Yield: Not the place to be

- "By December, most of Asia’s central banks will be hiking rates again and we expect their ranks will, by then, include China and Indonesia, Asia’s two key holdouts so far. Trouble in the US and Europe isn’t going to kill Asia’s recovery. In the two years since Lehman Brothers imploded, consumption in the US has gone absolutely nowhere – it still has not returned to precrisis levels. Ditto for Europe. Ditto for Japan. But compared to precrisis (3Q08) levels, consumption in Asia is up by 18%. That’s why Asia’s central banks will be back in tightening mode soon – because Asia’s recovery is not about the US. It’s about Asia. Asia is no longer too small to matter. Among other things, this means Asia can and will consume whether the G3 does or not. And it means Asia’s monetary policies will depend more on what happens here in Asia and less on what happens elsewhere in the world."
- "The market environment is likely to get more unfriendly and challenging for bond investors in 4Q10 and 2011. Yes, US real GDP growth will be slow in the coming quarters, but slow growth is a far cry from recession and USD yields need to be a lot higher, if recession fears drop out of the picture. USD yield curves will steepen to discount an earlier and more rapid rise in short-term interest rates. If that happens, the bond market is not the place to be. Yield curves will steepen not only in the US, but also in Asia. Improvements in the macro outlook will oblige many Asian central banks to tighten monetary policy further in 2011 and expectations of that will put upward pressure on yields well be before actual rate hikes push shortterm rates higher."
- "Unless economic conditions deteriorate to an outright recession, which would force investment portfolios to reduce allocation of riskier assets, we do not see much downside for equities. We think Asia equities will continue to be well supported, underpinned by attractive valuations and resilient domestic and regional growth."

China banks: Stronger case for soft landing

- More concrete case for soft landing. "August macro data were encouraging. Two pillars of China’s economy, retail sales and industrial production, came in better than expected. Meanwhile, inflation remained manageable and looks set to decline in magnitude in 4Q10. China appears on track for a soft landing, and this bodes well for banks’ asset quality and earnings outlook."
- Bigger banks have less provisioning risk. "According to mainland press reports, banks may be required to hold provisions of at least 2.5% of total loans. This rumoured requirement will not impact the Big 4 banks, but will add provisioning pressure for smaller banks. We believe this requirement is too crude and unfair, since it does not consider NPL differences. Therefore, its implementation chances should be low. Nonetheless, we believe larger banks have better risk/return prospects amid this uncertainty."
- Turning slightly more optimistic. "We maintain our view that banking stocks will remain range bound in 2H10. Yet, given the encouraging August data and upcoming rights issues from the large cap banks, we believe banking stocks can trade towards the upper end of their ranges. Our top picks are large caps CCB and ICBC. We like CCB as it should be next in line to issue rights in October. Meanwhile, ICBC is a good laggard play, especially after the bank’s stellar 2Q showing."

The immaculate recovery

- "Seems like every time you turn around lately someone in the G3 is falling over. Earlier this year it was Europe: the Greek debt crisis spread across the continent, sovereign spreads rose and, in shades of Autumn 2008, libor-OIS spreads headed wider too. Belt tightening became the order of the day. Growth forecasts were lowered. Market sentiment soured."
- "None of this could be good for Asia, which, after all, exports as much to Europe these days as it does to the US. The region’s central banks, which had begun to tighten monetary policy in March, paused in May and June. No surprise; discretion is the better part of valor. But they resumed their hikes in July and August. Why? Because Europe wasn’t holding back Asia’s V-shaped recovery or its rapidly accelerating rate of inflation like they thought it might."
- "A handful of hikes in half a dozen countries later, it’s the US’s turn to take a spill. GDP growth drops to 1.6% (QoQ, saar) in 2Q10 and fears of a double-dip consume the markets. The Fed makes a symbolic shift back to strict neutrality and, rather than assuaging markets, only convinces them the sky is falling. Private sector hiring, still barely positive, drops to 67k in August from 107k in July."
- "None of this looks good for Asia either. The region’s central banks – still far behind the curve in normalizing interest rates – will once again put tightening on hold. They will, once again, wait to see how things pan out. And they will, once again, resume tightening in very short order."
- "By December, most of Asia’s central banks will be hiking rates again and we expect their ranks will, by then, include China and Indonesia, Asia’s two key holdouts so far (though Indonesia did raise reserve requirements by 300bps at one go last week, a move that’s probably equivalent to two 25bps rate hikes)."
- "How can Asia’s central banks push ahead with monetary tightening when the Fed is discussing QE2 (additional long-term bond purchases)? More to the point: why isn’t trouble in the US and Europe killing Asia’s recovery?"
- "The short answer is: the US and Europe did not contribute to it. Or very little anyway. If you only thrown a nickel into the pot, taking it back out again doesn’t change much."

