As usual, we’re keeping it brief. Email us at if you’d like to dialogue further on anything you see below. Also, we are always happy to forward along prior notes which may contain additional color on the specific topics/countries you see below.
QE3 speculation puts hawkish policy back into the forefront.
Asian equity markets had a great week, closing up +2.7% wk/wk on both an average and median basis. The key outlier to the downside was China’s Shanghai Composite Index, which closed down -3.2% on QE3 speculation (more Fed-sponsored inflation). The +22bps wk/wk jump in China’s 2yr sovereign debt yields and +26bps wk/wk increase in China’s 1yr on-shore interest rate swap spreads is supportive of our view that the market will expect incremental tightening out of the PBOC alongside incremental speculation for additional easing out of the U.S. CDS declined broadly across Asian credit markets, with the fiscally conservative Australia and New Zealand leading the way on the downside from a wk/wk perspective.
China: Inflation remains the topic du jour in China, with Prier Wen Jiabao saying earlier in the week that “China’s top priority is stabilizing food prices” and that Chinese officials “do not plan to alter the direction of economic policy”. Though we expect Chinese CPI to decelerate going forward, we do think it will remain sticky enough on an absolute basis to justify the government’s hawkish bias – particularly if Chuck Evans and his Fed colleagues decide to pursue incremental monetary easing over the intermediate-term. China’s August manufacturing PMI, which accelerated marginally on a headline basis to 50.9, confirms our view with the input prices subcomponent ticking up to 57.2 vs. a prior reading 56.3. We have highlighted in the past the strong relationship between this series and China’s headline inflation reading.
As it relates to inflation on the fiscal policy front, Beijing decided to link a range of welfare payments to CPI (think: COLA) in order to boost the incomes of those most impacted by inflation. The change was fully implemented nationally at the end of August and should provide yet another incremental boost to Chinese consumption growth in 2H.
On the credit front, we highlight the drying up of China’s Local Government Financing Vehicle debt market as a key risk to Chinese banks, which coincidentally have seen their swaps widen dramatically over the last month (on the order of 60-70bps broadly). To the former point, this market, which is a key source of refinancing for China’s 10.7 trillion yuan of LGFV debt (24% of which matures this year), saw the least amount of issuance since Nov. ’08. Should investors start to materially lose confidence in this market, we could start to see a dramatic underperformance of Chinese financial shares as calls for a widespread uptick in defaults, NPLs, and capital raises become louder on the margin.
Japan: Earlier in the week, it was confirmed that Finance Minister Yoshihiko Noda will succeed the now-departed Naoto Kan as Japan’s next prime minister – the country’s sixth in five years and the third since the ruling DPJ party took control of the lower house in 2009. Noda, who is among Japan’s most fiscally conservative officials, has upheld rhetoric suggesting that he won’t back away from Kan’s desire to rein in Japan’s fiscal deficit (currently at 8.1% of GDP) and produce a balanced budget in ten years. In fact, he flat out said that the DPJ had let the country down in this regard and called for raising the 5% consumption tax by “the middle of the decade” in order to secure funding for accelerating social security expenditures and a third reconstruction stimulus package totaling around ¥10 trillion. Additionally, Noda appears to have enough internal support to at least begin to have a healthy debate about balancing Japan’s budget without letting politics get in the way of progress.
Elsewhere in the Japanese economy, the tired Japanese consumer continues watch from the sideline as consensus carries on with its bullish “reconstruction” storytelling. July retail sales growth slowed to a mere +0.7% on a YoY basis and also slowed to a -0.3% rate on a MoM basis – supportive of our call that upside to sequential gains in Japan’s economic statistics was limited from here. Small business confidence is supportive of this view as well, falling in Aug. to 46.4 vs. a prior reading of 47.1. All is not bearish, however; July housing starts growth exploded to +21.2% YoY (vs. +5.8% prior) alongside an acceleration in annualized housing starts to +955k MoM. Reconstruction lives on!… it just remains to be seen how the heavily-indebted sovereign plans to help finance it.
