Asia | Economics & Growth | Emerging Markets | FX | Rates
– CNY to benefit from rising yield differentials and a strong recovery
– INR continues to defy dismal economic reality due to equity inflows
– KRW still underperforming despite a third fiscal package
– TWD upside limited by rising competitiveness concerns
– SGD lags recovery in risk appetite
– IDR under pressure from debt monetization plan
China Triggers Risk Rally
Increased confidence in a V-shaped recovery in China and a sharp rally in Chinese equities have boosted risk appetite across emerging markets. New COVID outbreaks in the US and elsewhere leave ongoing risks that renewed lockdowns will hurt the recovery. But with further measures likely to be localised and recent macro data pointing to a strong rebound in the US and other major economies, a material set back in global economic momentum seems unlikely.
Global equity markets have rallied, and broad dollar weakness has continued. Asia FX has strengthened; the Indian rupee has been the best performer in recent weeks with TWD also doing well (Chart 1). The Indonesia rupiah is the main outlier, with the Bank Indonesia-Finance Ministry announcement that the central bank will monetize government debt leaving the currency under significant pressure.
Second quarter GDP data will start to trickle out later this month (China 16 July and the US 30 July). Headline numbers will show unprecedented declines across the world, but what matters now is the scale of the third quarter bounce. Mobility data show activity normalising in many countries (although renewed COVID outbreaks in the US have seen mobility drop back), and Q3 data should confirm the rebound. But the shape of the recovery partly depends on how long fiscal support is extended. One recent positive is that job support/furlough schemes have been lengthened in some countries and new targeted sectoral relief announced.
Next Week’s EU Summit Key to Continued Risk Appetite
A 17-18 July EU summit to discuss the proposed €750bn EU Recovery Fund (5.4% of 2019 GDP) is the next significant global policy event. Agreement on timing, allocations, composition (loans versus grants) and conditionality may mean July is too soon for a final agreement. But assuming EU leaders retain commitment to a more coordinated fiscal approach and some concrete progress is made, broad risk appetite should remain well supported and Asia FX with it.
US-China tensions continue to simmer. The US may yet impose sanctions on banks doing business with Chinese officials linked to the crackdown on Hong Kong’s pro-democracy protestors, and a raft of other measures are threatened. Stepped-up geopolitical tensions will therefore remain a significant risk to global sentiment in the coming months.
This article is only available to Macro Hive subscribers. Sign-up to receive world-class macro analysis with a daily curated newsletter, podcast, original content from award-winning researchers, cross market strategy, equity insights, trade ideas, crypto flow frameworks, academic paper summaries, explanation and analysis of market-moving events, community investor chat room, and more.
– CNY to benefit from rising yield differentials and a strong recovery
– INR continues to defy dismal economic reality due to equity inflows
– KRW still underperforming despite a third fiscal package
– TWD upside limited by rising competitiveness concerns
– SGD lags recovery in risk appetite
– IDR under pressure from debt monetization plan
China Triggers Risk Rally
Increased confidence in a V-shaped recovery in China and a sharp rally in Chinese equities have boosted risk appetite across emerging markets. New COVID outbreaks in the US and elsewhere leave ongoing risks that renewed lockdowns will hurt the recovery. But with further measures likely to be localised and recent macro data pointing to a strong rebound in the US and other major economies, a material set back in global economic momentum seems unlikely.
Global equity markets have rallied, and broad dollar weakness has continued. Asia FX has strengthened; the Indian rupee has been the best performer in recent weeks with TWD also doing well (Chart 1). The Indonesia rupiah is the main outlier, with the Bank Indonesia-Finance Ministry announcement that the central bank will monetize government debt leaving the currency under significant pressure.
Second quarter GDP data will start to trickle out later this month (China 16 July and the US 30 July). Headline numbers will show unprecedented declines across the world, but what matters now is the scale of the third quarter bounce. Mobility data show activity normalising in many countries (although renewed COVID outbreaks in the US have seen mobility drop back), and Q3 data should confirm the rebound. But the shape of the recovery partly depends on how long fiscal support is extended. One recent positive is that job support/furlough schemes have been lengthened in some countries and new targeted sectoral relief announced.
Next Week’s EU Summit Key to Continued Risk Appetite
A 17-18 July EU summit to discuss the proposed €750bn EU Recovery Fund (5.4% of 2019 GDP) is the next significant global policy event. Agreement on timing, allocations, composition (loans versus grants) and conditionality may mean July is too soon for a final agreement. But assuming EU leaders retain commitment to a more coordinated fiscal approach and some concrete progress is made, broad risk appetite should remain well supported and Asia FX with it.
