Markets have run into a rather dour spot having had to reflect on the vital distinction between a solution and resolution. Namely, how the former falls far short of the latter.
The vaccine is a solution to the pandemic as is Biden’s fiscal plan a part solution to riding out economic upheavals from the pandemic. But tragically, neither come close to a resolution. For a start, partisan politics threatening to impede Biden’s USD1.9 trillion fiscal relief plan is struggling just to be a much needed palliative; let’s not talk about resolution.
And a more virulent strain of the coronavirus sparking renewed Covid-19 outbreaks and a worrying spike in hospitalisations globally is a sobering reminder; that vaccine rollout, subject to its capacity, logistical and political challenges, while a solution is far from a guaranteed resolution if it is outpaced and outdone by the virus in scale and speed.
To be sure, markets are not in dire despair. But earlier optimism, and the consequent reflationary reactions are being subjected to some degree of re-calibration. And caution is being baked in.
A by-product of which is softer UST yields, well off the path towards 1.2%; now settling at sub-1.1%. This is however, a reactionary pause, not a new trend established. For which, more virus and fiscal cues will be required; especially given uncertainty about the scale and speed of reflation to be anticipated.
Even the FOMC, on the 27th, may have very little in terms of market guidance. For one, no policy action is expected. Nor are there scheduled updates to policy rate ir economic projections.
Crucially, the Fed will stick to a dovish pause, whereby it maintains capacity for monetary solutions to backstop, but qualifies that it cannot provide resolution in isolation.
Meanwhile, US data may be less relevant insofar that continued improvement since H2 2020 are undermined by the lack of “canaries” from pipeline economic risks due to Covid resurgence.
This is of course not peculiar to the US, but a global phenomenon; given how the more virulet strain of the virus has taken a global toll; impacting Europe and making a very disruptive landfall in Asia; subjecting Hong Kong to lockdowns last week, expanding restrictions in ASEAN economies.
All of which which cast a pall on somewhat on upbeat recovery trajectories forecasted from improving data that have been presenting themselves in the last few weeks/months.
On that note, Q4 GDP improvement for both Korea and Philippines, while welcome, are not unanticipated. More importantly, do not guarantee unencumbered recovery in H1 2021.
In a market with softer yields, interrupted equity rallies and a bearish USD finding traction, the overall mood appears to be one of caution. Not for the lack of solutions. But rather, how elusive a resolution remains at this point of the bumpy road out of the pandemic.
FOMC: Backseat Cruising
To be sure, we view this as a dovish hold, with scope for an outright expansion and/or calibration in QE and liquidity/credit tools depending on the extent of economic hit from continued Covid outbreak.
For now though, the USD120 billion/month QE commitment alongside flexible average inflation targeting (FAIT), pushing out rate hikes to no earlier than 2023, provide ample policy breathing room for the Fed to wait assess.
Yellen’s Nuanced USD Impact
And Yellen left ample free-play; and resultant uncertainty for EM Asia FX.
With the current stance, there is little clarity on whether Malaysia, Singapore, India and Thailand will be dropped from the ‘Monitoring List’; if at all. And for Vietnam, whether the ‘Currency Manipulator’ label will be lifted.
Our sense is not immediately, as the US could benefit from the leverage.
Meanwhile though, the softer USD and firmer EM Asia FX will buy EM Asian economies some reprieve.
The ‘improvement’ to Q4 growth will mostly likely be driven increased private consumption reflecting the lifting of social restrictions.
However, other key drivers including government spending/investment/exports are set to remain weak; with deep imports contraction reflecting weak domestic demand conditions.
Significant improvements to the growth outlook this year will continue to be hampered by the spread of Covid-19, which remains a concern in the Philippines.
More importantly, unlike in other economies in the region, the Philippines government has not been able to successfully expedite expenditures for operating or capital expenditure purposes. This has been one of the biggest stumbling blocks in the governments’ response to the pandemic. The government, as such, has come to heavily rely on the vaccination drive to bring the pandemic under control.
Although the government has a signed a deal with China to procure its Covid vaccine, the efficacy of which remains in question, the scope and scale of distribution remains uncertain. Partly because the logistical challenge of vaccine distribution across the disperse archipelago (amid poor connectivity) and pace at which the government may sufficient acquire vaccine doses.
Insofar that the magnitude of GDP contraction will not BSP, urgent easing is not required. But, equally, significant dent to growth, will underscore dovish bias with further cuts in H1 2021.
