EM FX ended the week on a mixed note, as investors await fresh drivers. US jobs data on Friday could provide more clarity on Fed policy and the US economy. Within EM, many countries are expected to report lower inflation readings for June that support the view that most EM central banks will remain in dovish mode for now. We remain cautious on the EM asset class near-term.
Caixin reports June China manufacturing PMI Monday, which is expected at 49.8 vs. 49.6 in May. Official manufacturing PMI was already reported at 51.7 vs. 51.2 in May. While the two series often diverge, we warn of upside risk to the Caixin reading. For now, markets are comfortable with China’s macro outlook.
Thailand reports June CPI Monday, which is expected to remain flat y/y. This remains well below the 1-4% target range. Bank of Thailand meets Wednesday and is expected to keep rates steady at 1.5%. Indeed, with no price pressures to speak of, we believe rates will remain steady into 2018.
Indonesia reports June CPI Monday, which is expected to remain steady at 4.3% y/y. This remains well within the 3-5% target range. Bank Indonesia next meets July 20 and is expected to keep rates steady at 4.75%. While the bank has signaled an end to the easing cycle, we do not see any tightening in 2017.
Thailand reports March CPI Monday, which is expected to rise 1.30% y/y vs. 1.44% in February. If so, this would be moving closer to the bottom of the 1-4% target range. BOT just left rates steady at 1.5% last week. We expect inflation to pick up again, and so BOT should tilt more hawkish as the year progresses. Next policy meeting is May 24, and we expect steady rates again.
The central banks of Korea, the Philippines, Thailand, Poland, and Peru all meet, and none are expected to change policy. Still, individual country risk matters. The Turkish lira hit a record low last week on intensifying political risks, and weakness should continue. More China data for October should confirm that the economy is stabilizing in Q4.
Consolidation of India’s public-sector banks would represent a final step in rebuilding a financial system capable of underwriting credit growth and job-creating investment in Asia’s third-largest economy.
First, though, the state banks must cleanse their balance sheets.
Vinod Rai, the veteran bureaucrat hired this year to head a new Banks Board Bureau, said a next step could be the merger of “two large Mumbai-based banks” that he declined to identify.
“Once that consolidation has taken place, in the second phase, we will put a weaker, smaller bank into this merged entity,” he said in an interview.
China returns from a week-long holiday, and markets may be a bit nervous after it reported lower than expected foreign reserves for September. Taken in conjunction with the softer yuan, capital outflows from China may be picking up. Elsewhere, the central banks of Korea, Peru, and Singapore hold policy meetings, though no changes are expected.
We have spent a lot of time talking about the unintended consequences of accommodative global central banking policies. Skyrocketing pension liabilities and the numerous corresponding reach for yield/duration trades, which have resulted in several of their own off-shooting market bubbles (in fact we just wrote about how one of the bubbles is bursting just yesterday “P2P Meltdown Continues: LoanDepot’s CDO Collapses Just 10 Months After Issuance”), is just one of the many unintended consequences.
But, as Deutsche Bank’s European equity strategist, Sebastian Raedler, points out today, even if central banks wanted to steepen the yield curve they likely can’t. Raedler disputes the common explanation that low bond yields are due to discretionary central bank policies and argues instead that the recent fall in bond yields has been due to sustained weak global growth. This suggests low bond yields are not principally due to discretionary central bank policies (which could be reversed at will), but to the weakened global growth picture, to which central banks have only responded by making policy more accommodative. Of course, if Raedler is correct, the question then becomes why continue with accommodative policies if they’re not driving incremental economic growth but clearly creating detrimental asset bubbles?
Raedler argues that global bond yields have fallen with central banking target rates but both have really just followed slowing global economic growth.
State Bank of India is expected to price the country’s first offshore “coco”, or contingent convertible, bond today in a test of international appetite for the country’s banks as they work through a mountain of bad loans.
The deal will also be a test of the growing divide between the cost of capital for Asian and European banks, with Asian banks recently borrowing at record low costs via the bonds, which are known as Additional Tier 1 capital in Basel regulatory terms
SBI’s bonds allow for their value to be temporarily written down if the bank’s capital breaches pre-agreed levels. They can also be written off permanently if India’s central bank deems that the bank would become unviable without either an injection of public funds or the cash from the bonds.
Asia’s AT1 market is in its infancy compared with Europe, where tougher regulatory standards are seen as increasing the risk of the bonds and thus their costs. In August, Standard Chartered sold $2bn of the bonds with a coupon of 7.5 per cent.
Banks leading SBI’s deal are offering its $1bn in dollar-denominated paper with a coupon of about 5.5 per cent.
While far above the record low 3.6 per cent achieved by Singapore’s DBS last month, a deal pricing at those levels would potentially open a funding route for SBI’s competitors and provide a benchmark to price against.
India’s banks – particularly the state-controlled lenders that account for three quarters of banking assets – have been hit hard by a wave of distress in loans to corporate sectors such as infrastructure, power and steel. SBI alone made Rs214bn ($3.2bn) of provisions for troubled assets in the first six months of this year.
India’s government is pursuing a plan to inject Rs700bn into the state-controlled banks over the three years to April 2019, when they will be required to comply with Basel III capital standards.
The bond market rally which began the Monday after Raghuram Rajan announced his decision to step down as Reserve Bank of India (RBI) governor has taken on a life of its own.
On Thursday, the 10-year benchmark bond yield fell 6 basis points to 7.19%, coming within striking distance of levels seen back in 2009. Yields are already at their lowest in more than three years and a drop of a few more basis points could take us back to the days of September 2009 when the 10-year yield was at 7.15%.
Such is the optimism in the market that even a fall to levels below 7% is not being ruled out. The last time India had a sub-7% benchmark yield was in July 2009. That was a time when the repo rate was 4.75%—175 basis points below the 6.5% policy rate today.
“…we continue to expect a further rally in rates with 10-year G-sec yield likely to drift lower towards 7% before the end of FY17 on the back of another 25 basis point repo rate cut by the RBI in Q3 FY17 and around Rs.1 trillion in incremental OMO (open market operation) purchases,” said Yes Bank in a research note on Thursday.
The factors that are driving the rally are a combination of global and local. Glocal, as many analysts call it.