SINGAPORE FOCUS I. Singapore MAS Policy Preview: It s Time To Catch Up With Policy Normalization

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1 Singapore MAS Policy Preview: It s Time To Catch Up With Policy Normalization The Monetary Authority of Singapore (MAS) is expected to release monetary policy decision on the 2nd week of April 2018 (9th to 13th April) and we expect the central bank to start policy normalization by allowing the SGD NEER on a mildly appreciating path (est: 0.5% pa) while keeping the midpoint and bandwidth of the policy band unchanged. Our policy normalization expectation is based on three key factors. Firstly, global and domestic growth-inflation-labour conditions have improved quite significantly since the lows of Central banks around the world today are biased towards tightening, rather than loosening monetary policy stance. Secondly, the forex market seems to be pricing in a more hawkish MAS stance as the SGD NEER has appreciated 1.2% since the start of 2017, while our UOB SGD NEER model also shows that the SGD NEER had been trading consistently above the midpoint 88% of the time in the same period. Thirdly, the MAS had perhaps signaled a normalization inclination by removing a forward guidance word extended from its oft-used phrase current neutral SGD NEER policy is deemed appropriate for an extended period of time in their last October 2017 policy statement. With the upcoming April policy normalization by MAS largely priced in, we see limited downside for USD/SGD below Furthermore, any escalation of trade tension between US and China risk negatively impacting Asian exports and consequently is a negative for the SGD. Overall, we see USD/SGD testing the low of 1.29 across 2Q18, before drifting back up to 1.33 by 1Q19. The Monetary Authority of Singapore (MAS) is expected to release its half-yearly monetary policy statement sometime in the 2nd week of April 2018 (9th to 13th April). We expect the MAS to start the normalization of Singapore s monetary policy. What this means is that the MAS may start to allow the SGD Nominal Effective Exchange Rate (NEER) to embark on a mildly appreciating path (which we estimate at 0.5% pa from 0% currently), while keeping the midpoint and bandwidth of the policy band untouched. We think that this is a one-and-done deal for 2018 although we acknowledge there could be room for another 0.5% pa increase in the October 2018 policy review, but that will be dependent on the data over the next few months. As a recap of the current accommodative monetary cycle, it all started when the MAS surprised the market by reducing the slope of the SGD NEER in an off-cycle policy action in January 2015 to cope with the uncertainties of slow global economic growth and disinflationary pressures. Central banks around the world were also adopting easy monetary policy stance then to support economic growth. In the two subsequent policy meetings (October 2015 and April 2016), the MAS continued to reduce the SGD NEER slope towards an eventual neutral appreciating path, a stance which it had maintained since April 2016 to date. 12 UOB Global Economics & Markets Research

2 Our expectations of a change of policy stance towards a mild appreciation SGD NEER slope is based on the following arguments: 1. Economics: Global and domestic growth-inflation-labour conditions have improved quite significantly since the lows of With that, central banks around the world today are leaning more towards monetary policy tightening, after many years of very loose monetary policy conditions. 2. Expectations: the forex market seems to be pricing in a more hawkish MAS stance (ie: appreciating SGD NEER) as the SGD NEER had appreciated 1.2% since the start of Moreover, our UOB SGD NEER model also shows that the SGD NEER had been trading consistently above the midpoint 88% of the time in the same period. Fast forward to today, things have improved. In their World Economic Outlook Update (11 January 2018), the IMF had upgraded global economic growth forecasts for 2018 and 2019 to 3.9%, from 3.7% previously. In the words of the IMF: The cyclical upswing underway since mid has continued to strengthen. Some 120 economies, accounting for three quarters of world GDP, have seen a pickup in growth in year-on-year terms in 2017, the broadest synchronized global growth upsurge since We reproduce the IMF s forecast during their October 2017 release in Exhibit 1. It can be clearly seen that even in October 2017, the IMF had expected stronger growth and inflation worldwide, and reaffirmed it in their January 2018 review. The synchronized recovery is evident in both developed (advanced) and emerging economies. Quoting the IMF again from the same report: Among advanced economies, growth in the third quarter of 2017 was higher than projected in the fall (ie: October 2017), notably in Germany, Japan, Korea, and the United States. Key emerging market and developing economies, including Brazil, China, and South Africa, also posted third-quarter growth stronger than the fall forecasts. Additionally, we also observed that both the emerging and developed economies purchasing managers indices are expanding in sync, across both the manufacturing and services sectors no less (Exhibits 2A and 2B). 3. Policy: the MAS had perhaps signaled a similar inclination by removing a forward guidance extended period from its oft-used phrase current neutral SGD NEER policy is deemed appropriate for an extended period in their last October 2017 policy statement. Exhibit 1: IMF s October 2017 Forecast For Global Growth And Inflation With the three factors at play, we think that the time is ripe for the MAS to embark on the normalization of Singapore s monetary policy. We will explain in details in the following sections. Global Economic Recovery Is In Sync The global economic landscape had improved quite dramatically over the past three years. As recent as the MAS October 2016 policy meeting, we were still very concerned about the global deflationary environment, hard landing risk from China, and the unknown but surely negative impact from Brexit. Exhibits 2A & 2B: Synchronised Growth In Manufacturing & Non-manufacturing PMI Domestically, policymakers were worried about the very slow economic growth in Singapore, disinflationary pressures, rising labour redundancies (particularly in the Professionals, Managers, Executives and Technicians or PMETs segment) and industry-specific risk factors (eg: from the offshore & marine industries). Those were the conditions for an accommodative and thus dovish monetary policy: a-la neutral SGD NEER slope. UOB Global Economics & Markets Research 13

