Brief stimulus-driven EMFX relief; can RBI keep up with expectations?

Asian currencies remain vulnerable to Chinese financial and growth risks despite stimulus expectations. Further pullback in INR 10Y yields will be shallow ahead of this week’s data releases.
Wei Liang Chang, Radhika Rao10 Sep 2019
    Photo credit: AFP Photo

    FX: Stimulus-driven relief may be short-lived

    Sentiment has improved on additional monetary stimulus from China via RRR cuts over the weekend, and Germany stating that it could review its budget plans amidst recession fears. The net impact is that safe havens have pulled back, with both the USD and JPY easing on a broad basis. That said, China’s structural issues may still outweigh near-term fiscal and monetary stimulus boost. Chinese corporate credit stresses had become uneven, with several corporate issues trading at distressed levels. These distressed bonds are slated to mature in 2020, and heightened default risks could induce volatility going forward. Refinancing risks still loom large for the HY corporate bond market. Furthermore, Chinese growth relief remains painfully absent. Underwhelming Chinese export outturn for August points to external demand remaining in a funk, while consumption has also softened. As such, Asian currencies remain vulnerable to Chinese financial and growth risks despite stimulus expectations.

    India: INR OIS curve prices in aggressive easing

    INR sovereign 10Y bond yield (generic) has been in a holding pattern between 6.5-6.6% in the past week. Rising rate cut expectations, after a weak set of growth numbers, cap yields, whilst an upcoming new 10Y issuance mark a floor at 6.5% for the old paper. Further pullback in yields will be shallow ahead of this week’s data releases – August inflation, due Thursday, likely hastened to 3.4% YoY vs FY-to-date average of 3.1%. Poor weather conditions hurt supplies, especially of perishables and vegetables. Retail fuel prices were marginally lower despite a weaker rupee but offset by a continued rise in the precious metal prices, reflected in a higher miscellaneous category. Industrial production likely stabilized at weak levels of 2.8% YoY. The uptick in August inflation will be factored into the early-October RBI rate review, but likely overwhelmed by growth concerns.

    Short-term INR yields continue to drift down on easing expectations. The OIS curve is signalling the likelihood of a steeper correction – 5Y OIS is down from ~6.7% in late 2018 to sub-5% this month, with OIS spreads vs 5Y bond yield at ~130bp presently, widest in seven years, vs 50bps in December 2018. 2Y OIS spreads have also widened to 136bps vs 70bps in late last year. While policy rates are headed down, the rates market is pricing in more aggressive easing than the RBI may be comfortable with, especially after undertaking 110bp of cuts already this year. More modest cuts are on the anvil, before fiscal policy assumes a bigger role in supporting growth. Lingering concerns over fiscal policy and non-banks stress has restrained a sharper fall in the INR bond yields this year. Offshore OIS rates have also fallen sharply, reflecting a drag from global yields as well. On the credit end, state-run banks are returning to the rupee bond markets, to tap a return in appetite, after the government announced mergers of multiple entities and jumpstarted capital infusion announced last month.

    Chang Wei Liang

    Credit & FX Strategist

    Radhika Rao

    Economist – India, Thailand & Eurozone

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