Monday s The Week Ahead

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1 Economies, Currencies, Rates Daily Breakfast Spread DBS Group Research 14 October 2013 US Fed expectations Implied fed funds rate Dec13 Jun14 Dec14 Market Current wk ago DBS Source: Bloomberg fed fund futures Notes: Given a FF target rate of 0.25%, an implied FF rate of 0.30 is interpreted roughly as the market pricing in a 20% chance of a Fed hike to 0.50% from 0.25% (30 is 1/5th of the distance to 50 from 25). DBS expectations are presented in discrete blocks of 25bps, i.e., the Fed moves or it does not. See also Policy rate forecasts below. Monday s The Week Ahead Greater China, Korea US-China: With no deal on the US budget / debt limit in sight, holders of US Treasuries are becoming increasingly upset with the brinkmanship in Washington. The standoff has reportedly made Chinese officials all the more determined to push forward with globalization of the renminbi as means to lessen China s reliance on the dollar and protect its reserves from a fall in the dollar and/or the value of Treasuries themselves. China holds US$1.28trn of Treasuries it doesn t want chaos in Washington to blow a hole in any of it. If only the renminbi was globalized. If only its reserves were denominated in yuan instead of dollars. That would solve everything wouldn t it? In fact, no. It wouldn t solve anything. China s problem has more to do with its 20 years of trade and current account surpluses than it does with whether the claims it has amassed are denominated in dollars or yuan. The easiest way to see this is to follow the buildup of China s Treasuries and a hypothetical attempt to redenominate them in local currency terms to renminbiize the dollar. First the buildup: China began running current account surpluses back in 1990 but only in 1998/99 did they start to become significant. In 2000, it s cumulative surplus of the entire preceding decade amounted to a mere $120bn and it held $60bn of Treasuries. By 2007, these figures had grown 8-fold its cumulative current account surplus had risen to $1000bn, its Treasury holdings to $480bn. Since 2007, both have grown by another 2.5x. As of September 2013, China s accumulated current account surpluses since 1990 add up to some $2500bn and its UST holdings stand at $1275bn. Then the hypothetical swap: China becomes worried about all this dollar debt it wishes it were denominated in its own currency, the RMB, instead. Economic czar Li Keqiang packs up all the Treasuries into a suitcase and flies to Washington, where he meets Barrack Obama at the White House. US foreign holdings of US Treasuries USDbn, Sept 2013, private plus official 1,400 1,200 1, ,277 1, China Japan OPEC T'wan Belg UK HK Spore N'way Can India 1

2 China current account surplus and US Treasury holdings USD bn, cumulative CAS 2,500 2,000 cumulative current acct surplus US$2475 1,500 1, UST holdings US$ Li explains his fears and asks Obama if he might take back all his Treasuries in exchange for new ones denominated in RMB. Obama graciously obliges but explains there is no need to issue new bonds he simply crosses out the $100 written at the top of each existing bond and scribbles in RMB 612 in its place, reflecting the prevailing exchange rate. With the stroke of a pen, China s Treasuries are now denominated in RMB. Its money is safe. The dollar s dominance in global markets has fallen by $1275bn; the RMB s stature has risen by the same. Obama and Li adjourn to the Rose Garden where they have a dim sum lunch before Li heads home to Beijing. Of course China s money is no safer than before, as the parable continues. Six months go by and China has run into difficulty. Two banks have gone bust and Li needs to fill a hole. Rather than print new RMB, however, Li returns to Washington to cash in some of his RMB Treasuries. Obama remains his gracious self. He d like to help but there s one problem: China is still running surpluses, the US, deficits. Obama has even fewer RMB to offer Li today than six months earlier. In short, China s RMB-denominated Treasuries are worthless. Unless, of course, Mr Li might accept dollars instead? Plainly, China s problems have nothing to do with the dollar s dominance in world markets and everything to do with China s current account surpluses. Globalizing the renminbi won t turn surplus into deficit. Renminbi-izing the dollar won t make China s foreign reserves any safer. At the end of the day the moral is a simple one: if you don t want credit risk, don t lend. None of this is to say that prudent currency diversification wouldn t lower China s dollar risk. It would. Buying euros and yen and pounds would go a long way towards stabilizing the value of China s $3,500bn of foreign exchange re- China US Treasury holdings as % of foreign reserves percent %

