Stress ahead for EM; USTs supported

Stress building in emerging markets. Treasuries supported amidst risk aversion.
Philip Wee, Eugene Leow, Radhika Rao13 Aug 2019
    Photo credit: AFP Photo

    FX: More stress ahead for emerging markets

    Recession fears continue to fuel investors’ flight from equities into bonds and safe-haven currencies such as the Japanese yen and Swiss franc. Manufacturing purchasing manager indices have been weak in China and across large EU countries and spilling over into the US. The US 10Y bond yield has fallen to 1.65%, its lowest level since October 2016. Back then, the Fed Funds Rate was only 0.50% vs 2.25% today. While the S&P500 Index has returned 28% of this year’s gains, it was still up 15% ytd.

    Emerging Asian (EA) currencies, already under pressure from renewed China-US trade tensions, are set to feel the heat from the Argentine peso’s plunge on Monday. At its worst intra-day level of 62 vs the USD, the ARS had depreciated 27% before ending the session 15% weaker at 53. Fears of Argentina defaulting on its debt increased after the centre-left opposition leader Alberto Fernandez won the election primary. His victory was viewed as a backlash against the austerity measures (put together with the IMF) under market-friendly and centre-right President Mauricio Macri. Argentine and emerging markets are likely to be volatile ahead of the Argentine presidential elections scheduled for October 27.

    In Singapore, the government has downgraded its 2019 growth forecast to 0-1% from 1.5-2.5% previously. The downward revision has strengthened, against a dovish global environment, the case for an easing in the SGD policy in October. The central bank has clarified that it was not considering an off-cycle policy meeting. The SGD nominal effective exchange rate (NEER) has been depreciating towards the mid-point of its policy band as we expected. In USDSGD terms, our model estimates the lower half of the policy band around 1.39-1.42.

    Rates: Lack of viable alternatives support USTs in dicey environment               
    Flight to safety, fear of missing out and increasing concerns on the global economy continued to support US Treasuries. While a lot of attention is focused on the 10Y yield, we are more worried about the 12bps collapse in 30Y yields to 2.14% (a fresh low for the year and just a few bps off the all-time low of 2.10% registered in mid-2016) in a single trading session. By many measures, the rally in USTs looks stretched and yields are now uncomfortably low relative to how the US economy is doing. Moreover, the equity selloff is not severe enough to prompt the Fed to act with more urgency.

    We reckon that yield scarcity at a time when uncertainties are abound probably exacerbated the yield collapse. Over the coming few weeks, market participants must deal with upcoming US tariffs on Chinese imports, the possibility of hard Brexit and political uncertainties in Argentina and Hong Kong. With a large chunk of European govvies already negative yielding, there are limited avenues for investors to seek safety. US Treasuries (and perhaps SGSs and gold) are the few choices that come to mind. We are neutral on USD rates, noting that these levels are expensive but the lack of alternatives may just prompt investors to pile on as the outlook gets more dicey.

    Philip Wee

    FX Strategist - G3 & Asia


    Eugene Leow

    Rates Strategist - G3 & Asia

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