Mizuho Week Ahead – Of Blocks & Boats

Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,

Week-in-brief: Of Blocks & Boats

Block trades that wiped out some $35bn from targeted stocks on Friday may not rock the boat if the focus is on a late surge to finish strong on Wall St. Not because panic is being blocked out. But perhaps due to the offending source, the forced liquidation at family office Archegos Capital Management is run by Bill Hwang, being identified. Fear of the unknown is afterall far worse.

Whereas, markets gearing up for Biden’s $3trln infrastructure plan, building blocks (literally!) to revive reflation trades, may lead equities and yields higher; especially in risk aversion is averted. This is not to ignore downside risks and latent volatility in markets. Quite the opposite. It flags markets piling into reflation bets at the peril of getting dislodged from the reality of economic outcomes.

The Suez Canal still blocked by the 220,000 tonne container ship ‘Ever Given’ lodged in narrow straits only accentuates cost-push running ahead of demand recovery as shipping costs escalate from weeks of delay/backlog as container ships and oil tankers re-route around the Cape of Good Hope. Not to mention supply-chain delays threatening to disrupt activity and the economic recovery. In which case, the “same boat” effect could eventually dampen commodity price rise.

What’s more, the vaccine tide apparently does not lift all boats. On one hand, optimism about US vaccine rollout alongside fiscal plans may be floating the boat of many investors. But in stark contrast, Europe’s impeded vaccine progress is its stumbling block as a “third wave” threatens. Point being, “re-opening” to pre-COVID activity levels will have to wait for “herd immunity” boat to come in; and certainly not a given off the blocks on vaccine rollout. India’s resurgence in COVID, despite managing to avert sweeping lockdowns, raises question about adequacy of vaccination pace.  Breakout of new mutations/strains in Philippines and cases in Vietnam are warnings that economies in the region cannot afford to let their guard down on testing and containment whilst vaccine rollout is underway; as the latter may stretch out till Q3, leaving gaping vulnerabilities in the meantime.

Admittedly, interim risks of COVID waves will probably not derail a more solid recovery into 2022, even if it delays and destabilizes the nascent pick-up from broadening out in 2021. But rising costs from reflation (which introduces “second round” risks to some degree) alongside surging UST yields (which accentuate financial channel volatility) raise the stakes, even if does not block policy options outrighht, for EM Asia central banks trying to steady the boat out of the pandemic and into a sustained recovery.

FX Theme: Bracing for Volatility

While UST yields are softer on the week, yields have clearly bounced/bottomed amid renewed reflation bets ahead of the $3trln Biden infrastructure plan; and perhaps cost-push elsewhere. But equally, it is not all sunshine and rainbows as fiscal stimulus bets in the US are flanked by European “third wave” COVID risks alongside more terse global geo-politics. The Myanmar situation worsening over the weekend does not mask pre-existing US-China tensions on thr rise and the prospects of coordinated G7 tightening on China sanctions on Xinjiang.

The FX outcomes then may be less UST yield dependent. Because higher UST yields on reflation may very well boost USD (especially against EUR) on US out-pacing the world on vaccination- and stimulus-driven recovery while softer yields from “risk off” could easily imbue USD in the context of safe-haven appeal. But while there may be a bias for a stronger Greenback, commodity currencies may still be alluring for those enamoured by the reflation story; especially directly linked to infrastructure pay dirt. And so, the manifestation of more volatile USD dynamics and opportunistic positioining in commodity and EM currencies may be likely. We expect to be cautious of stumbles in EM Asia FX on episodes of “risk off”.

US Treasuries

10Y UTS yields, while off the tests above the 1.7% handle, have bounced back above 1.6% after the capitulation earlier last week. This is in no small part due to Biden’s $3trln infrastructure plan. So details on that this week could provide another reinforcement of lift in UST yields. Also, the Suez Canal blockage adding to shipping costs and accentuating commodity delays may also result in perverse escalation in costs and a lift in yields, though it may ultimately dampen activity.

With data flows this week likely to reinforce the recovery rather than spots of vaccine delays, the case ffor higher yields may still be on the table, but perhaps not aggressively so. We expect 10Y UST yields to trade in the 1.55%-1.78% for now. Breach above 1.80%-1.85% is a potential risk of wider sell-off in asset markets.

BSP: Striking a Fine Balance

BSP has held its policy rate, as expected, and struck a fine balance between dealing with cost-push inflation and weak growth recovery prospects on account of a renewed wave of Covid-19 infections. Nonetheless BSP Governor has stated that supply-side inflation would be dealt with by increasing importation of goods (led by pork); whereas the priority was to maintain an accommodative monetary policy stance to aid the economy recovery and support credit growth are not displaced. That said, with inflation still set to overshoot the 4% target ceiling and “second-round” inflation risks that cannot be ignored, BSP may be compelled into a dovish hold rather than active easing.

This however is not to be mistaken for the lack of options as despite being forced to keep policy rate unchanged for the rest of the year, non-rate measures to support economic recovery are on the table. Market participants seemed to like the nuanced stance of a prudent check on inflationary trends without unnecessarily stifling the prospects for recovery; with PHP being buoyed on BSP’s rhetoric.

