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By Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,
The Easter Weekend, while fairly quiet, reveals a growing disquiet about emerging disparities in global recovery/vaccination progress as well as; the devilish details of uneven recovery/prospects embedded in the rosier narrative of getting to the “other side” in 2021.
Most glaring is the Atlantic vaccine divide. US building on its vaccine rollout success is in sharp contrast to Europe’s vaccine delivery disappointment exacerbated by a worrying “third wave”. There is also a larger global disparity in vaccine progress, with the likes of Brazil embroiled in an unabating surge of the pandemic, while India’s Covid cases surging past 90K a day has provoked a renewed (partial) lockdown in a few cities, including Mumbai.
In the region, Philippines has also extended restriction by at least a week in April as the proliferation of the pandemic leaves little comfort about an unfettered recovery.
The bigger picture in Asia is that vaccine rollout plans are likely to result in a more entrenched recovery in 2022, but for 2021, the details suggest a very uneven path out of the pandemic; depending on disparities of vaccine availability and the success of interim containment efforts up till “herd immunity” is achieved.
Meanwhile, travel bubbles are likely to be selective, and as a result, the global/regional recovery is also set to be patchy rather than broad-based.
And the US’ vaccine rollout advantages are even more enhanced by aggressive fiscal stimulus led by the $2 trillion (plus $1 trillion follow-on) infrastructure plans. And this begs the question of a consequent global policy disparity, which has resulted in sharply higher UST yields alongside a firmer USD. And with that, USD bears may want to keep clear until the dust has settled on real UST yields and the verdict on market perceptions of Fed policy shifts and timing vis-a-vis the ECB and BoJ.
But that should not blind market watchers to the disparity within the US amid an uneven recovery. And one need not look far. The bumper (NFP) jobs number for March must be viewed in the context of softer patches in accompanying wage data as well as leading claims data.
Meanwhile, FOMC Minutes (Wed) will probably continue to emphasise the Fed’s commitment to lower for longer rates and continued support; while RBI stands pat (Wed) as sticky inflation and yield volatility (posing macro stability risks) constrain the RBI’s reflexes to ease amid pandemic.
Elsewhere, the RBA (Tue) is also set to stand pat as front-loaded easing, a softer AUD, and some taming of long-end yields buys the RBA reprieve; but no panacea from future dilemmas. Disparities will continue to challenge making sense of markets while the details will differentiate outcomes. This will force a more nuanced re-think of indiscriminate vaccine optimism narrative.
FX Theme: Reprieve, Not Reversal
FX markets will probably get some reprieve from the bullish USD move that caught markets wrong-footed since end-Feb; but this is far from a conclusive start to a reversal.
The Greenback, which is up some 3% (but off off +3.5% peak at start-April) since end-Feb, continues to be supported by a trifecta of;
i) real yields being lifted (as the surge in nominal UST yields catch up with inflation expectations);
ii) US outperformance accentuated by vaccination disparities (especially vs. EZ), and;
iii) massive US infrastructure stimulus a potential catalyst for tip over into the “right-half” of the ‘USD Smile’*.
The upshot is that the current state of play, including upbeat US data alongside bullish fiscal plans, are more likely than not to keep the USD’s edge intact; even if it is not stamping its dominance outright.
So ahead of the FOMC Minutes, it looks as if nascent recovery in EUR and AUD off the lows may be a limited relief rather than the stage for sustained rebound/rally in EUR and/or AUD.
EM Asia FX are also likely to be kept in check by a softer CNY (USD/CNY propped above 6.55, consolidating around 6.57-6.58 for the time being). And post-FOMC , this may not change dramatically either.
UST yields also pose a devil and deep sea conundrum between “risk off” and yield driven USD support.
See Mizuho Chart Speak – FX Update: Unpicking the USD Smile, 23rd Mar 2021
US Treasuries
Despite soft spots in wage data, the US economy continues to be on a sufficiently resilient on jobs recovery; at least to ensure that the rise in UST yields are not significantly set back. Not only are 10Y yields buoyed above 1.7%, but notably, short-end (2Y) yields are closer to 0.2% than 0.1%.
