Mizuho Week Ahead – Between Sweet Nothings & Nothing Sweet

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

The biggest FOMC take-away last week was that the Fed could not bridge the gap between a robust recovery and taming the rise in UST yields. If anything, Fed Chair Powell’s convincing articulation of extended policy accommodation within flexible average inflation target (FAIT), underpins higher long-end yields (and inflation expectations). Point being, while markets did not treat Powell’s words as mere “sweet nothings”,with conviction about an exceptionally patient Fed, this reinforces the notion of reflation getting inflation expectations higher led by cost-push. And that is in fact consistent with higher 10Y UST yields and curve steepener. In other words, there was nothing sweet to go on for bond markets buying back bonds (and pushing down yields. Which was why the post-FOMC decline in UST yields proved shallow and short-lived.

In fact, higher UST yields ended up knocking back equities, with Wall St ending down some 0.5%-0.8% for the week, and USD was boosted from a combination of higher UST yields and “risk off”. To be fair, it was not as if the Fed intended to spook markets; quite the contrary. But the absence of express commitment to additional policy support for the bond market inadvertently disappointed.

US-China talks in Alaska also yielded nothing sweet. Quite the opposite as neither side extended even the obligatory diplomatic “sweet nothings”. US broaching human rights issues in Xinjiang and Hong Kong as well as opposing on Taiwan set the tone for a terse meeting where China in turn questioned US hegemony nad brand of “imposed” democracy. With UST yield market volatility not placated, and US-China tensoins coming to the fore, EM Asia sentiments are set to be somewhat less upbeat. This is despite intense chip shortage yielding some benefits to exporters such as Korea and Taiwan; perhaps even Vietnam.

Nonetheless, this limited chip supply constraint is a “sweet nothing” for prices rather than a bona fide demand boost throughout the supply chains in EM Asia. The wider point is that it does not adequately offset risks that may arise from rapidly rising UST yields and greater uncertainty on vaccine rollout timelines. Central banks such as BSP (Thu) and BoT (Wed) are thus likely to remian on hold. BSP, perhaps bound by risks of cost-push spillover to “second-round” effects to a greater degree, while; the BoT is more likley to defer to fiscal and non-rate measures. Bond measures may be considered for the BoT. For now, markets may still be hung on on looking for “sweet nothings” from the policy levels on extending and/or ramping up the recovery. There is nothing sweet enough in the horizon though.

FX Theme: USD Smile Inflection

With the FOMC having a very short-lived taming effect on UST yields, USD has turned more volatile; caught between rising UST yields and out-run in inflation expectations. So to some extent, resultant positive correlation between real yield impact and the USD.  But equally, the backdrop of a softer USD in response to improving global sentiments/vaccine rollout has not completely faded either. And this obfuscates the view on the USD.

Another way to frame this may be mulling about whether the USD reflects the left-half (negative sentiments correlated to USD strength) or right-half (positive sentiments correlated to USD strength) of ‘USD Smile’. For now though, FX drivers remain somewhat mixed, although the USD has gained a mild upper hand; or at least USD bears have been relegated to opportunistic positioning rather than conviction trades. Whether markets are spooked by higher UST yields, invoking the left-half of the ‘USD Smile’, or swayed by improving US prospects, succumbing to the right-side of the ‘USD Smile’, USD could remain supported. Other dimensions of reflation trades, such as AUD boost from commodity buoyancy, may still be expressed in mild forms.

US Treasuries

Nervous UST markets ahead of FOMC last week initially reacted with a bond market (price) rally, which resulted in UST yields pulling back. But that did not last. While Fed Chair Powell convinced markets about commitment to flexible average inflation targetting, and not moving until evidence emerges on durable inflation recovery, it was not sufficient to hold yields down.

In fact, that was just the catalyst needed for yields and inflation expectations to take off. And to be sure, inflation expectations were treated to a revival after being out-run by nominal yields in the pre-FOMC sessions. For now, it appears that without explicit extra bond market support from the Fed, buoyancy in UST yields wil be intact; even if checked on sudden surges. For now, it appears that without explicit extra bond market support from the Fed, buoyancy in UST yields wil be intact; even if checked on sudden surges. But the USD is likely to remain firm unless UST yields start to recede appreciably.

BSP: Hamstrung by Inflation

Rising headline inflation will hamstring the BSP’s ability to reduce policy rates any further. In contrast to regional peers, which have largely managed to keep headline inflation within’ official target and/or comfort zone, Philippines’ inflation trajectory has spiked on account of rising food and fuel prices. With the BSP itself stating at its previous meeting on (11 Feb) that it will be “vigilant in looking for the emergence of possible second-round effects”, scope for additional easing at this week’s MPC is limited.

