By Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,
The OPEC+ compromise deal drawn out, which agrees on;
i) a measured monthly restoration of 400KBpD;
ii) expands output base-line for some (UAE, Saudi, Russia, Iraq and Kuwait), and;
iii) extends the deal to end-2022 (from April 2022) speak volumes of the current ordeal.
First, oil’s price rebound alongside demand recovery acknowledged by OPEC+ restoration plan concedes that global vaccination should keep the broader demand recovery intact.
But the gradual 400KBpD recovery that is likely to fall short of demand for a while (amid low global stockpiles) is a reflection of caution about the interim demand disruption risks from Covid remaining a threat (with the delta variant unleashing healthcare ordeals in many EMs).
And the extended (output) deal braces for Covid being a prolonged source of demand recovery uncertainty, extending into 2022.
At this point, ASEAN is at the epicenter of this delta outbreak; with Indonesia eclipsing Brazil as the worst-hit in terms of cases (>50K) and deaths, while Malaysia continues to struggle with more than 11K cases a day, with Thailand knocking up against 10K.
Clearly, the ordeals dealt by “delta” will continue to cause hamper an unimpeded recovery into H2 this year. And the wider point is that this may not just be an “ASEAN” quirk.
Even countries such as UK, which have high vaccination rates, are not absolved of risks. Cases in the UK have rebounded to 50K casting doubts on UK’s plans for “Freedom Day” – marking extensive lifting of Covid restrictions – today. And the irony of UK PM Johnson self-isolating after being exposed to the Health Minister who has tested positive for Covid cannot be richer.
Tokyo Olympics set to kick off end of the week have also been marred by Covid cases in the Olympics village, with athletes also being affected.
“Citius-Altius-Fortius” … Faster, Higher, Stronger appears to be a misappropriation of the Olympics by the delta variant.
Despite Indonesia’s ordeals with Covid, BI may have its hands tied amid IDR wobbles (Thu), with the fiscal authorities likely to take center-stage in tackling the pandemic.
Meanwhile, ECB (Thu) could convey a much more fluid normalization plan erring in favour of growth support. “Delta risks” may also feature prominently in assessing downside threats.
US Treasuries: “Risk Off” Masking Taper?
Long-end UST yields continued to compress, with the 10Y UST yields dipping below 1.3% (to 1.27-1.28%); the lowest long-end yields have been this year!
The paradox of intra-year record low yields juxtaposed against record high US CPI is hard to miss; and not as easy to reconcile.
At face value, the justification for lower long-end yields in defiance of higher inflation has been attributed to hastened time-frame for Fed normalization being baked in by markets (and encouraged by the June ‘Dot Plot’).
To some extent, confidence in the Fed being expressed in lower long-end UST yields is not wholly unreasonable. But the “Fed normalization” factor bypassing “taper steepening” appears to be overdone. Especially given more generalised “risk off” in the markets may be accentuating the flight to safety into long-end USTs that is pushing down yields.
So while a reassessment of how the Fed’s response to CPI could sway the lift to long-end yields/inflation expectations, any presumption about UST yields settling into 1.1-1.3% range durably may be misguided.
For this week though, “delta risks” along with soft spots expected in global soft spots may continue to dampen yields in the 1.18-1.38% range.
FX Theme: USD’s Allure to Endure?
The single-biggest challenge to the USD’s dominance is the ECB meeting.
In particular, what the discussions on a gradual “transition” to removing policy accommodation down the road may invoke in terms of EUR reactions.
We expect that Largarde’s guidance on “symmetric” inflation target and tolerance for interim inflation overshoot ought to check EUR pick-up; even if the ECB falling short of the Fed’s “flexible average inflation targeting” starts to lift EUR on perceived policy differentials.
The bigger factor underpinning the USD’s tone is however the undercurrents of risk aversion as “delta risks” along with signs of interrupted, if not fading, demand recovery start to seep in.