3 serves. But China is doing this already. Holdings of UST as a percentage of foreign reserves have remained a fairly steady 37%-38% since In this light, the dollar doesn t appear that dominant to begin with. Nor is this to say that globalizing the RMB wouldn t lower other kinds of risks that China, indeed the world, faces as regards the dollar. A dollar-related credit crunch brought Asia s foreign trade to a standstill in late-2008 the use of RMB for trade settlement might have prevented much of that collapse. A global RMB market could also help finance the vast expansion in Asian trade volumes expected over the coming decade. We estimate that Asia s two-way trade will expand by $5trn-$6trn by 2020, an amount that surpasses the entire offshore dollar market by 40%-50% at present. A globalized RMB may be necessary to take some of the burden off the dollar. Bottom line? There are good reasons for China to want to globalize the RMB. Protecting the value of its foreign reserves from chaos in Washington, however, is not one of them. Southeast Asia, India SG: The economy is expected to contract by 1.0% QoQ saar in the third quarter based on the advance GDP estimates announced this morning (see Table). That translates into a 5.1% YoY expansion. The QoQ contraction is less than what market had predicted and the GDP growth figures for the first two quarters have also been revised upwards. That is, the growth trajectory for the entire year has been lifted. Table 1: GDP growth by sectors 3Q12 4Q Q13 2Q13 3Q13 (a) Percentage change year-on-year Overall GDP Manufacturing Construction Services producing Quarter-on-quarter annualised growth rate, seasonally adjusted Overall GDP Manufacturing Construction Services producing The manufacturing sector contracted by 3.4% QoQ saar in the quarter although the severity of the decline was less than predicted. Production in the key electronics cluster has so far been lacklustre and output has been shrinking for three consecutive months. In addition, the biomedical segment is undergoing a cyclical doldrum. Production level has bottomed in July and remained stagnant in August. But based on this advance estimate figures, a surge in production output is expected in September, which will erase a fair chunk of the weakness clocked in July-August. Separately, the contraction sector is likely to have contracted 8.8% QoQ saar. Higher business cost and persistently tightening in the foreign labour policy is finally taking a toll on this sector despite a healthy pipeline of infrastructure projects. Moreover, the cooling down in the property market probably has also affected project payments. Traditionally, the services sector is a stable and key engine of growth for the economy. But growth momentum in this sector has moderated sharply to 1.0% QoQ saar, from 12.3% previously. Higher business cost and the existing labour crunch are having an impact on the performance of this sector. Financial market risk aversion in August-September due to the risk of QE tapering has also affected trading activities. With the upward lift in the growth trajectory for the first half, risk on growth is certainly on the upside. Our forecast for the full year remains at 2.9%, pend- 3