To be sure, the worsening food shortage led by pork, does not requie a monetary response. Instead, the government’s on-going efforts to secure more imports to assuage the price surge is the right one. Nevertheless this backdrop of inflationary pressures makes it inconvenient for the BSP to ease at this point. But equally, the BSP is unlikely to sound anything but dovish given risks to growth. Point being, the BSP is set to continue to cite the need for accommodative monetary policy conditions as the economy grapples with a renewed wave of Covid-19 infections and a slow start to its vaccination drive.

Indeed, social restrictions were tightened across the country – restaurant capacity reduced to 50%, cinemas, gaming arcades and museums closed for a period of two weeks. Although the PHP has lost some ground to the USD since BSP’s last meeting, it has been more or less in line with regional peers and is therefore, unlikely to cause any undue concern for BSP.  Having said that, BSP will probably continue to highlight that it is closely watching global financial market volatility and is ready to smooth any massive currency gyrations, if needed.

Bank Indonesia Focuses on IDR stability

In line with expectations, BI kept its policy rate unchanged at 3.50%. Given the volatility that gripped the US bond market and subsequently global financial markets for much of March, BI’s decision to ease in February was timely. Now, the volatility around the IDR became a clear concern for BI, with Governor Perry Warjiyo emphatically stating so while justifying its decision to keep its policy setting unchanged at its 18 March meeting.

This, however, does not preclude BI from focusing on non-rate measures to bolster credit growth. Indeed, Governor Warjiyo stated that BI will “pursue accommodative macroprudential measures”. While policies announced at the previous meeting in February targeted the demand-side; at this meeting, BI was more focused on the supply-side.

Governor Warjiyo stated that bank lending rates had come down by only 78bp compared to the 150bp cut in the policy rate. He added that bank lending rates need to be lowered further and in a more timely fashion. In addition, to encourage lending vis-à-vis the bank’s funding, BI also announced a phased increase in the disincentives applied to banks that do not maintain the Macroprudential Intermediation Ratio (MIR). Banks with the lower bound of the MIR at less than 75% (applicable only to banks with gross non-performing loans of <5%) will have to put more reserves in BI’s current account, starting May 1; this threshold will increase to 80% from 1 September and to 84% from 1 January 2022.

BI’s focus on IDR stability remains a prudent approach given the ‘twin deficit’, i.e. the current account and fiscal balance deficits, vulnerabilities. With BI still directly monetizing the government’s debt, these vulnerabilities become more apparent.  Further, ahead of BI’s meeting there were concerns around potential legislation regarding BI’s independence. But these questions were not directly addressed and could potentially be a source of uncertainty looking ahead. This justifies our forecast for BI to remain on hold for the rest of 2021.

Malaysia: Wider fiscal deficit for 2020

Malaysia’s Finance Minister Tengku Zafrul announced an additional fiscal stimulus of MYR20bn (~1.3% of GDP) this week aimed at;

i) accelerating the vaccination drive;

ii) providing cash handouts to the poorest section of society and;

iii) grants to the palm oil sector.

Of the MYR20bn, MYR11bn (~0.7% of GDP) will be done with new financing and will impact the fiscal deficit as well as the debt to GDP ratio. The FM now expects the 2021 fiscal deficit to widen to 6.0% of GDP from a budgeted estimate of 5.4%, with the debt to GDP ratio settling at 58.5% of GDP by end-2021. To be sure, this is the second additional package that the government has announced since the start of this year. In January, the government announced an additional package of MYR15bn(~1.0% of GDP), but this package was largely funded by re-distributing existing money.

BOT: THB weakness a welcome respite

-Since its last meeting on 3 February, THB has been one of the worst performing EM Asian currencies (after IDR) and this will likely come as a much needed respite for BOT. BOT spent a large part of 2020 fretting about, and dealing with, undue THB appreciation, which diverged from the fundamentally weak economic recovery. Even with the vaccination drive underway, prospects of global travel opening up are still some months away (perhaps only in 2022) implying that tourism as a key engine of growth will continue to sputter.

To that end, BOT will remain on hold and possibly continue to explore non-rate measures to maintain an accommodative stance. The recent rise in UST yields, especially at the long-end of the curve, has put some upside pressure on Thai bond yields as well. Any comments from the BOT on its approach to dealing with increased market volatility will be welcome; in particular, if BOT is still considering a formal QE program should the rise in bond yields quicken.

Source: Mizuho Bank Ltd