Mizuho Week Ahead - Silver Linings (& Squeeze)?

Week-in-brief by Vishnu Varathan, Head, Economics & Strategy | Asia & Oceania Treasury Department | Mizuho Bank, Ltd.,

Reddit Day Traders have piled into bets on silver to flush out the shorts, explaining early-week bump up in Silver. Whose pockets (Reddit retail traders or hedge fund) silver bets will ultimately line is debatable. But it would be a mistake to read this a commodity silver lining. It is not.

Meanwhile, the broader question of how regulators will respond remains the elephant in the room. Hedge funds hoping for quick clamp down on Reddit activist traders will struggle to find any silver lining in the SEC’s reticence on the latter, but scrutiny of brokers who have curtailed access.

Elsewhere, positive US data in recent weeks are but flimsy silver linings; as resurgence of Covid globally, knocking back China’s recovery momentum and threatening to cast a pall on Q1 outcomes in DM and EM; especially as vaccine shortages/logistical challenges compound pain from resurgence.

Admittedly, the unambiguous case for more stimulus, rather than prematurely curtailing monetary and fiscal support for economies, may be deemed a silver lining in the current setback.

However, at this point, central banks may be more likely to wait and watch than hasten to pull the trigger or unleash the big guns urgently. We expect that the RBA (Tue), BoT (Wed) and RBI (Fri) will maintain status quo; albeit with a distinct dovish bias. Admittedly softer inflation for India does open up more policy space for the RBI to ease. But the details of India’s Union Budget (Mon) will perhaps be deferred to. And the RBI may also use the time to assess broader inflation trends and macro-stability risks.

As Reddit traders chase silver, markets appear to be chasing silver linings. Caution as such could continue to linger, even if it does not dominate.

India Budget: Of False Choice & Feasibility

India’s FY21-22 Budget will have to walk a razor-thin, tight rope balancing a path to consolidation, but not at the expense of growth restoration. To which end, FY21-22 headline fiscal deficit reduction needs to be a measured decline, not tumble, to ~6.0% of GDP from ~7.2% (by our estimates) in FY20/21.First things first. Undeniably, a solid, achievable fiscal consolidation roadmap is imperative.

But equally, the adverse, economic shock dealt by Covid-19 demands realistic, re-engineered fiscal consolidation plans; and not a hasty reversion to pre-Covid consolidation plans/time-line.

Point being, FY20/21 deficit blow out to 7.2% from pre-pandemic plan of 3.5% deficit, will not only strain fiscal math to get back to ~3.0% on a comparable timeline, but crucially, such fiscal extremism will risk undue, self-inflicted economic hardship.

In particular, ensuring that the most vulnerable segments of society and MSMEs get adequate financial support through the fragile recovery. In other words, India must avoid the trap of a false choice between restoring growth and getting back on a path to fiscal consolidation.

The latter is lost cause without the former. Whereas any sustainable consolidation must be anchored in revenue feasibility, which in turn requires restoring solid growth potential (6-8%).

To be clear, this is not an endorsement of profligacy with abandon.

Rather, it is phasing out public spending in a way that allows the private sector to sustainably pick-up the slack amid more even recovery.

The fiscal math equivalent of “growing out” of fiscal slippage and debt, enhanced by simultaneous “denominator” (higher GDP) and numerator (improved revenue-expense dynamics) effects. Revenue, and ultimately fiscal feasibility rely on the ability to monetise growth restoration as wider and deeper tax revenue base.

This ranges from improving GST collections to fund growth-enhancing investments (e.g. education, infrastructure) to realizing planned divestments towards sustainable debt dynamics. The hope is that rating agencies recognise the false choices and feasibility and refrain from myopic negative credit action that perversely penalise judicious fiscal consolidation plans.

RBI Status Quo on Budget Spotlight & Inflation Glare

The RBI is set to stay on hold as it; i) defers to the Budget spotlight, and

ii) buys time to ensure it is out of the inflation glare.

To be sure, receding inflation is in the early days; and far from a confirmed trend that creates policy comfort. As we has alluded to in a recent publication, inflation relief is indeed overstated by the decline in food inflation. Whereas India is not yet out of the woods with regards to stagflation-type risks.

And this ties the RBI’s hands.

What’s more, with focus on a still supportive, albeit less aggressively so, budget, the RBI has another reason to stand by the sidelines. But this is not purely for the reasons of not stealing the limelight from fiscal policy. More importantly, it is to mitigate the risks of fiscal slippage (from consolidation) plans and hedge against “taper tantrum” tail risks; which entails restraint on rate cuts as well.

Upshot being, deferring to Budget spotlight and not being free of stag-/in-flation glare, the RBI will resist the bias to ease for now.

Indonesia Q4 GDP: Modest Improvement, but Uncertainty Lingers– Q4 GDP growth is expected to contract less severely at to -1.5% YoY (vs. from -3.5% in Q3.); in line with improved monthly activity data showing domestic demand recovery. Improving confidence lifting retail sales and motor vehicle sales augurs well for consumption.

