Bank of Japan’s actions may make up for end of Fed easing in emerging Asia says Merrill Lynch

9th April 2013

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The actions of the Bank of Japan will have significant impacts on global markets outside of Japan too, especially those in emerging Asia argues Johan Jooste, chief market strategist, EMEA Merrill Lynch Wealth Management.

In a note issued today (09/04/13), Jooste says that historically, the performance of emerging market assets, including those in emerging Asia, have been heavily supported by low interest rates and, more recently, liquidity provided by Fed easing. He writes: “As a result, investors have begun to question whether emerging market equity performance can be sustained were the Fed to begin winding down its asset purchases. Additionally, investors are worried that were the U.S. dollar to continue its recent appreciation, this may pose a headwind to Emerging Market Asia.

However he says the actions of the Bank of Japan may well offset at least some of the risk from emerging market equity.

“While part of the new BoJ liquidity will likely end up in the Japanese stock market, we believe some will also flow to Japan’s neighbouring emerging markets. Flows data suggest that Japanese investment flows into international assets denominated in EM currencies have already begun. This trade may gain momentum, in our view, if the threat of yen appreciation is now reduced by the new stance of the BoJ. This trend may even offset some risk from lower liquidity support when QE3 by the Fed ends.”

“It is often underestimated how key the actions of the Bank of Japan are to this region in terms of liquidity support and an easing of financial conditions in emerging Asia. At present, the Fed continues asset purchases at a rate of $85 billion per month – a considerable amount of money supply. Were such easing to cease towards end-2013, asset markets in emerging Asia would likely suffer some short-term volatility. However, from now to end-2014, the BoJ will make gross purchases of Japanese government securities of JPY7 trillion per month, or over $70 billion. This is a sizeable amount that could offset much of the possible reduced liquidity by the Fed, in turn supporting emerging Asia.”

He also says that the recent appreciation of the dollar may also be increasing the risk appetite.

“Since the financial crisis, episodes of U.S. dollar appreciation have often been driven by risk-averse investor sentiment, due either to weakening economic indicators or to the eurozone financial crisis. Yet recently, the U.S. dollar has been appreciating due to better U.S. economic data relative to global activity. This has actually lifted risk appetite which we believe should prove beneficial for emerging Asia assets.”

He also notes that many emerging market economies have cut back on foreign owned debt while a weaker yen may help countries such as Thailand which rely on Japanese imports for local production.

“Since the onset of the global financial crisis, many EM Asian economies have reduced the scale of foreign debt to foreign savings reserves (notably India and Thailand, by around 0.5 per cent of respective GDP each) – i.e. they are less economically vulnerable to lower U.S. dollar liquidity. Having built up foreign currency holdings through export-led growth strategies, many open EM Asian economies may be able to reduce the potentially harmful effects of a strengthening greenback on debt servicing costs. Foreign savings buffers also reduce sensitivity to hot money outflows, should a rising U.S. dollar pressure corporate borrowing costs and therefore investment returns.”

“A weaker yen lowers import costs for EM Asian nations that use Japanese imports in local production. Thai exporters stand particularly to gain from this development, in our view. Better Japanese economic growth may also support firmer demand for raw materials from local neighbours.”

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