4 ing the final GDP figures for the third quarter, which we believe will be revised downwards. With a better than expected outcome on the growth front, the Monetary Authority of Singapore (MAS) has unsurprisingly stand pat on policy with no change in the slope, width and centre of the policy band. Ultimately, the official GDP growth forecast for the year was raised in August and the focus of the exchange rate policy is still on inflation rather than growth. Moreover, domestic inflationary pressure remains high. Business cost is still rising and the labour market is still tight. Juxtaposed with the rapid increase in the COE premiums in recent months as well as the lapsing of base effect from the car loan curbs, inflation is likely to breach the 4% mark by April next year. So with eyes still on inflation, the exchange rate policy will remain on a tightening bias in the coming quarters. IN: Aug industrial production IN: Consumer durable goods production (IP) out on late Friday bucked =100, sa the modest improvement seen in economic releases 220 in the past month. Headline IP underwhelmed by rising 0.6% YoY, down from revised 2.8% the month before and consensus at 2.0%. This takes the fiscal ytd pace to 0.1% further easing from FY12/13 s 1.2%. Despite the strength in the core industries output, positive exports growth and seasonal support, production Latest: Aug13 stayed below trend in Aug. The breakdown held little surprises. Accounting for two Apr-06 Oct-07 Apr-09 Oct-10 Apr-12 thirds of overall output, manufacturing output has declined for three of the five months so far in this fiscal year (Aug -0.1%). Mining remained in red while electricity production fared better, latter calming concerns over potential power shortages. Under the use-based classification, capital goods production fell 2%, a payback to the one-off 15.6% surge in Jul13 and back to trend of -1.6% average between Jun12-Jun13. More telling of the still subdued consumption spending levels was the contraction in the consumer goods segment. While the resilience in the nondurables output had supported the headline late FY12/13, persistent cutback in the consumer durables segment has emerged as a significant drag (Aug -7.6% YoY; fiscal year-to-date -11.1%). This suggests that manufacturers remain on a cautious keel and prefer to replenish inventories, rather than step-up production. While a brief reprieve is likely from seasonal factors and government s plans to offer concessional loans for purchases of selected durables, a marked turnaround lacks the required catalysts. PMI-manufacturing readings have also remained below the neutral 50-mark on moderating new domestic and export orders. The central bank s focus on anchoring inflationary expectations could translate into higher base-rates, even as the July s extraordinary measures squeeze on liquidity are withdrawn. Sep WPI and CPI inflation numbers are on the tap on 14 Oct (Mon) and are likely to be factored into the end-oct policy review. Both the headline prints are poised to remain firm on imported pressures, even as the rupee trimmed the scale of losses through the month. Sep WPI inflation likely rose 6.0% YoY little changed from 6.1% the month before, as the sequential pace flatlines around the 3-month average of 1.0% MoM sa. The core inflation (non-food manufacturing used as a proxy) could remain stuck at 2.0% mark, softening from 2.7% average last year. This signals that despite subdued demand conditions, cost- 4

5 push forces continue to underpin broader pressures. Further adjustment in retail fuel prices, still-elevated food prices primarily vegetables and pass-through of the currency weakness might have provided a floor to the inflation readings. The CPI inflation is also expected to be sticky on the downside and hold around 9.6% YoY up from 9.5% the month before. Our estimates for the core reading (ex-food, fuel) hovers around 8%. There are increasing indications that the RBI might align the benchmark policy decisions to the CPI gauge (and core), gradually shifting away from the WPI inflation. This being the case, there is headroom for the repo rate to be adjusted higher in the coming months. Hence even as the US Fed tapering fears dissipate, need to bring the repo and inflationary expectations on an even keel suggest that the policy rate might be tightened further. Currencies USD: There are still no signs that the Democrat-led US Senate and the Republican-led Lower House of Representatives are nearer to breaking the budget impasse before the October 17 deadline to life the statutory debt ceiling. The Senate voted, on Sunday, against a clean bill to increase the debt limit till end-2014 because it was not accompanied by deficit-reduction measured demanded by GOP lawmakers. Earlier on Saturday, President Barack Obama rejected a Republican proposal to extend the deadline by another six weeks. So far, markets have not panicked because both parties have come out to reassure that they are working towards a compromise after every failed vote, keeping alive hopes for a last minute deal. The Senate has reportedly taken over negotiations and is looking to extend the deadline to next March in exchange for watering down the next round of sequester due next year. Even if a compromise can be reached, this will only provide a temporary relief for the US dollar, and sets the stage for more budget fights ahead of next year s mid-term election. SGD: The Monetary Authority of Singapore (MAS) kept its current stance of appreciating the Singapore dollar nominal effective exchange rate (SGD NEER) policy band at its current modest and gradual appreciation pace. The fact that the SGD NEER was in the upper half of its policy band in the past six months underscored the authority s focus on inflation. Since bottoming at 1.5% YoY in April, inflation has risen to 2.0% YoY in August, at the bottom of the official 2-3% target for The currency stance is also supported by the better-than-expected performance in its economy. Advance estimate for seasonally-adjusted real GDP was -1.0% QoQ vs the -4.0% consensus in 3Q. Growth in the previous quarter was revised up to 16.9% from 15.5%. In YoY terms, growth accelerated to 5.1% in 3Q from 4.2% in 2Q and 0.3% in 1Q. The MAS expects the economy to keep growing in 2013 and For now, the better-than-expected services sector is helping to mitigate the weakness in the export sector. 5

