By Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,
Week-in-brief: Sell in May? Meh …
Except for the 1.5% drop on Nasdaq , there is no sign of “sell in May and go away” having any real impact. In fact, Dow was up 1.9% for the month, S&500 up 0.6%, EuroStoxx up 2.4% and Nikkei 0.9%. Even bond (prices) were up with UST yields a tad softer; and where European yields were up, it reflected rather optimism about Europe emerging from Covid on to a more solid recovery.
To be sure, your scribe is neither bemoaning nor relishing the lapse of the “sell in May” market adage. After all, seasonal factors (such as holidays) have been disrupted by Covid; and that being the case, such received wisdom (?) demand a far larger seasoning of salt than usual in any case.
Rather, the conspiracy of global inflation upswing and re-emergence of Covid devastation in many parts of EM led by India, could have set the stage for justifiable May sell off; inadvertently lending coincidental credence to the “sell in May” adage. But bears did not get the better of May.
For one, it appears that global policy-makers, led by US fiscal aggression and complementary US Federal Reserve managed to get the upper hand on winning market conviction. As a result of which, inflation has been acknowledged and priced in from a cost perspective, but without setting off a policy response. And the latter assurance of policy accommodation unfettered by rising inflation has been critical in backstopping, if not buoying markets.
As for Covid re-emergence, worries appear to be mostly ring-fenced as well as checked by hopes of vaccine “catch-up”. And so for now, the music continues for markets.
The support in PMI and ISM data will be mostly within the realms of expectations; although, it looks like the cost components of these PMIs and ISM will continue to factor into inflation expectations. And NFP data (Fri) will be watched to assess if last month’s jobs miss was a one-off or reveal larger labour market friction issues. Either way, for now, USD bulls are unlikely to come charging.
Quite the contrary; as CNY surge has provoked Beijing to warn against “one-way bets”. In turn, this may have some dampening effect on Asia FX, which have benefitted from USD slippage.
In Asia, apart from the usual PMI, inflation and trade data, the focus will be on Q1 GDP numbers for Australia (Wed) and India (Mon). Both are set for will unambiguous improvement. But jarring Covid interruption to India’s growth recovery will take precedence over backward-looking data.
As for Australia, patience to assess the recovery through fiscal fade will be what’s key for the RBA. Meanwhile, both RBA (Tue) and RBI (Fri) are both expected to stay on hold; with RBI wary of macro-stability risks while the RBA maintains policy insurance.
FX Theme: No Free Pass for USD Bears
Increasingly, FX trends are difficult to oversimplify. Certainly, hanging the call for stronger Asia FX on a a broad based bearish USD trend is fraught with risks. One of which is the growing differentiation within EM Asia FX varying Covid exposures as well as policy risks that result from stretched fiscal and monetary stance. Another is the policy push-back, led by China; and the attendant spillover impact expected on other EM Asia FX.
While CNY’s strong appreciation trend, with USD/CNY looking to break below the 6.36 mark, is not at odds with the recovery story in China and shifts in the policy stance (to less unequivocally accommodative monetary policy), especially in the context of a softer USD, scope for near-term CNY appreciation may be over-estimated.
In particular, CNY bulls jumping on suggestions that a stronger CNY ought to be used to counter imported commodity inflation looks like a miscalculation.
While policy-makers may not be averse to gradual CNY appreciation as part of the approach to cool excessive rise in commodity prices, CNY will not be used to fully counteract commodity inflation. And the warning by policy-makers that CNY is not a “one-way” bet, ought to be heeded. In turn, we expect that this will both limit further gains in EM Asia FX as well as render EM Asia FX more susceptible to reversing gains realised; especially on upside inflation and/or infection risks.
In other words, there wil be no free pass for USD bears as US advantage over Asia casts a harsher glare on Covid, “twin deficit” and inflation risks. And while these are not imminent pressure points, the risks are building.
US Treasuries: Capped by Policy Patience
Mild bull flattening in the UST yield curve appears to be consistent with inflation worries starting to recede; at least from the policy response point of view.
To be clear, it is not as if worries about cost-push pressures have been put to bed. Rather the narrative is more one of markets being placated that the surge in cost-push factors will not mechanically result in the Fed normalising much earlier.
The “patience” of monetary policy amongst major economies continues to be a dampener on long-end yields, while short-end yields are anchored. In addition, with global central banks still wary of downside risks, the data reactions of yields may continue to be asymmetric.
Specifically, it is more likely that UST yields may slip on soft spots within NFP details than surge uncontrollably on on a strong headline. Giving way to knee-jerk reactions, that is.