Especially with Biden’s S$2 trillion infrastructure plan widening the path for consideration after reports that Democrats are willing to negotiate on funding options; for Republicans loathe to up corporate taxes.
If in-coming ISM Services adds to optimism with a print above 59 levels, then long-end yields could get closer to a test of 1.8% this week. Though a dovish Fed/FOMC Minutes and caution ahead of the 2% handle for yields may interrupt an otherwise stronger and more unfettered rise in yields.
For now, we expect that UST yields will remain buoyant around 1.60%-1.85%; but perhaps wary of tipping exuberance (in yield rise towards 2%) into panic and contagion in wider asset market sell-off.
OPEC+ Surprises By Increasing Output
The OPEC+ meeting surprised market participants, again; only this time, the surprise was in favour of increased output. Specifically, both the OPEC+ cartel’s coordinated cuts and Saudi’s unilateral curbs are up for phased relaxation over the next three months (May to July).
For the cartel, production will increase by 350K BpD in May and June and by 450K BdDin July. As for the Saudi, it will add back 250K BdD in May, 350K BpD in June and 400K bdp in July; to trim its additional 1MBpD cuts to 600K BpD by July. This will amount to a combined 600K BpD in May, stepping up to 700K BpD in June and 850K BpD reduction in July.
The main reasons for the measured increase in output was the cautious optimism around;
i) global growth prospects;
ii) the progress of vaccination rollout led by the US and;
iii) a small, yet encouraging, pickup in commercial air traffic.
But the fact remains that “cautious” is the operative optimism automatically implies that caution has not been thrown to the wind.
For one, the phased increase in output is essentially a modest 10.8% step-down in curbs by July that will leave some 7MBpD of curbs intact (both OPEC+ and Saudi’s unilateral reduction) compared to the ~9.7MBpD of cuts originally enacted in April 2020 at the height of pandemic fears.
What’s more, the cartel will meet on a monthly basis to discuss production limits; with an implied flexibility to adjust either way.
Driving home this point, the Saudi Energy Minister noted that the OPEC+ alliance still needed to monitor the situation until the global economic was convincingly underway. As a result, the “surprise” increase in output really did not budge prices much.
Post-OPEC+ Brent and WTI Crude Brent prices both shrugged off initial knee-jerk volatility to settled a touch higher at mid $64 and above $61 respectively.
Myanmar’s Confiscation Risks
Myanmar’s descent into violence amid the military’s unrestrained use of force is first and foremost a humanitarian crisis. This unfolding tragedy reveals dangers of confiscation, at various levels and on several dimensions.From inception, the military coup is but a confiscation of rights, including democracy. Beyond which, the civil unrest and military atrocities are a political confiscation of livelihoods and wealth.
Livelihoods are clearly confiscated by tyranny and resultant unrest. But also more surreptitiously, and perhaps no less insidiously, by inflation. Disruptions to both production and flow of goods/services is a double whammy of adverse income shock and sharp escalation in cost; where basic access to goods and services are not impaired.
Finally, a dysfunctional financial system confiscates wealth on a frightening scale.
This ranges from outright misappropriation by the powers that be to inevitable asset devaluation resulting from civil unrest. Notably, foreign exchange risks comprising forced exports surrender as well as the widening dichotomy between “official” and black market exchange rates favouring those in power to the detriment of the rest.
The military’s wealth confiscation as a means to control is Myanmar’s tragedy. To miss this forest of large-scale confiscation for trees of piece-meal economic/political risks would be ours.
RBI’s “Forced” Hold
Bottom-line first. The RBI is expected to be be on hold at the April policy meeting. But this is a forced, rather than desired hold. This is because the RBI’s dilemma, between the desire to ease and the necessity to refrain from, continue to linger; after having eased for a bit.
