Asia bond markets bet on inflation in region staying low

HONG KONG (Reuters) – Asia's relatively stable bonds and money markets seem immune to the inflation fears that convulsed global equities recently, as investors bet the continent's major economies will keep interest rates low as price pressures remain benign.

The stock market rout began at the end of January, when US wages posted their fastest growth in more than eight years, fuelling expectations that the Federal Reserve's decade-long struggle to bring inflation back was finally bearing fruit.

That goal moved a step closer as data on Wednesday showed US consumer prices rose more than expected in January.

Central banks in the euro zone, Britain and Canada were also more upbeat on the inflation outlook, contributing to a fall of over 10 percent in the MSCI's 47-country world stocks index in about a week – a move which has since retraced slightly.

While Asian stock markets were taken hostage by the sell-off on fears faster rate hikes could hit global growth, short-term interest rates held steady or even dipped as investors saw an opportunity to trade the divergence in rates.

"When you buy the Kospi (stock index) in Korea, you're not buying because Samsung is going to sell their products to Koreans, you're buying because Samsung is going to sell to the rest of the world, predominantly in the US," one rates trader said.

"Interest rates apply much more broadly. In Asia, central banks are not signalling anything major and there's no inflationary pressures whatsoever."

Indeed, the latest inflation figures from Japan, South Korea, Australia, and New Zealand lagged market expectations and central bankers in Asia are signalling they are in no hurry to raise interest rates. In contrast to the other side of the Pacific, Japan's wages fell at their fastest pace in five months in December.

In fact, the Bank of Japan has been at pains to reiterate that its ultra-easy policies will remain in place until it gets stubbornly low inflation towards its 2 percent target.

The overnight index swaps (OIS) curve, derived from forward interbank lending rates and used as a gauge of policy rate expectations, has dropped 1-5 basis points since the start of the year in Australia, New Zealand and India and held steady in Japan.

In the US, the curve rose by up to 25 bps on tenors up to two years, meaning markets are pricing in one extra hike in the current cycle on top of what they expected at the end of 2017.

For this year alone, economists now expect three to four Fed hikes, while money markets, which have consistently been more conservative than forecasters, expect two to three increases.