As such, we thing that markets may still be inclined to fade sudden surges in UST yields beyond the 1.74% altitude is likely with current Fed stance. Meanwhile, 10Y yields are expected to extend consolidation in the 1.52%-1.74% range; no real direction conviction or change in near-term “center of gravity” to speak of.
Australia Q1 GDP: Solidifying Recovery
Q1 GDP is set for a third consecutive quarter of expansion, boosted by resilient consumer demand as underscored by monthly retail sales; which despite moderating from 4.5% QoQ expansion in Q4 to 1.9% pick-up in Q1, consistent with a solidifying recovery.
And while arguably less evident as a direct backstop for growth, fiscal support – led by job market support such as the JobKeeper Program through Q1 2021 – remains an integral part of Australia’s steady recovery; by helping to keep consumer and credit multipliers intact. Moreover, commodity tailwinds are also expected to have reinforced Q1 recovery. Not just from the terms of trade impact, with its attendant pick-up in activity, but crucially via the investment channels as evidenced by (nominal) private sector capex surging over 6% QoQ up from 4.2% in Q4.
This, encouragingly, suggests a broadening recovery. And these drivers of recovery are likely to underpin growth momentum momentum into Q2; especially as Covid resurgence appears to have impacted Australia to a far lesser degree, notwithstanding the recent outbreak in Melbourne, compared to gimmer realities in ASEAN.
So, in contrast to growing risks of interrupted recovery in ASEAN – and the attendant downward revisions to 2021 growth – risks of a major setback for Australia are subdued.
Nonetheless, beyond the solidifying recovery near-term, impending withdrawal of exceptional fiscal stimulus that has probably flattered the consumer confidence, will be the reason for the RBA to err on the side of caution; keeping stimulus in place as insurance.
RBA Set for Status Quo
With policy accommodation front-loaded, and the economy on a steady mend, the RBA has no reason to accentuate its dovish stance. But equally, it will not be in a rush to revoke policy accommodation either.
Status Quo is the name of the game for now. With i) the RBA cash rate at record low, and an ii) anchor for 3Y AGB yields under YCC, and; iii) a second A$100 QE (at A$5bn per week) set to run through Sep 2021; the bar is high for further policy action.
In fact, the point is that the RBA is wary of premature normalization talk watering down current policy efforts -whether due to upside yield volatility and/or excessive AUD surge.
What’s more, the RBA will also be inclined to wait and watch the path and pace of the recovery once fiscal support fades. This has understandably been a point of uncertainty for the RBA. And so “cruise control” is the optimal policy tone at this juncture.
India’s Q1 (CY) GDP Recovery Less Pertinent Lost on Covid Setback
With industrial production for Q1 up 4.5%, accelerating from 1.6% Q4 expansion, GDP growth is expected to have picked up more emphatically. Even after accounting for more subdued growth multipliers due to the lingering effects of COVID, Q1 growth is expected to be in the 1.2-2.0% YoY range.
But this will be cold comfort for India, which has recoiled back as Covid re-emergence has forced another wave of activity pullback. So the real focus is how the economy manages to get back on recovery track in H2 2021 given that setback expected in Q2.
The bigger concern is that scarring effects result in impaired multipliers via the; i) grey economy (that has been hit harder) and; ii) the banking sector that was already capital constrained and burdened with under-performing assets. Knock-on impact on fiscal strains and credit ratings are also growing risks.
Although for now, the likes of S&P suggesting that it will look through the Covid crisis and not take negative ratings action provides temporary relief.
CNY is More About Stability & Confidence than Unabated Bullish Ambitions
Last week, we opined that CNY appreciation was a case of too much too soon. And we stand by that.
Policy makers are also signaling that CNY is not a one-way bet. This is as good as jawboning.
A correction, while not imminent, is a growing risk; as CNY NEER has not only exceeded pre-Covid levels, but is back at US-China trade war levels of 2018.
The upshot is that while PBoC is not resistant to gradual CNY appreciation; it will not want to undermine stability; especially if gains are speculative.
RBI: Uncomfortable Hold; Targeted Credit Easing?
All else equal the RBI would have been justifiably expected to ease further in response to the devastating Covid crisis. But will probably stay on hold with regards to headline policy tools.
For one, inflation remains somewhat sticky albeit having peaked. Nevertheless, it remains in the realms of macro prudential risk should the RBI cut rates under current conditions given real rates are already significantly negative.
Moreover, the RBI would also be right in assessing that the healthcare crisis is best addressed by healthcare and fiscal policies. Whereas the RBI may resort to general liquidity/credit support, with;
i) targeted enhancement of credit access for MSMES;
ii) easing in credit rules/requirements and;
iii) easing NPA triggers so as to provide B/S relief to ride through the crisis.
Credit: Mizuho Bank Ltd