Triangulating Asia

This Week’s Topics:

  • Lunar New Year Distortions or Simply a Weaker Outlook for Global Growth?
  • Entertaining Elections in Hong Kong and Australia
  • Are the Ratings Agencies Fearful of Downgrading Japan Further? 

Lunar New Year Distortions or Simply a Weaker Outlook for Global Growth?

As Asian equities, FX, and corporate credit climbed higher in the YTD, both investors and the legacy media have written off the region’s generally-nasty JAN economic growth data as merely a function of Lunar New Year calendar distortions – in full anticipation of a return to higher growth rates in FEB and beyond.

 

While we certainly agree that there has been a fair amount of distortion resulting from Lunar New Year (and the resulting week of holiday) being on JAN 23 (vs. FEB 3 last year), we don’t think it pays to overlook the string of sour data as a one-off – particularly given where the slope of regional inflation is likely headed with Brent prices > $120/bbl. Asia remains the world’s largest consumer of crude oil from a regional perspective, at just over 30% of total world demand.

 

A quick look at Asia’s JAN export data highlights the general trend of weakness we are referring to:

  • China: -0.5% YoY vs. +13.4% in DEC;
  • Japan: -9.3% YoY vs. -8% in DEC (en route to worst monthly trade deficit on record);
  • South Korea: -7% YoY vs. +10.8 in DEC;
  • Hong Kong: -8.6% YoY vs. +7.4% in DEC;
  • Singapore: -2.1% YoY vs. +9% in DEC;
  • Taiwan: -16.8% YoY vs. +0.6% in DEC;
  • Vietnam: -11.1% YoY vs. +25.4% in DEC;

We’ve created an aggregated index for Asian export growth which weights each country according to its share of regional exports; on this metric Asian export growth slowed to -4% YoY in JAN from +6.4% in DEC (generously holding Indonesian, Filipino, Thai, Malaysian, and Indian readings flat sequentially due to the lack of reporting at the time of publication).

 

Triangulating Asia - 1

 

Again, we don’t want to make too big a deal out of Asian growth data slowing in JAN because of the obvious effects of the Lunar New Year calendar shift, but it’s worth mentioning that the U.S. and E.U. combine for roughly a third of Asian export demand and 40-50% of intra-regional trade is meant for re-export outside the region, likely upping the U.S. and E.U. share of Asian trade to ~2/3rds. With the developed world accounting for 60-70% of Asian exports, a negative YoY JAN export growth reading for the region portends negatively, to some extent, for the slope of Western demand in over the intermediate-term.

 

That’s something to at least keep in the back of your mind as you ponder what the slope of global growth is likely to look like at these currently-elevated energy prices.

 

Entertaining Elections in Hong Kong and Australia

It’s very hard to spot a parliament that rivals the 112th U.S. Congress in being dysfunctional. That said, however, Australia has certainly thrown its hat into the competition in recent days.

 

Kevin Rudd, the country’s now-former foreign minister (he recently quit) seeks to challenge incumbent prime minster Julia Gillard as head of the Labor Party in a FEB 27 referendum (2nd one in 20 months), which Gillard called to determine once-and-for-all who will lead the party into next year’s general election. Currently her Labor Party is Australia’s least-popular ruling party in at least 27 years, capturing only 26% of a SEP primary vote and only 32% in a recent poll (vs. 46% for the rival Liberal-National coalition, who appears poised to challenge for ruling party status next year under the leadership of Tony Abbot).

 

Rudd, who enjoyed record popular support during his tenure as prime minister during 2007-10, has been known to ruffle quite a few feathers among his colleagues. So much so that key officials such as Treasurer Wayne Swan and Defense Minister Stephen Smith have publicly stated how difficult it was/would be to work under Rudd’s leadership again. To be fair, Rudd has launched a series of campaigns documenting his changed behavior and he does have the public support of some key members of the Labor Party, such as Immigration Minister Chris Bowen.

 

Looking ahead, while next Monday’s referendum will do little to change the intermediate-term slope of Aussie fiscal and regulatory policy, it may have an impact on the perception of the party among voters, as a less-than-decisive victory by either candidate broadcasts a signal of low intra-party confidence. From a longer-term perspective, the party may be forced to employ more populist policies ahead of the 2013 elections to make up ground vs. the Liberal-National Party. Adopting a history lesson from 1992, the Labor Party did come from behind to secure a victory in the general elections of MAR ’93 by collectively refocusing on the enemy rather than its own internal issues.

