Oil Surges, Central Banks Galore

Oil prices jumped following drone attacks on Saudi Arabian oil facilities over the weekend.  Oil rose by around 20% to just shy of $72, before halving its gain later.  Even after failing to hold onto initial gains the rise in oil prices still marks one if its biggest one day gains.  Concerns about reduced oil supply have risen as a result of the attacks as they could reduce Saudi oil production for a prolonged period, with around 5% of global oil supply impacted.  Additionally the attacks could raise geopolitical tensions in the region.

As markets digest the impact of the drone attacks, there will also be several central bank decisions globally to focus on this week.  The main event is the Fed FOMC meeting mid-week, where a 25bp cut is largely priced in by the market.  Given that a rate cut is well flagged markets will pay close attention to the Fed’s summary of economic projections, in particular the Fed’s dot plot.  It seems unlikely that Fed Chair Powell is going to sound too dovish, with little to suggest that the Fed is on path for a more aggressive easing path.

Another major central bank meeting this week is the Bank of Japan (BoJ) on Thursday.  While a policy move by the BoJ at is unlikely this week BoJ policy makers have sounded more open to easing.  A consumption tax hike planned for next month together with a strong JPY have increased the pressure for the BoJ to act. Separately easier policy from other major central banks amid slowing global growth are unlikely be ignored.  However, policy is already ultra- easy and the BoJ remains cognisant of the adverse secondary impact of policy on Japanese Banks.

The Bank of England deliberates on policy this week too but it seems highly unlikely that they would adjust policy given all the uncertainties on how Brexit developments will pan out.  Until there is some clarity, the BoE is likely to remain firmly on hold, with the base rate remaining at 0.75%.  GBP has rallied over recent weeks as markets have stepped back from expectations of a hard Brexit, but this does not mean that a deal is any closer than it has been over the past months.  Elsewhere the SNB in Switzerland and Norges Bank in Norway are also expected to keep policy rates on hold this week.

Several emerging markets central banks will also deliberate on policy this week including in Brazil, South Africa, Indonesia and Taiwan.  The consensus (Bloomberg) expects a 50bp rate cut in Brazil, no change in South Africa and Taiwan and a 25bp rate cut in Indonesia.  Overall many emerging markets continue to ease policy amid slowing growth, lower US policy rates and declining inflation pressures.

 

Central Banks Galore

It’s a big week for central banks.  Several central banks globally meet to decide upon monetary policy this week.  The biggest focus will be on the Fed FOMC but this week also sees Norges Bank, Bank of England, Bank of Japan and central banks in Indonesia, Philippines, Taiwan, and Brazil meet.

Markets are already aggressive in pricing in Fed rate cuts.  As US-China trade tensions have worsened markets have intensified their expectations of Fed easing, with around 75bps of easing already priced in.  Given how much is priced in in terms of Fed easing, if the Fed does not validate this with a dovish statement and/or shift in the dot plot there could be a significant risks of disappointment, which could weigh on equities, but leave the USD on a firmer footing.

Admittedly the Bank of Japan is more constrained than the Fed in terms of policy room, but their rhetoric has become more dovish.  I don’t expect easing anytime soon but the BoJ is likely to sound dovish and could offer some enhanced forward guidance.  BoJ governor Kuroda outlined four options in terms of more policy stimulus, with one being a further cut in the deposit rate.  However, BoJ would need to outline how they plan to alleviate the pressure on bank profits from such a move.

Bank of England is unlikely to move.  Data in the UK has been mixed, with softening in Q2 growth but ongoing pressure on inflation given the tightness of the labour market.  It’s also difficult for the BoE given the large amount of Brexit uncertainty. GBP risks remain to the downside over the short term especially given the heightening political noise in the UK.  The Norges Bank is likely to stand out amongst the crowd, with a rate hike expected, its second in just three months.

Elsewhere in Asia I expect no change from Bank Indonesia, BSP in the Philippines, and CBC in Taiwan. Bank Indonesia is edging towards a rate cut amid low inflation and slowing activity, but will likely want to see further signs of IDR stability before pulling the trigger to begin reversing the 175bp of hikes implemented in 2018.

Weaker activity in Taiwan calls for some sort of stimulus but the reality is that a rate cut will do little to alleviate the pain given that much of the problem is due to external factors.  Instead much of the adjustment may take place on the currency front.

