Hawkish comments from several Fed officials last week, reinforced by Friday's stronger-than-expected July jobs data, have dashed hopes of a dovish Fed pivot. Markets now are likely readjusting to the prospects that the end of the Fed hike cycle could be further out in terms of timing and terminal rates could be higher. What does this mean for Asia swap rates, where hike pricings are currently quite fairly valued (vs aggressively overpriced in 1H)? We think that, all else equal, if the Fed is going to hike more than currently priced, then Asia central banks should be expected to hike more as well. After all, US-Asia rate differentials cannot widen excessively without compromising financial stability. Furthermore, fx reserves across Asia have already come down materially, and continued and sustained drawdown to offset outflows and currency depreciation pressures could impair reserve adequacy metrics.
That said, we think that any possible repricing higher of Asia rate hikes is likely to be of a smaller extent compared to for the US Fed. Ultimately, compared to the Fed, current reaction functions of Asia central banks attach smaller weights on achieving inflation targets and larger weights on supporting growth. Most Asian economies also have in place subsidies and price controls, together with other measures such as export restrictions, to partially absorb inflationary pressures. Most Asian economies are also more exports-oriented, and signs of slowing of external demand could weigh more on central bank considerations. Therefore, we think Asia rates outperformance (vs the US rates) could be a key theme for rest of the year - 1) Receive 1Y or 2Y Asia swaps vs pay US and 2) 1Y-2Y or 1Y-5Y Asia steepeners vs US flatteners could do well ahead.
RBI's 50bps hike last week was at the higher end of the forecast range of 35-50bps. Reaction in INR OIS rates appear to be reading the larger-than-expected hike as front-loading, rather than repricing for a longer hike cycle. The surge in OIS rates on the day of hike was also exaggerated - There was a plunge the day before on media reports of a pause. We have a BOT decision later today where consensus is for a 25bps hike while THB OIS pricing is split between 25 and 50bps. Front-end term premium has been relatively high compared to other regional swap markets because BOT has been slow to hike. If BOT goes for the larger 50bps hike, we think that would compress the term premium and allow the front-end curve to flatten.
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