Wanted: More Swap Lines

Transcription

1 Economics & Strategy Weekly Wanted: More Swap Lines DBS Group Research 2 November 2018 Taimur Baig Chief Economist taimurbaig@dbs.com Samuel Tse Economist samueltse@dbs.com Please direct distribution queries to Violet Lee violetleeyh@dbs.com Our analysis suggests that there will be no respite from rising rates and USD strength next year The risk of emerging market currencies facing further downward pressure in substantial FX weakness can spill over to financing difficulties, especially a rise in default probability There is a limit to domestic policy tightening and reserves drawdown to deal with this Activating bilateral and multilateral swap lines is the call of the hour How to manage sustained FX risks? A tough year for EMFX is drawing to an end, but the likelihood of a dollar relent causing some respite in 2019 is low, in our view. We see US growth momentum remaining intact through most of 2019; and perhaps more critically, consumer prices to firm up, compelling the Fed to keep hiking. We also expect China s economic stress to persist, trade wars to continue, and oil remaining elevated. This is a recipe for further currency stress in the non-usd world. Allowing the exchange rate to move as per the market is sound practice in most circumstances, but not at times of stress when contagion is spreading and a liquidity squeeze appears suddenly. Central banks and treasuries must intervene vigorously in such circumstances. The problem with most central banks in emerging markets is that it is hard to convince the markets that FX reserves are ample. Old rules of thumbs of maintaining at least six months import cover are woefully inadequate in this era. A country could have ample trade cover and still face currency pressure if there is a deposit flight and currency switching by residents, foreign portfolio investors engage in massive selling of their debt or equity holdings, banks and nonbank financial corporations begin to tighten rollover stipulations, or peer currencies are selling off. Tightening monetary (raising interest rates ought to bring in marginal buyers of debt) or fiscal (reduced spending ought to curb import demand, thus reducing the current account financing needs) policy is always on the cards in response to capital flight. But these strategies have backfired in the many cases in the past. Higher rates and/or reduced spending can also raise default probabilities as corporates and individuals find debt service costs to increase, companies see revenues decline, and there is a rise in counterparty risks. Intervening in the FX markets often only delays the inevitable. As the PBOC found out in 2015, if market sentiments remain poor, as much as 25% of reserves can be depleted (around USD1trln) from the war chest of a major economy in just one year despite an array of capital controls. Refer to important disclosures at the end of the report

2 A case for swap lines to assuage funding concerns We pointed out last week that external funding (scaled by reserves) needs of India and Indonesia in 2019 will be as challenging as this year, if not more. There has also been a marked decline in funding cover for China and the Philippines. It is ironic that Asia has countries with reserves cover issues while the region as a whole has more reserves than any other in the world. Just between the central banks of Japan, South Korea, Taiwan, and Singapore, there is about USD2.5trln in reserves. China s PBOC (USD3.1trln) and Hong Kong s HKMA (USD0.4bn) further underscore the abundance of hard currency assets in the region. Since conventional policy defence have not helped exchange rate dynamics, it is high time to take a page out of the playbook of the US Federal Reserve from A little background is in order here: countries like Mexico, which had been pursuing prudent policies in the lead-up to the global financial crisis, began facing liquidity squeeze and sudden stop in capital inflows as market panic spread worldwide. Having already extended swap lines to advanced economies earlier, the Fed moved, in October 2008, to provide swap lines of USD30bn each to the central banks of Brazil, Mexico, Singapore, and South Korea. The US was motivated to do this not just to reduce risks faced by these well-managed economies, it also was seen that market dislocation or demand contraction in important emerging market economies could come back to exacerbate conditions in the US. The swap arrangements provided USD-for-localcurrency lines ranging from 1 to 90 days. The USD recipient central bank was charged 100bps over OIS rates. Because most central banks in the world have some assets placed at the New York Fed, the collateral for these swaps were those assets, ensuring safeguards. We bring to light these details to argue that such mechanisms could help emerging market economies considerably. However, we see no move on the part of the US Federal Reserve to take any such measure at this juncture, especially since the risk of ongoing market stress is not yet being seen as relevant to the US outlook. If not the US, could it be China? As it began pushing for internationalisation of the RMB a few years ago, China signed a number of RMB-local currency swap arrangements. Today, 32 such agreements exist, stretching from Asia to Latin America. Since the RMB remains short of being widely used, the effect of these lines has not had been similar to that of a USD swap line. What about multilateral credit lines? The IMF has large liquidity and balance of payments support facilities, but there is virtually no demand for them in most of Asia under present circumstances, as the stigma associated with IMF conditionality (a legacy of the 1997/98 Asian financial crisis) continues to loom large. The much promoted USD240bn Chiang Mai + 3 initiative remains untapped, as anything beyond 20% of those lines need to be attached to an IMF program. It is therefore critical that Asian economies pool their risks in their own backyard. The abundant reserves in some Asian countries should be used to assuage market concerns about the likes of India, Indonesia, and the Philippines. Already, in this area, two promising developments have taken place in recent weeks. In mid- October, on the side lines of the IMF meetings in Bali, the central banks of Indonesia and Singapore, BI and MAS, announced that a deal would be signed for a USD10bn local currency swap and USD repurchase agreement. This amounts to nearly 10% of reserves held by BI. Then, in late October, the central banks of India and Japan, RBI and BOJ, signed a USD75bn currency swap agreement. India s side of the swap line will be INR-USD, while the Japanese side would be JPY-USD. The relative size of this deal is nearly twice that of the BI-MAS arrangement. There is ample scope for many more agreements like these. We would like to see Japan and Singapore extend swap lines to other Asian economies, and the central banks of South Korea and Taiwan follow suite. China and Hong Kong may have their own challenges and imperatives, but as the Fed recognised in 2008, helping well run large economies avoid liquidity squeeze is a winwin, as it avoids the risk of financial market contagion and unwarranted demand contraction. Taimur Baig Page 2

