Mizuho week ahead – Uneven worries of inflation and infections

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

Uneven Worries of Inflation & Infections

US FOMC Minutes gave reasons to fret cost-push pressures from reflationary policies as “some” and a “number of” FOMC members highlighted upside inflation risks.

Simultaneously,  in Asia, resurgence in Covid infections from more transmissible mutations, was causing consternation about lives and livelihoods; with tightening mobility/distancing restrictions across Malaysia, Singapore and Thailand, reflecting wider setbacks in India, Philippines and Taiwan.

Malaysia, with its latest and more stringent iteration of MCO (details below) announced over the weekend, is looking at a 1%-pt knock on growth projections from earlier. And the Finance Minister Tengku Zafrul has indicated that worse than expected outcomes may warrant further fiscal stimulus.

And Malaysia is certainly not an outlier in the region, where stretched monetary policies, amid unwelcome pick up in inflation (from cost-pressures), is increasingly casting a glare on the capacity and willingness for more fiscal relief. Worryingly, uneven infections-inflation up “payback” risks.

Which is to say, policy-makers, especially if constrained by “twin deficits”, will have the unenviable task of contemplating  the harsh trade-off between the need for urgent fiscal relief for Covid against the ability to demonstrate/convince investors/ratings agencies of fiscal consolidation further out.

Some economic toll appears unavoidable. Question is how deep and far the setback will be.

Optimists may find some consolation in the fact that vaccine ramp-up plans should put Asia on course for a fuller recovery, with corresponding economic gains, for 2022. Even then, the vaccine procurement and rollout timelines suggest a good degree of variability. And differentiation on the region may be based on the ability to quickly get up the vaccination curve.

Nonetheless, uneven worries of infections (extended Covid devastation) in Asia and inflation (upswing) in US reveals uncomfortable risks of policy dissonance dealing financial shocks (from quicker than expected “taper” in 2022) that catch Asia on a weak footing.

Which is to say that Covid, conspiring with the huge divergence in policy responses and risks, may cast a much longer shadow for some EMs compared to advanced economies.

This is admittedly not an imminent problem. Nevertheless, Bank Indonesia is subject to some of these constraints as it is poised for a policy hold (Tue) as it tends to macro-stability risks.

And while the BoK may not face as harsh a dilemma, the tailwinds from semiconductor chips should alleviate the central bank’s concerns to allow a hold (Thu) while fiscal policies continue to take the wheel.

The spate of better than expected activity/exports data should lift Singapore’s Q1 GDP revisions (Tue) to flash estimates. But the bigger and opposing risk is the outlook, given reimpose restrictions amid higher cases. So revisions to 2021 forecast may ironically have a downward bias.

The uneven infection and inflation on various dimensions continue to underpin Covid as a key dictator of the narrative and the unfortunate reinforcement of inequalities (of global outcomes).

FX Theme: Reflation Response Divergence

The divergence, if not dissonance, in policy response expected to reflation may be emerging as a a notable influence in FX markets. This has only been reinforced by the FOMC Minutes.

What is undoubted is that a boom-like scenario in commodity markets, surging shipping/transport costs and spots of capacity constraints leading to sharp price rises of key components (most notably in semiconductor chips) may inflict surprisingly large breadth and amplitude of price pressures via supply-chain impact, and perhaps more worrying in feedback interactions.

Much harder to predict is the evenness which cost -push impact amid varied scope for policy response.

US far ahead in vaccination and with the benefit of massive fiscal stimulus, is poised for “taper” as early as 2022 is in stark contrast to the setback from Covid resurgence elsewhere, which ups policy dilemma.

In turn, this sets the stage for USD to turn a corner and blind-side many currencies; including EM Asia FX that may be vulnerable to a shake-down; dependent on “twin deficits”, inflation and debt. To be sure, this shift will probably not take place unequivocally in the near-term given the Fed’s commitment to exceptional policy accommodation. But the seeds of this outcomes have been planted. And markets are susceptible to fretting these outcomes if the data support growing US-EM Asia divergence.

Meanwhile, USD will be prone to two-way volatility as whether long end (nominal) UST yields outpace inflation expectations (or not) will likely determine USD strength (continued weakness).

This reflation response divergence is a key determinant of USD turnaround. For now though, two-way consolidation moves in the Greenback is likely to persist as whether the USD breaks convincingly below the 90-handle is watched by the momentum traders.

US Treasuries: FOMC Range

A mild flattening of the UST yield curve, with capped upside in yields reflects two things.

First, FOMC Minutes surprising with non-negligible minority concerns of risks associated with inflation overshoot, and attendant policy accommodation excesses.

Second, already rich inflation expectations baked into the 10Y breakeven stifling excessive long-end (nominal yield) reaction to these risks amid Fed’s assurances of accommodation.

This former gently nudged 2Y yields up, while the latter anchored the long-end. What’s more, volatility in financial markets set-off by crypto-currency sell-off resulted in “risk off” reflex, which also helped to dampen long-end yields (amid haven demand).

For now, the inflation worries on one hand and waning risk appetite alongside policy “guarantee” on the other appear to be engineering a consolidation phase in UST yields/yield curve; at least until some clarity on inflation risks and policy response.

And so, 10Y UST yields are probably re-grouping in the 1.52-1.76% range for the time being, while the 10-2Y spread appears to be settling in the 135-165bps range.

This “consolidation” amid tensions however should not be mistaken for the absence of risks. And the warning is that any inflation/policy risks may trigger abrupt moves. And 10-2Y spreads spiking above 180-200bps may entail “taper”-like risks.

