Mizuho week ahead – Buying insurance & selling hope

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

US retail sales miss a week after the jobs disappointment helped to buy policy insurance (and buy time for doves to stand their ground), and this was tantamount to selling more hope to markets. Hope that an exceptionally accommodative Fed, now more inclined to defer “taper”, meeting with unprecedented fiscal stimulus in the US would indeed give rise to extended asset price inflation.

But therein lies the irony for the US and the risks that accompany growing divergence for EM Asia. For the US, hopes of extended policy boost makes it hard to determine and pin down whether to buy or sell bonds. Received wisdom appears to still align with short-end yields being better anchored as the Fed seems to chime in one voice about rate hikes being relegated to a post-“taper” period.

Nevertheless, long-end UST yields will probably be vulnerable to a lot more volatility as rising cost-side pressures from the commodity space meet spots of wage pick-up on one hand; while precarious risk dynamics are revealed amid  rising geo-political tensions alongside resurgent Covid in EM.

In any case, with the Fed’s dovish bias validated by soft spots in US jobs and retail sales data, which ought to quell worries about the CPI surge (which was accentuated by non-core component and used cars), the FOMC Minutes (Wed) is set to resonate with dovish restraints on UST yields.

But this need not translate into unequivocally weaker USD impulses, especially not in an unbridled pattern. For one, a resurgence of COVID in most of EM Asia, with a more nefarious mutation to worry about, is not quite consistent with sustained strength in EM Asia FX.

To be sure, there may be some support from continued improvement in China activity data. But this will probably be exaggerated by base effects. Whereas the rate of China’s economic pick-up may still be subject to circumspection. And that could in turn rein in CNY (and CNH) gains, cascading down as a cautious restraint for the opportunistic EM Asia FX bulls.

RBA Minutes (Thu) to take a cautious approach in linking policy positioning to the improvement in economic activity. Point being, the RBA, will still want to buy insurance for growth recovery. But selling hope to investors on Asia may be a higher bar; as Thai GDP (Mon) looks likely to underwhelm in the details, and perhaps more worryingly, in the outlook, as further delays in re-opening highlights the acute pain to travel and hospitality. And this threatens from negative multipliers.

But here’s the rub.

While selective spots of soft data may buy insurance and sell hope to investors, the underlying escalation in pent up caution may be build, and be prone to abrupt risk re-pricing, if subsequent waves of COVID intensify further while geopolitics sours the mood.

FX Theme: Tensions On the Rise

While spots of soft US data, the latest being an unexpected and disappointing contraction in retails sales, has corresponded to a dip in the USD; the Greenback pullback is neither unrestrained nor ubiquitous. What lies beneath appears to be a build-up in FX market tensions as the confluence of Covid re-emergence outside of US and EZ (quite prominently in Asia) amid rising geo-political tensions in the Middle East.

The latter (geo-political risks) could be a curve ball, setting the stage for softer UST yields to correspond to a stronger USD. And this could unravel some of the traction in the EUR abruptly. Of course a dovish FOMC may help to keep sudden USD spikes in check in the absence of heightened geo-political risks or wider meltdown in risk appetite.

Nevertheless, the outbreak of Covid in Asia that is casting a pall on economic recovery prospects means that it gets harder for EM Asia FX to simply latch on to a softer USD for a ride higher regardless of the mood. So even as a mellower USD post-retail sales helps to buoy EM Asia FX for the time being, tensions in the FX space are on the rise and the likelihood of higher volatility continues to seep through; even if not revealed.

Meanwhile support in the rupee on inflows, C/A deficit (amid demand) compression and “winners” in asset markets despite a devastating Covid crisis is not to be mistaken for sustainable de-coupling but rather rightly recognised as a precarious (opportunistic) positioning that is subject to risk of correction.

Amid these  rising tensions in the FX market, the risk would be to mistake two-way forces for quiet consolidation. We remain watchful of CNY trends and how markets price in the decelerating pace of rebound and lingering downside risks into CNY and CNY assets; as this will have a sympathetic impact on risk pricing for many other EM Asia FX.

US Treasuries: Relief not Absolution

Late week US retail sales miss helped to soften the rise in yields and  partially rollback some of the week’s bear steepening. But with inflation concerns merely assuaged, and not put to bed proper, hits and misses in US data may be a source of potential volatility in yields; particularly in long-end yields.

Though cause-and-effect will be complicated by somewhat more complex interaction between nominal UST yields and break-evens. With the FOMC Minutes likely to resonate more with the dovish camps, especially on the heels of the retail sales miss, long-end yields may be better anchored.

In fact a slight extension in terms of the partial reversal of bear steepening in the UST yield curve could continue to come through for the week. But the broader questions about cost push pressures amid job market friction and unprecedented policy stimulus remain unanswered. And that probably means that one should not read too much into the pullback in long-end yields to the point of declaring a reversal in upside trend in yields.

Instead, it is probably going to be a period of consolidation. 10Y yields are likely to be in the 1.54-1.75% range as in-coming data are assessed. Geo-political tail risks may knock 20-30bps from the low of the range.

FOMC Minutes: No Second (Thoughts)

A raft of  solid data, from CPI to ISM to a host of activity data/sentiments survey, suggesting spots of overheating in US are not the decisive catalysts for a shift in the Fed’s dovish bias. Not only because there have been soft spots in the other data points such as the non-farm payroll, industrial activity and retail sales; even after accounting for quirks amid unprecedented stimulus.