Vietnam: Still Looking Good

Vietnam’s growth prospects will continue to outshine regional peers. Q1 GDP growth is expected to pick up to 5.7% YoY from 4.5% in Q4 reflecting improve domestic consumption and export growth. Monthly activity data for January and February, notwithstanding the moving Lunar New Year holiday effect, points to strong growth in exports (25.7% YoY in Jan/Feb from 15.2% in Q4) as well as retail sales (5.5% YoY YTD compared to 2.2% as of end-Dec). Industrial production slowed slightly to 7.5% YoY in Jan/Feb from 8.1% in Q4, however, IP growth in March is expected to improve significantly and lift the boat for Q1.

Growth prospects remain strong but are subject to downside risks from renewed virus outbreaks, not unlike elsewhere in the world. Indeed, the Health Minister warned last week that the country faces a “high risk” of a new outbreak following some illegal border entrants, who tested postive.

Moreover, while the authorities managed to wrest the spread of the virus last year through strong contact tracking and stringent quarantine rules, they have struggled to get the vaccination drive off the ground. The vaccination drive, which began at the end of February, is already subject to delays following a pushback in the arrival date of AstraZeneca vaccine doses into April. Nonetheless, given that activity is more or less on an uptrend and that the authorities will, at all costs, try and avoid stringent lockdowns;

Vietnam will still outperform regional peers (see Mizuho Insights: 11 February 2021: Vietnam: 2021 Outlook: Resilient But Not Immune). From a policy perspective, fiscal policy will be the mainstay while monetary policy will remain accommodative. Additional rate cuts, however, are not needed with growth prospects improving.

BoT’s Expected Dovish Bias

In line with expectations, BOT kept its policy rate unchanged at its historical low of 0.50%. The decision was unanimous amongst the members of the MPC. Nonetheless, the BOT maintained its clear dovish bias as it acknowledged downside risks to growth. To that end, BOT lowered its 2021 GDP growth to 3.0% from 3.2%, previously. The downward revisions stemmed from lower tourist arrival projections than prior assumptions; not unrelated to slower roll-out of the COVID-19 vaccination.

Thailand began its vaccination drive only on 1 March (after a delay from mid-February) and is focussing on healthcare and front-line workers. The government plans to open up vaccination registration for the general public from May this year and aims to vaccinate ~50% of its population by the end of the year. On the inflation front, BOT raised its 2021 headline inflation forecast to 1.2% YoY from 1.0%, previously but this largely indicates that inflationary pressures remain well-contained and within BOT’s target range of 1-4%. Core inflation forecast for 2021 were left unchanged at 0.3%.

Overall, BOT kept the door open for further easing by stating that it stands “ready to use additional monetary tools if necessary”. While BOT acknowledged the recent rise in foreign and domestic bond yields, it said it was monitoring THB movements “closely”. Since the previous meeting and certainly since the start of 2021, appreciation pressure on the THB has been alleviated to a large extent. BOT noted in the press conference following the meeting that it expected the narrower current account surplus to ease pressure on THB going forward.

Finally, BOT emphasized the importance in the “continuity of government measures and policy coordination among government agencies” as “critical” to supporting the on-going economic recovery. Indeed, the government has been proactive in providing cash handouts to the poorer sections of society, initiating and maintaining domestic travel incentives as well as introducing credit and other liquidity support measures for SMEs and businesses in the tourism sector. The rhetoric is consistent with our view that the BoT will not lower the policy rate any further this year, barring unexpected and extreme adverse shocks. But equally, non-rate measures to support growth and stabilize financial markets are on standby should the need arise. Importantly, with fiscal policy shouldering much of the responsibility in supporting growth through targeted measures, the imminent need for monetary policy stimulus is reduced.

India’s Bet on Vaccinations

India has experienced a worrying, renewed COVID-19 wave since Feb, with infections surging in most states except Kerala and Rajasthan; and Maharashtra has become the epicenter of the current wave. Social restrictions have been tightened in some cities in Maharashtra, Punjab, and Madhya Pradesh. But the absence of large-scale and extremely restrictive lockdowns at national or at state level, indicates that India is heavily relying on the vaccination drive to help curb the latest wave.

Trouble is, India’s vaccination drive, which began in mid-Jan, has so far been restricted to the elderly, front-line and healthcare workers, while people above the age of 45 will receive vaccinations from 1 April. Admittedly, the aim to vaccinate 300mn people by August is commendable, given that amounts to ~85% of the US population. But at less than a quarter of India’s population, this a far cry from “herd immunity”, which raises worrying questions about vulnerabilities to subsequent waves between now and Q3.

What’s more, even at this pace, vaccine supplies could run into production capacity constraints; unless the less widely adopted of the two approved vaccines, Covaxin, is stepped up significantly. There are two vaccines that have been approved for dissemination, Covishield (the AstraZeneca vaccine being produced by Serum Institute of India) and Covaxin (India’s vaccination developed by Bharat Biotech). Of the two, Covishield has been the more widely used one so far and the government has stopped the export of this vaccine to prioritise domestic distribution. But vaccine brand agnosticism must still be achieved.

From a growth/activity standpoint, this latest wave will smudge recovery prospects but will not derail it given the absence of any stringent lockdowns. Regional, more targetted, lockdowns however cannot be ruled out given the surge in new infections in recent days.

Source: Mizuho Bank Ltd