Mizuho week ahead – A Job for Goldilocks

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

The US appears to have a job for Goldilocks, so to speak, as disappointing NFP data reverberates through markets without quite roiling the underlying risk appetite. Whether the staggering miss in US NFP should cause concerns of economic sputter is arguable; but it undeniably (and perhaps perversely) unleashes the “Goldilocks effect” on markets.

First, for the numbers. US NFP revealed that the economy created a mere 266K jobs when expectations were for a million! In other words about 730K more joblessness (than hoped for) has persisted. A total of 8.2mn jobless still in the US and unemployment at 6.1% (rather than the 5.8% hoped for) validates the Fed’s unequivocally dovish slant; and in equal parts may worry pessimists.

But equally, there are views that a generous unemployment package as part of the Covid rescue is holding back the return of workers, while hiring intentions remain solid, if not frustrated by the difficulty to find labour. Which means this is not quite the deflationary job market the Fed need worry about.

Yet the Fed being vindicated in keeping the spigots open in the face of such data disappointment means that cheap liquidity and anchored yields could continue to boost these Goldilocks markets. The accompaniment of a softer USD is even more welcome by high-yielders and EM asset markets; and may be striking close to what may be a “risk on” backdrop.

But the continued spread of subsequent waves of Covid in EM must worry even Goldilocks-types.

The good news is that “Papa bear” type of harder inflation numbers in US CPI data release may be discounted by “Mama bear” type of lapse in wage-price spirals given NFP data disappointment. And the “just nice” “Baby bear” dynamics that “Goldilocks” so loves will be derived from gathering sufficient confidence about on-going recovery but with sufficient policy boost for follow-through assurance.

In Asia, in-coming economic releases may contain the long shadow of renewed resurgence of Covid.

Malaysia may get some initial respite from contraction in its Q1 GDP while the Philippines’ Q1 GDP may be less upbeat as pandemic effects stretch out (with negative tourism multipliers).

But despite the soft Q1 GDP data, Philippines’ central bank, BSP (Fri) is likely to abstain from further easing as higher inflation constrains policy options. This reflects that policy makers have to struggle with what is the diametric opposite of “Goldilocks” conditions.

This is a wider policy dilemma for EM central bankers as rising commodity prices begs the question of how to navigate the incoming wave of cost -push whilst maintaining credibility around price stability.

No easy answers; knowing Goldilocks had to run off when the three bears returned!

FX Theme: Watching for the “Rehn Effect”

With the sharp shortfall in employment as per NFP keeping inflation expectations (and UST yields) in check, one may be forgiven for assuming that USD bears will be reassured, if not having a field day.

Maybe so. But this is a reflex; more a tactical reallocation than it is a strategic positioning. After all, jobs numbers that are more likely than not temporarily understating the strength of the recovery merely confirm the Fed’s bias to err on the side of accommodation. This has already been adopted in the Fed’s suggested rendition of flexible average inflation targeting (FAIT).

What’s more, any sustained decline in inflation expectations (over and above the decline in long-end UST yields) could perversely lead to real long-end rates rising; thereby diluting bias for a softer USD.

But above all, it is the cross-Atlantic (ECB) currents that USD bears need be concerned about. Specifically, for signs of the “Rehn effect” proliferating. By that, we are referring to Olli Rehn’s ability to sway other ECB board members on the need for the ECB to adopt Fed-like inflation overshoot mandate.

If this were to come into serious consideration, then a sharp convergence of the perceived ECB-Fed policy gap – between the single mandate ECB (with an inflation ceiling) and a dual mandate Fed (now with even more give for growth rejuvenation) – could potentially trigger a downward adjustment of the EUR.

And if the definitive “anti-Dollar” suffers an unexpected “policy hit”, US’ widening positive gap on the rest of the world may very well be a catalyst for USD bears to run into hurdles well before “taper” crashes the party.

Admittedly, the horizon for this to play out is not this week. Perhaps not even this quarter. But any policy watcher/FX market participant will want to pay attention to possible “Rehn effects”. For brushing this off as an “unprecedented” policy shift will be a failing to recognise unusual times requires exhausting all options.

