This Week's Topics:
- China Is Not Going to Ease at These Prices
- Is The Japanese Yen’s Underperformance a Canary in the Coal Mine?
- Is It Time for India To Take a Breather?
China Is Not Going to Ease at These Prices
Earlier in the week, we received word from Chinese Premier Wen Jiabao that China would look to continue “fine-tuning” macroeconomic policy in 1Q12. Speaking at a council of corporate executives, Wen said:
“To cope with economic hardships this year, the government will offer support to the real economy… We have to make a proper judgment as early as possible when things happen and take quick action.”
From a policy perspective this statement pledges is more of the same – a little tinker here and there (via differentiated reserve requirements, altering capital requirements on SME loans, favorable tax policies, etc.) to acquiesce to growing domestic concerns regarding China’s intermediate-term growth outlook.
Unfortunately, that’s not enough to materially move the needle on Chinese growth. For us to factor in as probable a 2012 re-acceleration in Chinese economic growth, Chinese policymakers need to do two things: 1) lower interest rates and RRRs; and 2) ease curbs on the property sector, given the relative size of fixed asset investment as a driver of Chinese economic growth.
Regarding the latter lever, Premier Wen’s comments last week were far less than supportive:
“China won’t waver on its real-estate curbs, which aim to bring home prices to a reasonable level... Although market mechanisms should play a fundamental role in the property market, the government will maintain restrictions to ensure fairness and stability.”
Regarding the first lever, rising domestic and global inflation expectations aren’t supportive of the PBOC easing Chinese monetary policy. Moreover, despite lower-highs over the past six months, headline CPI is still +50bps above the State Council’s +4% inflation target.
A return to being comfortably under the target rests largely with the outlook for global food and energy prices, which are largely a function of the price level of the U.S. dollar, which itself is a function of U.S. monetary and fiscal policy. Any hint of Qe3 actually puts incremental tightening back on the table in China. For now, Chinese rate markets are simply pricing in less easing on the margin.
All told, we think there is a fair amount of risk at current elevated prices across the higher-beta asset classes, given that the Chinese economic growth outlook is becoming re-subdued, on the margin, relative consensus expectations that are largely driven by a base case featuring interest rate/RRR cuts. The fact that Chinese equities failed to overtake their TREND line amid a YTD global equity melt-up is not a comforting signal.
Moreover, while it is not in our style to speculate on commodities or another country’s equities/FX using the Chinese demand curve as a singular factor, the reality of it is that there are a great many investors who do – hence why we flag a consensus reevaluation of China’s intermediate-term growth outlook as a potential negative catalyst in the short term.
Is the Japanese Yen’s Underperformance a Canary in the Coal Mine?
The Japanese yen has been dramatically underperforming of late, falling -2.4% vs. the USD week/week. On a YTD basis, the currency is down -3.3% against the USD vs. a regional median of +2.5% – good for a (-580bps) negative divergence versus the region and the second largest decline in the world (Ghana’s new cedi is down -3.8% vs. the USD; we track 48 currencies and/or currency indices).
While such large % changes are becoming increasingly more commonplace in the market for foreign currency exchange amid structurally higher global FX volatility, we can’t help but flag this outsized underperformance as a potential canary in the coal mine for what we see as heightening risks within the Japanese sovereign debt market.
While the mere presence of heightening risk is no guarantee of a sovereign debt crisis, we’ve been vocal in calling out Japan’s MAR maturity spike as the potential grain of sand that could facilitate stress in the JGB market. So from a timing perspective, it doesn’t make sense for us to casually write off the yen’s underperformance as merely a function of decreased global risk aversion and higher expectations for U.S. interest rates.
That said, however, we are cognizant that the aforementioned view could very much be the case after all – especially given that we aren’t a seeing similar degree of stress across the other Japanese asset classes over similar durations.
Of course that could change, however; look no further than the outperformance of Japan’s 5yr sovereign CDS over the past three months (+10.7% vs. a regional median of -17.9%) as another potential canary in the coal mine. All told, we don’t view heightening risk of a Japanese sovereign debt crisis as something to downplay given the events in Europe over the past six months and we will keep our eyes and ears glued to our screens for any/all warning signs.
