Fed Tightening Hits Asia's Deficit Economies Hard

The US Federal Reserve's tightening cycle is expected to have a significant impact on Asian economies and financial markets. The Fed has hiked its benchmark interest rate by 25 basis points, and officials' views indicate that one more rate hike is likely this year, with as many as three more hikes possible through the middle of next year.

The higher US yields are expected to draw global investors to dollar-denominated assets, leading to capital flight from emerging Asian markets. Economies with current account deficits, such as India, Indonesia, and the Philippines, will be hit hardest, as they rely heavily on foreign investments to finance their trade shortfalls. In contrast, economies running current account surpluses, like China and South Korea, may see their currencies appreciate.

The depreciation of local currencies can fuel imported inflation, which is already being amplified by global energy supply shocks and the El Nino weather pattern. Deficit countries in Asia with weak currencies are seeing high levels of inflation, with India's inflation rate at 4.8%, Indonesia at 3.2%, and the Philippines at 6.1%. China, Taiwan, and Malaysia remain notable exceptions to this trend.

Equity market valuations are also at risk across the region. Rising yields have historically led to declines in forward price-to-earnings multiples in various Asian equity markets, as rising discount rates drag down valuations. Different sectors will react differently, with 'long duration' equities, such as technology companies, being more affected by rising interest rates.