Market volatility as we see it

Transcription

1 Jul-07 Dec-07 May-08 Oct-08 Mar-09 Aug-09 Jan-10 Jun-10 Nov-10 Apr-11 Sep-11 Feb-12 Jul-12 Dec-12 May-13 Oct-13 Mar-14 Aug-14 Jan-15 Jun-15 Economic Research, Strategic Management Mohd Afzanizam Abdul Rashid Chief Economist Market volatility as we see it Problem statement The 2H2015 proved to be more difficult than we previously estimated. Dramatic fall in the FBM KLCI by 42.5 points on Monday as well as the steep rise in the 10-year MGS yields by 48 basis points in just a matter of one month suggests that the economic outlook is not forthcoming. Furthermore, sharp depreciation of ringgit (MYR) against the greenback has caused angst among the general population as imported inflation could add further pressure to the general price level. Already, the consumer price index (CPI) has gone up to 3.3% y-o-y for the month of July. We have listed some of the possible reasons for this to happen: i. US rate hike this seems to be the standard reasoning and perhaps, the most convenient factor to be brought up. Argument for the reverse carry-trade is the cornerstone for the capital flows as investors would favour for the US dollar denominated assets in view of the looming higher investment returns. However, it remains an open question as there are loop holes in their economy which have yet to be addressed. In particular, the 2.00% inflation target appears to be farfetched as lower oil prices, although some would like to think it as a transitory factor, is expected to keep the general prices low. It is not surprising that the odds for the September lift-off are now less than 50%. Chart 1: US core inflation rate Page 1

2 ii. China s economy the devaluation of Yuan on August 11 was a game changer. It indicates that Chinese authorities are keen to embrace market economy by implementing reforms as they try to unify the Yuan s daily fixing reference rate and the spot rate. This is essentially the government bid to be part of the IMF s Special Drawing Right (SDR) basket of currencies which mainly comprises the key international currencies such as the US dollar (USD), pound sterling (GBP), euro (EUR) and Japanese Yen (JPY). Another dimension to it is the move to weaken the currency in order to support the export sector. Yuan has been appreciating against a basket of currencies and the fall in the latest exports figure by 8.3% in July gives the impression that the government is likely to miss its 7% GDP growth target for the year. Chart 2: Yuan daily fixing and spot rate iii. Lower crude oil prices oil production by the OPEC and Non-OPEC member countries are not receding. In addition, Iran s nuclear deal with the US, France, China, Germany, UK and Russia which was announced on July 14 would mean economic sanctions are likely to be lifted. This should translate into more crude oil supply which can then have significant impact to prices. While the argument looks convincing, there are apparently several goal posts that Iran need to past through. This includes approvals from the US Congress, inspection by International Atomic Energy Agency (IAEA) and more importantly, massive investment for the Oil & Gas industry in order to extract more oil. Page 2

3 Chart 3: OPEC crude oil production Jul-13 Nov-13 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 iv. Malaysian politics this is the most talked about issue. However, it is beyond our scope and we would like to leave it as it is. Certainly, it could add some form of risk premium to Malaysian financial assets. Chart 4: Federal government CDS spread (basis points) What is the big picture? It s the economic cycle ith the all the market gyrations and uncertainties, the most pertinent question we should ask is where are we in terms of the economic cycle now?. In the Quran, Surah Yusuf verse 47, 48 and 49 clearly state the seven-year cycle. The translation and interpretation of the verses are tabled below: Page 3