But more importantly, as the Fed’s view of an uneven economy with loads of slack (as is evident in the over 8mn jobs that the economy remains short on vis-a-vis pre-Covid) is vindicated; and hence thus the dovish reflex in the Minutes will resonate with lived realities.

Kaplan’s views on favouring a reduction of QE sooner rather than later, given its distortions, will probably prove to be a sole voice; even if it not an unjustified position. To be succinct, the Fed Minutes will reveal no second thoughts on maintaining exceptional accommodation under the framework that will allow some degree of “running hot”.

And so, UST yields may get more reprieve, if not some reversal, from last week’s bear steepening.

Commodity Boom: Likely a Passing Inflationary Threat

Notwithstanding some moderation, sharp surge in commodity prices, is the latest iteration of inflation fears from a confluence of reflationary policies and vaccine hopes coming home to roost. This is not unfounded. And industrial commodities in particular are out-performing on, record fiscal stimulus with an infrastructure bent; stoking what looks like a commodity boom.

What’s more, capacity constraints from pandemic restraints means that supply quirks and attendant cost-push may be accentuated, notably with soaring shipping costs.

On one hand, spare capacity and stimulus set to fade suggest a supply response that will cool inflationary impulses. But, on the other, the worry is that the interaction of various cost drivers alongside unprecedented stimulus may unmoor inflation expectations.

All considered, the decisive factor may be subdued wage dynamics that renders this a transitory cost upswing as supply responses and demand adjustments/substitution kick in. In particular, the confluence of a surplus of labour, with global economies far from having restored pre-Covid employment levels, and exceptional fiscal wage subsidy set to fade, mean supply-demand mismatches are likely to ease in 12-18months; alleviating price pressures.

The policy challenge is to stare down the reflation barrel unflinchingly, looking through transitory cost storms to steady the growth ship. After all, premature cost resurgence that erodes profit margins and disposable income is a deflationary demand threat.

* For the full report, please see Mizuho Chart Speak – Commodities: Inflationary Impulses Likely to Pass, 11th May 2021

Thailand Q1 GDP: Struggling for Traction

In all likelihood, Thai GDP growth barely improved to -3.7%YoY in Q1 (Q4 ’20: -4.2%) based on monthly activity data; but this is hollow consolation for an economy struggling for traction. The lack of tourism and tourist-related activities continues to weigh on the Thai economy as any major improvements in the ‘high touch’ services sector still remains elusive.

However, modest improvements in the agriculture and manufacturing sectors helped support growth in Q1. On the demand-side, the slight pick-up in private sector demand from the consumption and investment sides, while comforting, may only prove temporary as the more intense second wave that hit the country in Q2 eating into private sector confidence.

Government consumption spending was somewhat weaker in Q1, as suggested by monthly data, but public sector investment spending seemed to have got a boost which will support growth. And this continued weakness in growth is accounted for by policy-makers seeing as the government and the BOT have recently downgraded their 2021 GDP growth forecasts.

BOT lowered its forecast to 1-2% growth for 2021 from 3% previously; while the Fiscal Policy Office cut its forecast to 2.8% from 4.5%, previously. The growth downgrades reflected slow progress on the vaccination drive and procurement during a time when another wave of CovidD-19 mutations set back hopes for re-opening sooner.

Indonesia, Malaysia & Philippines Q1 GDP: Hits & Misses

The releases of ASEAN Q1 GDP pains a picture of impeded recovery. Although improvements have generally continued, the fact remains only the only the pace of contraction has narrowed. Whereas, forward-looking risks threaten to interrupt recovery amid renewed Covid waves.

In terms of our own forecasts, we were the most disappointment by Malaysia’s print – which we had expected would show some positive growth but did not. We were also surprised to the downside in the Philippines while for Indonesia, we were surprised slightly to the upside.

A shared bugbear is lagging vaccination drive and shortfall in vaccine procurement (except for Malaysia) whilst renewed waves of infections force quasi lockdowns.

Accordingly, many ASEAN policy-makers have downgraded their 2021 growth forecasts on account of slow progress on the inoculation front and repeated waves of Covid-19.

Thus, any material improvements in growth momentum is likely deferred to 2022. Further, monetary policy is slowly hitting its limiting in terms of delivering on additional policy rate cuts while mainly resorting to credit and liquidity support measures.

This implies that fiscal policy will have to bear the greater burden of growth support, casting the spotlight on stretched fiscal deficit and debt situation coming under renewed and further strain.

While the justification for wider deficits and higher debt was easy last year when pandemic hit across the globe at once, increased differentiation among countries this year will lead to more differentiate concerns; especially for countries like Indonesia (with debt monetization concerns) or Malaysia (with elevated debt level concerns).

BSP: Tense Backseat Relegation

While BSP held policy at 2.00% as expected inflation elevated above the 2-4% target range since the start of 2021 tie BSP’s hands are tied on further, significant policy stimulus. And the binding policy dilemma for most of 2021 means that most of the heavy lifting is left to fiscal policy.

And fresh waves of Covid-19 infections demanding restrictive lockdowns in key activity centers including Metro Manila only accentuate policy dilemma and  strains. Specifically, the trade-off between growth and inflation will likely intensify for BSP in coming months; further complicated by an improving economic outlook and building inflationary pressures in the US, which will lead the Federal Reserve to remove some of its high degree of accommodation.

And if “taper” risks surface earlier than expected, the BSP will have an added policy conundrum on its hands; possibly forced to withdraw accommodation prematurely. For the time being, BSP will maintain policy accommodation despite a tense relegation to the policy backseat as fiscal authorities try to get a grip on the pandemic.

Credit: Mizuho Bank Ltd