First on growth, a worrying resurgence of Covid-19 threatening to dim the prospects of unfettered rebound in 2021. What’s even more worrying is that this interim setback in India’s growth recovery could exacerbate the unevenness of the recovery.
That being the case, the RBI would have desired the option to ease policy; or at least have more unconstrained options on the table.
However, with the policy rate already at 4.00%, and inflation back up above 5%, negative real rates compel the RBI to be more restrained.
Especially in the context of a
i) rapid rise in UST yields alongside;
ii) loftier oil prices, suggesting that that the confluence of deteriorating C/A position and eroding real yields could make for potentially destabilising capital flows.
As such, the RBI will be very mindful – forced to be – not to cut rates excessively; leading to wider macro-stability risks. Essentially an uncomfortable hold compelled by the policy dilemma. But that said, bond market and liquidity measures as required remain on the table
RBA’s Reprieve Ahead of Cross-Roads
The RBA is in a fairly comfortable position, where it can wait to assess where the policy ought to be steered.
The most fortuitous coincidence of factors that have helped to buy the RBA time are;
i) AGB yields being tamed, albeit at fairly elevated levels further out the curve though the 3Y is well-contained by YCC;
ii) AUD pulling back sharply from above 0.78 to ease back below 0.76
And so, the urgent need to ramp up on policy easing is alleviated. Which is to say that the RBA’s extended policy rate anchor, YCC and expanded/extended QE are now sufficient.
In fact, one may argue that the RBA’s next challenge would be to wean off balance sheet accommodation without creating wobbles in the market. Especially as the risks associated with excessive easing grows in the context of Australia’s recovery on course to get back on track, and housing market activity heating up.
But the reality is somewhat more complex on closer inspection as the current relief may prove temporary with the RBA finding itself at the cross-roads of two way-risks.
Between fading fiscal stimulus led by the JobsKeeper program as well as rising UST yields on one hand (requiring further policy support) and the overheating risks that come from a commodity and asset market boom on the other.
Malaysia’s Reaffirmed Bond Index Inclusion
FTSE Russell reaffirming Malaysia’s inclusion in bond index for government bonds last week will float the boats of investors and the BNM alike. The threat of Malaysia being dropped from the World Government Bond Index (WGBI) has blown over as FTSE Russell dropped Malaysia from the watchlist for possible exclusion.
This reaffirmation is wholly warranted and should provide backstop the ringgit (MYR). To be sure, worries of Malaysia’s exclusion from the WGBI on account of ratings downgrade by Fitch (from A- to BBB+) last year and/or increased debt issuances this year were misguided.
Point being, Fitch’s arguably ill-timed downgrade was neither definitive nor materially changed Malaysia’s status as an investment grade credit.
If anything, the recovery in oil and prospects for post-Covid recovery suggest positive economic spillover to the credit profile. Crucially, exclusions on (unfounded) credit and debt profile concerns would have been a case of bait and switch in any case given FTSE Russell’s justifications for Malaysia getting on the watch list were premised on concerns about market liquidity and (in)ability to hedge.
And the BNM has addressed these concerns; by introducing measures to significantly enhance the ability to hedge FX risks as well as deepen bond market liquidity/pricing.
Admittedly, the BNM has not fully lifted the ban on offshore MYR trades. But measures to avail (after-hours) MYR access and expanded FX hedging tools significantly mitigate risks.
Could FTSE Russell have a wishlist for more unfettered access? Sure. But is that justifiable grounds to keep Malaysia on the watchlist (much less exclude from the WGBI)? Surely not. Given Malaysia’s fairly high real rates, improving economic outlook (looking past near-term COVID-related bumps) and steady, not deteriorating, credit profile, FTSE Russell removing this artificial uncertainty should boost investor appetite for Malaysian assets; all else equal.
Against a backdrop of with reduced foreign holdings of MGS, “re-entry” may set the stage for better MGS prices (lower yields) and MYR boost.
But MYR bulls-in-waiting will have to defer to the current strong USD wave that is likely to be a more compelling for the time being.
Source: Mizuho Bank Ltd
