Reality check after last week's burst of optimism


MAS eases. Reality check after last week’s burst of optimism. Fed does QE-lite.
Philip Wee, Eugene Leow14 Oct 2019
    Photo credit: AFP Photo


    FX: MAS eases; reality check after last week’s burst of excessive optimism

    The decisions at this morning’s SGD policy review were broadly in line with expectations. As expected, the Monetary Authority of Singapore slightly flattened the slope of the SGD nominal effective exchange rate (NEER) policy band and kept its width and centre unchanged. According to our model, the band should start appreciating at a pace of 0.5%/year vs 1% previously. The central bank has kept the door for another easing should the already weak growth/inflation outlook deteriorate significantly.

    In our view, the SGD NEER is still considered strong in the upper half of its policy band. In USDSGD terms, the downside is constrained by the band’s limit at 1.36 and should be closer to the mid-point around 1.39. The recent fall in USDSGD to 1.37 from 1.3850 in early October was attributed to the temporary rollback in trade war and Brexit fears. A reality check is likely to set in this week after the burst of optimism last Thursday-Friday. Our forecast remains for USDSGD to rise above 1.40 by end-year.

    The partial China-US trade deal has suspended the US tariffs that is scheduled to increase tomorrow to 30% from 25% on USD250bn of Chinese goods. This has simply temporarily halted the escalation in China-US trade tensions. Longer term concerns remain that the trade war may widen from tariffs towards impeding investment flows between the two countries. The temporary truce between China and US could also see the Trump administration turning its tariff war towards the Eurozone.

    The Brexit deal that Prime Minister Boris Johnson is trying to put together with the EU is already considered worse than his predecessor’s withdrawal agreement. Without the consent of the House of Commons for the UK to exit the EU with or without a deal by October 19, PM Johnson is still required to request this Saturday the EU for a Brexit extension to January 2020. Brussels is keen to avert a no-deal Brexit on October 31 and would prefer a longer extension to June 2020 if UK supports new elections or another referendum. Unfortunately, the fragmented UK House of Commons has only agreed to disagree on all issues.

    Rates: Fading of excessive pessimism in the bond market; Fed announces QE-lite   
                           

    We had thought USD interest rates were overly low when 10Y yields were hovering around 1.50%. That has since played out as 10Y yields climbed above 1.70% on the back of a scaled down China-US trade deal (at the October round of tariffs got suspended) and fresh hopes of a Brexit deal. To be sure, the bond market has been the most pessimistic amongst the asset classes amid increasing uncertainties and increasing signs that even the US economy (which has been resilient through the global cyclical downturn) may be slowing. However, this rendered the market vulnerable to any bit of good news that has been in shortfall for much of the year. We reiterate our 10Y yield forecasts at 1.75% for end-2019.

    Meanwhile, the Fed announced a series of steps to address funding concerns (see here). The steps taken are aggressive – buying USD60bn of T bills through at least 2Q20 and the conducting of overnight and term repo operations through January. We had estimated that the Fed needs to expand its balance sheet by around USD150-200bn (see here) but the Fed indicated that it would buy at least USD400bn (if the programme stops in April). Liquidity should become flush by early 2020 and we suspect that the private sector’s use of the repo facilities should start to taper accordingly. We think that the Fed should have done enough to assuage concerns on funding. Beyond 2Q, we think that the pace of bill buying should slow into the USD10-20bn per month range.

    Philip Wee

    FX Strategist - G3 & Asia
    philipwee@dbs.com

    Eugene Leow

    Rates Strategist - G3 & Asia
    eugeneleow@dbs.com

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