Dovish ECB, Fed next; Trump-Xi to meet at G20; Indonesia & Philippines eye easing


The ECB has opened the door for easing. All eyes are on the Fed next. Trump-Xi to meet at G20 sparking optimism in the markets. Indonesia and Philippines may take the opportunity to cut rates.
Philip Wee, Eugene Leow19 Jun 2019
    Photo credit: AFP Photo


    FX: ECB turned dovish; Trump-Xi to meet at G20

    The euro did not recover with the Chinese yuan and other Asian currencies on Tuesday. The euro depreciated to 1.1180 from 1.1240 after European Central Bank President Draghi’s highly dovish speech at the ECB Forum in Sintra, Portugal. Draghi went from “we will ease if things worsen” to “we will ease if things don’t get better” sharply narrowed the gap with the bearish EU outlook baked into the bond market i.e. record low EU 10Y yields around -0.30%.



    Draghi’s remarks were followed by a plunge in ZEW Survey to -20.2 in June from -1.6 a month earlier, back towards the -20.9 reading in January. Draghi signaled that more stimulus could come at the next governing council on July 25 to return inflation towards its 2% target. Hence, the June EU CPI estimate scheduled for release on June 28 will be important. CPI inflation has been below 2% since November; it last fell to 1.2% YoY in May, its lowest since February 2018. Barring surprises in tonight’s FOMC meeting, we see a later Fed cut in September and more euro weakness towards 1.10.

    Emerging Asian currencies staged a relief rally after US President Trump tweeted the likelihood of an “extended meeting” with Chinese President Xi at next week’s G20 Summit in Osaka. Hopes for an easing of trade tensions bolstered the offshore CNH to 6.90 from 6.93 against the USD. Notably, the South Korean won soared to 1175 from 1186 in a single day, stronger than the 1177 level on May 10, the day when Trump increased tariffs on USD200bn of Chinese imports to 25% from 10%. Unlike the G20 Summit last December, there will be more caution than optimism in expecting both countries to return to the negotiation table and hold off Trump’s threat to hit, after next week’s G20 Summit, a 25% tariff on the remainder USD325bn of Chinese goods. What’s clear is that a further escalation in global trade tensions will hurt the outlook for China and the Eurozone with resultant policy measures that cushion their economies depreciating their currencies.

    Rates: Dovish ECB, Fed next

    Draghi opened the door for European Central Bank (ECB) easing, driving 10Y German below -0.3% (a fresh low). With rate cuts and quantitative easing (QE) both on the cards, shorter-tenor bonds also benefitted with 2Y yields dropping to -0.76%. Prolonged economic uncertainties and weak macro numbers have depressed inflation expectations driving the 5Y5Y inflation swap to an all-time low of 1.13% just a few trading sessions ago. The ECB is more dovish than what we and market participants have been expecting thereby explaining the sharp rally in European govvies. EUR rates now price in a 14bps drop (about 1.5 cuts) in the deposit rate by the end of the year. At this point, there does not appear to be any concerns on the unintended consequences of negative rates or the limited pool of sovereign debt in several Eurozone economies (notably Germany).



    The upshot is that DM rates are going to be lower for longer with the environment becoming increasingly like 2011/12 when the Fed and the ECB were running QE and dovish forward guidance. If the Fed turns out to be dovish (FOMC outcome tonight), US Treasuries would ride the easing tailwind from these two central banks. 10Y UST yields pushing below 2% has become a distinct possibility. In any case, yield is already scarce in the DM space with the amount of negative yielding debt ballooning to USD 12.5tn. With these developments, there are downside risks to our G3 rates forecasts.

    Rates: Indonesia & Philippines eye easing

    Conditions are favourable for Asia govvies, which generally offer higher absolute yields. Moreover, lower US yields (and a dovish Fed) should provide central banks enough cover to embark on further easing, Bank Indonesia (BI) and Bangko Sentral ng Pilipinas (BSP) meet tomorrow (post-Fed outcome) and we suspect that the probability of rate cuts is high. BSP has already cut rates once this year and consensus is looking for another to be delivered. The Philippines does not face external funding constraints and with inflation looking benign, we think government bonds will continue to fare well even after the sizable rally over the past few months.

    Meanwhile, BI has held back from cutting rates even as peers in the region have already embarked on easing. A widening trade deficit due to depressed commodity prices and concerns about USD strength have prompted prudence from the authorities. However, risks of rate cuts are significant. The timing of the cut may be predicated on the Fed’s tone and the reaction across the rates and FX space. An overtly dovish Fed, lower USD rates and stable USD/IDR could be sufficient to tilt BI towards easing.

    Philip Wee

    FX Strategist - G3 & Asia
    philipwee@dbs.com

    Eugene Leow

    Rates Strategist - G3 & Asia
    eugeneleow@dbs.com

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