China Data Fuels A Good Start To The Week

Better than expected outcomes for China’s manufacturing purchasing managers indices (PMIs) in November, with the official PMI moving back above 50 into expansion territory and the Caixin PMI also surprising on the upside gave markets some fuel for a positive start to the week.   The data suggest that China’s manufacturing sector has found some respite, but the bounce may have been due to temporary factors, rather than a sustainable improvement in manufacturing conditions.  Indeed much going forward will depend on the outcome of US-China trade talks, initially on whether a phase 1 deal can be agreed upon any time soon.

News on the trade war front shows little sign of improvement at this stage, with reports that a US-China trade deal is now “stalled” due to the Hong Kong legislation passed by President Trump last week as well as reports that China wants a roll back in previous tariffs before any deal can be signed.  Nonetheless, while a ‘Phase 1’ trade deal by year end is increasingly moving out of the picture, markets appear to be sanguine about it, with risk assets shrugging off trade doubts for now.  Whether the good mood can continue will depend on a slate of data releases over the days ahead.

Following China’s PMIs, the US November ISM manufacturing survey will be released later today.  US manufacturing sentiment has come under growing pressure even as other sectors of the economy have shown resilience.  Another below 50 (contractionary) outcome is likely.  The other key release in the US this week is the November jobs report, for which the consensus is looking for a 188k increase in jobs, unemployment rate remaining at 3.6% and average earnings rising by 0.3% m/m. Such an outcome will be greeted positively by markets, likely extending the positive drum beat for equities and risk assets into next week.

There are also several central bank decisions worth highlighting this week including in Australia, Canada and India.  Both the Reserve Bank of Australia (RBA) and Bank of Canada (BoC) are likely to keep monetary policy unchanged, while the Reserve Bank of India (RBI) is likely to cut its policy rate by 25bps to combat a worsening growth outlook.  Indeed, Q3 GDP data released last week revealed the sixth sequential weakening in India’s growth rate, with growth coming in at a relatively weak 4.5% y/y. Despite a recent food price induced spike in inflation the RBI is likely to focus on the weaker growth trajectory in cutting rates.

US/China Tensions Escalate

Risk appetite starts the week in poor form. The shock announcement of 5% tariffs on all Mexican exports (from June 10) to the US and an intensification of tensions with China, have fuelled growing expectations of a worsening in the global growth outlook. Safe haven assets such as JPY and CHF are likely to remain in demand while core bond yields are likely to continue to move lower, with markets continuing to raise bets on Fed rate cuts this year.  Indeed the 10y US Treasury yield has dropped by 1.1% since 8 November last year, with the fall in yields accelerating over recent weeks.

US/China tensions escalated over the weekend, with the deputy head of China’s negotiating team, Wang Shouwen, accusing the US of “resorting to intimidation and coercion”.  This coincides with the increase in US tariffs on $200bn of Chinese goods coming into effect over the weekend as Chinese shipments reached US shores, while earlier on Saturday Chinese tariffs on $60bn of US exports came into effect.  There is also growing speculation that China may curb exports of rare earth exports to the US.

Wang accused the US of abusing export controls and persisting with “exorbitant” demands and insisting on “mandatory requirements that infringe on China’s sovereign affairs”.   Meanwhile China’s defence minister Wei Fenghe, said that China will “fight to the end” on trade if needed.  China is also starting to investigate foreign companies who have violated Chinese law.  Soon after Chinese state media reported that the government was investigating FedEx for allegedly “undermining the legitimate rights and interest” of its Chinese clients.

Attention this week will be on several central bank decisions including the ECB (6th June), RBA (4th June) and RBI (6th June).  The market is fully priced in for an RBA rate cut to 1.25% this week.  The ECB is unlikely to surprise, with no change in policy likely.  Attention will be on terms of the TLTRO III while ECB President Draghi is likely to sound dovish in his press conference.  RBI is set to cut policy rates again, with Friday’s release of weaker than expected Q1 GDP adding to pressure on the Reserve Bank to boost growth amid low inflation.

Positive Start To The Week for Emerging Markets

Emerging Markets have started the week on a positive footing helped by some firm data releases.  Equity markets in Asia had a strong day while EM currencies except TRY strengthened.

Sentiment was helped by China’s official manufacturing purchasing managers index (PMI). This was released yesterday and came in at 50.5 in March (consensus 49.6) from 49.2 in February, while the non-manufacturing PMI also came in above expectations at 54.8 (consensus 54.4) from 54.3 in February.  An above 50 reading implies manufacturing expansion. This was followed by the Caixin PMI this morning, which came in at 50.8 in March (consensus 50.0).  The data suggests that China’s economy may finally be benefiting from official stimulus measures as well as hopes of a trade deal.

Aside from China’s index, PMIs across the region generally firmed, providing some relief to regional policy makers and markets.  A key event this week in the region is India’s Reserve Bank (RBI) meeting to decide monetary policy on Thursday, where a 25bp policy rate cut is likely.  Separately, attention will remain on US- China trade talks, with China’s top economic official Liu He due in Washington to continue discussions with US officials.  Both sides appear to suggest a deal is moving closer to fruition although sticky points on structural issues remain in place.

