Mizuho daily insights by Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,
Week-in-brief: Policy Course & Recourse
After a week of unsettling volatility in bond markets, specifically a sell-off in long-end bonds (lifting yields) that saw 10Y yields in a violent upswing to test pre-COVID levels of 1.6%, respite has come; with 10Y UST yields easing back to (a still lofty) 1.4%. But what markets are watching for is policy recourse. Especially given Fed Powel’s ostensible comfort with yields (albeit imaginably from a different reference point) at his Congress hearings where he ascribed yield ascendancy to to demand recovery expectations. So any Fed remarks about watching for excessive yield volatility may reinforce some near-term anchor in yields.
The BoJ has already expressly reiterated the 0% YCC target for 10Y JGB yields while the ECB did not mask its worries about the “evolution” of long-end yields. But rhetoric is one thing, and recourse quite another. So markets will be watching for action plan. Meanwhile at this week’s policy meeting (Tue), the RBA is likely to articulate “flexibility” in QE (to front-load bond buying) as well as YCC (to anchor yields further out the curve); underpinning bond market action already seen from last week.
The RBA though is unlikely to move on rates or have specific AUD position. Sustained improvement in Australia’s Q4 GDP (Wed) is likely to validate the RBA’s targeted recourse to subdue bond market volatility rather than a big bazooka, all-around expansion to stimulus as a whole. Like the RBA, BNM is set to hold on policy rate when it meets on Thursday as recovering Oil prices and vaccine rollout plans alongside fiscal backstops are seen as negating need for monetary recourse.
To be sure, US bond market volatility that may be souped up by trhe $1.9trln fiscal stimulus plan in the offing continues to be the main event as markets assess Fed policy course in respone to the fiscal recourse. OPEC will also pitch in to some degree with its monthly meeting, insofar that outcomes have some impact on Oil prices; thereby framing the reflation mood. With Saudi (leaning to maintainig output cuts) and Russia (preferring to step up production) split on views, the course for Oil market bulls is not patently clear.But the willingness of Saudi to restrain supplies will probably keep Oil prices broadly backstopped if not buoyed.
Policy course on OPEC, especially speculation of some relaxation on supply restraints in H2 may check Oil price trajectory to year-end, possibly softening the ascendancy bias; albeit in a bullish commodity backdrop. Arguably, China’s NPC (starting Wed) and CPPCC (starting Thu) are key indications of policy course that will be important to keep an eye on, even if it is expected to be devoid of “explosive” headlines. While explicit GDP target may not be the main attraction, fiscal and monetary policy; especially policy recourse for lingering growth uncertainties in the context of worrying asset/property bubbles means that PBoC’s credit policies will be assessed carefully in coming weeks/months. All said, market volatility and lingering uncertainties with respect to economic outcomes means policy course will require active “steering”, while recourse to market tantrums will be critical to steady the ride.
FX Theme: “RORO” USD Dynamics to Overtake Yields?
Despite a significant pullback in UST yields to ~1.4% from (last week’s) highs testing 1.6% (near pre-COVID levels), a sharply stronger USD suggest that “risk off” dynamics, rather than yield-driven moves, are back at work in FX markets. Specifically, the Greenback being bid by “risk off” moves.
Indeed, AUD dropping from 80 cents test to 77 cents illustrate the most extreme iteration of the volatility from a coincident USD and short UST position squeeze; laying bare market jitters as equities capitulated too. What’s notable is that USD/JPY was lifted despite “risk off” (which typically corresponds to a drag on USD/JPY from Cross/JPY). Whether this reveals a structural shift whereby JPY has shed its safe-haven status or merely a cyclical response due to USD squeeze accentuated by aggressive shorts is debatable. But given uncertainty about potentially destabilizing yield swings, conditions are not conducive for a sustained and sharp reversal of “risk off”.
That is, even if yields are subdued, strong resurgence in EM/Commodity currencies (and corresponding USD slump) is unlikely to be manufactured imminently. Instead, “risk on, risk off” (RORO) USD moves are likely to dictate the FX landcsape, with yield differentials being relegated to the backseat for now. AUD could claw back some ground though if RBA manages to anchor policy with QE and YCC flexibility. Meanwhile respite from “risk off” may only ease, not plunge, the USD as caution lingers.
Respite from a sharp upswing in yields (led by brutal bear steepening), resulting in 10Y UST yields settling back at 1.4% (from tests on 1.6%), bond market sell-off (and surge in yields) may not be safely behind us. In fact, the question is how soon, not if, yields will start surging again. Admittedly, there has been a good degree of bull flattening, sending 10Y yields back to 1.4% and narrowing the 2Y-10Y spread by almost 20bps from the widest during the week’s sell-off.
What’s more, fairly heavy short positions in bonds (betting on yields surging) could also mean that a consolidation in yields off last week’s high may be on the cards for now. Especially as global central banks push back against exessive (and excessively fast) surge in yields, notably with the RBA acting, and ECB as well as BoJ jawboning. The key question may be whether or not the Fed expresses discomfort with destabilizingly sharp yield run-up. If so, yield cap may harden a little bit more at the margin. For now, 10Y yields are likely to consolidate in the 1.24%-1.56%.
