Mizuho Daily – Ox, Not Bull | Misguided Inflation Fears | BSP’s Inflation Constraints

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

An Ox, Not a Bull

On the cusp of the Lunar New Year ushering in the “Ox”, hopes of shedding the scourge a once-in-a-century pandemic to strengthen the economic recovery are welcome, but it would be a mistake to characterize an Ox as a Bull. Fact is, the “Ox” has its work cut out.

US equity bulls have stalled (albeit near record highs) while UST yields have fallen back led by the long end; although the miss in US CPI  probably helped soften yields a tad more. USD is sideways on a soft footing; with EUR, JPY, AUD and SGD bulls impeded at familiar 1.21+, mid-104, 0.77+ and mid-1.32 levels. Fact is, the Ox may need work to sustain optimism.

First, uneven rollout of vaccines globally amid logistical constraints as new (possibly more virulent) mutations of the virus threaten to undermine vaccine efficacy; means that risks of interrupted recovery in 2021 remains continues to overhang; tempering bulls. More worryingly, the dangers of premature policy stimulus revocation emerge as a wedge in policy views increases against a backdrop of initial recovery in the US. And this may be the biggest bugbear for market bulls have gone to town with bets on further, unfettered stimulus.

Why US Inflation Concerns are Premature, if not Misguided

In some camps, unprecedented monetary policy stimulus alongside record stimulus is raising alarm about pipeline inflation, calling for fiscal restraint. Larry Summers and ex-President of the NY Fed, Bill Dudley are lining up on this side of the argument. The heated debate is understandable given the scale of stimulus. Nonetheless, concerns about the inflation genie being let out of the bottle are premature, if not misguided.

For one, record negative output gap reveals severe economic retardation, requiring sustained policy stimulus, not premature restraint. Especially given how uneven the recovery is. So admittedly, the shape of fiscal stimulus is a justifiable point; but not the need for support. Second, the initial manifestation of reflation – policy stimulus aimed at reviving demand resulting in commodity/logistics cost-push is a necessary course towards demand revival; in fact, deflationary in the interim due to the erosion of margins/disposable income.

So, rising costs from reflation is not an inflation inconvenience to be (prematurely) snubbed out, but a necessary inconvenience tolerated so that demand may be durably revived. Finally, enhancing quality of jobs/wage recovery may also require fiscal capacity building.

BSP: Inflation Constraints Bind … For Now

Despite 2020 growth at the low end of the official forecast range, inflation constraints may bind the BSP’s ability to act act on its dovish pre-disposition of. Specifically, sharp rise in headline inflation (above 4% in Jan) all but negates the option of a near-term rate cut for an economy still significantly below pre-COVID levels.

Although it is almost exclusively cost-push factors, led by a surge in pork prices, to blame for the recent inflation upswing, there is a non-negligible risk that the confluence of higher food and fuel prices will lead to significant second-round inflationary pressures.

A risk the BSP will not be inclined to discount lightly. As such, a steadfast dovish bias while deferring to data-dependency on additional rate cuts is the game plan. But once food prices are reined in by increased import quotas on specific products alleviate tight supply, still anaemic demand-pull factors will open the door for BSP to ease further. In the interim, additional liquidity and credit support measures to provide targeted support remain as attractive options seeing as credit growth remains in the doldrums.

Source Credit: Mizuho Bank Ltd