6 Economic calendar Event Consensus Actual Previous Oct 14 (Mon) SG: GDP (3Q, A) -4.1% q/q saar -1.0% q/q saar 16.9% q/q saar GDP (3Q, A) 3.8% y/y 5.1% y/y 4.2% y/y CN: CPI (Sep) 2.8% y/y 2.6% y/y IN: WPI (Sep) 6.0% y/y 6.1% y/y IN: CPI (Sep) 9.5% y/y 9.52% y/y EZ: Industrial production (Aug) 0.7% m/m sa -1.5% m/m sa Oct 15 (Tue) JP: industrial production (Aug, F) -0.7% m/m sa US: Empire manufg (Oct) PH: remittances (Aug) 6.6% y/y Oct 16 (Wed) KR: unemployment rate (Sep) 3.1% sa 3.1% sa EZ: CPI (Sep F) 1.1% y/y 1.3% y/y US: MBA mortgage appln (Oct 11) 1.3% sa Oct 17 (Thur) SG: NODX (Sep) -3.0% y/y -6.2% y/y US: initial jobless claims (Oct 11) US: housing starts (Sep) 913k 891k US: CPI (Sep) 0.2% m/m sa 0.1% m/m sa Oct 18 (Fri) CN: GDP (3Q) 7.8% y/y 7.5% y/y US: industrial production (Sep) 0.4% m/m sa 0.4% m/m sa Central bank policy calendar Policy Date Country Rate Current Consensus DBS Actual This week 14-Oct SG Currency policy No changeno change 16-Oct TH 1 day repo 2.50% 2.50% 2.50% Next week 24-Oct PH o/n rev repo 3.50% Last week 8-Oct ID o/n reference rate 7.25% 7.25% 7.25% 7.25% 10-Oct KR 7 day repo rate 2.50% 2.50% 2.50% 2.50% 6

7 GDP & inflation forecasts GDP growth, % YoY CPI inflation, % YoY f 2014f f 2014f US Japan Eurozone Indonesia Malaysia Philippines Singapore Thailand Vietnam China Hong Kong Taiwan Korea India* * India data & forecasts refer to fiscal years beginning April; inflation is WPI Source: CEIC and DBS Research Policy & exchange rate forecasts Policy interest rates, eop Exchange rates, eop current 4Q13 1Q14 2Q14 3Q14 current 4Q13 1Q14 2Q14 3Q14 US Japan Eurozone Indonesia ,365 11,150 11,200 11,250 11,300 Malaysia Philippines Singapore n.a. n.a. n.a. n.a. n.a Thailand Vietnam^ ,100 21,310 21,340 21,380 21,410 China* Hong Kong n.a. n.a. n.a. n.a. n.a Taiwan Korea India ^ prime rate; * 1-yr lending rate Market prices Policy rate 10Y bond yield FX Equities Current Current 1wk chg Current 1wk chg Index Current 1wk chg (%) (%) (bps) (%) (%) US S&P 500 1, Japan Topix 1, Eurozone Eurostoxx 2, Indonesia JCI 4, Malaysia KLCI 1, Philippines PCI 6, Singapore Ccy policy FSSTI 3, Thailand SET 1, China S'hai Comp 2,228 - Hong Kong Ccy policy HSI 23, Taiwan TWSE 8, Korea Kospi 2, India Sensex 20, Source: Bloomberg 7