 

Turning to Hong Kong, the short-to-intermediate term implications of its upcoming election are far more serious in nature. The territory – which has never experienced universal suffrage under Britain nor Beijing’s leadership – is seeing its system of transferring the highest-ranking title of Chief Executive via the vote of a 1,200-member election committee (a collection of largely old-money shot-callers ranging from property tycoons to legislators to mainland representatives) challenged en masse by the 7,098,800 citizens who will remain on the outside looking in come election day on MAR 25 (as an aside, they’ll finally get to participate in 2017).

 

The widespread discontent with the process is largely being driven by the scandal surrounding one of Beijing’s approved candidates, Henry Tang Ying-yen, who, up until a week ago, was the front-runner to replace the incumbent Donald Tsang. Now, a discovery of his illegally-built, overly-lavish 2,200-sqaure-foot underground luxury chamber has completely cost him his ethos with Hong Kong’s populace.

 

In a recent poll, Tang Ying-yen received only 16% of the popular support vs. 63.9% for former gov’t advisor Leung Chun-ying, another Beijing-approved candidate. Moreover, 77.8% of respondents identified the scandal as having a negative impact on his integrity and the proportion of those who favor his withdrawal for the election increased to 66% from 51.3% last week. Still, Tang vows to proceed on, having already secured a pledge of support from 31.5% of the election committee members – most notably the votes of Li Ka-shing (H.K.’s wealthiest businessman), Thomas Kwok, and Lee Shau Kee, each of whom control one of Hong Kong’s four-largest property development companies.

 

All told, Tang’s confident bullheadedness and big-money support underscores a rift of rising socioeconomic inequality within the territory – a key issue as recently as last year when the Tsang’s gov’t was literally forced to respond to public demonstrations by broadly increasing cash handouts. Should he ultimately win the office, we think it could lead to widespread public discontent with Beijing’s heavy hand in Hong Kong politics, as well as a renewed public vigor against income disparity and wealthy elites. The policy ramifications of such an outcome are many and worthy of an additional note at some point in the future.

 

Are the Ratings Agencies Fearful of Downgrading Japan Further?

Over the past week, both Moody’s and Standard & Poor’s have both come out with public statements affirming Japan’s Aa3/AA- sovereign debt rating. While we don’t look to the ratings agencies to lead our interpretation of a particular sovereign’s credit risk, we have been vocal about their ability to spark a JGB sell-off in recent months – particularly due to their importance in determining capital bank capital requirements under Basel II standards.

 

For example, Japanese banks, which hold ¥4.7T in Japanese government debt on their balance sheets (through DEC ’11), would be on the hook for roughly $75 billion in capital raises should Japan get downgraded to single-A status. As recently as this week, Bank of Japan governor Masaaki Shirakawa said a +100bps increase in benchmark yields would cause a ¥3.5 trillion ($43.2B) loss on bank balance sheets at current holding levels. The estimate, which is up from a figure of ¥200B in OCT, highlights just how difficult it is to wrap one’s head around the implications of a loss of confidence in nearly 1 QUADRILLION yen (and counting) in Japanese government debt.

 

Triangulating Asia - 2

 

For now, Japanese banks – which are the largest holders of JGBs – remain seemingly unfazed by these projections, given that they simply have nowhere else to invest their excess liquidity into (¥165.7T as recently as JAN 31). Additionally, the returns on JGBs (+2.2% in ’11) far exceed what Japanese lenders can garner via traditional spread lending (average net interest margin at the nation’s three largest banks = 100bps). It remains a challenge to pinpoint the timing of when Japanese banks start to favor risk aversion vs. return seeking regarding this particular asset.

 

Triangulating Asia - 3

 

To that point, we’re not sure what exactly will trigger a crisis of confidence in this historically-bulletproof market. One avenue we’ll explore in greater detail on next Friday’s conference call (email our sales team if you don’t have the invite) is increased inflation expectations stemming from A) a dramatic rise in imports costs due to structurally-higher expenditures on crude oil as a result of lost nuclear power generation (+25.2% in 2011); and B) a dramatic uptick in Bank of Japan participation in financing the nation’s debt issuance.

