Mizuho week ahead – Taylor troubles?

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

Week-in-brief: Taylor Troubles?

Buoyant markets suggest that US jobs numbers were in a sweet spot.

The so-called “Goldilocks” point where shortfall in jobs created (at 559K vs. 675K) was small enough not to derail recovery hopes, yet sufficient to quell worries from wages inflation surge well ahead of expectations. But to be fair, knowledge that transitory Covid and fiscal factors exaggerated the wage surge in hospitality and entertainment sectors (that accounted for most of wage pressures) was the greater relief.

Nonetheless, Treasury Secretary (and ex Fed Chair) Yellen alluding to conviction about massive fiscal spending, asserting any resultant rise in interest rates being beneficial, could have the unintended impact of raising questions about policy response to rising cost-pressures.

Specifically, how far from Taylor Rules the Fed may stray under the current “flexible” regime, assuming Taylor retains any relevance at all (for the time being). Whether policy runs into trouble maintaining recognisable allegiance to Taylor of blatantly abandons Taylor remains to be seen.

Meanwhile, all eyes on the ECB (Thu), where a review of PEPP (QE) settings amid a confusion of improving activity and rising inflation on one hand, but wider bond spreads on the other. Whether EUR can gain decisive traction will depend on ECB watering down dovish insurance.

Whether the ECB will be reveal appetite to allow for some degree/version of inflation overshoot like the Fed will be the main trigger for EUR moves.

The ECB’s trouble is that being a single mandate central bank, its troubles are not just adapting “Taylor Rules”; but rather adopting them!

In Asia, April industrial production data for India and Malaysia (Fri) could start to see soft spots as recovery is interrupted by COVID resurgence, with this disappointment set to prolong into Q2.

Elsewhere, China’s May data may will be underscored by market watchers looking for clues on calibration in credit data.

But in the headline producer inflation surge expected to race above 8% YoY will steal the show and occupy minds fretting inflation and Taylor troubles!

China’s Inflation: Not a Problem, But a Solution

But for all the worries, China’s is a(n inflation) solution, not worry. Admittedly, China’s surging PPI, which reflects mounting cost-push, is not without grounds for concerns.

In fact, there are three major ramifications. One, the rapid surge in price pressures may ironically retard the recovery if it impacts real disposable wages and profit margins adversely.

Moreover, if the policy dilemma unwittingly results in the policy missteps there may also be adverse effects.

Finally, if the “factory of the world” passes on surging producer inflation, large ripples of cost-push for the rest of the world may be hard to avoid.

But while all of these are legitimate concerns, these risks are overstated. And it comes down to margins, stockpiles and the ability to engage policy buffers.

First and foremost, Chinese industries, which have rapidly restored profitability, are well-placed to absorb disproportionate (but probably fleeting) cost surges; and the evidence suggests that they have already been doing this for some time.

Specifically, the China’s supply-chain exhibits proven ability to dampen upstream cost-push from commodities and a wider range of raw materials. What’s more, this is further bolstered by China’s ability to drawdown on its strategic stockpiles of industrial commodities to help mute speculative aspects of the commodity boom. This is critical in averting excessively self-reinforcing cost-push feeding off speculation.

Finally, the flexibility in its various policy tools, including a trade-weighted appreciation that absorbs imported price pressures, while steady USD pricing contains exports cost push.

The bigger picture, and upshot, is that China’s single-minded, sometime brutal, pursuit of productivity gains – as it chases value add and scales the value-chain – continues to be a source of inflation dampener (not amplifier) for the world.

US Treasuries: Deliberate Patience

The UST yield curve flattening further probably has less to do with receding inflation concerns and more to do with the “deliberate patience” that is expected of the Fed in confronting price pressures under the “flexible” regime.

Admittedly, the miss in NFP may be a trigger for long-end yields to decline; but this is an excuse and not a reason, given that stronger wage pressures contradict a fairly small (in the grander scheme of things) miss in jobs.

In any case, an unprecedented fiscal thrust points more towards price pressures, with questions around durability, rather than outright worries of dis-inflation or deflation.

In addition, as the ECB meets this week, the (upside) volatility in long-end yields is the bugbear.

And is the ECB does fret the curve steepening, then markets are also better positioned to have covered shorts at the long end. All of this translates into a flatter yield curve mostly maintained, if not desired. But only at the margin as the wider reflation theme is far from done.

As such, we look for 10Y UST yields to be in the wider 1.48%-1.68% range; with profit-taking likely to keep dips below 1.5% shallow.

After all, “deliberate patience” bets are within limits; and mostly state-dependent.

FX Theme: The ECB Pivot?

Last week, a weaker USD may not have been rejected outright. Nonetheless, a considered and distinct push-back in USD/CNY setting (above what markets expected) means that AXJ appreciation bias was indirectly checked by CNY bulls being subdued; if not tamed.

