Fear in Asian financial markets of what the Fed might do may have been greatly exaggerated, judging by how little foreign investment that entered Asia during the past four years has left so far in anticipation of tighter U.S. monetary policy.
Government bonds, currencies and equities in Asia have sold off since April after the U.S. Federal Reserve signaled it will soon cut back its bond-buying program, effectively beginning a tightening in its nearly five-year super-easy monetary settings.
Yet, despite a bloodbath in emerging markets in June that sent stock markets in Asia to multi-year troughs and currencies such as the Indian rupee to record lows, both the anecdotal evidence and the data suggest very little money has left Asia.
Going purely by foreign exchange reserves data, emerging Asia's top 10 economies, from China to the Philippines, received inflows worth $2.1 trillion between November 2008 and April 2013, the period when the Fed pumped massive amounts of cheap money into markets.
Since April, about $86 billion, or 4 percent of that cash, has left Asia. Half of those outflows have been from China.
That's pretty modest by most standards for financial markets, typically prone to buying the rumor and selling the news.
Currency reserves may not be the best barometer to estimate fund flows since the numbers include the impact of central bank intervention, possibly current account flows and fluctuation in the values of currencies.
But other independent measures of capital flows point toward the same conclusion. Deutsche Bank estimates that foreign investors have withdrawn roughly $19 billion from Asian local currency debt markets between June and August. Despite that, net flows for the year are a positive $5 billion and the outflows pale when compared with inflows of $203 billion since early 2009.
"Ten years of large capital flows into emerging markets cannot be unwound in 10 weeks," said Stephen Jen, co-founder of London-based investment firm SLJ Macro Partners.
Jen reckons that because emerging market assets were treated as safer than vulnerable developed markets during the years of easy money, any meaningful recovery in those developed markets would lead to more outflows from emerging markets.
Jen said in a note to clients this week: "... the risks of a 'sudden stop' in capital flows into emerging markets will remain high."
The Fed first embarked on its quantitative easing policy to revive an economy devastated by the 2008 financial crisis in November of that year, when it snapped up $1.3 trillion worth of mortgage-backed securities and bonds in a program that ran until March 2010.
A second round of easing was between November 2010 and June 2011, when the Fed printed an additional $600 billion buying long-term Treasuries. QE3 was announced in September last year and is open-ended, with the Fed purchasing $85 billion of bonds and mortgage-backed securities a month.
That cash, and the cheap near-zero rates in Europe channeled trillions into high-yielding emerging markets. In all, $3.05 trillion of foreign money was pumped into emerging markets since 2009, data from the Institute of International Finance showed.
Only $231 billion of that was official money, so theoretically a good chunk of cash which isn't a dedicated allocation by funds to specific countries could leave if the Fed starts normalizing interest rates.
But the money has been slow to leave. And analysts looking for guidance from previous episodes of Fed policy tightening, such as in 1994, 1999 or more recently 2003, run foul of overlooking key differences in the situation.
First, the Fed is merely talking of reducing bond purchases, for which there are no historic parallels, rather than raising rates. It has pledged to keep short-term rates near zero until mid-2015.
Secondly, no one's quite sure how soon the cheap money will vanish or what the accompanying U.S. economic revival will look like.
Thirdly, the climb in U.S. yields has been modest: even after a 110 basis point climb since April, 10-year yields are at 2.9 percent, less than half the levels in 2000 and far from peak yields of 8 percent during the 1993-1994 cycle.
Morgan Stanley estimates that since the beginning of the sell-off at the end of May, emerging market funds have seen $24 billion of outflows, which is nearly 10 percent of their assets under management but a fraction of inflows into these funds since 2009.
GUILT BY ASSOCIATION
Equities have been spared the brunt of the selling so far, possibly because investors still view the sell-off as one spawned by a climb in long term U.S. yields.
Rising U.S. yields would raise the cost of holding assets funded in dollars and undermine high-yielding bonds in Asia whose yields are pegged to Treasurys. The consequent rise in the dollar and capital outflows have pushed Asian currencies down.
But rising U.S. yields could be good news for equities if they are accompanied by stronger global growth, which would mean improved global demand and higher corporate earnings. Unless, of course, yields spike to levels that generate a fear of inflation, higher funding costs and extreme volatility across markets.
MSCI's emerging Asian index is down 11 percent since the end of May, giving up a fraction of the 153 percent gains since late 2008. Jakarta's stock exchange had risen 380 percent between November 2008 and May this year. Since May, it has given up a mere 24 percent of value.
In contrast, Indonesian bonds, typically less volatile than stocks, have fallen so fast that yields are up 350 basis points this year, giving up a third of the rally since 2008. Likewise, JPMorgan's emerging market bond index has fallen 10 percent this year.
"This issue is more fundamentally about local fixed income than about equities," said Michael Kurtz, chief Asian equity strategist at Nomura. "When money is coming out of local fixed income and the currency gets volatile, equities get dragged along for the ride."
The numbers bear that out. Stock market data show $916 million has left Indonesia so far this year and $3.8 billion has exited Thai stocks. In India, where a record high current account deficit has frightened foreign investors, the stock index is still up nearly 3 percent and 75 percent, or $11.5 billion, of foreign money invested in stocks this year still remains in the country.
Markets such as the Philippines and Korea, seen as less vulnerable to volatile capital flows have been spared selling. The Philippines has seen inflows of $1.4 billion so far in 2013.
The selling in equities has also been a fraction of what foreigners hold in those markets. In Korea, they hold $308 billion worth of stocks, $117 billion in Malaysia, $204 billion in India and $123 billion in Thailand, according to Credit Suisse estimates.
Meanwhile the bond selling in emerging Asia markets has been relatively more severe. Foreign holdings in Indonesia, a market which had heavy foreign participation in local currency debt, are down to $27 billion, which is about 30 percent of total outstanding bonds and down from a peak of 35 percent. And the selling could intensify as bond fund managers face redemptions, analysts say.
"We could see further redemptions in emerging market local currency debt funds, putting pressure on the regional cash bond markets," Deutsche said, referring to the decline in local currency bonds.
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