3 Stronger economic activities and higher prices point to the improvement in aggregate demand worldwide and this is also evident in the recovery in world trade since 4Q 2016 (Exhibit 3). Exhibit 3: Recovery In World Trade Since 4Q 2016 However, this also implies higher export and import prices across the world (Exhibit 4). Eventually, these will pass-through to higher global consumer inflation another indication that central banks may need to tighten monetary policies at a faster pace. Our global monetary environment scan across 52 central banks actions since Mar 2017 shows a total of 18 central banks hiking interest rates to a combined amount of 1,846.5bps; 26 central banks keeping interest rates unchanged; while 8 central banks cutting rates to a combined amount of 1,475bps. Collectively, there had been an inclination for central banks to tighten rather than loosen their respective monetary policies (Exhibit 5). Exhibit 4: Strongest Growth In Export and Import Prices Since August 2011 Domestic Growth Drivers Are Improving In Singapore, the growth-inflation-labour dynamics had improved too. The government s report card on 2017 economic performance probably scored an A in our opinion as actual GDP grew 3.6%, above the upper end of the initial forecast range of 1%-3% back in early Core inflation, the intermediate target of the central bank when it comes to assessing the direction of its monetary policy, averaged 1.5% in 2017, higher than the 0.9% in 2016 and 0.5% in Exhibit 5: More Global Central Banks Embarking On Monetary Tightening Source: Bloomberg, UOB Global Economics & Markets Research The labour market has also been improving as indicated by various labour market statistics including better job vacancy-tounemployed persons ratio and stronger wage growth. On growth, another way to assess the current economic condition is to compare it with the potential economic growth. If the actual GDP growth rate is higher than the potential GDP growth rate, then there is a positive output gap which may result in a higher inflationary environment and justifying a more hawkish monetary policy (ie: an upward sloping SGD NEER). Note: Central banks that hiked rates since March 2017 includes (375bps: Argentina), (300bps: Egypt, Ukraine), (125bps: Mexico), (85.5bps: Oman), (75bps: Bahrain, Canada, Hong Kong, UAE, US), (70bps: Czech Rep), (50bps: Romania), (41bps: Venezuela), (25bps: Malaysia, Pakistan, Qatar, South Korea, UK). Central banks that cut rates since March 2017 includes (-625bps: Brazil), (-275bps: Colombia), (-250bps: Russia), -125bps: Peru), (-75bps: Iceland, Chile), (-25bps: South Africa, India). 14 UOB Global Economics & Markets Research

4 As such, we compare Singapore s quarterly real GDP growth rate with its potential GDP growth rate (derived using the Hodrick-Prescott filter) and found that after suffering from 10 consecutive quarters of negative or weak positive output gap (since 2Q 2014), the stronger growth spurt of 3Q 2017 had finally pushed Singapore s economy into registering a positive 2.4% output gap in that quarter (Exhibit 6). EXHIBIT 6: Finally Out Of The Negative/Weak Output Gap Trap With the uplift from stronger external demand, overall corporate profits had been robust and posted the strongest expansion (6.9% y/y) since 2010 (Exhibit 7). With profits expanding at a record pace, businesses are more confident and investments had also expanded for the first time, after five consecutive quarters of contraction (3Q 2016 to 3Q 2017) (Exhibit 8). Exhibit 7: Corporate Profits Expansion At Its Strongest Since 2010 Domestic consumption also expanded at a healthy clip from the improvement in the labour market conditions (low unemployment and stronger wage growth). Looking ahead, the government s composite leading indicator (Exhibit 9), which leads GDP growth by 1 quarter, shows that we can expect continued strength in economic growth. That said, we believe that GDP growth for 2018 could come in at a slower pace of 2.8%, due to the high base in 2017, and the expected slower growth in the manufacturing sector. On inflation, Singapore s core inflation had averaged 1.5% in 2017, higher than the 0.9% recorded in 2016 and 0.5% in 2015 (Exhibit 10). Exhibit 8: Continued Strength in Domestic Consumption, While Investments Expanded Finally For 2018, we forecast core inflation to average 1.5%, while the MAS is expecting an average of 1-2%. With prices rising at a structurally higher level compared with the period, we believe that there is some room for monetary policy to catch up vis-à-vis SGD NEER appreciation stance. UOB Global Economics & Markets Research 15