US-China tensions continue to simmer. The US may yet impose sanctions on banks doing business with Chinese officials linked to the crackdown on Hong Kong’s pro-democracy protestors, and a raft of other measures are threatened. Stepped-up geopolitical tensions will therefore remain a significant risk to global sentiment in the coming months.
Recovery Brings Higher Rates and Supports Further CNY Strength
A decade high in the Caixin services PMI is just one example of the ongoing pick-up in domestic activity in China. At 58.4 the index is up more than 30 points from the February low and leaves both the manufacturing and services PMIs in expansionary territory for two consecutive months. IP growth has also recovered after narrowly turning negative in March, and any concern that Beijing’s lockdown measures would delay the recovery have been allayed.
China’s strong economic recovery has pushed 10-year bond yields to a five-month high at 3% early this week, and central bank policy is also playing a role. The PBoC has indicated a more targeted approach to further easing and is beginning to scale back liquidity provision. Further cuts to both reserve requirements and the policy rate cannot be ruled out given weak price pressures (PPI is negative), rising unemployment, soft retail sales and below-trend fixed-asset investment. But this will be moderate. And, with the authorities openly supporting the stock market as a way to further the recovery in consumption, the CSI jumped 5% on Monday marking a 15% gain over just five days.
A widening yield differential and outperforming stock market should provide significant support for the yuan (Chart 3). The currency is trading at its strongest level since March and is up by almost 1% over the past two weeks. Political risks are the main headwind. With four months to go until the US election, tensions with Washington are likely to remain high. Threatened sanctions could sour risk appetite, but this will likely be rhetoric rather than concrete policy measures and is unlikely to change China’s economic trajectory. As such we expect CNH strength and so USD/CNH to head lower.
One-off Inflows Leave INR Performance at Odds With Bleak Macro
The Indian rupee remains detached from the country’s economic reality. Recent appreciation leaves INR at a three-month high and comes despite ongoing reserves accumulation by the RBI to stem the rupee’s ascent. The only good news on the macro front has been a rare C/A surplus reported for the January-March quarter. A lower trade deficit was the main driver, with a declining oil import bill (India has by far the largest share of oil imports in Asia at 30% of total) and reduced non-oil imports as COVID lockdowns brought the economy to a standstill (Chart 6). This may well last into Q2 and beyond as a very weak domestic economy keeps imports subdued (imports contracted by over 50% YoY in both April and May) but import compression is an unsustainable way to narrow a C/A deficit.
BoP data for the second quarter should confirm the role of equity inflows as a significant driver of currency strength. Q2 equity inflows were the highest in Asia at $4.2bn, with Reliance Industry’s digital services business Jio Platforms an important factor. Saudi Arabia’s Public Investment Fund recently invested $1.5bn into Jio, while Facebook bought a 10% stake for $5.7bn in April. RBI intervention in the face of these one-off flows is prudent, particularly given the weak macro outlook.
Digital services have been one clear winner in the COVID pandemic, but there are few other examples of this in India’s highly informal economy. PMIs have started to recover from the earlier slump, but they remain lower than elsewhere in Asia. The same is true for both IP and exports, reflecting India’s severe and fairly lengthy lockdown. But the modest policy response has not helped. The RBI last cut interest rates in an emergency meeting in May and said it would do more if needed. Other measures have been introduced to ease credit constraints, but, compared with the sizeable stimulus from other central banks, India’s looks modest. The same can be said of the fiscal response. Despite Prime Minister Modi’s announcement of a 10% of GDP package, new fiscal outlays are expected at just 1.5% of GDP.
Given the size of India’s economic collapse and the fact that it now has the third-highest number of COVID cases globally, further lockdowns cannot be ruled out. This leaves the pace of recovery particularly uncertain. The improving C/A position and capital account inflows are unlikely to provide continued support to the rupee. And, given the fragile macro, we remain neutral on INR but consider it attractive as a carry trade.
Competitiveness Concerns Mount for TWD
TWD has continued its steady appreciation trend. The currency has strengthened for five consecutive weeks now and remains less sensitive to global risk than others in the region. CBC intervention is dampening what would otherwise be more pronounced appreciation (FX reserves increased by $4bn in June and $10bn YTD to stand at almost $489bn). Competitiveness concerns are coming into play with Taiwan’s NEER index now more than 5% above its rolling three-year average, marking the first time since mid’ 2017 this has been true (Chart 7).
A more competitive currency cannot offset the slump in global demand, but it could promote continued growth in the country’s electronics sector. Electronics exports have held up remarkably well, partly because the COVID crisis has boosted demand for digital services and equipment in a world of social distancing. Exports of electronic components (which include chips) are running at around 20% YoY so far this year (3mma basis) versus modest declines in total exports (Chart 8).
