The US Fed delayed lifting off from its near-zero interest rate of the past several years following the Federal Open Market Committee (FOMC) meeting on Sept 17.
But there is no doubt that a hike in rates is coming; it's just when, not if. When it does, this will be the start of one of the most important regime shifts in global financial conditions in a long time and it will be a mistake to underestimate its impact on emerging market (EM) economies, including those in Asia.
A rate hike per se by the US Fed is unlikely to be problematic, even though a swathe of the global market expects a delay. Some will argue that one could well see the market heaving a collective sigh of relief as a major global uncertainty is resolved and because the rate hike is likely to be accompanied by assurance from the Fed that the normalisation would be a deliberately slow process. And, by starting soon, the commitment of the Fed to move gradually becomes that much more credible.
Far more important is whether the Fed will have the luxury of delivering on its promised gradual normalisation.
Central to such a commitment is the Fed's belief that the potential (capacity) growth rate of the US economy is 2.2 per cent. To achieve this, US labour productivity has to surge in the coming years from the subdued levels of the past four years.
If productivity rises only modestly, as it looks likely to, then potential growth could fall well short of the 2.2 per cent. In this case, even with moderate GDP growth, the excess capacity could disappear much more quickly than expected, pushing up costs - particularly wages.
With the economy reaching the inflection point in wages earlier than expected, the Fed could be forced to tighten more aggressively - resulting in a sharp realignment in US interest rates.
We must also ask whether EM Asian countries can defend themselves against such a shock. Much has been made of the increased foreign exchange (FX) reserves of regional central banks, but even China's mammoth war chest of more than US$3.5 trillion (S$5 trillion) reserves wasn't an effective deterrent, as recent events have shown.
Thus, the region will need to be prepared to lose substantial reserves if it plans to defend its currencies through FX intervention. The alternative is to match the rise in US interest rates by raising domestic ones - a possibility that is not even on the radar of either the market or most of the region's policymakers.
Adding to the uncertainty is the slowdown in China and the attendant adverse impact on global demand - implicitly referred to by the Fed as a decisive factor in staying on hold.
Whether this is merely a reflection of China-specific factors, or part of a global structural change that raises questions about the region's vaunted export-led growth model, is yet to be untangled. Chances are that both sets of factors are at play.
More importantly, the direct export exposure of the region to China is compounded by the rise in the share of EM Asia's exports to other commodity-exporting EM countries, all of which have been severely affected by the China slowdown.
Related to the slowdown in China is the decline in commodity prices which, in the case of oil, has been complemented by a rise in global supply following the thawing of a trade embargo on Iran.
But neither corporate investment nor household consumption has increased commensurate with the massive fall in oil and other commodity prices.
Instead, they have increased their savings - a reaction more consistent with rising uncertainty rather than good fortune.
So, what should policymakers do in such uncertain times? The prudent course would be to hunker down and preserve stability, awaiting greater clarity, rather than turn to policy adventurism.
Barring China, few economies in the region have implemented any meaningful reforms since the 2008 crisis. Where reforms are being planned, such as in India and Indonesia, the focus seems to be on those that implicitly assume the world will go back to the pre-2008 world of seemingly limitless expansion in global trade.
The global economy has been undergoing multiple structural changes since the 2008 crisis, including experiments with unorthodox policies. Many changes have not fully run their course.
Policy mistakes now could turn out to be costly later. Hunkering down as a strategy is not exciting, but it may be the right thing to do.
- The writer is the chief Asia economist at J.P. Morgan Chase. These are his personal views