GBP on a slippery slope; INR and equities underperform
The UK parliament voted 328-301 yesterday to block a no-deal Brexit, with some Tory voters openly defying PM Johnson in order to avoid a no-deal scenario, and are thus forced out of the party. As such, Johnson’s coalition has lost its majority of one, and he now leads a minority government. On Wednesday, the anti-“no deal” faction will put forward a draft law to force the PM to delay Brexit until Jan 31, which heighten risks of a general election. This will require support from two-third of MPs, and the Labour party might demand that legislation be put in place for an extension before acceding to elections. We expect GBP to remain extremely volatile as political developments evolve.
The RBA left rates unchanged yesterday, as it sees the outlook to be supported by tax cut, signs of housing market stabilization and more positivity over the resources sector . Importantly, the Bank noted signs of a turnaround in the Sydney and Melbourne housing markets. This could imply a higher hurdle for more rate cuts, even as it expects below target inflation in 2020. AUD/USD rebounded post-RBA to trade back towards mid-0.67. Australia will likely report its lowest y/y growth since the GFC today, but Q2 sequential growth may come in less negative, supported by election-related spending.
In Asia, the INR was the worst performer in Asia yesterday, with USD/INR surging to a 2019 high of 72.40 in a delayed reaction to weak Indian Q2 GDP and news of a government-led banking consolidation. Equity investors largely reacted negatively to the government’s plan for the four state-owned banks to merge with weaker lenders, and are also perhaps shaken by the markedly weaker Q2 growth outturn on Friday. The Nifty 50 index dipped by over 2%, while the four anchor banks at the centre of the mergers—Punjab National Bank, Union Bank of India, Canara Bank, and Indian Bank—also saw significant 2-6% declines in their share prices. A coincidental rating cut for a large Indian NBFC yesterday added further to the glum mood for the rupee and the economy.
India: Rate-cut repricing bets to steepen the yield curve
India’s markets reacted negatively to a weak set of growth numbers out on Friday (markets were closed on Monday), after 2Q19 GDP rose 5% YoY, the slowest since 2013. Benchmark indices were down 2%, dragged by bank stocks which declined in reaction to a government driven banking sector consolidation. Caution spilled over into the rupee, which was already under pressure from a strong USD and weak CNH; the INR depreciated >1% in the day, to a fresh low for the year. 3Q-to-date decline in the INR stands at 4.7% vs USD, weakest amongst AXJ peers.
In rates, INR 10Y yields (generic) eased at open but found a floor at 6.5% as the growth slowdown brings stimulus expectations back to the fore. Dips in the 10Y yields are likely to be shallow in the near-term on profit-booking interests and ahead of upcoming issuance of a new 10Y paper. Recent policy measures have tread the thin line of corrective measures and tightening implementation gaps, but with minimum fiscal costs. If the slowdown appears entrenched, calls for broader stimulus may gain traction.
Weak growth and concerns over earnings have seen foreign portfolio investors rotate out of equities and into debt. INR debt markets have attracted USD3.6bn inflows this FY and into equities has thinned to USD0.3bn, following a hefty USD4.3bn outflows since July.
For rest of the curve, repricing in rate cuts are likely to drag yields lower. Following the weak growth numbers, we expect another rate cut in December, in addition to a move in October. As noted last week, yields in the belly and short end of the curve have continued to soften, with bias for further downside, steepening the yield curve. Policy transmission has been more pronounced in the debt markets than bank lending rates, as systemic liquidity has been in net surplus in the past two months, suggesting a subtle change in the RBI’s liquidity stance. A handful of banks have already signaled a move to link their lending rates to external benchmarks (repo rate as a start), which opens the room for further reduction in borrowing costs in the immediate term.
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