For now , a softer USD post-NFP is likely to be consistent with higher EM Asia FX, led by the likes of AUD.

Low-yielders benefit from UST yields being dampened by inflation expectations being knocked back. And Covid risks containment likely to influence differentiation within the region.

US Treasuries: What Really Matters

While the UST yield curve bull flattened (yields lower; 10Y-2Y spreads narrower) on the week, the softer than expected US NFP triggered steepening with 10Y UST yields rising marginally by 2bps while 2Y yields fell shy of 1bp.

To some extent, this may be reflecting the still persistent divergence between cost-push (inflamed by reflation) expected to lift longer-term inflation; whereas short-end yields were dragged by the jobs baggage on policy.

This tug-of-war may persist for a while as data undulations, a dovish Fed and resurgent costs collide; and sometimes, confuse. Nonetheless, the overall upside trend in yields, as vaccinations gain more traction and the US economy lifts further away from the bottom – aided by policy – is more a matter of time than it is a two-way risk.

Meanwhile, the interactions between inflation expectations (to cost realities and policy responses/Phillips Curve hypotheses) and nominal UST yields could be of far greater interest in assessing how real US rates evolve.

For if this establishes an upward bias as well, then asset markets need to sit up and get ready to smell the coffee. For now though, 10Y UST yields are likely to consolidate in the 1.48-1.72% range.

India: RBI Numbs Credit Pain Amplifiers

We had earlier flagged* three key pain amplification risks with respect to adverse economic impact from India’s devastating third wave. These were;

1. multiplier effects through the grey economy, (given disproportionate pain at the lowest income/most vulnerable part of the economic spectrum;
2. banking sector/credit multipliers that amplify balance sheet risks, and;
3. ratings risk that set off negative growth-banking-fiscal-ratings feedback loop.

It is therefore a welcome relief that the RBI has stepped up to the plate to simultaneously incentivise term liquidity facility of INR500bn for healthcare-related firms, set up a special 3-Y LTRO of INR100bn for Small Finance Banks (SFBs) and extended credit incentives for MSMEs.

Ensuring that critical liquidity/credit made available, prioritised by sectors (healthcare) and the under-banked (MSMEs), alongside back-end funding for “last mile” SBFs, helps avert a financial contagion born out of credit seizure tipping a liquidity crunch into a solvency crisis.

Yet, the RBI being careful to resort to sweeping loan moratoriums shows acute cognizance of banking balance sheet stresses that predated COVID elevating “last straw” banking risks.

As welcome as the relief is, there are no illusions about being out of the woods as the RBI has no panacea to offer; only the ability to numb pain and constrained ability to steer away from the worst economic consequences from negative feedback loops/multipliers.

* Please see Mizuho Flash – India’s COVID Tragedy: Misdiagnosis & Maladies, 23 Apr 2021

ASEAN-5: Social restrictions stay tight as COVID-19 cases rise

Covid-19 cases have been rising in the ASEAN-5 region which is leading to an extension or a tightening of social restrictions.

In the Philippines, where social restrictions had been tightened significantly around the Easter period, the government has issued an extension of the strictest form of lockdown from May 1 until 14 May for Metro Manila, Bulacan, Cavite, Laguna and Rizal.

Similarly in Malaysia, the strictest form of lockdown in Selangor and Kuala Lumpur were extended; the restrictions for the latter will last until 20 May.

In Singapore, the limit on gatherings which were previously restricted to a maximum of eight people was reduced to five people until 30 May, 50% of staff are now mandated to work-from-home from 25% earlier and international travel restrictions especially for flights to/from India have been tightened.

In Thailand, the quarantine period for visitors was increased to 14 days from 7 days starting May 1. This move will hurt tourism and tourism-related sectors, a major driver of growth for the Thai economy, as a reduced quarantine period allowed for more travel related flexibility.

Although Indonesia has not tightened restrictions recently, the ban on the Adil Fitri related travel, usually involving large intra-country migration, remains in place from May 6 to 17.

