Week in brief by Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,
As the Chinese Lunar Calendar ushers in the Year of the Ox (bidding good riddance to the scourge that was the Year of the Rat), it may be a timely reminder not to mistake an Ox for a Bull. Point being, (particularly) this Ox is likely to first and foremost be a beast of burden, and not a Bull charging at matadors or adorning Bowling Green (“Wall Street Bull”).
Don’t get your scribe wrong. With all the monetary spigots on flush and fiscal stimulus on the tap, bull markets may to thrive in the Year of the Ox. But that does not distract from the long hard slog for the “Ox” to get back on track; as vaccines navigate subsequent outbreaks/strains.
So, while Yellen has predicted “full employment” in 2022, this is predicated on Biden’s USD1.9 trillion fiscal support plan, which is being bull-dozed by Democrats given the resistance of Republicans. Her warning of “scarring” if the support does not get out soon is perhaps motivating a more aggressive push by the Democrats and appears to be validated by disappointing NFP data with a disappointing 49,000 for Dec (and a -159,000 revisions to prior two months of jobs).
The soft details of jobs data, despite headline improvement in unemployment rate (to 6.3% from 6.7%) underscore need (and a path) for additional monetary-fiscal accommodation.
In turn to expectations of pump-priming (be it fiscal or monetary in nature) may be inviting for bulls. But make no mistake, it is hosted by the Ox, which has a lot of work left to instill recovery. US-China relations in the Year of the Ox will also entail a lot of effort on both sides to avoid collateral damage to the global economy; even if Covid efforts relegate US-China issues initially.
In Asia, ushering in the Ox may be a reminder of hard work required rather than bullish jubilation.
For one, Malaysia’s Q4 GDP (Thurs) may struggle to show appreciable improvement as re-instituting restrictions takes some wind out of the recovery sails. Meanwhile, BSP (Fri) may have to stand pat as inflation ties its hands.
India’s inflation and industrial data (Fri) will validate the need for continued fiscal-monetary support; as demand deficit plagues from the “Rat” are not fully obliterated by the Ox. Although bond bulls may be wary of RBI’s diminishing space.
As the “Ox” makes an entrance, beware damage left by the Rat and Bulls getting too far ahead.
Bear steepening of the UST yield curve, may quite broadly be attributed to i) US out-performance in terms of vaccine rollout coupled with; ii) hopes of fiscal stimulus.
But that perhaps does not capture the nuances embedded in the details. For one, softer US jobs data is not without some economic recovery concerns; even if it masked by the propensity for Democrats to bull-doze the stimulus through given Kamala Harris’ deciding Senate vote.
And so the risk of yields slipping back cannot be discounted, though markets appear to be positioned for a test above 1.2% in 10Y USTs; especially with buoyant oil pushing reflation buttons alongside Yellen’s emphatic support for a large front-loaded fiscal package. 10Y UST yields could thus be dealt in the 1.06%-1.28% range for now as markets digest stimulus and reflation versus risks of soft spots in the economy.
FX Theme: Will the Ox Box Up a Fledgling USD Bull?
Despite rising (nominal) UST yields, real UST yields have started to pullback again as reflation expectations surpass the underlying economic recovery (lifting break-even more than UST yields) and monetary policy response. In turn, this has taken some edge off the USD, which had gained some traction last week. That provides cause to explore the question of whether the “Ox” is compatible with a USD Bull; or if the USD will indeed defer to bearish baggage from 2020.
Our sense is that it may be difficult to paint all of FX land with one USD brush. For one, peculiar risks may rule the roost, weighing on the likes of the MMK amid the coup in Myanmar while reflation bets like the AUD may be on a better footing if USD eases and commodities get a leg up.
Meanwhile, US-EZ gap in vaccine rollout could contain how far up the EUR may go; all while JPY is caught between USD and Cross/JPY cross-winds; in the context of “risk on” amid US fiscal hopes.
So, FX may be like a (B)Ox of Chocolates .. we may not able to pre-determine what we may get.
Myanmar Coup: What Next?
In a shocking, but not entirely unflagged, political gambit, Myanmar’s military staged a coup last Monday (Feb 1), declaring a year-long State of Emergency citing widespread election fraud. This thinly veiled power grab by the military elites to deny election outcome inevitably drives up political risks and subjects investors to significantly elevated uncertainty.
