Mizuho Week Ahead – Reflating the Ox

Market Analysis and Insights by Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,

Week-in-brief

Lunar New Year holidays in North Asia means that the calendar is fairly light and the sessions in Asia may be somewhat quieter; at least in the early part of the week. But that said, the (Year of the) Ox appears to be set for a bullish start, thanks to reflation optimism. With Trump’s impeachment trial over (and lost in a 57-43 vote of guilt that is 10 short of the 2/3 majority required for Senate impeachment) – focus has turned to Biden’s USD1.9 trillion fiscal stimulus plan that is expected to hit the US economy one way or another; and soon enough.

What’s more, US Yellen calling on the G7 to “go big” on fiscal support for their respective economies adds an element of significant fiscal stimulus coordination.

No surprise then that reflation has dominated as a theme. And perhaps the nuances matter. For one, reflation is still being seen a a source of revenue restoration via demand channels and as such squares with higher UST yields (10Y above 1.2%) coinciding with higher equities. This optimistic version of reflation relies on global central bankers maintaining accommodation; a bet that has been given credence by Powell’s remarks not to prematurely yank stimulus.

A resultant soft USD from inflation expectations remaining buoyed ahead of nominal yields in turn is supportive of risk sentiments and EM currencies/assets. But issues of vaccine rollout unevenness globally may continue to bog down some aspects of this reflation wave.

Q4 Thai GDP (Mon) probably showed the recovery being stifled by pandemic imposed restrictions; especially badly hit by tourism starved sectors and the spillover from that.

While BI consensus is for a 25bp to 3.50%, we think that despite a weak USD creating the window of opportunity for the cut, BI may choose to abstain on grounds of prudence.

Finally, Singapore’s Budget will feature a highly accommodative fiscal stance, despite tapered deficit and far more targeted. Crucially, budget measures will be tilted for boosting future growth potential.

Reflation in the Year of the Ox reflects economic necessity requiring hard work for demand recovery in the real sectors; and not just stimulants for market bulls.

Singapore Budget 2021: Tapered, Targeted & (Future-)Tilted 

Singapore’s 2021 Budget will see the deficit being reined in dramatically; but this should not be mistaken for a contractionary fiscal impulse.

Point being, the 2020 Budget response to Covid was an exceptional in scale and scope (sweeping aid ~20% of GDP); and so, cannot be feasibly sustained. Moreover, the 2020 response was commensurate with the degree of “circuit breaker” measures that were severely stifling for economic activity.

Whereas, for 2021, the fiscal stance has a lesser need to compensate for circuit-breaker type of restraints on activity/growth; even if vaccine optimism is not. What’s more, as the uneven recovery gets underway, maximising the boost from fiscal multipliers warrant more targeted support to help re-balance; especially as fiscal sustainability issues, which were justifiably relegated to the back seat earlier, begin to re-emerge gradually (amid vaccine rollout).

In addition, a more targeted fiscal boost not only optimizes bang for the buck, but crucially, also starts to take into account growing risks of widening inequality that is exacerbated into the recovery.

The approach to addressing  justifiable concerns about widening inequality – manifesting as a so-called ‘K shaped” recovery – may have some elements of redistribution to alleviate immediate pain. Far more importantly, it will focus on sustainable improvements to livelihoods  by focusing on job preservation, enhancements and transition via retraining and productivity boost.

Above all, Singapore’s 2021 Budget will be tilted to emerge stronger, with funding to facilitate structural shifts in industries and jobs in the post-Covid world.

The upshot is that while the deficit will be tapered, and support schemes will be targeted, the fiscal stance will remain highly accommodative, tilted for future re-structuring.

FOMC Minutes: Playing Dovish Defense 

The Fed’s decision to defer to (USD1.9 trillion) fiscal stimulus is widely understood and validated. A high chance of this fiscal stimulus being passed in its intended form means that the Fed can indeed wait and watch; whilst maintaining the current policy accommodation (plans) of prolonged ZIRP (until  2023/23) and USD120 billion of QE at least through the rest of 2021.

Admittedly, the case for not rushing further stimulus is  not contentious. In fact, quite the opposite. Concerns of inflation break-out at some point as a consequence of  unprecedented monetary-fiscal stimulus combo may require the Fed to defend its policy of accommodation.

We think these inflation fears are premature, if not misguided. And so the Fed Minutes will not be examined for the decision. Without economic forecast and “Dot Plot” revisions, further statements will be closely watched.

But for now, Powell has demonstrated unwavering policy support; deflecting premature inflation fears to ensure scarring is prevented.

China’s Credit Policy Nuances

January’s credit data has allayed earlier concerns that  the PBoC is beginning to tighten policy. Specifically, the staggering jump in aggregate financing to CNY5.17 trillion from Q4 average of CNY2.64 trillion suggests higher than usual policy accommodation; even after accounting for the seasonal pattern of front-loaded credit in the beginning of  the year.

