By Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,
Week-in-brief: Baby Bear
The ‘Goldilocks’ allusion was extremely tempting given a NFP jobs report that was strong enough to incite a rally in equities; but sufficiently soft around the edges to dampen yields (and USD) on the premise of the Fed having some flexibility around normalisation (i.e. nothing imminent).
But your scribe has opted for a more precise rendition of the Fairy Tale reference. Specifically, the “baby bear” reference.
As one will recall, it was baby bear’s chair, food and bed that Goldilocks found just nice (with Papa bear’s being too hard/hot and Mama bear’s being too soft/cold). And so, NFP print at 850K beating expectations (hard/hot) was tempered by jobless rate edging up to 5.9% (soft/cool) disappointing expectations of 5.6% (from 5.8% previously). Baby bear!
But the wider point is that baby or otherwise, it is still a bear! And those who read Goldilocks will recall her being startled from slumber (on baby bear’s bed) when all three bears returned. And that is what the baby bear warning is for markets. The bears, are associated with “taper” around the corner, and COVID resurgence, may return to jolt markets out of “risk” “slumber”.
That’s arguably fretting tomorrow’s problem or threat, and one cannot expect US markets to response imminently. But European markets may very well be turning cautious sooner as the delta variant upsets the narrative of a smooth, unfettered recovery from here.
Whether the ECB chimes in on these risks, and perhaps goes on to outline symmetric inflation goals with some give either way (in a Fed style insurance move) will be interesting to watch.
Meanwhile, we expect the RBA to extend both YCC and QE at the July meeting (Tue).
The former being more of a technical point on reference bonds. Whereas the QE question on pace and size will dominate as markets watch for a calibration of QE given the strong economic rebound so far.
The RBA will try to strike a “baby bear” tone ; between optimism about recovery yet caution to leave in sufficient accommodation; especially as COVID resurgence (necessitating fresh lockdowns) means that bravado about a strong recovery may prove misguided, if not outright cavalier.
As such, we expect a calibrated QE size scale back (A$75bn this round from A$100bn previous two rounds) with the A$5bn/wk pace of purchases maintained.
Elsewhere in the region, BNM (Thu) is expected to hold policy, deferring to fiscal cushion to see through the extended MCO 3.0 as Covid cases remain above the threshold for comfort.
Finally, Indonesia’s lockdowns in Java and Bali, with the aim to halve cases from over 20K a day reflects risks of bears overtaking “baby bear” type of targeted restriction to spare the economy.
FX Theme: Acquiescence, Not Abdication
” Not all those who wander are lost.” – J.R.R Tolkien
The Greenback appears to have wandered off the bullish path post-NFP. Admittedly, this may point to some regrouping and perhaps even moderation in post-FOMC USD strength; especially if in-coming data point to a case for Fed retaining “patience” while awaiting “substantial” improvement in the economy. But a wandering/wondering USD may not be lost.
Critically, the Greenback need not have lost it’s post-NFP allure; given that “taper” is merely kicked (just a little) down the road rather than being taken off the table.
Point being, “King USD”, whose coronation took effect since the 16th June FOMC (revealing more hawkish ‘Dot Plot’) may not quite have abdicated, but is acquiescing to softening UST yields.
For now, this has translated into some traction in G10 currencies against USD.
But as stated above, this should be recognised as a moderation of post-FOMC USD upswing rather than a decisive turn in the USD, relinquishing its bullish bias to go into retreat. Especially if the ECB talk this week tilts towards a more symmetrical inflation target rather than it’s preference for price pressures on the close to, but below 2%; in turn taking some tone off the EUR, possibly diminishing any gains against the USD.
Crucially, underlying caution about COVID resurgence led by the delta variant could be a far greater bug bear for Asia, where the outbreaks continue to setback recovery timelines.
And so, gains in EM Asia FX against the Greenback, in response to the post-NFP slip in the USD, are likely to be measured. Perhaps even fleeting, if sentiments remain unsettled.
CNY cues will remain a key moving part to watch in the equation.
Meanwhile, AUD could have some reaction to RBA; in particular with regards to the form adopted for QE and YCC extension. Underlying bias is for the AUD to remain soft given RBA-Fed divergence.
US Treasuries: A Load of Bull (Flattening)
Bull flattening (drop in yields led by long-end) even with a higher than expected jobs in NFP data may be reconciled with a bump up (rather than a drop) in the accompanying unemployment rate, COVID delta risks and OPEC+ tensions.
