Asia FX caught between Fed cut & a slowing China; Take a wider perspective on Fed easing


Asia FX caught between Fed easing and slowing Chinese growth. Fed cuts should be viewed from a global perspective.
Philip Wee, Eugene Leow15 Jul 2019
    Photo credit: AFP Photo


    FX: Caught between Fed cut and a slowing Chinese economy
     
    Emerging Asian currencies are caught between a dovish Fed and prospects for a slower Chinese economy. Fed Chairman Jerome Powell has opened the door for a 25 bps insurance rate cut at the next FOMC on July 30-31. The Fed’s Beige Book report scheduled for release on July 17 will be heavily scrutinized on the timing of the second cut expected later this year. Given the Fed’s emphasis on global headwinds on the US economy, advance GDP estimate on July 26 will probably be more important. Consensus expects growth to slow markedly to 1.8% QoQ saar in 2Q19 from 3.1% in the first quarter. Our view remains for a second cut in the final quarter of the year. The USD Index (DXY) has proven resilient and has continued to hold the 96-98 range it has been mostly within since February.
     
    China’s economy is expected to resume its slowdown after the re-escalation in China-US trade tensions in May-June. We forecast today’s real GDP growth to slow to 6.2% YoY in 2Q19 after two straight quarters of stable 6.4% growth. This coupled with Fed cut expectations have opened the door for more monetary easing to support growth at the floor of this year’s official 6-6.5% target range. Worries have also surfaced that if China and US cannot agree to a trade deal this year, they are unlikely to strike one during the US elections next year. China wants the US to roll back all tariffs while the US is unhappy with China’s state-directed economic model. For now, the market sees the mid-rate for USDCNY holding the 6.85-6.90 range it has been after mid-May.
     
    Rates: Take a wider perspective on Fed easing

    Aside from the payroll bounce last month, US core CPI is also running above 2%. Based on the Fed’s dual mandate and the fact that equity markets are holding up, it does seem odd that consensus and the market are aggressively reflecting a Fed easing cycle over the coming quarters. Based on this narrow view, Fed cuts (if delivered), would deliver steeper US curves (3M/10Y). Shorter-term USD would have to follow the Fed funds rate lower while longer-term rates would reflect high inflation expectations. Some of this is already happening as USD rates are implying much steeper forward curves.

    Upcoming Fed easing can be better understood from a global standpoint. Rather than waiting for US data to weaken, policy makers have gravitated towards “insurance cuts” to preempt a slowdown. Notably, with data across China (GDP numbers are due today) and the Eurozone not showing any signs of a turnaround, risks of negative spillover unto the US economy should not be underestimated. In any case, the Fed has embarked on “insurance cuts” before. In these instances, the easing cycles tend to be much shallower (2-3 cuts).

    Also, ongoing global growth slowdown has a dampening effect on longer-term USD rates. As 10Y German yields (and European counterparts) push new lows, US yields (which are highly correlated) get dragged down. The interplay between global growth dynamics and Fed action will determine the shape of the USD curve. An aggressive Fed response points to a steeper curve and vice versa.

    Philip Wee

    FX Strategist - G3 & Asia
    philipwee@dbs.com

    Eugene Leow

    Rates Strategist - G3 & Asia
    eugeneleow@dbs.com


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