Oil-driven Asian bond rally could boomerang

Sun Jan 11, 2015 2:06am EST
 
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By Vidya Ranganathan

SINGAPORE (Reuters) - Plunging oil prices have sparked a big rally in Asian government bond markets as lower fuel costs cut inflation expectations, but the rally could be built on shallow foundations as monetary policymakers remain out of step with tumbling bond yields.

The price of oil CLc1, of which Asia is a net importer, has halved in less than six months, driving bond yields down across the region, from India to South Korea, as markets anticipate looser monetary policy to accommodate the resulting disinflation.

The imminence of further monetary easing in Europe and Japan builds a strong case for bond yields to drop further.

But there is little sign yet of official rate cuts, particularly in markets such as Indonesia, Malaysia and the Philippines, where central banks were sounding hawkish or even raising rates into the final months of 2014.

"The oil price has caught central banks by surprise," said ING's chief Asian economist Tim Condon.

"The panic of 2013 is right now foremost in their minds, and they are looking at a Fed rate hike, and so I think they will remain pretty dug in," he said.

The fear of a repeat of 2013's "taper tantrum", when talk of the Federal Reserve withdrawing monetary stimulus prompted vast sums of foreign capital to bail out of the region, helps explain why Asian central banks might err on the side of tighter monetary policy.

But there are other factors that also suggest official policy will stay tighter than the bond markets imply.   Continued...

 
A man fills up his car at a petrol station in Rome January 6, 2015.  REUTERS/Max Rossi