Sticky Stagflation. Period.
As consensus continues to investigate the health of the global economy, we’re starting to see some alpha being generated across Asian equity markets. Indices were mostly up, but the 610bps delta between the region’s best performer (China’s Shanghai Composite Index) and the region’s worst performer (Thailand’s Stock Exchange of Thai Index) highlighted the heterogeneity of wk/wk performance this week.
In Asian currency markets, the Aussie dollar (+1.7% wk/wk vs. USD) and the New Zealand dollar (+2.6% wk/wk vs. USD) were supported by bullish hope across the commodity complex ahead of what many expected to be the Fed’s next attempt to inflate global asset prices.
In Asian fixed income markets, the +23bps wk/wk increase in Australian 2yr sovereign debt yields also took a cue from Fed speculation (the hawkish RBA board is likely to tighten further if the Fed chooses to perpetuate global inflation once more). The move was supported by a +16bps wk/wk move in Aussie 1yr interest rate swaps. Another interesting callout on the inflation side was the +13bps back up in 10yr Honk Kong sovereign bond yields on inflation risk. Despite the territory teetering on the brink of recession, CPI backed up to a near 16-year high of +7.9% in July!
China: The key developments out of China this week centered on the direction of monetary and fiscal policy. The China Securities Journal reported that it was likely that Beijing increases fiscal spending and eases monetary policy in “certain sectors” in the event the global growth slows incrementally from here. On the tightening side, it was reported today by Bank of America that China’s central bank broadened bank reserve requirements regulation to include margin deposits. The new measure, which begins on Sept. 1st and is fully implemented on Feb. 15th, is roughly the equivalent of a +130bps increase in reserve requirements (per BAC analyst Lu Ting).
A +130bps increase in RRRs would be rather significant given the scope of China’s previous tightening (+600bps in RRRs since Jan. ’10; +125bps in interest rates since Oct. ’10), so we’ll look for clues in market prices to determine whether or not the Chinese economy is facing yet another headwind from a liquidity perspective. For now, China’s money market rates aren’t confirming Ting’s aggressive assumptions (O/N Shibor down -11bps d/d; 7-day repo rate down -41bps d/d). We’ll continue to closely monitor for changes on the margin in China’s official policy rhetoric, as speculation around China’s next big policy initiative is likely to take a front seat to growth and inflation dynamics in the event global growth continues to slow.
Hong Kong: Inflation and bad macroeconomic policy continue to have us bearish on Hong Kong. July CPI accelerated to +7.9% YoY (vs. +5.6% YoY in June), though largely on a one-off property market distortion. Even still, the distortion was created by a policy decision a year prior (waiver of public housing rentals), reminding us that we cannot get something for nothing when it comes to the economy. Whether or not they’ll be in office to see the outcome, there is a price to pay for every decision policymakers make.
In Hong Kong’s case, their continued insistence on pegging the Hong Kong dollar to the USD means they are unable to hike interest rates to fend off a pending inflationary spiral driven largely by a property price bubble (higher rents) and tightness in the labor market. The recent elevated minimum wage introduction and the +7% increase in civil servant pay will only perpetuate the fodder by which inflation is being fanned throughout the Hong Kong economy. As we called out a few months back, Hang Seng investors are appropriately paying a lower multiple for Hong Kong’s Sticky Stagflation.
Japan: For the sixth time in five years, Japan’s head of state is quitting on the job. Prime Minister Naoto Kan announced his resignation today, and will officially step down early next week. Beyond the sloppy political posturing to become his replacement, there isn’t much more to report. Aside from electing a leader who isn’t afraid to challenge and overcome the country’s stubborn Keynesian resolve, Japan is likely to continue to see economic stagnation over the long-term TAIL (nominal GDP grew ZERO percent from 1991).
A lack of effective political leadership is one of the key reasons Moody’s downgraded Japanese sovereign debt one notch to Aa3 with a stable outlook. We downgraded Japanese equities in 4Q10 via our Japan’s Jugular presentation and we continue to point to exponential growth in Japan’s sovereign debt burden (over 220% of GDP) as being a major constraint on consumer and corporate confidence, as well as a major constraint on crafting and implementing sound regulation and monetary policy – all of which ultimately contributes to structurally depressed rates of economic growth.
