Asian stocks set for weekly gain on fading US rate hike wagers

Asian stocks surged on Friday, on track for their strongest week in two months, as subdued inflation data diminished the likelihood of an imminent U.S. interest rate increase. Despite faltering negotiations to resolve the conflict in the Middle East, the market's risk sentiment remains tempered. Brent futures hovered around $87.03 per barrel, after a drop on Thursday but were poised for a 4% weekly gain, reversing a two-week decline following US threats to intensify economic sanctions on Iran, including extending a naval blockade.

Investors have largely disregarded the lack of progress in resolving the Iran conflict, instead focusing on the broader artificial intelligence theme and the global monetary policy outlook. Recent U.S. inflation reports indicate that pricing pressures are still under control, reducing the probability of a rate hike from the Federal Reserve next month.

Charu Chanana, chief investment strategist at Saxo, stated that current risk appetite is sustainable as the immediate Fed hike risk has been reduced, and softer oil prices are further supporting the outlook. However, Chanana cautioned that this rally is primarily driven by headlines rather than a genuine risk-on environment. "Without clarity on the Middle East/Hormuz situation, another oil price spike could quickly reignite inflation and Fed concerns," Chanana noted.

In the stock market, MSCI's comprehensive index of Asia-Pacific shares, excluding Japan, increased by 0.28%, setting up for a 2.7% weekly gain, its strongest performance since mid-June. Japan's Nikkei also rose by 1.5%, on track for an over 5% gain throughout the week. A peculiar aspect of the market in recent months has been the increasing disconnect between geopolitical uncertainty and asset price volatility, according to John Sidawi, senior portfolio manager for fixed income at Federated Hermes.

"For now, markets seem willing to put up with a considerable amount of uncertainty without demanding higher risk premiums. However, this balance is unlikely to last indefinitely," Sidawi commented. "A significant escalation in conflict or a clear path to resolution could ultimately push investors from their sidelines, potentially leading to a much larger volatility response than currently priced in the market."

The Japanese yen remained trapped in a cycle of interventions, trading at 159.40 per US dollar, near the critical 160 level that traders anticipate could prompt additional yen-buying by Japan. After an unsuccessful joint intervention with the U.S. at the end of July, traders have become more receptive to the possibility of the Bank of Japan initiating a rate hike next month, although the risk now is that investors might be disappointed if the BOJ fails to demonstrate sufficient hawkishness at the September meeting.

Padhraic Garvey, head of global rates and debt strategy at ING, attributed the yen's weakness to "an overly cautious Bank of Japan and a policy rate that remains too low," and emphasized the importance of rate hikes to ease the tension. While this could be viewed as negative for the economy, Garvey argued that prioritizing the protection of the yen is also a choice.