This USD dominance may also be reinforced against the GBP as “Freedom Day” re-opening in the UK could unleash fears of burgeoning delta outbreaks rather than prompt lift in sentiments about the resumption in activity (and economic upswing) from re-opening. And so, despite softer UST yields the Greenback is likely to stamp its dominance.
And arguably mostly against AXJ as Indonesia becoming the epicenter of Covid delta risks with Malaysia, Philippines and Vietnam also battling outbreaks; and casting a pall on the hopes of an unfettered recovery in H2.
Admittedly, softer Oil following the OPEC+ agreement may on a relative basis buoy INR; but this is really a reflex to reshuffle rather than a sustained reassessment of underlying risk.
On the whole, it appears that the USD’s allure could continue to endure, in defiance of materially softer UST yields. In other words, rather than being driven by yields, the USD may for now be functioning in the “left half” of the ‘USD Smile’ once more; whereby USD rises on “risk off” corresponding to a drop in UST yields as well.
ASEAN’s Delta Doldrums
The more transmissible delta variant is delaying the recovery for the ASEAN economies and pushing them further into the doldrums.
Just this week, the daily case count in Indonesia (>54,500), Malaysia (>11,000) and Thailand (>9,500) hit the highest on record. While the seven-day moving average of cases is lower than the daily record numbers, they paint a grim picture.
Although the case count in the Philippines is easing, the country recorded its first local case of the delta variant on 16 July. Furthermore, its struggle with vaccine procurement continues elongating timelines around its vaccination drive.
Indonesia will likely extend the social restrictions it has put in place in Java, Bali, some areas of Sumatra and Papua at least until early August from 20 July.
Indonesia’s struggle to break the chain of transmission, constraints around hospital capacity and a vaccination drive unable to keep pace with the rate of infections all cast back to India’s struggles in April/May, when the daily case numbers rose to 400,000.
For Thailand, its experiment with opening Phuket to tourists is hitting a wall as infections across Bangkok and social restrictions there make for a more worrisome picture.
Despite over a month and half under lockdown, Malaysia’s challenges in the delta variant have become a cautionary tale. The good news is that the vaccination rate is picking up pace but will take some time yet to outpace the rate of new infections.
The reliance on the vaccination drive in many of these ASEAN countries has become ever more apparent. Until the pace of vaccinations can outpace the rate of infections, the authorities will likely struggle and the path of the pandemic stretches out ever longer.
This ECB will be closed watched for two reasons: One, it will be the first meeting since the shift to “symmetric” inflation target earlier in July in the first strategy review since 2003.
The other, increased expectations around this meeting given talks of the Council getting ready to start discussing plans around unwinding some of its highly accommodative policy.
With regard to the new monetary policy strategy, the ECB lay emphasis on three factors:
a) that the price stability objective is “best maintained by aiming for 2% inflation over the medium term”;
b) the symmetry around the inflation target will be important for the ECB, implying both upside and downside deviations from this target will be considered undesirable;
c) the medium-term orientation tolerating short-term deviations given “lags and uncertainty in the transmission of monetary policy to the economy and to inflation”.
Finally, the new strategy also introduced climate change considerations into ECB’s policy.
Ahead of the 22 July meeting, ECB President Lagarde intimated market participants that the “…forward guidance will certainly be revisited”.
ECB’s current EUR1.85 trillion bond buying program will run at least until March 2022, following which most investors were expecting a gradual unwinding of the program.
While that expectation may still very well be valid, President Lagarde has hinted at a possible “transition to a new format”.
Numerous ECB Council and Board members have expressed a gamut of opinions ahead of the meeting, following the President’s remarks.
The will likely generate a lot of internal debate around various strategies: the new monetary policy framework, the exit strategy out of Covid induced high accommodation and strategy around forward guidance.
To anticipate the outcome of the meeting at this point would be pure conjecture: one this is more sure, there will be a lot strategising and debate.
Bank Indonesia: Forced to stay on the sidelines
Indonesia’s struggle with the delta variant are becoming more acute. With daily cases crossing 50,000 last week and social restrictions likely to be extended further, the path out of the pandemic looks long and bumpy.
