Weak German PMIs; INR bonds and fiscal stimulus

The German economy has been hit by the global manufacturing slump and ongoing trade tensions. Indian bond markets shift focus from oil to fiscal math.
Eugene Leow, Radhika Rao24 Sep 2019
    Photo credit: AFP Photo

    Rates: Weak German PMIs should stoke fiscal stimulus odds

    Germany’s manufacturing PMI slumped to 41.4 (against expectations of 44.0), increasing the odds of a technical recession. The German economy has been hit by the global manufacturing slump and ongoing trade tensions with GDP shrinking by 0.1% (QoQ) in 2Q. Industrial production also touched a decade low of -4.2% (YoY) in July. With PMIs showing a deepening contraction, the German curve bull flattened, with 30Y yields diving by 9bps overnight as market participants bet on even more aggressive monetary policy.

    While it makes sense to buy govvies in an economic slowdown, we are wary with German yields at these depressed levels (yields out to the 30Y tenor are back below zero). Conditions for fiscal stimulus are building and there is an increasing chance that a package could be in the offing. While a balance budget was presented in early September, there is a possibility of off-budget spending on climate-related initiatives. Perversely, we think that the worse the economic data, the higher German yields should be as fiscal stimulus gets considered.

    India: INR bonds focus back on fiscal health

    Indian bond markets shift focus from oil to fiscal math. The government’s move to cut corporate taxes (see here) triggered >20bps jump in 10Y yields towards 6.79%, before stabilising at 6.75% on Monday.

    Markets seek clarity on how the revenue shortfall will be funded, and official commentary is being watched closely. Signs emerged that the fiscal deficit target will be reviewed later in the year, when the need for extra borrowings will also be assessed. Unofficial remarks tempered expectations that a relook at the offshore sovereign bond issue was on the cards. Signs are that 2H borrowing schedule, which is due shortly, will remain unchanged. 1H borrowings stood at INR4.4trn (62% of annual) conducted through a weekly auction of INR170bn through April-September. This might leave the 2H quantum at less than INR3trn, with any increase likely to surface in the final quarter. New 10Y bond issue is also due, with the auction calendar under watch. Longer-tenor yields have thereby found a floor above 6.60-6.65% ahead of the new issue and in midst of fiscal uncertainty, likelihood of extra borrowings in late FY and still lingering Middle East tensions (reflected in a smaller correction in oil after last week’s jump).

    Curve steepening bias remains, as the short to belly of the yield curve is held down by rate easing expectations (following a spike post-corp tax cut). With the fiscal boost focused on investment revival and not consumption (hence not inflationary), we reckon that the RBI MPC might proceed with a 20bp cut at the October MPC. Governor Das also reinforced his dovish bias recently, due to weak inflation and a negative output gap.

    Eugene Leow

    Rates Strategist - G3 & Asia

    Radhika Rao

    Economist – India, Thailand & Eurozone

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