 

It’s among the best-kept secrets in all of Global Macro that Japan, laden with Z.I.R.P. since ’99, has among the highest real interest rates in the developed world, proving a strong inflation-adjusted return for holders of Japanese sovereign debt. An erosion of this tailwind, particularly stemming from a rise in long-term inflation expectations, could force the Japanese state to pay a higher nominal price for capital to fund its largely-fixed operating budget (debt service and social security account for 53.5% of total expenditures in the FY12 budget).

 

Triangulating Asia - 4

 

Triangulating Asia - 5

 

Ironically, its Japanese politicians, including recently-elected Prime Minister Yoshihiko Noda, that are demanding that the BoJ adopt a more bold stance in its efforts to end deflation via increasing its underwriting government debt, among other alternatives. Earlier this month, the BoJ bowed to mounting political pressure by setting an inflation target of +1% “for the time being”. We applaud Shirakawa and his team for resisting calls to adopt a +2-3% target, given that such a level of inflation would likely erode demand for Japanese fixed-income assets to a dramatic extent – especially considering that Japan has averaged -0.2% YoY deflation over the last ten years!

 

Briefly turning our attention back to the ratings agencies, we are a bit puzzled by their decisions to not downgrade Japan, given that each of their criteria for a potential downgrade(s) have been or look to be met at some point over the long-term TAIL. For now, they remain comfortable with the status quo of slow-moving train wreck. Time will tell if the markets, again, force them to move just as they did in the U.S. MBS market and the European sovereign debt market. Getting front-run by three financial crises in five years would go a long way towards eroding what little credibility these organizations have left.

 

We’ll discuss their criteria in more detail on our conference call next Friday. For now, enjoy the weekend with your respective families.

 

Fundamental Price Data

All % moves week-over-week unless otherwise specified.

  • EQUITIES:
    • Median: +0.8%
    • High: Vietnam +5%
    • Low: Indonesia -2.1%
    • Callout: Indonesia -2.5% over the last month vs. a regional median of +5.2%
  • FX (vs. USD):
    • Median: flat wk/wk
    • High: Thai baht +1.6%
    • Low: Japanese yen -1.8%
    • Callout: The Japanese yen is down -5.9% in the month of FEB ahead of a massive sovereign debt maturity spike in MAR ($705 billion needs to be rolled over)!
  • S/T SOVEREIGN DEBT (2YR YIELD):
    • High: Philippines +53bps
    • Low: Vietnam -16bps
    • Callout: China’s 1yr sovereign yield +35bps YTD as rising inflation expectations erode easing speculation
  • L/T SOVEREIGN DEBT (10YR YIELD):
    • High: Indonesia +21bps
    • Low: Vietnam -5bps
    • Callout: Australia +43bps YTD vs. India -36bps
  • SOVEREIGN YIELD SPREADS (10s-2s):
    • High: Thailand +14bps
    • Low: Philippines -48bps
    • Callout: China (10s-1s) spread has narrowed -25bps YTD
  • 5YR CDS:
    • Median: -1.5%
    • High: Australia +2.4% ahead of Monday’s referendum
    • Low: Malaysia -4.8%
    • Callout: Japan +8.1% over the last six months vs. a regional media of -8%
  • 1YR O/S INTEREST RATE SWAPS:
    • High: Indonesia +45bps
    • Low: Vietnam -30bps
    • Callout: China -7bps wk/wk
  • O/N INTERBANK RATES:
    • High: China +15bps
    • Low: Vietnam -67bps
    • Callout: India -50bps wk/wk
  • CORRELATION RISK: Asia, the world’s largest crude oil consumer, needs a  strong dollar to shield its economic growth from rising energy prices. The MSCI AC Asia Equity Index has developed an immediate-term -6% correlation to the U.S. Dollar Index, vs. -70% over the LTM. The receding of this once-high inverse correlation is a leading indicator for a positive correlation – which is exactly what we began to see around this time last year. The buck can only be burned to a point before it’s really, really bad for global growth.

Darius Dale

Senior Analyst


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