5 On labour market conditions, we observe some improvements across various labour market statistics. Exhibit 9: Composite Leading Indicator Points To Robust Economic Growth First, there had been some improvements in labour market slack. Although there are currently only 87 vacant jobs to every one hundred unemployed persons, this is an improvement from a recent low of 77 vacant jobs in 4Q 2016 (Exhibit 11). Second, with demand for labour increasing, we also observed that wage growth is also on an uptrend (Exhibit 12), further supporting domestic consumption, and potentially generating higher pass-through to consumer prices in the months ahead. Expectations For Monetary Policy Normalisation Are Rising With the improving growth-inflation-labour conditions, the forex market had been pricing in expectations for the MAS to turn more hawkish and to normalize the SGD NEER slope sooner, rather than later. Exhibit 10: Core Inflation At A Structurally Higher Level Compared with Indeed, the SGD NEER had appreciated 1.2% from the start of 2017 to date and our UOB SGD NEER had been trading persistently above the midpoint (88% of the time) in the same period (Exhibit 13). This expectation was perhaps further fueled by the MAS removing a forward guidance word extended period from its oft-used phrase current neutral SGD NEER policy is deemed appropriate for an extended period in their latest October 2017 policy statement. With the above-mentioned conditions, we believe the MAS will start policy normalization in the upcoming April 2018 meeting, where the SGD NEER slope will be on a mildly appreciating path (we estimate at 0.5% pa, from 0% pa currently). We think that this is a one-and-done deal for 2018 although there remains a possibility of another increase (of 0.5% pa) in the October 2018 policy review, depending on data over the next few months. Exhibit 11: Improvement In Labour Market Slack 16 UOB Global Economics & Markets Research

6 Limited Room For Further Downside In USD/SGD Below 1.30 As mentioned above, ahead of the widely anticipated policy normalization by the MAS in mid-april, the SGD NEER has been trading predominantly at a premium above its estimated mid-point of the current neutral range. Similarly, exacerbated by the weak overall tone in the USD, the SGD has been trading on a strong note as well. As a result USD/SGD continued to head lower across 1Q18, from 1.34 at the start of Jan18 to current level of just around Going forward, we believe that it may be difficult for the SGD to strengthen further against the USD. Rather, with increasing trade tensions between the United States and China, trade and exports from Asia are at risk of getting negatively impacted. Given that Asian economies have large export components, there is an increasing risk that Asian currencies like the CNY, KRW and including the SGD may weaken somewhat should trade tensions rise further. This also comes at a time when the US Federal Reserve is poised to continue its monetary policy normalization, with gradual rate hikes and on-going balance sheet reduction. As such, we maintain our view that it may be difficult for the SGD to strengthen further. In other words, there may be limited downside for USD/SGD below Overall, we forecast USD/ SGD at 1.29 in 2Q18, 1.30 in 3Q18, 1.32 in 4Q18, 1.33 in 1Q19. Exhibit 12: Wage Growth Back To Healthy Levels Exihibit 13: Market Pricing In MAS Hawkishness Since April 2017 Source: CEIC, UOB Global Economics & Markets Research Easing Round 1 Easing Round 2 Easing Round 3 MAS shifted SGD NEER MAS shifted SGD slope from 2% to 1% in NEER slope from 1% an off-cycle decision to 0.5% MAS shifted SGD NEER slope to Neutral MAS kept neutral stance unchanged in Oct 16, Apr 17 and Oct 17 meetings SGD NEER was trading above midpoint 88% of the time since Jan Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 SGD NEER Upper-end: 2% Mid-Point of Estimated Policy Band Lower-end: 2% UOB Global Economics & Markets Research 17