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What Impact Will QE3 Have On South East Asian Markets?
Malaysia Perspective | 23 October 2012

By Yeoh Mei Kei

The US Federal Reserve announced the third round of quantitative easing (QE3) in an attempt to boost stronger economic growth that in turn would generate sustained improvement in labour market conditions as well as maintain price stability with inflation at 2.0% over the long run. The QE3 is different from the previous two rounds of quantitative easing; the first two rounds of quantitative easing entailed the purchase of fixed amounts of mortgage-backed securities, agency debts and treasuries over set periods, while the QE3 this time entails purchases of USD40 billion of mortgage-backed securities per month with no end or cap being set. This open-ended QE3 will continue until the labour market conditions improve significantly.

While the Federal Reserve has the tendency to keep the unemployment rate within the range of 5.2-6.0% over the long run, and given that the Federal Reserve is forecasting the unemployment rate to fall from the current 8.1% to a range of 7.6-7.9% by 2013, 6.7-7.3% by 2014 and 6.0-6.8% by 2015, the Federal Reserve is likely to continue QE3 until 2015. At a rate of USD40 billion per month, this adds up to a hefty amount of USD1.44 trillion for QE3.

Will QE3 Relieve the Weakening Export Growth?
The economic growth model of Southeast Asian (SEA) markets (particularly for Malaysia, Indonesia and Thailand) has gradually shifted after the 1997 Asian Financial Crisis and 2008 Global Financial Crisis, from an export-oriented market to a domestic-driven market, with domestic consumption and investments set to become major economic growth drivers for the SEA markets. Currently, net exports contribution to GDP has reduced to around 10-15% in the SEA markets. Although this contribution is not as significant as the contribution from domestic consumption and investments, a slowdown in export growth as a result of softening demand from major trading partners such as Singapore, China, US and Europe will still impact the economic growth of SEA markets negatively. The moderately strong import growth in SEA markets, attributed to the post-flood recovery in Thailand and strong domestic consumption in Indonesia, could also cause net exports to remain as a laggard contributor to the economic growth.

Chart 1: Export/Import Growth for SEA markets and Their Trading Partners

Improved consumer spending in the US could increase its import demand from its major trading partners, which includes China, Japan and Singapore. This will benefit SEA markets as other than directly exporting goods to the US, SEA markets also export intermediate goods to China, Japan and Singapore. In light of the current weakening export growth in the SEA markets, we expect the SEA markets to benefit from QE3 as this may help to boost their export growth.

QE3 May Create A Difficult Dilemma For Central Banks
The US dollar is likely to gradually depreciate against major currencies over the duration of the QE3. During the QE1 and QE2, the US dollar had depreciated against the Malaysian Ringgit, Indonesia Rupiah and Thai Baht (see Chart 2). A similar situation is expected to happen again in QE3 and a weaker US dollar means a stronger Malaysian Ringgit, Indonesian Rupiah and Thai Baht. Other than that, printing a hefty amount of the US dollars may also push up commodity prices and result in cost-push inflation.

Chart 2: US Dollar Depreciated Against Malaysian Ringgit, Indonesian Rupiah and Thai Baht

Unlike Indonesia, inflation in Malaysia and Thailand have gradually subdued from 2Q 2012 (refer to Chart 3). As at end-August 2012, inflation in Malaysia, Indonesia and Thailand still remain within their respective central banks’ 2012 target of 2.5-3.0%, 3.5-5.5% and 3.3-3.5% respectively. However, given the possible cost-push factors, inflation in the SEA markets is likely to pick up next year.

Going forward, unless inflation stays within the central banks’ target and economies grow healthily and stay solid, central banks in SEA markets could face a difficult dilemma in deciding the direction of monetary policy as they would need to strike a balance between controlling inflation, promoting economic growth and maintaining currency stability. This is similar to the situation in the 1H 2011, when central banks in the SEA markets were struggling to decide whether to hike interest rates in order to control inflation. However, an interest rate hike could probably weaken the already fragile economic growth and also further attract the inflow of cheaply-funded hot money, resulting in a strengthening currency which might harm exports.

Chart 3: Inflation and Interest Rate in SEA Markets

Will SEA Markets Soar Again Under QE3?
Most of the markets including the SEA markets were oversold when the 2008 Global Financial Crisis happened. Hence, valuations were extremely cheap before the start of QE1 (refer to Table 1). Given the low interest rate environment in the US market, the SEA markets with extremely low valuations looked attractive to investors back then. When the global economy is plunging into recession, an economy that can still show positive growth looks like a safe haven for investors to shelter their money. In the case of the 2008 Global Financial Crisis, domestically-driven Indonesia was the resilient economy with positive economic growth. Because of its resiliency, investors were pegging Indonesia at a much higher market premium; PE ratio reached as high as 35.3X while the average PE ratio was 23.9X during QE1.

Before the announcement of QE2, SEA markets were traded at less attractive valuations, with these markets’ PE ratio higher than their fair level. In this case, the additional USD600 billion purchases in QE2 did not further push PE valuation higher but just helped to sustain the premium PE valuations at the level before QE2 was announced. This explains why the Malaysian, Indonesian and Thai equity markets (represented by FBM KLCI, JCI and SET Index respectively) surged by 53.5%-140.6% during QE1, but only gained 2.7%-7.8% during QE2 (refer to Chart 4).

QE3 is likely to have lesser impact on the SEA equity markets as compared with QE1 and QE2 due to the law of diminishing effect and also smaller amount of monthly bond purchases (USD40 billion per month as compared with USD75 billion per month during QE2 and over USD150 billion per month at one point of time during QE1). We do not exclude the possibility that investors’ sentiment could improve, especially during the beginning stages of QE3. This may speed up the equity markets to normalise to their fair level. But we doubt that the improved investors’ sentiment and heightened risk appetite for risky assets would raise the market premium over the period of QE3 to the level as we have seen in the previous two QEs.

Table 1: Valuations for SEA Markets

Source: Bloomberg, iFAST compilation. Data as at 8 October 2012

Chart 4: SEA Markets Surged In QE1 But Not In QE2

If the market normalises to its fair level, the upside potential for SEA markets by end-2014 is estimated to be around 17.9%-25.0% (as at 8 October 2012). As the SEA markets have the lowest 3-year upside potential compared with the other 14 markets that we cover, we have rated the SEA equity markets as “2.5 stars – Neutral” to “3 stars – Attractive”, the lowest rating among the markets that we cover to reflect their relative attractiveness as compared with those 5 stars markets such as China, Hong Kong and South Korea. We advise investors who are currently invested in the SEA equity markets to rebalance their portfolio and switch part of their investments in the SEA equity markets to more undervalued markets such as the Greater China region and South Korea.

Yeoh Mei Kei is a Research Analyst at

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