This comes as a relief after weeks of hand-wringing on whether the PBoC might be tightening policy given sustained liquidity tightening. As we have continued to emphasise, the PBoC’s versatile use of a very large toolbox is fine-tuning policy adeptly to balance diametrically opposed policy objectives.

First and foremost, adequate and appropriately directed credit (to where it is most needed in productive sectors) continues to be pumped out to ensure strong recovery stays intact. But at the same time, excess liquidity is also being drained to ensure that the froth in the property market is not exacerbated.

This targeted approach to credit and liquidity sets the stage for “growing out of debt”  rather than drowning in debt at a later point. In addition, financial stability is also not unnecessarily compromised as a by-product of needed policy stimulus.

Thailand Q4 GDP: No Real Recovery Underway

Monthly activity data for Q4 suggests that the economic recovery in Q4 remains constrained: we forecast growth of -4.0% YoY from -6.4% in Q3. Although public and private sector spending improved on the consumption and investment fronts in Q4 relative to Q3, the pick-up was modest and kept headline YoY growth in negative territory.

We expect more of the same this year as the mainstay for growth, i.e. tourist arrivals will unlikely return until the vaccination drive domestically and globally has gathered momentum. In addition, the uneasy political situation will keep domestic and foreign investments on the sidelines depriving the economy of much needed support.

Resuscitating the Thai economy through fiscal policy alone, while not at risk of raising alarm bells since public debt remains well below the 60% of GDP ceiling, will hit its limitations as private sector multipliers are not stimulated. Further, financial stability concerns for households persist, with household debt rising to 86.6% of GDP and weak wage growth hurts financing prospects.

Bank of Thailand, which lowered its policy rate to a historical low of 0.5% last year, will unlikely pull the trigger on further rate cuts. Statements from BOT officials in the past suggested that a YCC-style QE program could be considered but with yields on government bonds low, there is no imminent need for such a program, in our view.

That said, credit and liqudity support will continue until growth is firmly back to pre-Covid levels.

Bank Indonesia: Patient Doves?

Although the conditions are ripe for Bank Indonesia (BI) to deliver a 25bp rate cut, if it so wishes, it may not be in a rush to do so. From a more fundamental perspective, the stability of the IDR, low inflation and the weak growth backdrop support further easing from BI.

However, with financial markets on a bit of an inflection point and UST yields rising sharply, BI could choose to wait out this period and deliver the cut in March. More importantly, given demand and supply-side constraints on credit growth, BI may not see any immediate value-add in delivering a cut at its meeting on Thursday.

Our forecast pencils in only another 25bp rate from BI this year as the cherry on the cake to its deep rate cutting cycle from 2020. Admittedly, there is a rising risk that this cut may not materialise given that BI may be more inclined to support growth by reducing the non-rate barriers for credit growth, using macroprudential policies and other liquidity support measures.

In addition, with the outlook for growth still uncertain from repeated, intensifying waves of Covid-19 domestically and abroad, BI could feel it more prudent to save its rate cut bullets for later.

US Treasuries

Bear steepening has intensified in the transition into Year of the Ox as reflation themes dominate.

Notably, the 10Y UST yield surged past 1.2% and looks set to be buoyed by the political focus in the US shifting to the passage of Biden’s USD1.9 trillion fiscal stimulus/pandemic support. What’s more, with US Treasury Secretary Yellen calling on the G7 to “go big” on fiscal support, the world view of reflationary policy and consequences have been entrenched.

Nothing revelatory is expected from the FOMC Minutes, that will justify the Fed maintaining policy accommodation necessary to entrench a more solid and durable recovery. For now, this will accentuate the UST yield curve steepening bias by anchoring short-end yields more emphatically; whereas 10Y UST yields rising on reflation expectations will not be upended as the Fed is not expected to ramp up QE to rein in upside in 10Y yields; not at this juncture anyway.

For now, 10Y yields are likely to consolidate with some upside bias in the 1.09-1.36% range.

FX Theme: Reflation Trades .. But on a Short Leash?

With the reflation theme getting “second wind”, the question is whether FX markets will be an exact re-run of earlier reflation trades is the question to ask. The answer may not be so clear-cut.

First things first. The reflation trade impact on FX markets, in its earlier iteration, was skewed to a softer USD, against which commodity currencies such as AUD exhibited the most emphatic gains. Whereas currencies with higher inflation, “twin deficits” and imported oil reliance (such as INR) underperformed.

For now, it appears that the USD remains subdued; but sharp and sustained weakness in USD may be limited by how much faster inflation expectations (10Y Breakeven) will rise compared to nominal UST (10Y) yields. And so, while EUR may be buoyed, decisive upswings past 1.22 to 1.23 may be less compelling.

Meanwhile, AUD rallies on reflation boost acting via commodity conduits could stretch a little further, but the absence of fresh stimulus boost may also subject this to a fairly short leash. For now, reflation re-run alongside “risk on” will provide some boost to EM Asia FX in the context of a milder USD; but this will be a measured affair, not an unbridled rally in EM Asia FX.

Credit Source: Mizuho Bank Ltd