Reprieve for EM, for now

Transcription

1 Economics & Strategy Weekly Reprieve for EM, for now DBS Group Research 9 November 2018 Taimur Baig Chief Economist taimurbaig@dbs.com A much-awaited reprieve, but for how long? After a torrid October, there is finally some breathing space for market participants and policy makers. Volatility markers have eased (see chart below), FX selloff against the USD has been tempered, bond markets have seen a return to investments, and the equity market has brought back some EM value seekers. Irvin Seah Economist irvinseah@dbs.com Please direct distribution queries to Violet Lee violetleeyh@dbs.com Recent economic and geopolitical developments have likely paved the way for a few months of reprieve for EM assets Iran sanctions waivers may limit the upside on oil price for the time being After a sharp selloff, EM asset valuations have begun looking attractive, offsetting the pressure from USD liquidity squeeze US mid-term election results are being seen as a potential check on President Trump s brand of hyper unilateralism, which could reduce frictions over trade and security There is however a good chance that this reprieve will prove to be temporary. Iran sanctions could intensify by Q2 as waivers expire; US curves could steepen and USD liquidity tighten if the Fed keeps hiking; President Trump could push for assertive foreign policy through the executive route. Caveat Emptor. Source: Bloomberg, DBS Three developments have helped stabilise emerging market sentiments in recent weeks: First, oil prices have eased for now, reflecting buoyant production in the US and some waiver for oil importers from Iran. On the US, production has soared lately, solidifying its ranking as the largest oil producer in the world. This has pushed down US oil prices (WTI) steadily in recent weeks. Indeed, forecasts are being revised upward for US production for next year, which is now expected to exceed 12mn barrels/day by mid Outside of the US, Russia and Saudi Arabia have ramped up their production as well, helping stabilise Brent prices. Regarding Iran sanctions, which were re-imposed by the US on Monday November 5, waivers for some key importers, including China, India,, Japan, South Korea, and Turkey, have eased fears of a supply crunch. Refer to important disclosures at the end of the report

2 Second, since the IMF meetings in Bali a month ago, concerns about USD funding for certain beleaguered economies have eased somewhat. 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. These arrangements ought to be beneficial for IDR and INR; indeed, since the announcement of the swaps, both currencies have shown new-found stability. With respect to USD liquidity and rates, recent Fed communication makes it amply clear that there will be no let-up in the policy normalisation cycle amid a tight labour market, rising wages, and strong consumer demand. We continue to see the risk of inflation as asymmetric in the US, with the chance of an upward surprise of core PCE printing well above 2% to be much higher than any downward surprise. Trade wars, wage pressure, and tight capacity have given US producers plenty of excuses to raise prices, in our view. Also, US debt trajectory is firmly on the rise, while the supplydemand dynamic for new treasury issuance is not favourable. Curve steepening and USD strength could return quickly, against this backdrop. Third, the US mid-term election outcomes, with House majority going to the Democrats, are being seen as positive for EM, as checks on President Trump s brand of aggressive unilateralism could reduce the risk of exacerbating frictions on trade and security. These three developments could well mark a few months of reprieve. Going toward the end of the year, companies are engaged in share buybacks, some value-seeking investors are deploying funds, and there is little in the pipeline that could dampen the above three developments, in our view. But the reprieve could well prove to be temporary. Note that Iran sanction waivers will last just 180 days, after which the US could either reduce the amount of Iranian oil that could be imported under the waiver or refuse to extend waivers altogether. Geopolitical friction around the shipment of oil through the Persian Gulf could easily flare up as well. Furthermore, while we expect US oil production to remain robust, we are not sure if Russia and Saudi Arabia can keep pace. Concerns about oil supply could readily return next spring, in our view. Source: Bloomberg, DBS Finally, pushing back against domestic challenges posed by a resurgent Democratic-majority Congress, President Trump could well push for assertive foreign policy through the Executive route. Thus noise around Iran and China, as well as the immigration issue, could get ratcheted up next year. Confrontation in the Middle-East or South China Sea would hurt risk sentiments considerably, making the ongoing respite look distant. Taimur Baig Page 2