8 Contributors: Economics David Carbon Singapore (65) Irvin Seah Singapore (65) Tieying Ma Singapore (65) Radhika Rao Singapore (65) Gundy Cahyadi Singapore (65) Chris Leung Hong Kong (852) Currencies / Fixed Income Philip Wee Singapore (65) Eugene Leow Singapore (65) Nathan Chow Hong Kong (852) Administrative support Violet Lee Singapore (65) Please direct distribution queries to Violet Lee on Client Contacts Singapore DBS Bank (65) DBS Nominees (Pte) Ltd (65) DBS Vickers Securities (65) The Islamic Bank of Asia (65) China DBS Beijing (86 10) DBS Dongguan (86 769) DBS Guangzhou (86 20) DBS Hangzhou (86 571) DBS Shanghai (86 21) DBS Shenzhen (86 755) DBS Suzhou (86 512) DBS Tianjin (86 22) Hong Kong DBS Hong Kong (852) DBS Asia Capital (852) India DBS Chennai (91 44) DBS New Delhi (91 11) DBS Mumbai (91 22) Indonesia DBS Jakarta (62 21) /8 DBS Medan (62 61) DBS Surabaya (62 21) Japan DBS Tokyo (81 3) Korea DBS Seoul (82 2) Malaysia DBS Kuala Lumpur (6 03) DBS Labuan (6 08) Hwang-DBS Penang (6 04) Philippines DBS Manila (63 2) Taiwan DBS Changhua (886 4) DBS Kaohsiung (886 7) DBS Taichung (886 4) DBS Tainan (886 6) DBS Taipei (886 2) DBS Taoyuan (886 3) Thailand DBS Bangkok (66 2) United Kingdom DBS London (44 20) UAE DBS Dubai (97 1) USA DBS Los Angeles (1 213) Vietnam DBS Hanoi Rep Office (844) Ho Chi Minh City (84 8)

9 Recent Research Asia cyclical dashboard: better on the margin? 11 Oct 13 ID: BI and the new normal 9 Oct 13 IN: Room for front-end OIS rates to go lower 8 Oct 13 JP: Growth risk reduced, fiscal risk remains 4 Oct 13 CNH: Onshore deregulation, offshore 30 Sep 13 expansion India rates: Higher but not by much 26 Sep 13 CN: Shanghai Free Trade Zone & the 26 Sep 13 reinvigoration of China US: A pre-fomc pulse-check 16 Sep 13 Qtrly: Economics-Markets-Strategy 4Q13 12 Sep 13 US unemployment: call off the search 9 Sep 13 CNH: Will Qianhai jeopardize Hong Kong s 6 Sep 13 position? Asia-vu 3: are we there yet? 5 Sep 13 IN: Down to fiscal support 4 Sep 13 US: Excess capacity, no inflation 21 Aug 13 IN: Short-term focus, longer-term perils 19 Aug 13 SG: Restructuring on track 16 Aug 13 TW: Coping with China s transition 15 Aug 13 China: a blueprint for expanding RMB usage 7 Aug 13 Asia: new drivers, new risks the impact of a 2 Aug 13 slower China on regional economies and currencies CNH: Key messages from the Sino-US Dialogue 30 Jul 13 CNH: PBoC relaxes rules for RMB crossborder 12 Jul 13 activities TW: Less vulnerable than most 9 Jul 13 US Fed: Three up, three down 8 Jul 13 Asia cyclical dashboard: grinding it out 3 Jul 13 IN: Fretting over Fed QE 28 Jun 13 US Fed: too hot to trot? 24 Jun 13 VN: At easing s end 21 Jun 13 TH, ID, PH: Roadmap to Jun 13 Qtrly: Economics-Markets-Strategy 3Q13 13 Jun 13 Asia property: How high the moon? 4 Jun 13 CN: Sino-South Korean economic 29 May 13 relationship CNH: Qianhai to offer CNH trust products 16 May 13 KR&TW: Examining the yen s impact 7 May 13 CN: Sino-Australian relationship reaching 29 Apr 13 new highs JP: Abenomics - one achievement, three 17 Apr 13 challenges CN: Deepening economic ties with Russia 9 Apr 13 MY: Sing-Iskandar: Creating synergies 8 Apr 13 SGD policy - a balancing act 5 Apr 13 IN: Where to inflation? 4 Apr 13 PH: Harnessing liquidity 3 Apr 13 US Treasuries: Expensive 1 Apr 13 TW: Is Taiwan exiting China? 27 Mar 13 CNH: RQFII will not deplete offshore liquidity 21 Mar 13 Qtrly: Economics-Markets-Strategy 2Q13 24 Mar 13 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 and the particular needs of any specific addressee. The information herein is published for the information of addressees only and 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 and its associates, their directors, officers and/or employees may have positions or other interests in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and 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. 9