3 Strategy FX: US midterm elections preview The market is looking to bottom fish after October recorded the worst outflows from emerging market stocks since the Taper Tantrum episode in However, any recovery in risk appetite is likely to be driven by opportunistic short-term flows rather than fundamentals, in our view, unless some much-awaited constructive talks take place between China and the US in the forthcoming G20 meetings. Against this background, the market is pitching the US midterm elections on November 6 as a game changer, betting that the US dollar would falter when the Democrats wrest control of the House of Representatives from the Republicans. Even so, US President Trump will veto any attempt to repeal his tax cuts, while trade policy is driven by the White House and not by Congress. We expect no change in Fed policy, nor do we see any meaningful move toward fiscal consolidation after the elections, and hence expect the USD strength to persist. Total seats Up for election House Currently Probability of control Democrats % Republicans % Total seats Up for election Senate Currently Probability of control Democrats % Republicans % Source: 538 project, DBS US 2018 midterm elections Rates: USD rates are buoyant Risky assets had a good bounce with the S&P 500 rising by 3.8% since the low on Monday. However, the index is still down by 6.5% from the peak. There was also limited recovery in the credit space. IG and HY option adjusted spreads (OAS) 11bps and 48bps wider respectively compared to the end of September. Meanwhile, US Treasury yields appear buoyant. Although risk aversion did drag 10Y yields briefly below 3.10%, yields are now back at 3.15%, up by 9bps over the same period. Similarly, expectations for Fed hikes were largely undented. The implied Fed-funds rate for end-2019 now stands at 2.81% (about three hikes), unchanged from what the market was pricing in at the start of October, before the US equity market rout took place. We maintain our view that USD rates are biased higher. There is little to suggest that US economic momentum is slowing. October s ADP employment numbers touched 227k (consensus: 187k) setting up for firm payrolls (due Friday). With the labour market tightening, the employment costs index also rose by 0.8% sa (consensus: 0.7%) in 3Q. Fundamentally, the strength of the economy requires higher USD rates. This can come with the level of the UST curve shifting up when the Fed hikes (and the market reflecting this) or via a selloff in longer-term rates if the market views the Fed to be too dovish relative economic conditions, thereby raising inflationary risks. Next week s FOMC meeting and mid-term elections could have implications on USD rates as the market digests fiscal implications and possible guidance on the Fed s rate trajectory. Eugene Leow Philip Wee Page 3

4 Asia Equities: NIM expansion and dividends hold key to relative performance among Singapore Banks Singapore s system loan growth for September dipped slightly by 0.2%mom, reflecting declines in business loans to general commerce, business services, financial institutions and share financing. YTD loan growth (9M18) is at 4.6%, which represents annualised loan growth of 6.1%. Total outstanding loans have largely been flat since July. We believe there are downside risks to loan growth, given the slowing global economic growth, the impact of ongoing trade conflicts, and currency weakness in emerging markets. Most banks have been guiding for around mid-to-high single-digit growth. Surprisingly some banks did not sound particularly negative on loan growth in their latest 3Q earnings briefings, and see the trade war as an opportunity for some of their customers to expand into the region. Cross-border loans could increase, in their prognosis. Two local banks posted mixed results over the past week. One posted negative q-o-q earnings growth in line with expectations, while another registered positive quarterly earnings growth and hence was above expectations. We believe investors should focus on three aspects of the results which can determine the relative performance among the banks: (i) net interest margin (NIM); (ii) ability to increase dividends; (iii) fee income, which remains a wild card to downside surprise, given the current volatile environment. There are high hopes that the banks can benefit from NIM expansion as interest rates have been rising. However, competition for deposits has been strong, leading to rising cost of funds. It remains to be seen whether loan yields can outpace the increase in cost of deposits. This would depend on the CASA mix, as well as geographic and currency mix in loans, and pricing strategy, in our view. Credit: Selective value in high grade amid lacklustre new issue market Despite new issues generally seeing issuers coming with generous new issue premium this week, order books were not particularly strong (1-1.5x cover in many cases) reflecting week investor sentiment. Consequently, the bonds were generally off to a sluggish start in the secondary market and were up only Friday morning after continued market strength. The sentiment around new issues is unlikely to be lifted going into year end, with there being little incentive for investors to add risk with market tone staying volatile. That said, for long-term investors, some new issues offer opportunity to pick up value given the meaningful new issue premium, especially high grade issuers (for example a quasisovereign 5Y bond at T+240bp). A weak primary market will be a drag on secondary market performance in the near term. A pick up in primary market sentiment and performance of new issues in secondary would be essential to improve sentiment. In the secondary market, political risk was back in focus. Sri Lankan sovereign bonds sold off following the unexpected dismissal on 26 October of Prime Minister Wickremesinghe and appointment of Rajapaksa in his place (Macro Strategy dated 29 October). The government s statement on 31 October that bond maturities for 2019 have been taken care of provided some relief. We recommend staying cautious on Sri Lanka given the country s high external dependence with large repayments due between 2019 and 2022 ((Macro Strategy dated 2 November). The attractiveness of Singapore s banking sector lies in its asset quality as compared to that of other countries, and its high dividend yield. The sector currently trades at a 4.3% dividend yield, which is higher than the market s 3.9%. We are positive on Singapore Banks and look for those that can expand their NIM as well as raise dividends. Joanne Goh Neel Gopalakrishnan Page 4