Malaysia’s MCO Tightening Reflects Wider Asia Vulnerabilities

With new cases in worryingly elevated (above 6,000 for five days straight), now flirting with 7,000, Malaysia tightened the MCO (movement control order) last Friday

The details furnished over the weekend reveal significant tightening of restrictions as follow:

• Business operations are restricted (from 8am to 8pm);
• “high-risk” places will be shut with immediate effects and,
• 80% of public sector workers and 40% of private sector workers will have to   work from home, projected to affect 7-8 million workers, and;
• public transportation capacity will be reduced by 50%.

Finance Minister Tengku Zafrul estimates a resultant 1%-pt knock on GDP from restrictions,  implying earlier growth forecasts of 6.0-7.5% may be lowered to ~5.0-6.5%. He has announced additional MYR200mn ($48mn) for the Health Ministry to procure screening kits and PPE; suggesting that a worsening of the situation may warrant further fiscal stimulus.

But this worsening virus outbreak is not peculiar to Malaysia. Far from. In fact, it is depressingly familiar to the region; with India the worst-hit, but not alone either.

In addition, Thailand, Singapore, Vietnam, Taiwan and Philippines all subject to varying forms of more stringent mobility and distancing measures in response to a worrying outbreak of Covid mutations. Renewed (and more transmissible) outbreaks conspiring with lagging vaccine rollout means EM Asia has some way to go on a bumpy road to more unimpeded  economic resumption/recovery.

But this is not just an unavoidable delay, but perhaps a necessary one; to ensure the pandemic is adequately and appropriately tackled as a precondition to restoring the economy.

Whereas putting the economic carriage ahead of the healthcare horse risks far greater economic pain/scarring further out.

While we had earlier (late-April) revised down GDP forecasts for India, Philippines and  Thailand, risks remain tilted to the downside as COVID casts a long shadow for these countries. And it was our below-consensus GDP outlook for Indonesia that has spared it further cuts on our part so far.

In addition, downgrades to growth for Singapore, Malaysia and Vietnam will be hard to avoid. This upshot is that a fuller recovery will be impaired in the near-term and delayed into 2022. Beyond which, policy dissonance with the US (“taper”, rising UST yields, etc) may stifle capacity for catch-up growth as financial market contagion risks overtake Covid contagion fears.

Bank Indonesia: Prioritising Macro-Stability

Despite the growth backdrop being weak and uneven with subsequent waves of Covid – 9 infections hurting domestic demand, BI will prioritise macro-stability at its 25 May meeting, as it has in the past few months.

Hence, we see no change to the policy rate at 3.50%.

Moreover, with the minutes of the Federal Reserve meeting last week suggesting that some form of policy normalisation may not be altogether so distant, BI will have to be even more cautious given the attendant vulnerabilities to the IDR that might inadvertently result.

True to form, USD/IDR popped higher following the release of the Fed minutes after some weeks of relatively stable trading. This suggests that IDR depreciation pressures remain a top concern given the fundamental ‘twin deficit’ concerns.

Unfortunately for BI, and increasingly a number of EM central banks, the growth outlook remains indisposed to dealing with a tightening in monetary policy, in contrast to the DM central banks; seeing as the differentiation between EM and DM markets are widening on vaccination progress and repeated COVID-19 infections.

In the interim, BI will continue to resort to credit/liquidity support complemented by macroprudential policy; all of which carefully calibrated to maintain macro-stability.

Bank of Korea: Comfortable Hold

BOK will be comfortable in its position to keep its policy unchanged at record low of 0.50%.

Even if this may across as the BOK being unwilling to support the unevenness in economic growth improvements and still weak labour market conditions, the fact remains that BOK is one of the few central banks in the region expected to upgrade their 2021 GDP growth forecasts to “mid-3%” from 3% earlier, is telling of a general improvement in economic conditions.

Discussions around when BOK will start normalising monetary policy, we think, maybe deferred until substantial progress has been made on ensuring that the economic recovery benefits all sectors and importantly, leads to a perceptible improvement in labour market conditions.

For now, we expect fiscal policy and continued progress on the country’s vaccination drive to be backbones of an improving growth outlook this year.

BOK will be justified in maintaining policy at this stage and supporting the ongoing recovery.

Philippines: Supply-side Curbs to Dampen Imported Inflation

President Duterte signed two executive orders on 15 May modifying the import tariff rates for rice and pork.  For rice, import tariffs were lowered to 35% for ‘Most Favoured Nations’.

This is from 40% for rice which is imported within the ‘Minimum Access Volume’ (MAV) and from 50% for rice imported outside MAV. This suggests a ~20% reduction in rice import prices.

For pork, the situation is a bit more complicated. In a bid to quell the sharp rise in pork prices in recent months, the President signed an executive order in April (EO128) reducing pork tariffs by an average 66%.

However, following appeals by domestic hog industry players, pork tariffs reductions were partly rolled back. As it stands, pork import tariffs are ~50% lower compared to tariff before the April reduction.

The government also raised the MAV for pork by ~370%. Meat inflation in recent months has risen sharply (leading the upswing in food inflation) on account of a shortage of supply in pork driven by the African Swine Flu.

The reduction on rice import tariffs may be prescient as retail rice prices are only just starting to climb, despite rice inflation in and of itself remaining low.

Although these measures have precedence, the impact from lower import tariffs on retail pork prices has not yet come through; and it may take a few more months to show up.

These supply-side dampeners on imported food inflation will be a welcome relief for consumers already hit by the pandemic as much as for the BSP in easing the apparent policy dilemma;

BSP will have more policy room to maintain policy accommodation for a fuller recovery.

Credit: Mizuho Bank Ltd