Activity is nevertheless recovering more broadly. Taiwan’s manufacturing PMI has climbed from the 11-year low recorded in May, and, while the headline remains in contractionary territory, business confidence is now positive and the pace of decline in new orders and output have eased. Retail sales have also recovered from the earlier lows, and confidence is coming back. Despite the positives, CBC intervention will cap further appreciation, and we continue to prefer short TWD (or SGD) positions against high-yielders.
KRW Reverses Earlier Weakness, But Outlook Remains Relatively Poor
Korea has also benefitted from positive risk sentiment, with the KOSPI now back close to levels prior to the mid-June dip and the won recovering in tandem. KRW has strengthened by around 0.3% over the past two weeks, in line with the recent performance of TWD but still significantly worse YTD (the won is down 3.3% versus appreciation of almost 2% for the Taiwanese dollar). The economic recovery remains subdued, particularly next to Taiwan or China, with export declines remaining in double digits in June and May IP coming in at a much-weaker-than-expected 9.6%.
Electronics should provide some relief, with Samsung announcing guidance on Q2 profits at a better-than-expected 22.7% YoY. But the electronics sector has not been enough to shift the deteriorating C/A dynamics. The $2.3bn C/A surplus for May compares with a $5.2bn surplus in May 2019 and pulls the rolling 12-month surplus down to $60bn, versus around $80bn a year ago. The narrowing surplus leaves significant headwinds for the currency particularly when compared with others in the region as Singapore’s C/A surplus has remained stable while the deficits in India and Indonesia have narrowed (Chart 9). Capital account dynamics are doing little to support the won either, with foreign equity flows remaining negative through most of the past month in sharp contrast to inflows in Taiwan and India. This is evident in the recent relative underperformance of the KOSPI versus others in the region.
Parliament approved a third budget earlier this month in an effort to boost the economic recovery. At KRW35.1tn, the extra budget was the largest ever and brings total additional spending this year to KRW60tn (4.1% of 2019 GDP). Another fiscal boost is welcome, but, as the latest package focuses on job creation through investment, implementation risks will linger as projects get off the ground. With few positives for the won, we reiterate our call for KRW/USD to head lower from here.
$NEER Remains Anchored
SGD remains little changed versus the USD over the past month, with the recovery in risk appetite failing to lift the currency (Chart 10). S$NEER is fractionally weaker over the past month, and versus the last policy statement at end March, reflecting the shift to a zero % appreciation band and a lowering of the midpoint of the band at the then-current rate. The March easing from MAS and a substantial fiscal response have provided some cushion to the domestic economy, but the collapse in global trade and tourism leaves Singapore on track to record one of the steepest Q2 GDP declines in the region. The 40-50% YoY declines in retail sales in recent months, double-digit drop in exports, and a slump in IP are all clear signs of the very deep contraction. The government’s projections from late May see a GDP contraction of -4% to -7% this year, and the current consensus for Q2 GDP is at -10.3% YoY (or -34.8% saar). Sectoral GDP details on biomedical manufacturing (and pharmaceuticals) and information and communications should show areas of resilience in the Singaporean economy, with exports there remaining positive given COVID-related demand.
With S$NEER set to remain stable until at least the next policy statement in October, versus the USD we do not see much room for manoeuvre. SGD is likely to continue to underperform in a risk-on environment, and, as a low-yielder, we prefer SGD (or TWD) as a carry trade to the high-yielders.
IDR Slumps on Debt Monetization Plan
The Indonesian rupiah has borne the brunt of concerns over the country’s planned debt monetization. BI is set to buy IDR570tn (4% of GDP) in bonds directly from the government with funding directed to health care, food security and social safety nets. Concerns that the debt would be at zero interest pushed the currency down by just over 2% last week, leaving it at the weakest level for a month. Subsequent clarifications on the interest rate and that the debt will be tradeable have allowed the currency to recover, although it remains the underperformer in the region. A narrowing C/A deficit should provide a floor under the rupiah, and, despite the possibility of further rate cuts, we consider IDR attractive as a carry currency.
Q2 GDP Data Will Go Down in History
Second quarter GDP data will be released later this month with Singapore (14 July), China (16 July), South Korea (23 July), the US and Euro-area (30 July) and Taiwan (31 July) among those scheduled. Macro forecasting during a pandemic has never been tested before, and given the wide range of estimates within the consensus forecasts combined with the unprecedented difficulties in collecting the data, we could see significant misses. The low base set in Q2 will set up space for large quarterly rebounds in Q3, and, with mobility data showing activity levels normalising in most major economies, Q3 data should correct part of this slump. The exception is China where the earlier virus outbreak meant Q1 was the low for GDP growth (-9.8% QoQ saar), and forthcoming Q2 data will show a sharp rebound with consensus currently at +9.6% QoQ saar.