Mizuho daily insights by Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,
Week-in-brief: Between Cheer & Caution
It is difficult to divorce the caution that accompanies cheer in the current environment. Even an optimist will have to concede conditional cheer; and this is showing up in fading US equity market rallies. And sharply higher UST yields encompass both caution and cheer.
On one hand, cheer about the USD1.9 trilion US fiscal stimulus that Yellen has doubled down on after Texas power disruptions is driver of higher yields on reflation mechanics. Yet on the other, higher yields induce caution about extending “risk on” positions.
Question is, at which point does cost(-push) of reflation overtake cheer from demand recovery/reflation.Trouble is, this is not a static equilibrium; thus varying with pandemic/vaccine outcomes and subsequent policy response. Case in point being the mixed news on vaccines.While the update that Pfizer-BioNTech no longer requiring ultra-cold storage is welcome cheer as eases logistic/storage issues, reports that it may be significantly less effective against the South African strain is reason for caution. The upshot is that vaccine rollout face several dimensions of challeneges from production capacity and ability to acquire to the logistics of distribution and durable efficacy amid mutations.
Overall, the progress on plans to rollout vaccination on a global scale validates cheer, but at the same time, the risks along a bumpy path to the other side of the pandemic means caution cannot be abandoned. Against this backdrop, policy-makers will stick to their guns about maintaining policy accommodation even amid signs of recovery in the data (such as upbeat EZ PMIs). And Fed Chair Powell will be no exception as he testifies to the Senate Banking Committee (Tue) and House Financial Stability Panel (Wed).
Powell’s caution about the fragility of the recovery and lingering risks of scarring to jobs may be the reason for market cheer (insofar that this is deemed a Goldilocks scenario of flush central bank liquidity amid recovery). Bond markets will watch for any signals that long-end yields are rising too fast too soon. Specifically, whether any “Operation Twist” types of options are placed on the table. This may not be imminent.
Meanwhile the BoK is likely to be on a dovish hold (Thu), with a keen eye on FX/markety stability and playing a supporting role to complement fiscal stimulus. The RBA, meanwhile will assess capex data (Thu) to gauge confidence ; although recent A$100bn extension of QE suggests cruise control, not a step-up in easing.
India’s Q4 (CY) GDP (Fri) could emerge back into positive territory; but probably only marginally so; and well below its growth potential still. Cheer about the inflection cannot be devoid of caution about lingering weaknesses/risks; exacerbated by higher oil prices. Upshot: With the global economy some way off “escape velocity”, caution, not unbridled cheer, the survival mechanism.
FX Theme: Between Real & Relative
While 10Y UST yields have surged powerfully, spurred by reflation, the USD has been more subdued. In fact, the Greenback gave back early gains last week. To be sure, it is not as if USD bears are in control, with a distinct downtrend being established. But equally, USD does not appear to be able to properly regain traction. And this time, real yields are not to blame. Fact is, real yields have risen fairly sharply by ~20bp from ~-1% to -0.8%. Instead, a softer USD may have to do with relative yields.
Yields for Gilts and AGBs have risen more sharply. And while Bund yields are up around the same as USTs, overall European yield catch up is also notable. Upshot being, relative yield moves are leave USD subdued. With European PMIs looking buoyant, general “risk on” could also rein in USD upside despite loftier UST yields. But that said, with (steady or softer) relative UST yields, rather than real yields (which are now higher), subduing the Greenback, EM Asia gains against USD may not be even or substantial.
While reflation boost gives AUD a leg-up, higher real yields could take some wind out of INR, IDR and PHP gains; especially alongside higher nominal yields and a steeper yield curve. All said, it is not as if yields are the only drivers of the USD. But it is worth noting that the real-relative shifts will differentiate FX performance.
“Bear steepening has intensified”. That was our opening line last week. And we can simply double down on that; with 10Y UST yields surged past 1.3% and 30Y above 2.1%. Reflation continues to rage on as a theme for the bond market with Yellen doubling down on the need for Biden’s $1.9trln stimulus; and despite the IMF seeing limited inflation risks from this.
With Fed Chair Powell set to testify to the Senate Banking Committee (Tue) and House Financial Services panel (Wed), there is a possibility that upside in UST yields may be dampened; especially if Powell comes across as diovish as he recently has. But the steepening bias may remain intact insofar that Powell stops short of committing to “Twist” type of QE slant to hold down long-end yields. Meanwhile, bond markets continue to watch 1.5% barrier for the 10Y yield. For now, 1.22%-1.46% range looks likely.
Bank of Korea: On a Prolonged Pause
BoK will likely keep its policy rate unchanged at the current (historical low) level of 0.50%. Apart from financial stability risks that emerge with the policy rate and concomitantly bank lending rates being so low, rising inflation risks will also be a factor.
The rising prices of agricultural products and global oil have been highlighted as causes for concern, according to recent statements by the First Vice Finance Minister. The government is said to be drawing up plans to respond if the price surge in these products continue. Even with the number of Covid-19 cases resurging, BoK will unlikely be inclined to ease as the onus of lifting growth through these bouts of Covid resurgence will continue to fall on the government.
More fundamentally, labour market condition remain weak as underscored by unemployment rate spike to 5.4% in January; up from 4.5% in December. To that end, the BoK Governor (following a joint meeting with the FM) confirmed that the central bank will maintain an accommodative stance and; extend financial support including allowing banks to roll over principal and interest payments for small businesses and self-employed individuals.
Simultaneously, it will be interesting to understand how BoK characterises the sharp pick up in yields across the curve following the rise in UST yields.
India Q4 GDP: Encouraging Green Shoots, Not Unfettered Rebound
Source: Mizuho Bank Ltd