By Vishnu Varathan, Head, Economics & Strategy | Asia & Oceania Treasury Department | Mizuho Bank, Ltd.,
For all appearances, risk sentiments continued to improve as Wall St extended rallies (+0.8-0.9%) and European equities surged 1.8%. UST yields edging up (10Y nearing 1.3%) further alongside a dip in the USD is also square with the demand for safe-haven diminishing. The drivers for this lift in mood appears to be a solid round of earnings releases on Wall St. But key to the relief is a convergence to the view that efficacy and improving penetration of vaccinations will dampen delta risks; rendering it as a delay to not derailment of, the wider recovery story.
Question is whether “delta deflection” market boost will endure.
Our sense is that “delta deflection” obscures “delta differentiation; the uneven impact of delta. Necessarily, that means USD dips allowing AUD lift off 0.73 lows, and USD/SGD to dips to low-1.36 is not to be mistaken for AXJ/EM rallies either.
Just ask Bank Indonesia.
Bank Indonesia’s Delta Difficulties
Bank Indonesia will have to sit on its hand. Ironically not despite, but because of delta. Let us explain. Admittedly, Indonesia’s acute delta outbreak, impairing the recovery superficially suggests policy scope to ease; especially given that inflation remains low.- But “on paper” policy flexibility doesn’t paper over policy/macro risks amid low “on-paper” inflation.
For a start, low inflation anchored by price controls suggests inflation risks are merely transferred to the fiscal account. Which means increased fiscal burden from managing delta will be even more acute. In turn, public finances/indebtedness will be even more stretched, leading to a near-term deterioration in Indonesia’s credit metrics.
This is arguably a necessary transitory phase to avert greater economic pain. But market perceptions are far more myopic than sensible economic policies would require.
So unfortunately, perceptions of credit/macro risks piling on to a strengthening USD (and sliding rupiah) raise the stakes and costs of – perhaps prohibitively – easing; as a weak rupiah compounds capital flight, in turn feeding back as further rupiah weakness in a vicious cycle that policy-makers simply cannot afford given all the pre existing fragilities.
Of course BI may, and should, lean into fiscal buffer by enhancing liquidity/credit facilities. But any extension of this as direct fiscal financing or other easing (B/S or rates) is risky affair.
Will ECB Sway EUR?
A likely loaded post-strategy review MPC sets the stage for the ECB to sway the EUR.
There is no doubt that this ECB meeting will be the stuff of hair splitting and obsessions. Not just because this is the first MPC following early-July strategy review, but crucially as the ECB is obliged to enact the new strategy shift to a “symmetric” inflation target.
On the surface this may appear clear cut, but closer examination reveals this to be fraught with potential interpretation minefields; especially gauging relative ECB-Fed shifts.
To be fair, the ECB makes the distinction between its “symmetric” and the Fed’s “average” inflation targets. Specifically, that the ECB shuns sustained deviations either way whereas the Fed imputes a decided inflation overshoot to compensate for earlier undershoot.
But the problem is with distilling this monetary ideology into policy triggers and response. And so, the ECB’s allusions to its degree of tolerance around the (still) 2% inflation target may be far more pertinent than the text book “symmetric” shift.
If “forward guidance” suggests limited tolerance for deviations, as may be the case given the ECB’s northern hawks, the ECB may unwittingly unleash EUR bulls; even if only fleetingly so.
In contrast, allusions to or assertions of “transitory” inflation pressures will water down prospects of near-term policy response to inflation overshoot; anchoring/setting back EUR.
Upshot being, the ECB’s lens on inflation assessment is more important than symmetry and average for now. After all not all inflation are created or considered equal.
Credit: Mizuho Bank Ltd