On US jobs and the Fed, higher jobless rate in the mix specifically is deemed sufficient to push out the case for Fed normalisation; ostensibly the overarching determinant of yield direction (both 2Y and 10Y yields softer post NFP).
Meanwhile, if global worries about COVID resurgence fuelled by the significantly more transmissible delta variant continues to grow, then softer 10Y yields from marginal “risk off” may not be at odds with US recovery and inflation.
Finally, OPEC+ rift (even if it is reportedly only UAE opposed to the plans for extending the agreement into 2022) speaks volumes of the economic/fiscal toll of self-imposed output curbs beginning to test commitments to hold back.
Simply put, without Saudi’s vision/insistence, the underlying inclination and pressures may be for a much larger output and resultant softening in crude prices from currently elevated (somewhat higher than pre-Covid) levels.
And this will be ultimately consistent with softer long-end yields. In the midst of OPEC+, Covid and Fed signals, 10Y UST yields may consolidate 1.36-1.55%.
RBA: To QE or Not to QE
Well, that’s not quite the question that will confront the RBA. Instead, it may be more of how much – in terms of pace and size – to QE. Admittedly, some camps are looking for the RBA to cease QE, which has thus far totalled A$200bn in two equal installments art a pace of A$5 billion/week. But we think that this is too brutal.
Debates about the Australian economy having enjoyed a robust enough recovery being distilled into a case for RBA to forgo QE miss the wider point about lingering uncertainties. Not just from the worrying resurgence of Covid (led by a far more transmissible ‘delta’ variant), but more critically, fading fiscal stimulus, including the JobsKeeper; the impact of which (over time) is somewhat of an unknown.
And so, it would be nothing less than cold turkey to flip the QE switch off; arguably a cavalier, if not negligent move in the midst of another outbreak of Covid.
Instead, a calibrated bow out of QE, contingent on continued recovery past Covid resurgence, may be a far more optimal policy option that forsakes neither prudence nor well-being.
As for the details of how a scale down may be effected, this could entail tempering pace or size.
Dialing back pace of QE in the midst of COVID outbreak is hardly the most desirable option. As such, the merits of that preserving the pace (A$5bn/week) have greater appeal; perhaps by reducing the pre-committed size (implicitly duration) of QE (to say A$75bn rather than A$100bn).
This will help to avoid self-imposed Fed-like “taper” risks compared to a plan for “open-ended” QE (pared back in pace or not) to be assessed on a regular (weekly or monthly) basis.
Whether AUD is jolted into a snap-back or is depressed will depend on a combination of; i) pace of QE; ii) size of QE commitment (or “open-ended” program), and; iii) accompanying rhetoric.
A sufficiently generous QE commitment alongside YCC maintenance (our base case) alongside a more dovish time-based low rate assurance (in contrast to the Fed’s state-dependent commitment) means that the default may be for a soggy AUD on its back foot.
India: Fiscal Measures May Fall Short
The wave of Covid-19 infections is proving to be devastating for economies in the region.
India and Malaysia are amongst a few other countries which have been subjected to their most severe waves of Covid-19 infections yet.
In India’s case, peak of the wave, in terms of damage to lives and livelihood, was in April/May as main metropolitan cities of Delhi and Mumbai bore the brunt of the hit. That’s the good news. But the bad news is that India’s limited fiscal cushion may nevertheless cast a shadow on the recovery; interrupting, if not delaying restoration and widening inequalities.
The latest set of measures announced by the FM total 2.8% of GDP on a headline basis but include a number of credit guarantee schemes that do not account for fresh spending per se;
- INR1.1trn in credit guarantees for COVID-hit sectors such as health care and tourism;
- INR1.5trn extension of the emergency credit line guarantee scheme and;
- INR 5.7bn worth of credit guarantee for banks for on-lending to MFIs.
Measures to boost demand through direct cash transfers were far fewer; limited to an extension of the free food grain scheme and fertiliser subsidies; which together will have an impact ~0.3% of GDP. As such, the package will do little to support near-term growth.
Worryingly, the drag from sharply rising retail fuel prices will further hurt consumer purchasing power at a time when demand is already languishing; denting recovery prospects.
So the real risk is that fiscal measures, owing to understandable debt/credit constraints will fall short of significantly offsetting Covid resurgence hit in Q2-Q3 2021.
