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Developed-market central banks are in a tightening cycle as they combat crude oil price-led inflation. The US Federal Reserve’s 25 basis points interest rate hike last week was its first in three years, and another rate hike is on the cards before 2026 ends. The European Central Bank and Bank of Japan have raised rates, too. Asian markets’ reaction to the Fed’s much-anticipated move was mixed. The jury is now out on the timing and quantum of the next Fed hike, with the Fed meeting in October and December. A lot depends on crude oil price, which is already at $110/barrel. A higher-for-longer interest-rate scenario exerts pressure on risk assets such as emerging market (EM) equities and Asian currencies. Local currency weakness invites imported inflation, making the central banks’ inflation fight trickier. Further, a higher-rate-led rise in Treasury yields usually triggers capital outflows from other markets into the US. A renewed tightening cycle by the Fed means a stronger US dollar and firmer bond yields. Higher yields weaken corporate balance sheets as the cost of capital rises, hurting earnings growth prospects. The US 10-year bond yield climbed above the 5% mark last week—its highest level since 2007. Higher government bond yields make fixed-income assets more attractive than equities. EPFR data collated by Elara Securities showed that last week, US funds saw a sharp $64 billion rebound in inflows (a 3-month high) following the Fed’s rate hike, while global emerging market funds recorded their first outflow in 10 weeks of $877 million. Among Asian countries, South Korea and India-focused funds saw outflows. Taiwan-dedicated funds attracted $1.7 billion in inflows, but the underlying trend is showing early signs of moderation. This divergence suggests that the Fed decision may have triggered a relative re-allocation toward US equities, as the hike was accompanied by a resilient growth backdrop rather than signalling economic weakness, said the Elara report dated 18 September. Lately, the artificial intelligence (AI) theme has dictated foreign flows into Asian economies such as South Korea, Taiwan, Thailand and Malaysia. India has been an exception to this trend since it is widely regarded as a non-AI hedge. But Shrikant Chouhan, head of equity research at Kotak Securities, cautions about outflow even from AI-focused markets as the borrowing costs of firms investing heavily in AI capital expenditure inch higher on elevated interest rates. The room for Asian central banks either to ease or maintain interest rates is shrinking. September marks an inflection point in a broad-based developed-market hiking cycle, but the path forward for EM central banks is far less uniform, said Emkay Global Financial Services. “Domestic conditions are driving considerable divergence across Asian countries: this week, Brazil remains on an easing path, while Taiwan is likely holding steady, supported by the AI-led growth boom and ongoing disinflation,” added Emkay. The Reserve Bank of India left the repo rate unchanged at 5.25% at its last meeting. But the clamour for an interest rate hike at the October meeting is growing louder, especially after retail inflation in August rose to a multi-month high of 4.82%, driven by food inflation. Plus, the rupee has weakened to ₹96 per dollar. Amid this, Indian equities are feeling the heat. The MSCI India index is down 7.5% in 2026 but trades at a one-year forward price-to-earnings multiple of 17, a premium to peers in Asia and emerging markets, according to Bloomberg data.
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