- "Take a look at the consumption plots on the previous page. It’s important because consumption is the final demand that drives all other final demands, like investment or imports. At the end of the day, consumption drives global growth, period. And who is doing the driving? Asia. Almost by itself."
- "In the two years since Lehman Brothers imploded, consumption in the US has gone absolutely nowhere – it still has not returned to precrisis levels. Ditto for Europe. Ditto for Japan. But compared to precrisis (3Q08) levels, consumption in Asia is up by 18%."
- "Eighteen percent? Hold on a minute. This is Asia – the place that everyone said had to consume more. The place that could only save and could only export. The place that could not possibly grow unless the US was growing because the US was doing all the buying."
- "Yet there it is. Zero buying in the US. Zero buying in Japan and in Europe. And a boatload of buying in Asia. It’s the immaculate recovery – the thing that everyone said could never happen. The pregnant Asian shopper standing next to an utterly superfluous US, JP and EU."
- "That’s why Asia’s central banks will be back in tightening mode soon – because Asia’s recovery is not about the US. It’s about Asia. And there’s nothing fishy and certainly nothing religious going on here. The hard fact and simple arithmetic (that we’ve shown regularly over the past 4-5 years) is that Asia has been growing rapidly for years and, after a few decades, it adds up: Asia is no longer too small to matter. Among other things, this means Asia can and will consume whether the G3 does or not. And it means Asia’s monetary policies will depend more on what happens here in Asia and less on what happens elsewhere in the world."
- "Still, something doesn’t add up. Much of this report (below) argues that Asia is finally starting to slow down. If so, why will central banks start hiking again?"
- "Because Asia’s slowdown is being driven – or, rather, constrained – by the supply side, not by a slowdown in demand. Asia’s V-shaped recovery and double-digit GDP growth over the past 4-5 quarters have exhausted the excess capacity that used to exist. When that happens, output growth starts to fall and inflation starts to rise."
- "Asia may be slowing on the margin but central banks will have a tougher time dealing with inflation, not an easier time. And if the Fed (counter to expectations) goes ahead with QE2, Asia’s tightening will become all the more difficult. And all the more ‘ironic’."

China's medium-term inflation outlook

- "Average inflation, as measured by the CPI, has been largely on a downtrend in the past decade till early 2007 (Chart 1). Such a downtrend not only permits the central bank to cut interest rates in times of economic difficulty, but also encourages authorities to keep rates low even when the economy recovers. Real GDP growth is likely to accelerate to 10% YoY this year from 9.1% in 2009. The CPI is likely to rise from -0.7% to a projected rate of 4% (CPI averaged 2.7% in the first seven months of 2010) during the same period. Acceleration of the general price level has been faster than that of the real economy. Yet, the PBoC has chosen to keep lending rates on hold despite the fact that most Asian central banks have hiked interest rates."
- "We reckon that the PBoC's decision to hike rates will depend on the timing of the Fed hikes. The Fed seems unlikely to raise rates until mid-2011 and perhaps not until later. Weak economic data in the US have renewed fears of a double dip recession and mounting speculation over whether Beijing will start loosening (at least pertaining to those measures placed to cool the property market) towards the end of the year. Inflationary pressure, however, has been rising on most fronts, including wages (See China: Rising wage concern and China: Implications of rising wages (Part II)). China will soon have to choose between sustaining high growth at the cost of higher inflation or dampening growth in return for lower inflation."
- "Policymakers might be tempted to let interest rates remain at the current levels. After all, an annual inflation rate of 3% is perfectly acceptable when the real economy is growing at 10%. From a monetarist's perspective, the current inflation level may seem too good to be true. Broad money supply (M2) was advancing at 3.27x of nominal GDP in 2009, compared with an average of 0.91x between 04 and 08. The general price level started responding only one year later."