Indonesia: Bites the Bullet on Tighter Social Restrictions
President Joko Widodo (‘Jokowi’) finally took steps to implement more stringent regional social restrictions, moving away from ‘micro restrictions’, in an attempt to break the chain of transmission of the ‘delta’ variant of Covid-19, blamed for the surge in cases across the country.
The islands of Java and Bali will be subject to the following restrictions from July 3-20:
a) All workers in ‘non-essential’ sectors must work from home; while ‘essential’ sectors will operate at 50% capacity.
b) Religious, cultural and sports related activities are banned.
c) Malls will be closed; restaurants are only allowed to cater to takeaways.
d) Capacity at groceries and traditional markets is capped at 50%.
e) Domestic air travel limited and plans to re-open Bali to international tourists is postponed.
The government aims to bring daily cases down to 10,000 from a record 24,836 on 1 July. With hospital capacity increasingly becoming stretched and the vaccination drive lagging the record number of cases (see Mizuho Flash: 23 June 2021: Indonesia – Hit By Its Most Severe Wave of COVID-19 Yet), we see high chance that the lockdown will be extended.
With the virus already spreading beyond the island of Java and Bali, admittedly not to the point where hospital capacity is stretched, the government will also need to consider the possibility of implementing a country-wide lockdown policy.
As it is, with Java and Bali accounted for 60.8% of 2020 GDP, the lockdown will without doubt impact retard the recovery; a setback that may be exacerbated if indeed Indonesia is forced to lengthen and broaden restrictions.
The government has introduced some measures to alleviate the economic blow including extension of cash handouts by two months, increased electricity subsidies and food aid.
Fiscal policy continues to be the main source of pain relief as Bank Indonesia’s options are constrained by macro stability concerns around IDR and the ‘twin deficits’ remains its focus.
Our 2021 GDP growth forecast at 3.9% takes into account the pandemic setback but is nonetheless subject to further downgrades, especially if Covid outbreak prolongs.
Malaysia: Extending Lockdown & Economic Pain
Malaysia’s nationwide Movement Control Order (MCO 3.0) meant to end on 28 June, has been extended by another two weeks; as daily cases remained above the government’s threshold of 4,000. On Sunday, the daily case count was 5,586 new cases of Covid-19 infections.
The one measure that has been relaxed is that restaurants and eateries will be allowed to operate longer hours (6am to 10pm from 8am to 8pm, previously).
The continuation of the lockdown is not completely inconsistent with the government’s National Recovery Plan, which aims ease to Phase 2 from the current Phase 1 some time in July.
But with daily new cases still above 5,000 and increasing anecdotal evidence suggesting flouting of social distancing rules, reining the case count particularly challenging for the authorities.
The latest fiscal package announced by the FM in order to cushion against the extension of the lock down includes;
- MYR10bn in cash transfers along with;
- electricity bill discounts, cooking oil subsidies;
- extension of a wage subsidy program and;
- an automatic 6-month moratorium on loan repayments for applicants;
These will have a sizeable fiscal impact. We estimate that the last two fiscal packages (announced on June 1 and June 28) will involve an additional MYR15bn (1% of GDP) in new spending.
This will lead to a further widening of the 2021 fiscal deficit, which following fiscal stimulus measures in Q1 2021, the government estimated at 6.0% of GDP from the original 5.4%. But in contrast to India, the rise in global oil prices will be a welcome revenue-positive turn for Malaysia.
Given 2021 Budget assumptions of $42/barrel Oil prices, Crude above $70/barrel, may significantly increase oil production/exports revenue to the additional spending.
Revised fiscal/growth forecasts are set to be updated in August on greater Covid clarity.
Bank Negara Malaysia: Deferring to Fiscal policy
Even with the lockdown extended and the economy taking a hit from the recent spike in COVID-19 infections, BNM will prefer to keep its policy rate on hold.
Its focus will remain on providing credit/liquidity support measures to avert deep balance-sheet recessions for firms and households.
The onus to support the economy will remain on fiscal policy, which has the ability to be more targetted towards the most vulnerable sections and sectors of the economy.
Moreover, from a monetary conditions standpoint, the recent depreciation in MYR against the USD (USD/MYR is trading around 4.16 levels) will also provide BNM some wiggle room against the risk of tightening financial and liquidity conditions.
We expect BNM’s next move to be raising interest rates in Q2 2022 following ‘taper’ announcement from the US Federal Reserve.
Credit: Mizuho Bank