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Post date: Oct 24, 2013 9:30:18 AM
by Chang Ngee Hui & Veena Loh
The quantitative easing in the US is likely to end once the US economy recovers as expected, Ben Bernanke said in June 2013. The key indicator of the state of the US economy is the unemployment rate which is forecast
to be reduced to 6.65% by next year.
The current actual unemployment rate is 7.25%, which was recently revised from the earlier estimate of 7.5%. If the improvement of the US economy continues on trend, Bernanke said that it is likely that QE may end by mid-2014.
Ben Bernanke’s mere statements about the tapering of US bond purchases roiled both world stock and bond markets. The expected end of QE is setting in motion an unwinding of world stock and bond markets which have previously benefited from it. QE is the US Fed’s strategy of pumping liquidity into the US economy via the purchase of bonds by the Fed from banks. This has the impact of pushing up bond prices, thereby keeping bond yield and other interest rates down. QE1 started in November 2008 and QE2 in November 2010. The current round QE3 which
started in September 2012 raised the purchasing to US$85 billion a month of US government bonds and other bonds.
Subsequent to this reaction, Bernanke has tried to calm fears in the market by saying that the Fed will still want to maintain a low interest rate environment. However, as Bernanke will be stepping down by early next year, the new replacement may be likely to depart from the old school of thought.
At that time, Lawrence Summers who had voiced his thoughts that QE has not been effective and he was likely to be chosen as the new head. Summers is no longer in the running and the next likely candidate is Yellen who has been
working closely with Bernanke. Markets have since responded with a relief rally as continuity is expected and Yellen is likely to keep interest rates low for a long time.
The end of QE and its impact
The end of QE has three very different consequences. One is that there will be no additional inflow of liquidity into the US economic system through the central bank which has the effect of expanding the money supply.
The end of QE however does not necessarily mean a reduction in liquidity as liquidity will have to be sufficient in order that the economy can continue to recover on its own without the unconventional intervention by the central bank. Two is the effect on the interest rate. If QE is removed because liquidity is sufficient, then interest rates are unlikely to shoot up. Interest rates may not be kept at near zero without QE, but the Fed can still continue keep interest rates down through its federal funds which can be borrowed daily by banks, and federal fund rates are kept at a quarter of one per cent.
If the end of QE means a reversal of capital flow from the world stock and bond markets, then all the more the
pressure is for interest rates to stay low.
Three is that the US financial system may have already been stabilised and it can now begin to function properly
in creating money through loans in the normal fashion. The open-ended nature of the bonds that the Fed could purchase from the market under QE3 means that the financial system may have begun to start lending tobusinesses which in turn create more jobs.
What does it mean for Asia?
Hot money which flowed into Asia will see a reversal. For the past 5 years while the US has been pumping money into the system, much of the money did not stay in the US. Instead much of it went abroad. A number of assets, including stocks around the world, have advanced over the past few years is that the money created by central banks through QE has found itself in financial markets particularly in emerging markets like
Asia. (Figure 1)
Will there be a crisis? It depends on how swift hot money moves around the globe, the impact of liquidity on real estate prices and higher interest rates has on household debt.
Will real estate prices hold?
Based on real estate prices during the global crisis, Singapore and Hong Kong fared less well compared to Malaysia. It can be seen from Figure 2 that Singapore and Hong Kong faced 4 to 5 quarters of declining house prices whereas Malaysia only encountered a 1.8% drop in house price index in one quarter. This is because more than 90% of Malaysian homes are owned by locals whereas in Singapore 30% of private homes are owned by foreigners.
The hot money from the US would have come in search of higher yields which could only be obtained from sustained inflows in the stock market if these funds were short term and if they were interested in returning home when the time is right. It is therefore likely that the immediate impact of the end of QE is on the stock market rather than the property market.
For investors to enter the property market, they will only do so on longer term funds. But longer term funds would be borrowings from banks as banks suffered from excess liquidity as a result of the inflow of hot money.
The low interest rates provided an additional incentive to borrowers who were interested to invest in the property market. As such, therefore, it is unlikely that there will be an immediate pullout by investors in real estate.
However, there may be an end to the expected increases in real estate prices as the end of near-zero interest rates
may have attracted savers back into bank deposits as well as reduced the number of new borrowings from the banks
Some correction of prices in real estate must be expected. Borrowers who have over-extended themselves may be
caught by marginal acquisitions which they are unable to unload.
Higher interest rates
As a result, the exit of funds from Malaysia by foreigners in proportion to the entire market will be much less compared to countries more open to foreigners.
Furthermore, Malaysia also had sizable landbanks and a relatively lower density versus neighbouring countries.