I expect the BSP in the Philippines to maintain its overnight borrowing rate at 4.50% at this week’s meeting while signalling more RRR cuts ahead. Although CPI came in above expectations in May, at 3.2% y/y, it remains close to the midpoint of the BSP’s 2-4% band and I don’t expect it to stand in the way of further easing, but think BSP may wait until at least August to move again.

 

 

Central Banks Galore

Although markets are quietening down and liquidity is thinning ahead of the holidays there are still a few important and potentially market moving events this week.   These include several central bank meetings, with the Fed FOMC at the top of the pile on Wednesday.  The Fed is widely expected to hike by 25bp to between 2.25% and 2.50% and remove any remaining forward guidance.

A few weeks ago there was little doubt that the Fed would hike rates this month, but since then it has looked like less of a done deal.  Dovish comments from Fed officials suggest that there will be a lot of attention on Fed Chairman Powell’s press conference, especially following his recent comments that interest rates are “just below neutral”.   Although the Fed is likely to hike, it is likely to be seen as a dovish hike, which ought to leave the USD without much support.

In Asia there are three central bank meetings in focus.  On Wednesday the Bank of Thailand (BoT) is likely to hike its benchmark by 25bps to 1.75%, largely due to financial imbalances (household debt and bad loans) rather than inflation concerns.  On Thursday Taiwan’s central bank meeting (CBC) is likely to keep its benchmark interest rate unchanged at 1.375%, with low and declining inflation, suggesting the long held status quo will be maintained.

Also on Thursday I expect no change in policy by Bank Indonesia. Inflation is clearly non-threatening from BI’s perspective and unless the IDR weakens anew, BI will increasingly be in a position to keep its powder dry. Elsewhere in Asia, the Bank of Japan will be in focus.  No change in policy is widely expected on Thursday, with the central bank still well away from any tightening in policy given still low inflation.

Asian currencies vulnerable to equity outflows

Asian currencies are set to continue to trade cautiously. One big headwind to further appreciation is the fact that there has been a substantial outlook of equity capital over recent weeks. Over the last month to date Asian equity markets have registered an outflow of $3.3 billion in outflows. However, whilst Taiwan, South Korea, Thailand and India have seen outflows Indonesia, Philippines, and Vietnam have registered inflows.

The net result is that equity capital inflows to Asia so far this year are almost flat, a stark contrast from 2009 and 2010 when inflows were much higher at the same point in the year. The odds for further strong inflows do not look good, especially as the Fed ends QE2 by the end of June. While a sharp reversal in capital flows is unlikely, it also seems unlikely that Asia will register anywhere near as strong inflows as the last couple of years.

This will have a significant impact on Asian currencies, whose performance mirrors capital flows into the region. Almost all Asian currencies have dropped against the USD so far this month and could remain vulnerable if outflows continue. Given the relative stability of the USD over recent weeks and imminent end to QE2, the better way to play long Asia FX is very much against the increasingly vulnerable EUR.

The THB has been the worst performing currency this month but its weakness has been attributable to upcoming elections on July 3, which has kept foreign investor sentiment cautious. Thailand has seen an outflow of $812mn from its equity market this month. Polls show the PM Abhisit’s party trailing the opposition and nervousness is likely to persist up to the elections at least. THB weakness is not likely to persist over coming months, with USD/THB forecast at 29.2 by year end.

USD/KRW has been whipsawed over the past week but made up ground despite a continued outflow of equity capital over recent days. KRW has been particularly resilient despite a firmer USD environment and a drop in consumer sentiment in June. Next week the KRW will likely continue to trade positively, helped by a likely firm reading for May industrial production on Thursday. USD/KRW is set to trade in a 1070-1090 range, with direction likely to come from Greece’s parliament vote on its austerity measures.

TWD has traded weaker in June, having been one of the worst performing currencies over the month. USD/TWD does not have a particularly strongly correlation with movements in the USD or risk aversion at present but the currency has suffered from a very sharp outflow of equity capital over recent weeks (biggest outflow out of all Asian countries so far this month). Next week’s interest rate decision on Thursday by the central bank (CBC) will give some direction to the TWD but a 12.5bps increase in policy rates should not come as a big surprise. TWD is likely to trade with a weaker bias but its losses are likely to be capped around the 29.00 level versus USD.

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