On the investment front, cement consumption, capital goods imports and investment loan growth picked up. Government spending also improved reflecting higher capex and Opex spending.

On the external front, export growth improved significantly. However, given the improvement in import growth, the contribution of net exports will only be slightly better in Q4 versus Q3. That the gradual improvement in GDP growth in Q4 2020 will be carried forward into 2021 cannot be assumed given the rise in Covid-19 cases through the end-December and early January period.

Although the social restrictions imposed by the government were targeted and not akin to a complete lockdown, it will drag Q1 GDP growth. Fundamentally, improvement in growth will be uneven, possibly even temporary, depending on the pandemic situation as infection rates rise in waves. The government has come to rely heavily on the vaccination drive to rein in the pandemic but there are many challenges with this reliance.

First, the vaccination has been procured from China and its efficacy remains in question. Second, the are spatial challenges in distributing the vaccine across the sprawling archipelago, which is already constrained by connectivity issues. Third, outbreaks as the virus mutates will become more challenging to manage.

While government spending will continue to be the mainstay for growth, we expect Bank Indonesia will also chip in by supporting credit and liquidity conditions. It will complete its rate cutting cycle with a final 25bp cut in Q1 2021, contingent on IDR stability.

Bank of Thailand: Status Quo

BOT will keep its policy rate unchanged at its historic low of 0.50%, even as the Ministry of Finance last week cuts its 2021 growth forecast to 2.8% from 4.5% citing the resurgence of Covid-19 infections. Although BOT has not ruled out further rate cuts, the need for immediate support is reduced with the government introducing additional fiscal stimulus.

On 19 January, the cabinet approved THB210bn (~1.3% of GDP) in cash handouts to low-income households, self-employed people and farmers. This handout compliments other incentives provided by the government including reduced electricity and water bills for February and March; a plan to discount internet cost, 90% reduction in land and building taxes and an extension of liquidity to farmers and smaller business by state banks.

The recent weakening of THB will provide BOT with some confidence that the currency is not on a one-way appreciation trajectory; further reducing pressure on any immediate action.

RBA Hold: Front-Loaded Stimulus & Subpar Inflation

The RBA is set to be on hold; as it meant to be most of this year. Fact is, the RBA has front-loaded stimulus (erring on the generous side) of; i) RBA policy rate at record low 0.10%;

ii, YCC (3Y) tagged to this rate;

iii) YCC buying not limited to the front end, NS;

iv) AUD100bn (5% of GDP) QE committed over six months

And this mean that the RBA may comfortably remain on cruise control for most of 2021 unless the wheel comes off the wagon unexpectedly. What’s more, inflation remaining below 1%, but in-line with expectations validates the current policy course/hold.

On one hand, AUD may be bumped up if the rhetoric sounds less dovish; especially in comparison to Major central banks poised dovishly. But on the other, even if the RBA does not lean against a buoyant AUD at current levels, sustained rise towards 80 cents does accentuate this risk.

US Treasuries

Bull flattening (softer yields led by the long-end) of the UST yield curve, viewed alongside the drop in equities, quite clearly points to “risk off”; and the ensuing flight to safety. Renewed fears to do with the new strains of Covid giving rise to record infections, hospitalizations and deaths in January cannot be blameless.

But to some extent, concerns that Reddit Day Traders setting off a series of short squeeze (from GameStop to Silver) could inadvertently trigger an unintended contagion of liquidation across. To be sure, it is not as if the wheels have come off the wagon, and Oil holding up (Brent above $55) suggests cautious positioning rather than a panicked rout in the markets.

Against this backdrop, we expect 10Y UST yields to be in the 0.94-1.14% range for now; with traction in yields above 1.10% looking more tenuous unless reflation trades kick in emphatically.

FX Theme: Reflation Reined in by Reddit

To be specific, our suggestion is that USD bears and broad-based reflation bets may be reined in by the Reddit activist Day Traders; particularly as risk sentiments take a beating. This is more conjecture than a confident pronouncement of market dynamics.

But here’s how we break down the “Reddit impact” on FX markets.

First, “risk off” associated with contagion risks resulting from deep losses suffered by hedge funds on the wrong side of the Reddit short squeeze, will probably prompt some degree of safe-haven demand. And to a large extent, flight to safety from financial market (liquidation) risks is more often than not tied to USD demand (rather than JPY or CHF demand). And so, USD bears could be stalled, if not knocked back, exposing stretched long positions in EM and commodity currencies being compromised to some extent.

Admittedly, commodity currencies will be differentiated and stratified according to the fortunes of their underlying commodity exposures. But on the whole, renewed pandemic concerns and vaccine shortage disappointments, are likely to rein in reflation bets that had boosted commodities and other demand proxy trades.

So this week could be marked by AUD and MYR on a cautious footing ahead of OPEC meet; and a boost to oil price will be required to prompt sympathetic gains in AUD and MYR. CNY gains being tempered meanwhile could reveal softer SGD and KRW.

But on the other hand, if oil looks softer from Reddit and pandemic, INR could out-perform. Before that though possibility of Budget and/or RBI boost for INR is watched.

Credit Source: Mizuho Bank Ltd