Is It Time for India To Take a Breather?
Earlier in the week, India posted a solid inflation report, with its benchmark WPI gauge slowing to a 26-month low of +6.6% YoY in JAN (vs. +7.5% in DEC). This deceleration marks a cumulative -340bps decrease in India’s headline inflation rate since peaking in SEP from an intermediate-term perspective and, more importantly, puts the series well below the RBI’s forecast of +7% YoY inflation by the end of the fiscal year (MAR).
The deceleration in Indian inflation and subsequent monetary easing speculation has been quite supportive of foreign inflows into Indian portfolio assets YTD: foreign ownership of Indian equities is up +4.8% YTD and foreign ownership of rupee-denominated fixed income is up +12.9% YTD.
A growing outlook for growth-supportive monetary policy and earnings tailwinds via FX translation have fueled a melt-up in India’s benchmark SENSEX equity index, which is up +18.3% YTD – the best performance in the region over that duration and good for a +750bps positive divergence vs. the regional median gain.
Due to the dramatic uptick in inflows, India’s currency has had similar outperformance in the face of monetary easing speculation, gaining a regional-best +7.7% against the USD in the YTD – which compares to a regional median gain of only +2.5%. More importantly, the rupee is outperforming global food and energy prices on a rolling 30-day basis, which we use to guide our expectations for sequential inflation readings on a real-time basis.
Net-net-net, rupee-denominated assets are firing on all cylinders right now, which, again, is largely driven by the anticipation of a shift to growth-supportive monetary policy. In light of this, we’re flagging the risk that the RBI fails to deliver on consensus expectations for rate cuts in the short-to-intermediate term, given the bullish quantitative setup across global energy prices and lack of fiscal consolidation – which was highlighted by Governor Duvvuri Subbarao as a prerequisite to lowering rates as recently as this week.
While the fundamentals would suggest that India is not necessarily a top short idea, the risk of a short-to-intermediate-term correction in Indian assets is inflated, given that monetary easing might be farther out in duration than consensus hopes. We point to a developing trend of incrementally-less pricing in of monetary easing into Indian rate markets as supportive of this view.
Fundamental Price Data
All % moves week-over-week unless otherwise specified.
- Median: +1.5%
- High: Japan +4.9%
- Low: New Zealand -1.8%
- Callout: Philippines +26.2% over the LTM vs. a regional median of -3.1%
- FX (vs. USD):
- Median: +0.1%
- High: New Zealand dollar +0.7%
- Low: Japanese yen -2.4%
- Callout: Japanese yen -3.3% YTD vs. a regional median of +2.5%
- S/T SOVEREIGN DEBT (2YR YIELD):
- High: Thailand +12bps
- Low: Vietnam -38bps
- Callout: Indonesia -88bps YTD
- L/T SOVEREIGN DEBT (10YR YIELD):
- High: Indonesia +12bps
- Low: Vietnam -47bps
- Callout: China +11bps YTD
- SOVEREIGN YIELD SPREADS (10s-2s):
- High: Philippines +9bps
- Low: Vietnam -9bps
- Callout: China (10yr-1yr) -26bps YTD
- 5YR CDS:
- Median: -0.1%
- High: Japan +0.6%
- Low: Australia -3.1%
- Callout: Japan +19.7% over the last six months vs. a regional median of +1.6%
- 1YR O/S INTEREST RATE SWAPS:
- High: Australia +16bps
- Low: Thailand -4bps
- Callout: China +50bps YTD
- O/N INTERBANK RATES:
- High: China +181bps
- Low: Vietnam -71bps
- Callout: India +40bps YTD
- CORRELATION RISK: The MSCI All-Country Asia Pacific Index is trading with a very slight positive correlation of +4% to the DXY on an three-week basis -- a large directional shift from -89% on a six-week basis. We would expect this correlation to intensify in the coming weeks, given the inflationary risks of further dollar-debauchery.