Malaysia was less affected because over 90% of homes were bought by locals.
For land hungry city states like Hong Kong and Singapore, governments put a stop to the inflow of foreign capital into real estate by introducing punitive taxes on foreign buyers.
Five years of loose monetary policy in the US has led to hot money flowing out from the US to other parts of the world, particularly emerging countries like Asia which has been one of the few engines of growth. This has led to a rise in asset purchases in both the stock market and real estate. Countries like China, Indonesia, Malaysia and Singapore were some of the recipient countries.
Asian currencies, particularly Indonesian rupiah and the Indian rupee have seen a depreciation in their exchange rates because of their large current account deficits. Apart from hot money leaving the country, countries which have higher imports relative to exports will find their currencies under strain. Countries like India, Indonesia and Malaysia which are experiencing a sharp decline in exports to China due to China’s slowdown have experienced greater downward pressure on their exchange rates. (Table 1)
Can Asia’s Real Estate Hold While US Exits Quantitative Easing?
As interest rise, hot money will again seek to park itself under the US Treasuries which has served as a safe haven in the past, especially if the stock markets in Asia and elsewhere are seen to have peaked directly as a result of the
impending end of the QE. Importantly, funds will move into US stocks to be the first to capture the upturn in economy.
The immediate concern of the central banks must be to manage liquidity whilekeeping interest rates within current
levels, in order to provide time for the markets to adjust to the announcement.
Nonetheless, while the immediate impact of the end of QE may be an end to nearzerointerest and hence higher interest rates can be expected, it is quite another question whether interest rates will henceforth rise steadily and significantly.
Household debt is now at its highest. There is concern that with rising interest rates, this could trigger inability of house buyers to pay up their loans. Not surprisingly, Bank Negara Malaysia has been watching the situation closely and reining in on loans.
Since early 2012, Bank Negara has introduced new measures that required banks to use net income rather than
gross income to lend to house buyers. Singapore has introduced more than seven measures before the property
market in Singapore cooled down in 2013.
After all, this is the purpose of the latest announcement by Bernanke – to give the market time to adjust to the new
expectations. In other words, the central banks are rather cautious in ensuring that the adjustment in the markets will be slow and steady. Monetary measures can be reversed very quickly if need be.
Will currency hold?
It is likely that the currency will hold, although in the short term, there may be some weakness as the US dollar
strengthens and some outflows are experienced from Asian currencies. In fact, in June 2013, Bank Negara’s foreign
reserves showed a small net outflow of US$4.3 billion during the month. Since July 2009, there was a net inflow of
portfolio capital into Malaysia amounting to RM159 billion or US$52 billion to March 2013. This could be the biggest
risk in the outflow of hot money. The international reserves of Bank Negara Malaysia amounted to RM432.8 billion
(equivalent to USD136.1 billion) as at 28 June 2013. These foreign reserves would be sufficient to support the currency should there be a risk of the hot money exiting the country at the same time which is unlikely. The
Malaysian economy remains healthy, as its external account has enjoyed a surplus of about RM130 billion a year in the last four years.
In fact, countries in ASEAN like Singapore and Malaysia are now substantially stronger after the unpleasant experiences which all these countries faced during the Asian Financial Crisis in 1997. Together with China, South Korea and Japan, the ASEAN+3 countries have created a pool of funds under the Chiangmai Initiative which can be used to mitigate threats to financial stability in this region.
Conclusion
The concerns over the risk of yet another global crisis should the adjustment as a result of the end of QE in the US be significant may be unwarranted. In the past, abrupt monetary changes were the result of the collapse of the real estate market and its impact on bank solvency.
This time round, the end of QE is a signal that the patient is leaving the intensive care unit and should be able to function under normal conditions on its own.
Whether or not the adjustments in the rest of the world will be adverse will depend on whether the US becomes
the star attraction for global investors as it recovers. That really depends on the nature and pace of recovery of the US economy, bearing in mind that the focus of the global economy may have been shifting to the east.
The adjustment in local markets is most likely to be largely in the stock market where hot money may have been parking to earn some decent returns. The currency should be able to hold as the outflow may be moderate given the absence of systemic risk. As global interest rates are unlikely to rise significantly in the immediate or near term, as the real economy is still trying to recover in the US, there is unlikely to be a liquidity squeeze in the local economies.
But there may be the end of this round of speculative demand for real estate and prices should adjust to the real demand supported by current incomes and income growth. The banks have emerged much stronger after the Asian
Financial Crisis and are well capitalized to manage their finances and housing developers have also been careful to adjust their supply in response to weaker demand conditions, having learnt their lessons from the past.
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