BI will meet against this grim backdrop. The central bank lowered its 2021 GDP growth forecast to 3.8% earlier this month and will likely formalise the downgrade at this meeting.
Notwithstanding, BI will be forced to stay on the sidelines as it prioritizes macroeconomic stability seeing as a firmer dollar, higher oil prices (of which Indonesia is a net importer despite being a net commodity exporter, overall) and the subsequent depreciation pressure on IDR will remain BI’s main concerns.
It will continue to defer the heavy lifting in terms of recovery support to the government.
The announcement of additional fiscal measures cannot be ruled out if social restrictions are extended into August.
The fiscal deficit target of 5.7% of GDP for 2021 may be breached with the FM already indicating that the deficit in 2022 would remain wide at 4.7-4.8% of GDP.
BI, in the meantime, will remain dovish and reiterate its stance that it will provide non-rate support where possible.
Three Take-Aways From China’s Q2 GDP
For all intents and purposes, China’s recovery is not just intact, but resilient even. That 7.9% YoY Q2 GDP was a tad hair short of 8.0% consensus merely split hair over decimals.
For not only was H1 growth in line with 12.7% expectations, but YoY momentum in June retail sales (12.1% vs 10.8%), IP (8.3% vs. 7.9%) and FAI (12.6% vs 12.0%) beat consensus.
Yet headlines conceal key moving parts in China’s recovery and attendant policy implications.
First, for all the encouraging signs a durable and robust , the larger picture is that the recovery momentum is in fact fading; and set to ease well below ~8% rates.
Point being, the cyclical upswing from global re-opening globally, which boosted tailwinds from China’s activity recovery since Q2 last year, is set to fizzle.
Even taking into account spasms of from COVID variants that may cause demand recovery to sputter in H2, thereby inducing more volatility in sequential growth, the broader story of structural growth factors levelling China’s growth momentum back to 5.5%-6.0%.
Which is to say, broad overheating risks are not the overarching concern; especially given that the industrial buffers and spare capacity can absorb transitory cost push pressures.
Second, the drivers of growth in China remain appreciably uneven.
Once distortions from a low base are backed out, it is clear that retail sales remains weak; well below the recovery levels attained in industry and investments.
What’s more, the property sector remains a disproportionately large driving force behind the economic momentum, whereas underlying consumption momentum.
What this means is that policy-makers in Beijing are confronted with a two challenges. One is boosting consumption to ensure that the “dual circulation” that requires domestic demand, does not falter. The other, to keep property bubble and financial stability risks in check. Third, uneven and dissipating recovery momentum warrants that China’s policy response be acutely targeted and appropriately fluid to navigate the cyclical bumps as well as the wider structural impediments (and geo-political risks).
And so, markets should not be wracked by perceptions of policy dissonance from over-interpreting RRR cuts as China lurching back into easing mode, and then panicking that China’s property tightening is a mercurial swing back to tightening.
Instead, it may help to recognise that keeping financial risks in check (to avoid a Minsky moment), tempering the property market to prevent bubbles/social unrest is wholly consistent with boosting credit access for SMEs for economic support/jobs preservation.
All of PBoC’s varied roads lead to the destination of stable and sustained growth, to ensure the means to attain advantages in new technologies that China deems imperative in a global order where the US is turning up the heat on China’s economy, politics and diplomacy.
Bangko Sentral ng Pilipinas: Another loan extended to the government
BSP extended a fresh PHP540bn (~2.4% of GDP) loan to the government to help finance its efforts to rein in the pandemic.
This is the fourth such loan that the BSP has provided since March 2020; a fresh loan is issued only once the outstanding loan is repaid.
The prudent and rule-based approach to generating funds undertaken by the government and BSP significantly reduces risks around outright debt monetisation. Especially since the burden of pandemic support rests with fiscal policy given that headline inflation, although easing, remains above the BSP’s 2-4% target range.
Credit: Mizuho Bank Ltd