While the pace of vaccinations has been increasing in these countries and governments’ have been focused on building their vaccination procurement pipelines, the recent extension/tightening of social restrictions will likely hurt, albeit only in targeted regions, the growth recovery.

Malaysia: Moving in positive growth territory in Q1

Despite the imposition of the most stringent social restrictions in Jan and varying degrees of restrictions Feb-Mar, economic growth in Q1 does not seem in particularly bad shape.

We estimate, based on monthly activity data for Q1 2021, that the economy actually grew 0.2% YoY in Q1 after contracting 3.4% in Q4. And encouragingly, the pick-up appears broad-based.

On the supply-side, the continued improvement in manufacturing IP (6.8% YoY in Q1 from 2.8% in Q4) and mining IP (-4.1% in Q1 from -11.1%) will more than offset weaker agriculture sector production as measured by palm oil production (-5.6% from -2.8% in Q4).

Consistent with the improvement in manufacturing IP, export growth also rebounded to 18.2%YoY in Q1 from 5.1% in Q4.

Although import growth also picked up, we estimate that the contribution of net exports will be significantly higher in Q1 versus Q4. Government spending and private consumption also picked up in Q1 judging by central government expenditures and car sales.

The pick-up in Q1 GDP is consistent with Bank Negara Malaysia’s assessment that ” latest indicators point to continued improvements in economic activity in the first quarter and into April”.

BNM also noted that “while the recent re-imposition of containment measures in select locations will affect economic activity in the short term, the impact will be less severe as almost all economic sectors are allowed to operate.”

With BNM likely to remain on hold for some time, the government will do the heavy lifting to support growth through targeted fiscal measures for regions most impacted by Covid-19. The boost from elevated commodity, especially oil, prices will be a bonus for government coffers.

Philippines: Still Struggling in Q1

We estimate that the contraction in GDP narrowed to -3.5% YoY in Q1 from -8.5% in Q4 2020. While is points to some ‘improvement’ in the growth momentum, it is more lip service rather than a the definitive start of an uptrend. Herein lies the rub.

The country is still battling Covid-19 infections and the government was forced to reimpose stringent lockdown measures in Manila and surrounding areas since the end of March, implying that economic momentum heading into Q2 will likely weaken before it improves. The timing of the improvement is far from certain.

Also, the country’s vaccination drive has been slow to take-off as vaccine supplies have been delayed. The government is increasingly relying on China for vaccines with India unable to follow through on its commitments as the latest wave in India has been completely devastating.

The good news is that the government has finally managed to expedite spending, which had been delayed due to administrative reasons for most of 2020. Government spending growth rose to 14.9% YoY in Q1 from 5.1% in Q4.

This bodes well for the government achieving its 2021 fiscal deficit of 8.9% of GDP. Last year, the fiscal deficit widened to 7.6% of GDP (from -3.4% in 2019) but was short of the governments’ target by 2% of GDP.

This year it is even more imperative for fiscal policy to better its game as monetary policy support will have to be more calibrated and measured given that headline inflation remains elevated.

Bangko Sentral ng Pilipinas: Forced to take a back seat

The fact that headline inflation has remained above the 2-4% target range since the start of the year has tied BSP’s hands in terms of supporting growth, even as the latest wave of Covid-19 infections crashes growth momentum.

BSP nonetheless still has some ammunition its in its war chest; for one, it has held back on delivering another additional 200bp in RRR cuts following a 200bp cut last year and second, it can still extend liquidity and credit support to business, especially SMEs, as it sees fit.

Outright rate cuts, however, are probably not on the cards as it would risk BSP undermining its inflation targeting credibility and equally importantly, ignore the risks of second-round inflationary pressures.

Admittedly, the stickiness of headline inflation has been mainly driven by food prices and pork prices, specifically, which the BSP can look through. But, to its credit, BSP has stated that it is vigilant of second-round price pressures and hence seems to be taking a more cautious approach.

As the importation of pork and other meats increases, the pressure on retail prices should ease and provide BSP with some breathing space.

For now, however, BSP will stay in wait-and-see mode and defer policy support to fiscal policy, which finally appears to be playing catch-up.

Source: Mizuho Bank Ltd