Easing, tightening, and easing of global financial conditions

In 2024, global financial conditions were generally calm in the first half, before giving way to heightened volatility in the second half of the year.

The relatively accommodative conditions during the first half of the year were an outcome of major central banks signaling the end of their hiking cycles, bolstered by optimism surrounding global growth and the technology sector, particularly artificial intelligence (AI)-related stocks. That said, markets were not entirely tranquil as periodic fluctuations were sparked by shifting market expectations around the Federal Reserve’s (Fed) monetary easing path as well as geopolitical tensions in the Middle East.

The calm was disrupted in the third quarter, with market volatility rising markedly due to concerns about US economic growth, potential overvaluation in the technology sector, and growing political uncertainty in the US ahead of the November elections. This was further exacerbated by the unwinding of the yen carry trades following the policy rate hike by the Bank of Japan (BOJ).

Financial conditions tightened in early August but gradually eased, especially heading into the Fed’s September meeting, when it delivered a 50-basis-points cut.

ASEAN+3 markets reacted not only to global but also idiosyncratic factors

Fluctuations in global financial conditions had spillover effects on the ASEAN+3 markets. The easier financial conditions during the first half supported most regional equity markets but markets weakened during the third quarter in tandem with global market developments. Regional currencies remained sensitive to the interest rate differential with the US, with most experiencing weakness during the first half of the year before gaining ground during the third quarter, reflecting the Fed’s easing trajectory.

Beyond the global factors, idiosyncratic factors also played a key role in determining the performance of ASEAN+3 markets. Equity sectors and markets which are perceived to benefit from the AI boom outperformed in the region. Domestic growth prospects, political and policy developments, and foreign portfolio flows contributed to diverse performances across the ASEAN+3 markets.

Notably, the BOJ’s exit from negative interest rates and the stimulus measures provided by the Chinese authorities were key developments shaping market dynamics.

Foreign portfolio flows into most ASEAN+3 markets were subdued during the first half of 2024, reflecting less attractive valuations amid rising US Treasury yields. However, as US Treasury yields eased in August, foreign inflows increased and may continue in the coming months if volatility remains low.

ASEAN+3 markets face existing and new risks

While less likely now, the risk of a resurgence in inflation remains a potential concern. Heightened geopolitical tensions could result in a renewed commodity price spike, which could also increase market volatility and dampen growth. The worst scenario would be if inflation rises amid faltering growth. This would force global central banks into a challenging balancing act between maintaining price stability and supporting growth.

Within the region, the financial stress of developers in several economies amid a downturn in the property markets pose a risk of spillover to their financial systems. The interconnectedness among ASEAN+3 economies has increased the propagation of shocks across borders. Moreover, the region’s high reliance on US dollars amplifies its vulnerability to global shocks.

ASEAN+3 central banks weigh domestic factors amid Fed easing

Inflation in most regional economies have declined to target level or within the target band in 2024, while growth has remained resilient. In addition, the Fed’s monetary easing has led to a strengthening of regional currencies against the US dollar, thus removing a key hurdle toward cutting policy rates.

However, domestic macroeconomic and financial stability will remain important considerations. These considerations vary across economies and can create divergence between the timing and extent of policy rate cuts among ASEAN+3 economies. For example, Indonesia and the Philippines have lowered interest rates amid a supportive domestic environment. Meanwhile, China and Vietnam both cut their policy rates in 2023, with China continuing monetary easing in 2024, while Japan increased its policy rate in 2024.

Strengthening resilience against emerging risks

Overall, the financial stability risks in 2024 appear to be lower than in 2023. Regional authorities can use this opportunity to rebuild policy space and financial buffers while remaining vigilant of emerging risks.

In the near term, an inflation resurgence will require a skillful recalibration of fiscal and monetary policy to curb inflation while supporting growth. An escalation of geopolitical risks or a sharp deterioration of growth outlook may test the resilience of ASEAN+3 financial systems, requiring swift action to facilitate orderly market adjustments.

Conversely, during periods of risk-on, authorities should be vigilant about strong foreign inflows, which may lead to excessive credit growth and unsustainable debt accumulation over time. Finally, keeping up with structural changes in the financial system will help harness the benefits of green finance and technological advancements.