We expect that CNY will continue to be anchored by stability cues of the PBoC. In turn, this could help to moderate, but perhaps not overwhelm, any AXJ appreciation in the event of USD capitulation. So the PBoC will be a stabiliser, not agitator this week.

Instead, the ECB could be a potential source of FX market inspiration; depending on the take-away from ECB policy stance on QE (PEPP), and perhaps critically, on any perceived shifts in inflation targeting regime.

Given that the ECB, unlike the Fed’s dual-mandate approach;

i)  takes a strict singe (price)- mandate approach to policy and;

ii) has a critical bias (near, but below 2% target) that favours inflation undershoot; any signs that a Fed-like approach of deliberately allowing inflation overshoot will be a far bigger game-changer. And in turn, this could take the EUR down a notch; at least on the “surprise factor”.

This policy regime shift is admittedly not the base case, and we have christened this the “Rehn effect”, after ECB member Rehn who appears to be almost alone in preferring this shift.

But any sign that Rehn is getting traction could result in EUR losing some (traction).

And consequent USD strength may unravel recent gains in EM Asia FX.

For now though, consolidation remains the base case given the central bank rhetoric by and large tries to cover more bases and leaves plenty of wiggle room on either side. So the ECB may be a reason to push trades one way or another within limits; but the bar is higher for ECB to be truly a pivot for the USD.

ECB: Striving to Strike a Balance

ECB’s meeting on 10 June comes at a tricky time: activity data and vaccinations are improving, inflation is rising and the tussle between the ultra-dovish and the less dovish within the Governing Council will become more apparent.

After its initial struggles with AstraZeneca and its vaccination drive, European countries have finally managed to pick up vaccinations to a respectable pace. This converges with the improvement of activity data in the manufacturing and services sectors but also importantly in labour markets.

At the same time, inflation is rising but ECB officials have been sure to highlight this pick-up as temporary and not something that will trigger alarm bells.

Consensus expectation for the June meeting is for:

• ECB to extend its bond buying at the accelerated pace of ~EUR20bn/week until September.
• The EUR1.85trn pandemic bond buying program to end by March 2022.
• ECB to revise higher its growth and inflation forecasts for this year and the next.

The bigger questions, however, will be around how the members of the Governing Council are spilt on the timing around the withdrawal of ultra-accommodative monetary policy.

Communication around the timing of policy withdrawal and threshold around rising inflation will take center stage at the 10 June meeting.

Thailand: Suffering a Tourism Drought

While the initial impact of the pandemic was uniformly devastating for all countries, increasing differentiation is beginning to emerge, with some countries impacted more adversely than others.

Within the context of EM Asia, Thailand stands out for painful reasons. The pandemic effectively wiped out one of the most important sources of revenue for the economy, tourism.

Tourist arrivals dropped to naught during April-September 2020 and since then the increase to 8k tourists in April 2021 (from an average 3.3mn/month in 2019) has been cruel consolidation.

Multipliers from the travel and tourism industry are closely linked to other services and to broader economic growth in Thailand.

According to the World Travel & Tourism Council, tourism’s contribution to GDP dropped to 8.4% in 2020 from 20% in 2019 and over 15% of jobs have been lost in the sector.

The spill-over impact onto sentiment indicators is also evident: the Consumer Confidence Index (by the University of Thai Chamber of Commerce) is languishing at the lowest levels since the Asian Financial Crisis and is likely to sink further in May as the situation remains grim.

Thailand is a case in point that the global vaccination drive, and not just the domestic vaccine rollout, gaining momentum is crucial. Although international visitors to Thailand in recent years have been dominant by the Chinese, tourist arrivals from other destinations including the ASEAN countries, the US and Europe are no less important.

Reflecting the dearth of tourism revenues, the current account slipped into two consecutive quarters of deficit in Q4 2020 and Q1 2021.

Notwithstanding the emerging disparities in acquiring vaccinations between EM and DM countries, Thailand’s domestic vaccination drive is moving slowly because the government initially relied solely on AstraZeneca for its vaccination needs.

Encouragingly, the government has managed to diversify its sources of vaccinations away from solely AstraZeneca into Sinovac as well; it is also in discussion with Pfizer and J&J for additional shots. Even then, the process has been slow to take off.

As tourism and tourism related sectors continue to reel from the impact of the pandemic, the mainstay for growth will remain export growth and government spending. Exports, especially electronics exports, have picked up lately but this one-trick pony can hold up only for a time.

Eventually, structural constraints will start to bite as Thailand’s electronics export sector still caters to HDDs as compared to the more in demand SSDs.

Government spending will continue to support growth in a targeted manner but will becoming increasingly constrained by rising public debt. Although not an imminent concern, will be something the authorities will keep an eye on.

Admittedly, the upshot of a current account deficit and some US dollar strength implies that weakness in the THB will be a welcome respite for the Bank of Thailand (BOT).

BOT will be comfortable with keeping the policy rate unchanged at the current historical low of 0.50%. But will continue to provide targeted liquidity and credit support.

Credit: Mizuho Bank Ltd