India Q4 GDP: Welcome Relief, Not Unfettered Rebound
India’s Q4 GDP 0.4% YoY (positive!) growth is prima facie all the more encouraging as it emerges from a recession on domestic private sector demand. Particularly encouraging are;
i) investment contribution turning emphatically positive (+0.8%-pts from -2.1%-pts in Q3) and;
ii) consumption contribution turning markedly less negative (from -6.4%-pts in Q3 to -1.4%-pts)
So the half-full take is that confidence has improved substantially, reviving investments and greatly healing consumption. But this upturn, welcomes as it is, must not be mistaken for being out of the woods; and not just due to backward-looking 7.0% contraction in 2020. For one, investment pick-up is not inconsistent with pent-up boost in early-stage recovery that is led by resumption of activity rather than a resurgence of ground-up demand.
What’s more, a fairly large 1.1%-pt boost from “Discrepancies” literally cautions about the unknowns around the Q4. To be sure, this is not just about discomfort with an accounting quirk, but rather legitimate doubts about a bumpy path and uneven recovery. Point being, coming out of the pandemic does not automatically resolve the pre-existing banking sector overhang and resultant confidence deficit that has been a bugbear to reviving demand durably.These issues predated the pandemic, and will still require challenging policy recourse that is capable of conjuring “crowding in” to help restore 6-8% growth potential.
Unfortunately, sharper inequality amid displaced informal workers and (the myriad) farm sector challenges may considerably raise hurdles to growth restoration that can last. And inconveniently, rising oil prices pose major headwinds to sustained recovery in corporate profitability and household spending power; despite headline inflation easing. Perversely then, lingering stagflation-type risks tie the RBI’s hands, requiring awkward policy contortions to help stimulate the economy. The upshot is that as encouraging as the growth inflection is and fiscal support may be, a quick and unfettered rebound to potential growth is not a given.
Bank Negara Malaysia: At the Cross-Roads
The widely expected base case appears to be for the BNM to stay on hold; despite Q4 GDP disappointment, and some setbacks as far as the pandemic impact is concerned. Fact is, Bank Negara Malaysia (BNM) kept it policy rate unchanged at 1.75% it previous meeting on 20 January, it did not seem to suggest that the door for further easing is closed. And, since the previous meeting, we are increasingly of the view that BNM may not need to cut the policy rate further, at least not imminently. So we concur with the call for status quo. For one, although the recent wave of COVID-19 infections has hurt growth recovery prospects given the imposition of the Movement Control Orders (MCO), the number of new cases seems to be on the decline.
This suggests that the economy may be past its worst hit to activity. More importantly, the government has started the vaccination drive and our estimates suggest have procured (atleast on paper) enough vaccines to inoculate over 90% of the population (see Mizuho Insights: 25 February 2021: ASEAN-6: COVID-19 Inoculation Drive Slowly Getting Off The Ground).
To that end, the government’s more targeted fiscal efforts and healthcare focus will provide more greater support to the economic recovery, at the margin, than additional rate cuts. Second, the case for lower rate amidst sharply rising UST yields may be less compelling. Although the MYR has remained fairly stable, BNM may not want to test the waters jusy yet. That said, BNM will likely continue to complement the government’s fiscal and healthcare efforts by providing credit and liquidity support.
Australia’s Sustained Recovery & RBA’s Yield Challenges
Australia’s Q4 GDP is set to show continued sequential pick-up underpinning the recovery that began in Q3 (+3.3% QoQ); with commodities acting as a key pillar to supply-side boost to activity. But that said, the pace of recovery may ease to ~2.5% QoQ; as exceptional base effect boost fades.
The bigger picture is that while the initial recovery through H1 2021 may still be subject to air-pockets and jobs vulnerabilities linger (merely masked by fiscal support), Australia is unambiguously on a surer path to sustained recovery. And the commodity boost meanwhile may very well add to tailwinds. Against this backdrop of improving activity resumption and growth prospects, the RBA is expected to hold its horses; especially after the extension of QE (at the current A$5bn/week pace) by another A$100bn. At the margin, the RBA’s greatest challenges may be;
i) buffering against upside yield pressures rippling from UST yield surge and;
ii) leaning against excessive and abrupt AUD strength.
Conveniently, the two challenges appear to be mutually exclusive. But as the RBA maintains a dovish stance near-term, YCC and QE are likely to assume greater prominence in RBA policy calculus amid global bond yield volatility. In particular, with the QE program already extended by another A$100bn,;
i) flexibility to front-load the A$5bn of QE purchases as well as;
ii) explicitly targetting further out the curve (from current 3Y AGB target) for YCC;
are perhaps the key aspects of fine-tuning markets will be fixated on.
Bank of Korea: Hold, but Hung Up on Yields
As expected, BoK kept its policy rate unchanged at 0.50% and at the press conference that followed, sounded ambiguously dovish; stating readiness to act if bond market volatility persisted. Sooner than he said it, did he need to act on his words. On Friday, a day after the meeting, BoK announced that it would buy anywhere between KRW5-7trn worth of government bonds in H1 2021 compared to KRW11trn in 2020.
BoK made clear that these purchases would be different from QE and that it would be done in reaction to the global bond market rout instigated by the UST sell-off. More fundamentally, BoK continued to defer to the government to provide targeted economic support. The government will be announcing an additional fiscal stimulus package next week which will include additional cash handouts.
Furthermore, the growth outlook is looking increasingly better as export growth remains strong; importantly, the government has started its domestic COVID-19 vaccination drive which will, in time, bolster domestic consumption.
Finally, BoK did not sound particularly alarmed by the rising inflation trajectory and stated that it was too early to remove the accommodative monetary policy stance.
Source: Mizuho Bank Ltd