5 Highlights of the week: Trip notes from India cautious but not outright bearish Eurozone: Growth and politics reinforce go-slow on policy normalisation Chart of the Week: Asia s 2019 external funding needs; more challenging than 2018 for most Monthly: 2019 funding gap and FX outlook Page 5

6 GDP growth, % YoY Key Forecasts CPI inflation, % YoY, ave f 2019f f 2019f China Hong Kong India* Indonesia Malaysia Philippines** Singapore South Korea Taiwan Thailand Vietnam Eurozone Japan United States*** * refers to year ending March ** new CPI series *** eop for CPI inflation Policy interest rates, eop 1Q18 2Q18 3Q18 4Q18 1Q19 2Q19 3Q19 4Q19 China* India Indonesia Malaysia Philippines Singapore** South Korea Taiwan Thailand Vietnam*** Eurozone Japan United States * 1-yr lending rate; ** 3M SOR ; *** prime rate Exchange rates, eop Q1 18 Q2 18 Q3 18 Q4 18 Q1 19 Q2 19 Q3 19 Q4 19 China Hong Kong India Indonesia Malaysia Philippines Singapore South Korea Thailand Vietnam Australia Eurozone Japan United Kingdom Australia, Eurozone and United Kingdom are direct quotes Page 6

7 Rates forecasts Q1a Q2a Q3a Q4 Q1 Q2 Q3 Q4 US 3m Libor Y Y Y-2Y Japan 3m Tibor Y Y Y-2Y Eurozone 3m Euribor Y Y Y-2Y Indonesia 3m Jibor Y Y Y-2Y Malaysia 3m Klibor Y Y Y-3Y Philippines 3m PHP ref rate Y Y Y-2Y Singapore 3m Sibor Y Y Y-2Y Thailand 3m Bibor Y Y Y-2Y China 1 yr Lending rate Y Y Y-3Y Hong Kong 3m Hibor Y Y Y-2Y Korea 3m CD Y Y Y-3Y India 3m Mibor Y Y Y-2Y %, eop, govt bond yield for 2Y and 10Y, spread bps Page 7

8 Group Research Economics & Strategy Taimur Baig, Ph.D. Chief Economist - G3 & Asia taimurbaig@dbs.com Nathan Chow Strategist - China & Hong Kong nathanchow@dbs.com Masyita Crystallin, Ph.D. Economist Indonesia & Philippines masyita@dbs.com Joanne Goh Regional equity strategist joannegohsc@dbs.com Neel Gopalakrishnan Credit Strategist neelg@dbs.com Eugene Leow Rates Strategist - G3 & Asia eugeneleow@dbs.com Chris Leung Economist - China & Hong Kong chrisleung@dbs.com Ma Tieying, CFA Economist - Japan, South Korea, & Taiwan matieying@dbs.com Radhika Rao Economist Eurozone, India & Thailand radhikarao@dbs.com Irvin Seah Economist - Singapore, Malaysia, & Vietnam irvinseah@dbs.com Samuel Tse Economist - China & Hong Kong samueltse@dbs.com Duncan Tan FX and Rates Strategist - Asean duncantan@dbs.com Philip Wee FX Strategist - G3 & Asia philipwee@dbs.com Sources: Data for all charts and tables are from CEIC, Bloomberg and DBS Group Research (forecasts and transformations). Disclaimer: The information herein is published by DBS Bank Ltd (the Company ). It is based on information obtained from sources believed to be reliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation & the particular needs of any specific addressee. The information herein is published for the information of addressees only & is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Company, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further c ommunication thereof, even if the Company or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Company & its associates, their directors, officers and/or employees may have positions or other interests in, & may effect transactions in securities mentioned herein & may also perform or seek to perform broking, investment banking & other banking or financial services for these companies. The information herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Sources for all charts & tables are CEIC & Bloomberg unless otherwise specified. DBS Bank Ltd., 12 Marina Blvd, Marina Bay Financial Center Tower 3, Singapore Tel: Company Registration No E. Page 8