India: Inflation and interest rates continue to dominate the headlines coming out of India. Inflation largely accelerated on a YoY basis in the week ending 8/13: food inflation came in faster at +9.8%; energy inflation was flat at +13.1% YoY; and primary articles inflation accelerated to +12.4% YoY. As we continue to point out, Sticky Stagflation keeps the Reserve Bank of India in a hawkish stance at least through 3Q (our models have WPI peaking in August on a YoY basis). RBI Governor Duvuuri Subbarao affirmed our belief with his recent commentary:
“With weak supply response, inflation remains an important macroeconomic challenge. As a result, both fiscal and monetary space is limited for any counter-cyclical stimulus if global conditions deteriorate.”
India’s interest rate swaps market took his word for it, with the one-year tenor backing up a marginal +2bps wk/wk (still down -53bps MoM, however). They are, however, trading below the RBI’s benchmark policy rate of 8%, suggesting that the market is pricing in the RBI’s next move over the NTM to be a rate cut, rather than the 12thrate hike of this current tightening cycle. The current setup of market expectations is largely due to a slowdown in India’s economic growth rate, and, combined with slowing credit growth (+18.5% YoY in July), is supportive of Indian lenders purchasing record amounts of bonds in July ($18.9 billion). For reference, India’s 2yr sovereign debt yields have fallen -6bps wk/wk and -11bps over the last three months. This compares to a +133bps rise over the last year.
Australia: The key news out of Australia this week largely centered on monetary policy and the Reserve Bank of Australia’s likely next move. As we point out earlier, Australia’s bond market and interest rate swaps market are aggressively betting for rate cuts. Australia’s currency, the Aussie dollar, largely continues to anticipate tighter policy ahead (up +1.7% wk/wk and +19.4% YoY vs. USD). As we have pointed out in our recent research on Australia, Sticky Stagflation is keeping RBA Governor Glenn Stevens and his crew in a box. On the brighter side of things, in the event global economic conditions take a turn for the worse, Stevens has adequately prepared his country to weather the storm – just as he did in ‘08/’09, saying at a hearing today:
“If we did see a very dramatic change for the worse in the global economy, certainly we have plenty of interest rates to play with if need be.”
Singapore: The trade-heavy, open economy of Singapore (exports = ~216% of GDP) continues to be a bellwether in our model as a gauge of the state of the global economy. Unfortunately, that gauge remains bearish. Sticky Stagflation dominated Singapore’s economic data this week: industrial production growth slowed in July to +7.4% YoY (vs. a prior reading of +10.7% YoY) and CPI accelerated in July to +5.4% YoY (vs. a prior reading of +5.2% YoY).
Looking at Singapore’s domestic economy, the country will hold a presidential election tomorrow – its first in 18 years. This is more ceremonial than anything, as the president of Singapore is largely a symbolic role. In fact, Singaporean Law Minister had this to say in response to recent campaign promises of “checks and balances” out of candidates Tan Jee Say, Tan Kin Lian, and Cheng Bock (none of whom are officially endorsed by the ruling People’s Action Party):
“A president would be acting unconstitutionally by engaging publicly on political issues or contradicting the government. Direct elections do not give the elected president the right to speak independently. The president must follow the Cabinet’s advice and cannot act or speak on issues of the day except as advised by the Cabinet.”
Regardless of the outcome of tomorrow’s election, the incoming president will have little ability to actually govern. While the president can veto budgets and key public appointments, such action is easily overturned by a majority vote in parliament – where the PAP holds 81 of 87 seats. As such, the election will be perceived as little more than a broad-based gauge of sentiment towards the ruling PAP regime.
Thailand: Sticky Stagflation rears its ugly head yet again, this time in Thailand’s real GDP growth, which slowed in 2Q to +2.6% YoY (vs. +3.2% YoY in 1Q). The stagnating economic growth was met with a +25bps rate hike designed to front-run simmering inflationary pressures being brewed via the new regime’s lax fiscal policy, its decision to aggressively hike minimum wages, and its rice price-fixing scheme. Opposition leader, Abhisit Vejjajiva, who was recently stripped of his title of Prime Minister as a result of the recent election, had this to say regarding the new government’s aggressive initiatives:
“If we destroy the disciple and independence in fiscal and monetary policies, inflation will accelerate.”
A worthwhile lesson indeed.