Turkey hasn’t quite embraced the risk on tone following local elections there. President Erdogan’s AKP appears to have lost control of the capital Ankara to the main opposition CHP, while opposition parties are also likely to take control of several coastal cities. In Istanbul, the gap between the AKP and opposition is extremely close, with less than 0.1% between the two.  Overall, the AKP led alliance has garnered about 51.7% of the national vote, while the opposition led by CHP, has 37.5%, with 98.9% of the votes counted, according to the state-run Anadolu agency. This was sufficient for the Erdogan to declare that the ruling party “emerged as the winner” though it is clear that AKP’s coalition party MHP played a large role.   Further developments are awaited, with Turkish markets in limbo.

 

RBI Governor Patel’s resignation hits India’s markets

Reserve Bank of India (RBI) governor Patel resigned yesterday in a surprise move.  Patel cited “personal reasons” but it is likely to have much to do with tensions between the government and RBI.  Although it had appeared they had reached a compromise, it appears that Patel didn’t feel that the RBI came out of it well. Patel’s resignation came just ahead of a RBI board meeting on Friday, and has hit India’s markets.

The timing is not good.  Patel’s resignation comes just ahead of the release of five state election results today, with Madhya Pradesh, Rajasthan, Chhattisgarh, Telangana and Mizoram, all having gone to the polls. Exit polls have suggested a weaker showing for PM Modi’s BJP, with Madhya Pradesh and Rajasthan likely to deliver blows to the BJP.  The outcome of the elections will be scrutinised for clued ahead of next year’s general elections.

Issues such as dealing with non-bank financial companies (NBFCs), implementation of the Insolvency and Bankruptcy code and even interest rate setting, have all been under scrutiny over recent months. How to deal with tightening liquidity has been a source of contention, with the government wanting the RBI to do more to ease liquidity and lending conditions. The RBI pushed back against the government’s request for a
higher payout from central bank reserves.

Although the government has not yet announced a replacement to Patel it will clearly be important that whoever it is, will be seen as independent of the government. The RBI under Patel has been seen to be overly hawkish by some and in this respect the government may be able to install someone who is more open to easing both monetary policy and lending constraints.The next steps will be important.

If the government nominates someone to replace Patel who is seen as more susceptible to political influence it could have much further and deeper negative consequences for India’s markets.  If however, the government is seen to nominate someone who can maintain the independence of the RBI it will bode well for confidence in Indian assets.

India braced for a new era under Modi

Dear readers, it’s been a long while since I wrote a blog post and I must apologize for their absence. I have left my job at Credit Agricole CIB and will be moving from Hong Kong to Singapore to work for another bank. I am currently on gardening leave and am therefore not following market developments anywhere near as closely as I was until I start my new job at the end of June. Nonetheless, given the major events in India over recent days, with the victory of Narendra Modi and his Bharatiya Janata Party (BJP) in general elections, I felt compelled to write something.

Firstly the fact that the BJP won a landslide victory with 282 seats out of a total of 543 ensures that for the first time in decades the government in India does not have to be encumbered by a wide range of political beliefs and views. The consequent inaction a wide ranging coalition would have entailed would lead to renewed policy paralysis. As it is the BJP can form a majority government, with Modi able to emulate the successful reform policies he implemented in his home state of Gujarat while he was Chief Minister there. Being a Gujarati I can’t help but be caught up in the euphoria of what this could mean for India.

In contrast the Congress party and its leaders from the Nehru/Ghandi dynasty suffered a massive defeat, not only throwing them into opposition but shoving them to the margins in terms of political strength. Admittedly there has been a lot of money that has poured into Indian stocks and bonds over recent months but this does not necessarily mean that a BJP majority was priced in. On my last visit to India many of the clients I met actually thought that Modi may have been ousted while it was not felt that he and the BJP would be able to gain an outright majority. In the event he proved doubters wrong. In other words there is still plenty of scope for upside for the rupee and Indian stocks and bonds.

Now before we all get too excited a dose of reality needs to be brought into the mix. The “Gujarat model” was one of rapid improvements in infrastructure, reduction in bureaucracy and red tape and an encouragement of foreign investment. Clearly nothing in India is going to change overnight and adapting the model implemented in Gujarat, a state of 60 million people, to a country of over 1 billion people will not be easy. There will also be risks in terms of social tensions given the more right wing views of Modi and his party. Nonetheless, the strong mandate given to Modi by the electorate was for tough reform and this is what Modi and his style of government is best at.

There is little to time for a Modi honeymoon. The country’s bloated fiscal deficit, persistent current account deficits, elevated inflation, high indebtedness in some sectors, job market rigidities, inconsistent tax policy and masses of red tape and corruption, are only a few of the issues to contend with in a country with a wide spectrum of socio economic standing and religious views. Modi may also have to show some new secular credentials to ensure that his policies do not fuel sectarian tensions, something that may not come easy.