India: 2Q real GDP growth in India came in at a marginally slower rate of +7.7% YoY, which suggests to us that the Reserve Bank of India is more than likely to maintain its hawkish bias over the intermediate term. In fact, RBI Governor Duvuuri Subarao, architect of the fastest tightening in the RBI’s 76yr history, echoes this sentiment with his recent commentary:
“If global financial problems amplify and slow down global growth markedly, it would impart a downward bias to the growth projection. Still, the immediate challenge to sustaining growth lies in taming inflation.”
This view is in stark contrast to Brazil, which earlier in the week cut interest rates by -50bps to help support its ailing economy. This is to be expected, however, given that India’s real GDP growth is running at nearly double the rate of Brazil’s.
Still, Indian GDP growth is slowing, as evidenced by the country’s manufacturing PMI reading falling in August to a 29-month low of 52.6, which is still healthy on a relative basis to the world’s larger economies. Looking past the intermediate-term slowdown and viewing India from a longer-term perspective, we believe that Prime Minister Singh’s tax regulatory overhaul and the recently enacted anti-corruption legislation (Lokpal) are going to reduce the inflationary pressure within the Indian economy and help the country’s real-adjusted economic growth rates accelerate on the margin. The “flows” support this conclusion, with longer-duration FDI accelerating to an all-time high of $13.4 billion in 2Q. This is in heavy contrast to a near three-year high in monthly foreign capital outflows from Indian stocks through Aug. 25 ($2.3 billion).
Korea: In a contrarian research note published in early June, we appropriately signaled that Korean economic growth was going to have a meaningful deceleration alongside a pickup in inflation, which would cause the Bank of Korea to be hawkish or, at the very least, limit their ability to respond to the slowing Korean economy via monetary easing. CPI came in much hotter in August, at +5.3% YoY vs. a prior reading of +4.7% and the rate of core inflation also increased to +4% YoY.
Meanwhile, Korean economic data – especially the cyclical components – came in quite soft this week: manufacturing business survey ticked down in Sept. to 86 (vs. 91 prior); Sept. non-manufacturing business survey came in flat at 83; industrial production growth slowed in July to +3.8% YoY (vs. +6.5% prior); manufacturing PMI slowed in Aug. to 49.7 (vs. 51.3 prior) – indicating a contraction; and trade balance growth decelerated in Aug. to -$384.5 million YoY (vs. +$1.3 billion prior). It’s no wonder South Korean Finance Minister Bahk Jae Wan hinted that the government might cut its 2011 GDP growth forecast on Monday. Moreover, our model suggests their forecast of +4.5% YoY real GDP growth in 2011 is indeed too high (by roughly 100bps).
Thailand: This is yet another Asian economy where inflation remains the key focus of policymakers, which means we’ll continue to see a hawkish lean out of the Bank of Thailand over [at least] the intermediate term. Headline CPI accelerated in August to +4.3% YoY (vs. +4.1% prior) and core inflation also came in faster at +2.9% YoY (vs. +2.6% prior). Recent growth data is supportive of the BoT’s hawkish bias, as Thailand’s trade balance growth accelerated in July to +$3.5 billion YoY (vs. -$662.6 million prior). Furthermore, falling business sentiment (51.2 in July vs. 53.1 in June) would suggest Thai corporate executives are feeling both the pressure and specter of rising interest rates.
Australia: After a noteworthy plunge in bond yields across the maturity curve, Australia’s consumer, which is 1.6x levered and has a variable-rate mortgage on 90% of all home loans, finally came off of life support and contributed to Australian economic growth (retail sales growth accelerated in July to +0.5% MoM vs. -0.1% prior). It will be interesting to see how long this lasts, given the weakness in Australia’s manufacturing sector which is weighing on employment growth (manufacturing PMI ticked down in Aug to 43.3 – a 2yr low), falling home prices (growth in RPData’s House Price Index slowed in July to -0.6% MoM vs. -0.4% prior), and the consumer’s general distaste for additional leverage (mortgage loan growth decelerated to +5.9% YoY in July – the slowest pace on record).
Net-net, we continue to believe Glenn Stevens and the Reserve Bank of Australia’s next move on the interest rate front is down, though the recent collapse in sovereign debt yields should allow the consumer to cushion the slowing Aussie economy on the margin as its collective interest rate burden declines.