DBS Economics 20100827

Singapore: GDP contributions of the IRs

- "This year witnessed the openings of the two iconic integrated resorts (IRs), the Marina Bay Sands and Resorts World at Sentosa. While the government and the private sector had earlier provided estimates on the IRs’ contributions to the economy, latest GDP data may have shed more light on that. Based on our analysis, the IRs have added about SGD 470mn (0.3%) to the economy in the first half of the year. In fact, we can now expect a full year GDP contributions of about SGD 2bn from these two projects, which will account for about 0.7%-pt out of a 15% growth this year."

DBS Economics 20100826

JPY intervention risk rising

- "The prospect of currency intervention to stem the appreciation of the yen has surfaced in the past week. In examining the market’s arguments, and comparing Japan’s situation with other major economies, we think the risk of intervention is real and rising."
- "Intervention is normally considered an option when markets can not be relied upon to adjust prices according to fundamentals. The main conundrum confronting the yen is that markets have favored the currency in both bad times and good.
• When the global recovery story was strong, the argument was that Japan stood to benefit from increased demand in Asia. This sounds logical except that, unlike other Asian stock markets, the Nikkei slides when the yen appreciates. The stronger yen not only hurts the operating profits at Japanese manufacturers, but are encouraging more companies to consider shifting production offshore.
• When risk aversion sets in, the yen becomes a safe haven currency. With 56% of Japan’s exports headed for Asia, does it make sense for the yen to appreciate while Asian currencies depreciate during this period? Probably not.
• A more plausible explanation for yen strength is the inability of the US economy to shake off post-crisis worries that it was headed towards a Japan-style deflation. Put simply, it is more reasonably a case of USD/JPY accompanying US bond yields lower. But the thing is, investors are seeking safety in US bonds, not Japanese bonds during periods of risk aversion."
- "In our view, markets should not be too quick to dismiss Japan’s complaint about the excessive strength in its yen. To be sure, in falling alongside US interest rates, a lower USD/JPY has dragged Japan’s equities lower. In reflecting US deflation risks, a stronger yen increases the odds of deepening Japan’s deflation woes. With China’s economy surpassing Japan this year, it does not make sense for the yen to bear the brunt of the currency adjustment on behalf of the yuan. In this regard, the yen has already delivered more than its fair share of appreciation since 2008."

DBS Asian Currency Research 20100818

China: Implications of rising wages (Part II)

- Capital – labor substitution to accelerate "Rising wages should lead firms to to substitute labor for capital over time."
- Migration of investment to inland will intensify "Some manufacturers will choose to diversify their production across Asia as labor costs in China increase."

DBS Economics 20100804

Asia: votes of confidence

- "After a brief pause in June, Asia’s central banks are tightening again"
- "In the past two weeks, Taiwan, India, Malaysia and Korea have all hiked interest rates"
- "This is bread-and-butter economics. GDP in Asia is far above precrisis levels; inflation is nearly back to average. Interest rates must return to normal too, and they are"
- "The rate hikes are a loud vote of confidence from Asia’s central banks that growth will continue, despite weakness in Europe (and more generally, the G3)"
- "The world has not decoupled. The G3 matters, but Asia matters more"
DBS Economics 20100709

The ascension of the CNY

- "More strength to the CNY"
- "CNY flexibility is also about monetary policy, not just the exchange rate"
- "Trade data supports flexible CNY and gradual appreciation bias"
- "The yuan will become more international with reforms"
- "CNY policy changes tend to be forward looking"
DBS Asian Currency Research 20100709

China: Rising wage concern

- "Rising wage pressure is a growing concern for China. Major foreign invested enterprises (FIEs) such as Foxconn and Honda reportedly increased wage by an average of 30%. These numbers are seemingly alarming and will generate some spill-over effects to a certain degree."
- "From a historical perspective, total wages as a share of GDP has persistently fallen from 56% in the early 80s to around 35% in 08. Profit as a share of GDP, on the other hand, shot up rapidly from 20% in mid-90s to 31% in 08. Considering the fact that labor does not share as much as economic prosperity as entrepreneurs during the booming years amidst rising inflationary pressure, a one-off hike of 30% this year seems more like compensating their lost years."
DBS Economics 20100707