The hope among Indians and foreign investors is that Modi can once again push the economy back onto its fight and move to growth rates closer to 8-9% rather than 4-5% that the country under Congress rule has settled into. The selection of officials especially the Finance Minister will give important policy clues while ensuring that the well regarded central bank governor Rajan retains his post will help solidify confidence. Having been disappointed so many times in the past it is tough not to be skeptical but it may finally be time to throw caution to the wind and give Modi the benefit of the doubt. If anyone is up to the job it appears that Modi has the right credentials for it.

Bernanke awaited, RBI stays on hold

Central banks are very much in the spotlight. Whether it’s poor communication or disappointment over the lack of fresh stimulus measures in Japan or opposition to the European Central Banks’ (ECB) OMT policy being debated in the German constitutional court there is much to focus on. Against the background of heightened volatility and elevated risk aversion the Fed FOMC meeting on Wednesday will garner even more attention than usual.

Although no change in policy settings is expected the ability of Fed Chairman Bernanke to communicate effectively the Fed’s strategy over ‘tapering’ will be crucial to determine whether market volatility persists or lessens. Ultimately markets are likely to successfully transition to a world of reduced Fed asset purchases but this may take a while. In the meantime market stress is set to remain elevated.

Aside from the Fed FOMC meeting US data releases are likely to continue to show encouraging signs of housing market recovery, with US May housing starts and April existing home set to reveal gains. Meanwhile, CPI inflation will remain benign in May while the June Empire manufacturing survey today will reveal a slight improvement.

In Europe, there will be attention on a Eurogroup meeting on Wednesday where banking union will be discussed while data releases include the June German ZEW investor confidence survey (slight drop likely) and the flash estimates of June purchasing managers’ indices. These are likely to look less negative although they are set to remain in contraction territory. In Japan, May trade data will likely show a widening in deficit as weaker external demand outweighs the impact of a weaker JPY.

In FX markets USD selling against major currencies is likely to slow. The 4.4% drop in the USD index from its highs in late May has been rapid but it has led to a major shift in positioning. Speculative USD long positions have been cut back significantly, while EUR positioning is almost back to flat after being extremely short in previous weeks. Similarly JPY short positions are beginning to be pared back. I suspect that the EUR in particular will struggle to make much more headway.

Weakness of the USD against major currencies has contrasted sharply with USD strength against emerging market currencies. The sell off in Asian currencies has been particularly sharp although there was some tentative recovery towards the end of last week. The INR followed by the most risk sensitive currencies including PHP and THB have suffered the most over recent weeks.

The INR’s vulnerability has been particular high due to its external funding requirements although it may show some tentative signs of recovery over coming days as its sell off has looked overdone. The Reserve Bank of India policy meeting today offered no help for the INR. Although it was a close call there was a significant minority looking for a rate cut to boost growth. The lack of action will weigh on the INR in the short term.

Indian Rupee – How low can it go?

Sentiment for the Indian rupee (INR) has gone from bad to worse. A number of concerns have hit the currency including weak economic data, deteriorating confidence in government policies, and intensifying risk aversion. The latest blow to the rupee came from data showing that economic growth in Q1 2012 slowed to 5.3% the slowest pace of growth in nine years. Worryingly high interest rates in the wake of persistent inflation pressures have damaged investment spending, a major weak point in the Q1 data. High inflation at over 7% means that the Reserve Bank of India has limited room to ease policy but the central bank has hinted at lower rates in the wake of lower oil prices.

These economic pressures have come at a time when the global environment has worsened. India was already more vulnerable compared to its Asian neighbours due it’s twin current account and fiscal deficits. Strong growth had put concerns about these deficits on the backburner but with growth slowing it only exposes India’s fragility. While less exposed to a global trade slowdown compared to other countries in the region India nonetheless is highly exposed to financial contagion. The INR is a high beta currency, sensitive to the vagaries of risk. The rise in risk aversion over recent weeks left the currency highly vulnerable as its sharp decline attests to.

Despite a host of regulation changes from the authorities the INR has continued to fall, with no let up in sight. While the RBI has suggested that it could sell USDs to oil companies to stem the decline in the rupee it may only result in slowing INR declines in the current environment. It’s decline against the USD has surpassed other Asian currencies. Interestingly there has not been a major exodus of portfolio capital from India, surprising given that other Asian countries such as Korea and Taiwan have seen significant outflows of equity capital. Nonetheless an escalation in the Euro crisis could quite easily change the picture for the worse.

It is not all bad news for the INR. While it will remain under pressure for some time yet from a valuation perspective the INR is looking increasingly cheap. I wouldn’t run out and buy it just yet but I would argue that a lot of bad news is already priced in to the currency. Investors will need to see some better news both externally and domestically and unfortunately this is lacking, but should risk appetite began to turn around the potential for rupee appreciation is significant for a currency that has lost close to around 20% of its value over the last 12 months. In the meantime, the best that could be hoped for is a slowing in the pace of depreciation, with a fall to around 57-58 versus USD on the cards over coming weeks.

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