4 Verse Translation Interpretation 47 For seven consecutive years, you shall sow as usual and that (the harvest) which you reap you shall leave in ear, (all) except a little of it which you may eat. 48 Then will come after that, seven hard (years), which will devour what you have laid by in advance for them, (all) except a little of that which you have guarded (stored) It means that for seven years, the economy is in good state i.e production of goods and services will increase. GDP growth is expected to be in positive territory and likely to be at or above its potential level. But there is also a need to save as income during strong GDP growth is likely to be higher (Eg: pay rise and bonus for salaried workers, good profits for entrepreneurs). Apart from savings by the individuals and businesses, government s fiscal consolidation could also be deemed as savings as it gives the flexibility to engage fiscal pump priming during economic stress. Similarly, the normalisation of Overnight Policy Rate (OPR) is also a form of savings since it will add more resources to cut rates in the future. It s economic downturn. Therefore, it s time to use our savings in order to sustain. In the case of government, we could expect some form of fiscal pump priming to ensure growth will not slip further. From monetary policy stand point, BNM could cut the OPR to support growth. 49 The thereafter will come a year in which people will have abundant rain and in which will press (wine and oil). After that, the economic growth would resume and normalize. Premised on this, we decided to use industrial production index (IPI) in order to establish the Malaysian economic cycle. We apply some econometric tools to seasonally adjust the numbers and to smoothen the gyrations. Page 4

5 Jan-85 Apr-86 Jul-87 Oct-88 Jan-90 Apr-91 Jul-92 Oct-93 Jan-95 Apr-96 Jul-97 Oct-98 Jan-00 Apr-01 Jul-02 Oct-03 Jan-05 Apr-06 Jul-07 Oct-08 Jan-10 Apr-11 Jul-12 Oct-13 Jan-15 Economic Research, Strategic Management Chart 5: IPI using ARIMA and HP Filter 14.0% 12.0% 10.0% Peak: May-89 Trough: Jan-92 Peak: Jun % Peak: Mar % 4.0% Trough: Jan-85 Trough: Aug-98 Peak: May-15? 2.0% 0.0% -2.0% Trough: Dec-08 Source: Strategic Management, Bank Islam Based on the IPI trend, it appears that the economic activities have been on expansionary mode for 6.5 years since December As such, guidance from the Quran as stipulated in the Surah Yusuf verse 47 suggests that the economic activities could have peaked in 2015 and should decelerate in 2016 onwards. Premised upon such information, we have gathered the previous cycles and look at the duration for each cycle (see Table 1). It appears that the current up cycle is the longest since 1985 given the previous up cycle lasted from August 1998 to March 2004 (5.7 years). As such, there is a merit that a down cycle could happen in Table 1: Peak and trough Jan-85 May Up Peak Trough Months Years Cycle May-89 Jan Down Jan-92 Jun Up Peak Trough Months Years Cycle Jun-94 Aug Down Aug-98 Mar Up Peak Trough Months Years Cycle Mar-04 Dec Down Dec-08 May Up Source: Strategic Management, Bank Islam Page 5

6 So what if it s a down cycle? With this information we should set a realistic expectation. From macro point of view, may be it s not sinful to talk about expansionary policy for fiscal as well as monetary. This should anchor expectations with regards to the government s ability to stabilize the economy should slower growth become increasingly protracted. Therefore, a slightly wider fiscal deficits (2015 target pegged at 3.2% of GDP) as well as reduction in OPR should be seen in a positive context. Also, a cut in the EPF members contribution should also be considered as a means to provide an extra boost to consumer spending. Such measure has been implemented during Global Financial Crisis in 2008 whereby EPF members contribution was reduced from 11% to 8% between January 2009 and December Thereafter, the contribution rate was restored back to the 11% level once the economy regained its strength. Page 6

7 Produced and issued by BANK ISLAM MALAYSIA BERHAD (Bank Islam) for private circulation only or for distribution under circumstances permitted by applicable laws. All information, opinions and estimates contained herein have been compiled or arrived at based on sources and assumptions believed to be reliable and in good faith at the time of issue of this document. This document is for information purposes only and has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. No representation or warranty, expressed or implied is made as to its adequacy, accuracy, completeness or correctness. All opinions and the content of this document are subject to change without notice and may differ or be contrary to opinions expressed by other business areas or groups of Bank Islam as a result of using different assumptions and criteria. No part of this document may be used, reproduced, distributed or published in any form or for any purpose without Bank Islam s prior written permission Page 7