International condemnation has been swift and expected. But whether this translates into tangible action that reveres the course of events remains highly unclear, if not suspect. For one, the cover of Constitutional legitimacy to prepare for re-elections buys time.
Crucially, implicit support from China and Russia within the UN Security Council set the stage for impeding efforts towards on-the-ground delegations to facilitate a resolution; and could also soften the resolve for, and effectiveness of, coordinated economic sanctions. The latter will be most critical in determining the severity of economic and FX shocks.
For the week, MMK has dropped 6-7% (from ~1330 to ~1407) levels; but this is merely the illusion of having a price in a market that is barely functioning. Being able to transact at that quoted price and actually buy dollars may be the bigger challenge; and one that may only grow.
In any case, the specter of extended military regime and uncertainty are set provoke the worst fears of stagflation-like economic pain and the dangers of steeper currency devaluation.
Dollarization, both a cause and consequence, will invariably subject MMK to some degree and duration of depreciation pressures; even if the central bank has tools to mitigate. Regardless of the ensuing MMK exchange rate, the single biggest risk in terms of FX markets may be the ability to access USD funding onshore.
India Budget: Highly Supportive on Cranked-up Multipliers
India’s FY21/22 Budget deficit at 6.8% last week was well above market expectations of ~5.0-5.5%. We expect this budget to be highly supportive of the economy not only in the headlines; but in the details as well. For one, even if total expenditure is not up substantially, capital expenditure is bumped up substantially to 2.5% of GDP.
Capital expenditure, not only enhances growth potential over the medium-/long-term, but is also known to have a larger multiplier effect. In other words, for the same fiscal dollars spent, the tilt towards capital expenditure could lead to even more positive growth outcomes. What’s more, the plan to set up a “bad bank”, while hard to quantify, is expected to bare also a large positive in terms of the fiscal stimulus impact.
Fact is, many of India’s public sector banks being hobbled by bad assets means that credit growth remains impaired and impeded; which in turn dial down the capacity for “multiplier effects”.
Whereas a “bad bank” that frees the banking system from bad debts could help revive credit growth; the critical driver for a broad-based boost to the multiplier effect. The upshot is that India’s approach in aiming to “grow into fiscal consolidation”, rather than resort to back-firing austerity looks promising with “multipliers” being cranked up.
But the biggest risk to this plan for invoking “multipliers” is that credit rating agencies fail to look through the cycle; and resort to negative ratings actions that may deal a significant setback; especially with interest servicing at 3.6% of GDP .
On the supply-side, the improvement in agriculture output, particularly palm oil will help offset the deeper contractions in all other key sectors namely manufacturing, services and construction as the economy was hit by a renewed wave of COVID-19 infections from end-September.
The demand-side breakdown will mirror a similar story with as poor confidence and higher infection rates weighed on private sector demand (consumption and investment). While government consumption spending provided some support through the quarter, progress on public sector investment projects likely remained slow.
Unfortunately, the growth outlook for Q1 2021 underscores a significant deterioration as the more rampant spread of Covid-19 forced the government to institute strict Movement Control Orders across most of the country (see Mizuho Flash 12 January 2021: Malaysia: A State of Emergency But Less Stringent) along with announcing a state of emergency.
Point being, a lasting improvement in the growth outlook hinges on a credible vaccine distribution program; details of which are still sketchy. Although the government has announced a fairly growth supportive budget 2021, fiscal policy may be forced to play a bigger role in propping up growth as Bank Negara Malaysia will likely only deliver another 25bp in rate cuts this year. It will, however, continue to provide strong credit and liquidity support measures to the market (see Mizuho Flash 20 January 2021: Malaysia: BNM On A Dovish Hold).
Even with 2020 GDP growth coming in at the low end of the government’s official forecast range, BSP will be constrained to deliver further rate cuts on account of rising headline inflation. Although cost-push factors, namely higher food prices of pork, have been responsible for the recent uptick in inflation, there is a non negligible risk that the confluence of higher food and fuel prices will lead to significant second-round inflationary pressures.
A risk the BSP may not be inclined to discount lightly. As such, it will likely maintain a dovish bias while continuing to cite data-dependency on pulling the trigger on additional rate cuts.
But once higher food prices are reined in as increased importation quotas on specific products alleviate tight supply, still anaemic demand-pull factors will open the door for BSP to ease further.
In the interim, additional liquidity and credit support measures to provide targeted support remain as attractive options seeing as credit growth remains in the doldrums.
Source Credit: Mizuho Bank Ltd