Although Korea has, so far, managed to avoid large-scale lockdowns, its social distance measures have had a negative impact on the services sectors namely outdoor dining and retail.
While the infection rate slowed in Jan, the economy is not out of the woods yet as infection rates across the world has picked up and South Korea has not completely locked down its border to travellers.
The mainstay of domestic demand will remain government spending reflecting the governments’ timely implementation of fiscal stimulus measures.
As 2020 GDP contraction will slightly better than Bank of Korea’s -1.3% expectation and thus will justify Bank of Korea keeping its policy rate unchanged.
Asia’s Covid Resurgence Casts a Pall on Recovery Path
The start of the New Year did not bring as much cheer as many hoped for, as the pandemic outbreak roared back amid more virulent strains led by Europe, US; and with notable spillover to Asia.
The case count in Indonesia, Malaysia, Thailand and the Philippines have risen significantly in recent days; with the death toll hitting its highest on record in Indonesia.
Although case counts have slowed in South Korea, the resurgence of cases in China namely in the largest cities of Beijing and Shanghai ahead of the Chinese New Year holidays is a cause of concern. Even in Singapore, which in recent months reined in the spread of the virus, is seeing a rise in community infections.
Economic/social restrictions may be less severe than 2020 being nuanced with the benefit of experience. But may be as pervasive; Malaysia’s MCO widening out quickly being a case in point.
What’s more, after aggressive counter-cyclical fiscal support last the year, stretched fiscal resources could place exceptional strain on budget and debt positions.
As such, the growth recovery for 2021 will likely be more modest than previously expected. Especially as hopes of mass immunisation run ahead of the reality resulting in a pre-emptive move back to pre-Covid normality and a further deterioration in the pandemic situation.
This in turn may be a more prominent differentiator of macro/fundamental risks as credit/debt metrics haul up ratings risks; and the inadvertent steering of monetary policy towards debt monetisation emerge.
That said, with central bank policy rates at record lows, scope for further cut, while not negated, may be limited. Whereas, provisions of credit and liquidity facilities will be welcome.
10Y UST yield have halted last week’s slide ; coming off the lows below 1.08%; but only marginally so. Nevertheless, a slight re-steepening has been reinstated, as 2Y yields have softened as well. To be sure, the lack of clear direction muddles UST yield trend for now. Fact is, while reflation remains intact, it has been suspended amid worrying news of Covid outbreak getting ahead of vaccination positives.
Meanwhile, optimism about Biden’s inauguration and fiscal plans have also been subject to a few reality checks as partisan politics re-emerge. So, for now at least, there could be consolidation as bond markets reassess the tensions between degree of fiscal boost and monetary cushion as the virus-vaccine headlines compete.
As such, we expect 10Y UST yields to be in the 0.98%-1.16% range for now.
FX Theme: Curtailed by Caution
“There is nothing more deceptive than an obvious fact” – Sherlock Holmes
Holmes may not have been thinking about the relation between UST yields and the Greenback when he said this, but he might as well. Fact is, looking to 10Y UST yields for USD cues may be misleading at the least; doomed to failure at worst. For one, the coincidence of reflation trades and the Fed’s FAIT (flexible average inflation targeting) driving a huge wedge between inflation expectations and nominal yields, means that rising UST yields may ironically coincide with falling real yields.
In which case, the Greenback may fall despite a rise in UST yields (and vice versa if nominal yields fall less than inflation expectations during episodes of calibration).
Moreover, the “USD Smile” dynamics also underpins a weaker USD during periods of “risk on” but the reverse when markets turn caution or downbeat. So this adds a layer of distortion to simplistic headline (nominal) interest rate/yield cues. And so, given caution seeping into markets, any shifts in UST yields from a fairly softer position (compared to recent 1.15% highs) will not provide definitive direction one way or another.
Above all, relative Covid infection fallout in various countries could also set into motion more peculiar FX market reactions rather than a generalised USD-trend based impetus. On this account, KRW, MYR, IDR and PHP may be subject to headlines from new cases/reporting, as well as China impact. And so a softer USD may not be expressed to the same degree.
Similarly AUD gains may also be blunted by indirect softening via commodity channels.
As caution seeps in, scope for buoyancy in Asia FX will be curtailed; regardless of softer UST yields.
Credit Source: Mizuho Bank Ltd