds to growth from the US tariffs on imports, and expected reductions in the US policy rate.
Restrictive real (inflation-adjusted) policy rates in Asia are a push factor for more monetary easing. Despite the recent rate cuts, real policy rates in most Asian economies are far above their historical averages (see Exhibit 2).
China likely to ease further
The latest data argues that China’s economy needs more support to underpin growth. Though August’s purchasing managers’ index rose by 10 points to 49.4 from July’s number, the PMI is still in contractionary territory.
In addition, property market data shows that sales volumes of the top 100 developers shrank by 31% month-on-month in August after a 19% contraction in July.
Continued weak growth momentum has prompted Beijing to double down on its support since August. The authorities have eased monetary conditions and property market restrictions further and boosted consumption-related fiscal spending.
The government’s macroeconomic strategy is to combine supply-side reforms and demand-expansion policies. Sustaining this two-prong approach should help end deflation and improve the outlook for China’s asset market in the coming months.
Stagflation dilemma for the US
The Jackson Hole economic symposium of central bankers a fortnight ago saw relief in the policy tensions around the Fed’s dual mandate as Chair Jerome Powell shifted the tone towards an easing bias. However, the prospect of rising inflation and a weakening labour market still leave the US central bank with a tough juggling act.
Uncertainty over the impact on inflation and growth of the import tariffs looks likely to last now that a federal appeals court has ruled that the tariffs, which Washington raised under the International Emergency Economic Powers Act (IEEPA), were illegal. The White House plans to appeal.
Meanwhile, US inflation remains a concern. Core and headline personal consumption expenditure (PCE) inflation rose to 2.9% and 2.6% YoY, respectively, in July – that’s well above the Fed’s 2.0% target for core inflation.
There are scattered signs of an economic slowdown. Factory orders have contracted for four months so far this year, the ISM manufacturing index has remained soft (at 48.7, August’s index has been below 50 for six consecutive months), and the labour market is weaking (see Exhibit 3).
The Job Openings and Labor Turnover Survey (JOLTS) report showed job openings falling to a one-year low, while non-farm payroll data rose by a weaker-than-expected 22,000 jobs. Both will fan the Fed’s worries over the risks to US growth.
The conflicting inflation-growth dynamics have trapped the 10-year US Treasury yield in the 4%-5% range for over a year (see Exhibit 4). The yield tested the ceiling of the range when inflation fears increased and touched the floor when concerns mounted over a sharp economic slowdown or even a recession.
Short and long yields
The US labour market could weaken further amid deportations of immigrant workers, restrictions on immigration and tariff-related uncertainty. Such an outlook would add to downward pressures on short-term Treasury yields as the Fed begins a rate cut cycle.
At the long end of the yield curve, the battle over the legality of tariffs will increase uncertainty over the path of inflation, but concerns over the Fed’s independence and the US’s large fiscal deficits could cause the curve to steepen.
The global rise in long-duration bond yields at the beginning of the week of 1 September reflected this dynamic.
