Sustainability of the ongoing asset market rally

There is little room for complacency. Many preconditions are still needed to sustain the relief rally on easing trade tensions and Brexit worries.
Philip Wee, Duncan Tan11 Oct 2019
    Photo credit: AFP Photo

    FX: A welcome relief rally but is it sustainable?

    The week is looking forward to end on an optimistic note, a stark contrast from its dismal start. The offshore Chinese yuan has appreciated 0.4% on October 10, fuelled by hopes for a partial trade deal on the first day of China-US trade talks in Washington. The British pound surged 1.9% on Thursday that UK Prime Minister Boris Johnson and his Irish counterpart Leo Varadkar may have found a “pathway to a possible Brexit deal”. Even so, there is little room for complacency. Many preconditions are still needed to sustain the relief rally on easing trade tensions and Brexit worries.

    To affirm a temporary trade truce, the second day of trade talks (today) will need US President Donald Trump to suspend or cancel the US tariffs that are scheduled to hit on Chinese goods October 15 and December 15. Longer term, the broader China-US trade war remains unresolved. The US’s latest measures to limit capital flows to China and US investments in China suggest that the US is looking beyond tariffs to step up pressure on China towards the “big deal” that President Trump wants.

    Any Brexit deal would need the support of all EU27 nations and fragmented UK House of Commons. Expect more rhetoric and volatility into the European Council meeting on October 17-18. UK lawmakers will probably prefer Prime Minister Johnson to request, under the Benn Act, the EU for a Brexit extension by October 19. Brussels is willing to consider a delay if UK holds and election or referendum. A no-deal Brexit can be averted on October 31 if PM Johnson abandons his “do or die Brexit” for a “People vs Parliament” election in December or later. Unless the polls are wrong about a hung parliament at the next elections, there is still no resolution to the Brexit mess.

    Rates: Fiscal easing in Asia to steepen bond curves

    Three Asian countries (India, South Korea and Thailand) have recently stepped up on fiscal support, to complement easier monetary policy, in boosting economic activity. All else equal, fiscal loosening and the resultant increase in bond issuances should steepen bond curves and widen bond-swap spreads. For India, the government has cut the corporate tax rate from 30% to 22%. While the estimated USD20bn tax cut cost is expected to be partly offset by RBI dividend, our economist sees rising risk of a miss to the FY20 fiscal deficit target of 3.3% (budgeted). This has been greatly reflected through steepening of GSec curve and persistent widening of GSec-OIS spreads.

    For South Korea, prospects of more expansionary budgets have had little impact on the KTB curve. Based on the 2020 Budget proposal (link), fiscal deficit is expected to increase from 1.9% to GDP in 2019 to 3.6% in 2020. From 2021 to 2023, government spending is projected to rise at an average rate of 5.6% per year. As a result, government debt to projected to climb significantly, from 37.1% to GDP in 2019 to 46.4% in 2023. We think markets are under-pricing the size of future increases in net issuances and its impact on KTB curve. Steepening pressures could intensify in the following months as market pricing catches up. In terms of yield levels, greater supply-related risk premium would offset some of the downward pull by the weak economic outlook. Hence, we have turned more neutral on the direction of KRW rates vs bullish previously.

    Philip Wee

    FX Strategist - G3 & Asia

    Duncan Tan

    FX and Rates Strategist - Asean

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