3 Strategy FX: Back to fundamentals after the US midterms Selling the US dollar into the US midterm elections on November 6 has turned out to be a buy the rumour, sell the fact event. The USD Index (DXY) fell bottomed at 95.7 on November 7 after polls confirmed that President Trump s Republican Party lost the US Lower House of Representatives to the Democrats who, however, failed to capture the Senate. The DXY rebounded to 96.7 after the FOMC meeting affirmed that it was business as usual regarding the Fed s stance to gradually increase rates, starting with another quarterly hike in December. Based on our expectations for the Fed Funds Rate to end 2018 and 2019 at 2.50% and 3.50% respectively, we see the DXY extending its appreciation to 100. Notably, the Chinese yuan has bucked the trend by depreciating into and after the US midterms. The central parity for USD/CNY has risen to yesterday from on Monday. This should not come as a surprise. Trump s trade war agenda has bipartisan support in Congress i.e. the support of the Democrats. The Sino- China trade war is also increasingly viewed as a prolonged political and ideological conflict. Hence, it would be unrealistic to expect any meaningful Sino-US trade deal at the upcoming G20 Summit in Argentina on November 30-December 1. We have not changed our forecast for USD/CNY to end the year at 7.00 and holding above this level in Reality is also returning to Europe. The British pound has started to retreat from the ceiling of its range of the past 3-4 months. The prospect for Prime Minister Theresa May to reach a Brexit deal with the EU by end- November is still considered at best, a possible but improbable outcome. Failure here would also mean a leadership challenge to May thereafter. The euro has retreated quickly to on Thursday after touching 1.15 a day earlier. The euro was never going to sustain any flight after Eurozone GDP growth fell to 1.7% YoY in 3Q18, below 2% for the first quarter since 3Q16. In conclusion, we look for focus to return to fundamentals after the US midterm elections, and for America s relatively stronger economic and rates outlook to keep the USD on its uptrend. Philip Wee Rates: Election uncertainties fade Risk appetite generally improved through the week as the US mid-term elections offered no surprises. To recap, the elections ended with a split Congress (the lower house went to the Democrats while the Republicans held on to the Senate) was in line with what polls had been suggesting. This dampens the risk of an even more expansionary fiscal stance and should allay concerns that the supply of USTs could drive longer-tenor yields much higher over coming few years. The Dow extended its rally, heading up by 3.6% thus far this week. UST yields were somewhat volatile as the market oscillated between an improved fiscal outlook and better risk appetite. While the Fed stayed on hold in November, another hike in December is pretty much a done deal. Bearing in mind that Fed policy is likely to head towards restrictive territory in 2019, UST yields were generally buoyant with 10Y yields staying above 3.20%. The improved sentiment filtered into Asia. The combination of higher US equity indices and a weaker USD encouraged risk taking, allowing equities and local government bonds to extend their fledging rally after a volatile October. In particular, the rally in Indo govvies and the rupiah is noteworthy. 10Y IDgov yields have fallen 45bps since the start of the month while the rupiah is 4.4% firmer versus the USD over the same period. While it is tempting to extrapolate the risk rally through to the end of the year, we are somewhat wary in the immediate term given the scale of the rally. In any case, it must be noted that a split Congress should have no bearing on how Trump intends to handle the US-China trade war. On this front, market participants are hoping that Trump will be able to cut a deal with Xi, with further meetings planned for the G20 summit at the end of the month. Eugene Leow Page 3

4 ETF Equities: Equities still preferred Good riddance to the month of Red October, which garnered attention like no other with the worst sell-off since the global financial crisis of Despite the heightened volatility in October, US-listed ETFs saw monthly inflows of US$4.4bn, primarily driven by non-us exposure. International equity ETFs took in US$6.1bn, while US equity ETFs suffered US$595m of withdrawals. Equities had since November regained a solid footing on a confluence of corporate earnings and the removal of overhang on US mid-term elections. The winning streak is over for fixed income ETFs after posting net outflows for the first time in 39 months. US fixed income ETFs faced redemptions of US$5.0bn largely led by US$2.8bn outflows from equity-sensitive highyield bonds. International fixed income ETFs showed US$738m inflows though. The month also saw US 10-year bond yields hitting the highest level since We continue to expect bond yields to rise to 3.6% by the first half of 2019 driven by Fed hikes as well as higher inflation amid a strong economy. Credit: Indian bank fundamentals remain weak despite recent positives Indian banks Q2 FY2019 (year ending March) earnings of showed some positive signs. Most banks reported lower gross non-performing loans (NPLs) as well as new NPL formation. The chart below shows the aggregate NPL and new NPL formation for five large banks (SBI, ICICI, Bank of Baroda, Canara Bank and PNB), which together represent around 40% of the Indian banking system assets. Lower credit costs also helped the bottom line of the banks with SBI and ICICI returning to profits after losses in the prior quarter. Commodities had US$819.88m of inflows, with outflows from oil-related ETFs, and inflows into gold ETFs. Bearish sentiment is returning to the oil market on renewed concerns over excess supply. US listed ETFs monthly flows Source: ETF Asia Analytics, ETF.com, DBS Despite this, fundamentals of the Indian banking system still remain a long way from turning healthy. Gross NPL ratio of our sample remains above 10% while capitalisation remains just about adequate (Tier 1 ratio of 9-10%). Asset quality issues are unlikely to be resolved without exceptional measures, and hence will remain a long-term issue. Valuations of Indian bank USD bonds remain relatively expensive and do not offer much upside from current levels (5Y bonds trading at a z-spread of around bps). Hence, they have not reacted to the Q2 results unlike equities of the banks which have seen a rally. That said, bond valuations are driven by government ownership and supported by the strong technicals (absence of new bond supply). At best, Indian bank bonds are suitable for buy and hold investors for coupon carry. Joanne Goh Neel Gopalakrishnan Page 4

5 Highlights of the week: India: Non-banks not out of the woods Malaysia Budget 2019: Recalibration Chart of the Week: Soybean as a proxy for trade war sentiments 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 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 Exchange rates, eop 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 communication 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