Yellen to Markets: Winter is Coming, Eventually -- Barron's Asia

        By WAYNE ARNOLD
        By now, you all know that Jon Snow gets it in the end. One of the most popular characters in "Game of Thrones," he kept warning that winter was coming. But being a Cassandra is no way to win friends, and Snow's own men finally dispatched him in this week's finale to the latest season of the HBO series. While ostensibly retribution for the compromises Snow struck to prepare for winter, his killing seemed an act of exasperation, as if to say, yeah, yeah, we know: winter is coming. That's why there's snow everywhere here in Winterfell, you nunce.
        You get the same feeling of exasperation nowadays when talking to market participants and financial professionals around Asia about the Federal Reserve. On Wednesday, Fed chair Janet Yellen warned that rate hikes are coming. But folks are starting to doubt just how frightened they should be by Yellen's warnings. Some would prefer the Fed just get on with it.
        What had spooked market-watchers most was that investors were betting the Fed would raise rates later and more gradually than members of the Fed's own rate-setting committee were predicting. This seemed to set markets up for a big shock: the Fed would raise rates sooner and more dramatically than markets expected, touching off a painful correction. Conditions after all seem ripe: investors have used low rates to borrow heavily and push up asset prices indiscriminately, leaving assets dangerously overvalued; Yellen has said so herself.
        Add to this shrinking liquidity within markets and we've had some rather harrowing scrapes, with markets - particularly bonds - suffering volatile rides reminiscent of 2013's taper tantrum.
        But the Fed's increasingly dovish messages are starting to leave the impression the market has a better sense of when the Fed will raise rates than the Fed does. Yellen's latest message is no exception: reiterating that the Fed would base its decisions on incoming U.S. economic data, Yellen suggested the Fed's hikes may be more gradual than its members had anticipated.
        The Fed's statements and inaction are thus playing catch-up to the market's own predictive power. How? One explanation is that while the Fed is using historical data to determine its policies and predict their future, the market is using its own particular voodoo to predict what the data will be. Another is that European economic weakness was pushing foreign investors into the higher yields available in longer-dated U.S. Treasuries, depressing forward rates and with it expectations for a Fed rate hike. In this way, markets were expressing how weak global growth would eventually weaken the U.S. recovery, which is arguably what has happened as a rising U.S. dollar saps American exports.
        Whatever the case, today's low rates are undoubtedly positive for risky emerging market assets in Asia. Rate hikes - however gradual - will inevitably cause some turmoil across the region. But how much? Despite recent ructions in Asia's bond markets, Joyce Poon at Gavekal Dragonomics notes that Asian governments and central banks have generally managed to strengthen their balance sheets since the Taper Tantrum - particularly India but to some extent Indonesia, too - and so their bonds have proven less vulnerable to sudden outflows of capital.
        This suggests that it may be time to start buying into high-yielding Asian bonds with short maturities. Asian monetary conditions are tightening, according to Morgan Stanley, meaning Asia's central banks will need to keep cutting interest rates.
        Stocks in the region may also face a predictable pattern. Asian stocks tend to fare the worst in the run-up to a rate hike, and then for a short time afterwards, only to recover as markets digest the fact that a U.S. rate increase is a herald of improving U.S. economic growth and Asian exports. A move by Yellen could thus be a harbinger of a long-awaited Asian export recovery.
        Conversely, Citigroup strategist Markus Rosgen has found that countries whose stock markets are already expensive and that run current account deficits tend to suffer most from U.S. rate hikes. That leaves stocks in India and Indonesia, which gain less from exports, most vulnerable when the Fed finally moves. Malaysia, South Korea and Taiwan, conversely, appear likely to benefit.
        But what's perhaps most fascinating about the prospect for a U.S. rate hike is how eagerly the financial community secretly desires one. Low rates have created a world in which most assets move together, making it increasingly difficult for financial advisors to earn the kind of above-market returns they need to justify their fees. Investors have thus been ditching their hedge funds, private bankers and annual newsletters in favor of so-called robo-advisors and free, on-line analytics.
        The human investors yearn for winter. They need its harsher climes to separate the strong from the weak in the investing herd. They crave the differentiation it would create: Higher rates will raise the cost of making mistakes and reward those able to discern value and divine the next trend.
        Yes, winter is coming. But don't be surprised if the next time a dove walks out of the Eccles Building in Washington, it is ambushed by a pack of feral fund managers, who driving home their blades intone the fateful words of Jon Snow's betrayers: For the Watch!
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        Comments? E-mail us at wayne.arnold@barrons.com
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        Comments? E-mail us at asiaeditors@barrons.com
        (END) Dow Jones Newswires

        June 17, 2015 22:19 ET (02:19 GMT)

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