28 September 2018
Asia week ahead: Calm after the storm

After a hectic week, the Golden Week holiday in China should bring some calm to markets. The key question for next week is whether the Indian central bank will hike policy rates by more than 25bp?

A holiday-shortened week

Asian market liquidity is expected to be thin, as Chinese markets are closed for a holiday during 1-7 October, and Hong Kong, Korea, and India are also out on public holiday on other days of the week. Nevertheless, it's quite a busy economic calendar dominated by manufacturing, trade, and inflation releases and the central bank meeting in India.

The weekend release of China’s purchasing managers index, followed by PMI releases for other Asian economies on Monday will set the tone for the markets. The key focal point in PMIs will be the new export order components and we'll be keeping an eye out for what that says about the trade war impact. However, this is still a soft indicator.

ASEAN Morning Bytes

General market tone: Wait and see. The Fed’s widely anticipated rate hike was met with mixed reactions with Powell espousing looking more at economic data reports rather than Fed statements for clues as to where the FOMC were going.  Energy prices continued to trend higher as we inch closer to losing Iran’s oil supply in the world market

International theme: Keep watching the data in the US

  • Powell reiterated that the Fed would remain data dependent as it continues to gauge the appropriateness of monetary policy, telling markets to weigh economic data releases more than statements from FOMC officials.  Economic data showed core capital goods fell into contraction as did pending home sales. 
  • On the trade front, the US continues to be at odds with China and Canada, with prime minister Trudeau refusing to budge at the negotiating table while China denied allegations of favoring the Democratic party at the US mid-term election.
Philippines central bank whips out another 50 bps rate hike

The central bank raised its policy rate by 50 basis points to 4.5% as it looks to anchor inflation expectations

Central bank hikes to counter second round effects

With inflation well above the central bank's 2-4% target and clear signs of second round effects evident, the Bangko Sentral ng Pilipinas (BSP) looked to wield yet another 50 basis point rate hike to sniff out brewing concerns about prices pressures. 

The BSP hiked its policy rate to 4.5%, a move widely expected by the 20 out of 22 analysts surveyed by Bloomberg, as it continues to chase its inflation target for 2019. Price pressures persistently come from the supply side. However, the central bank has now vowed to reduce volatility in the exchange rate to help anchor inflation expectations. Furthermore, so-called second round effects in the form of wage increases and transport fare adjustment have been implemented.

Indonesia: BI walks the talk, hikes rates by 25bps

Bank Indonesia (BI) followed through on its pledge for pre-emptive steps by carrying out a 25 basis point rate hike. The bank's decisive stance has calmed markets as it promised to remain hawkish into 2019

Governor Warjiyo looks to remain ahead of the curve

Following through on his 5 September pledge to take “pre-emptive” steps to stay ahead of the curve as Indonesia faces new developments, the Bank of Indonesia nudged its 7-day reverse repurchase rate by 25 basis points higher to 5.75%. The move was widely expected and predicted by 27 out of 37 economists in the latest Bloomberg survey.

BI has increased its policy rate a total of 150 basis points for the year with Governor Perry Warjiyo looking to stabilise the Indonesian Rupiah (IDR) and keep local bond yields attractive to draw in foreign funds. In addition to rate hikes, Indonesia looks to roll out non-monetary measures to curb IDR weakness, expanding its policy toolkit to include measures such as limiting luxury goods imports, hedging instruments for corporates, and enticing exporters to convert half of their earnings to IDR. 

IDR stabilises after decisive BI

The Indonesian rupiah has depreciated by roughly 9.9% year-to-date as Indonesia’s current account deficit to GDP deteriorated to -2.36% in 2H 2018 from -1.71% at the end of 2017. In the wake of the emerging market contagion at the start of September, the IDR slumped to 14935, the weakest level since the Asian financial crisis, prompting Governor Warjiyo to signal immediate countermeasures to stem the tide. Since then, the IDR has stabilised with the government deploying further measures to stem the foreign currency outflows. 

Hawkish now, hawkish again tomorrow

With BI officials telegraphing that monetary authorities will maintain their current stance until next year, we can expect BI to remain busy deploying a host of measures to address IDR volatility. Central bank rate hikes moving in tandem with its planned hedging programmes and tax incentives for exporters will likely contribute to IDR stability in the near term, especially as Governor Warjiyo appears to enjoy a degree of credibility from the market.

Trade war eating up China industrial profits

While other data still have yet to show the trade war impact, industrial profits seem to show that the trade war is eating up profits of manufacturers in China, and even more so for foreign manufacturers

Trade war impact has started

Industrial profits of manufacturers in China slowed to 9.2% YoY in August from 16.2% YoY in July. These manufacturers include foreign investments in China.

Not only have profits slowed but account receivables have increased. The data pair reflects that manufacturers could, in fact, be earning much lower profit margins than reported if the account receivables cannot be collected in the future. 

At the same time, sales growth has also fallen.

Trade war has hit foreign-owned factories in China

Foreign-owned factories have faced slower profit growth (+7.6% YoY) than Chinese-owned private enterprises (+10.0% YoY), and of course more so compared to state-owned enterprises (SOEs) at 26.7% YoY. We believe that the higher profit growth of SOEs come from some projects that could be related to fiscal stimulus, eg, railway infrastructure projects. And those no so profitable infrastructure projects, eg, anti-pollution, could be under local government financial vehicles, which are not considered as local government entities but corporate entities.

Are these the result of the trade war? Yes!

We would like to explore alternative factors affecting industrial profits in China, but it is difficult to find an excuse not to blame the trade war.

Overcapacity reform has stopped since the start of the trade war in the middle of the year. In fact, financial deleveraging has become re-leveraging as interest cost has lowered quickly.

We, therefore, conclude that this slowdown in industrial profits is a result of the trade war. 

Taiwan central bank on hold while we cut our GDP forecast

We expect the central bank to stay put for 2018 and perhaps even for 2019 as it is difficult to cut interest rates to help a gradually slowing economy. The central bank has to save rate cuts as a last resort.

In the meantime, the trade war between China and US makes us revise our GDP forecast downward.

Economy is not good but not bad either for a rate cut, but it deserves a GDP downgrade

As the economy is too reliant on the manufacturing sector, and the trade war between Mainland China and the US could hurt the supply chain of the semi-conductor industry, Taiwan may be hurt by this trade war indirectly. 

This makes us revise our GDP forecasts downward for 3Q18 from 2.4% YoY to 2.0% YoY, from 2.5% to 2.4% for 2018, and from 2.4% to 2.0% in 2019.

We had thought that Taiwan might be able to gain from this trade war as a substitute manufacturer, but it seems that either this takes a long time or Taiwan's products are in fact part of China's products, which is very likely. Therefore Taiwan is hardly benefiting from the substitution effect of China's slower production of electronics due to this trade war.

So the Taiwan economy is not growing as fast as we have thought.

But it is not as bad as in a recession either. The central bank can only stay put for now and save the rate cut as a last resort.

Reading time around 7 minutes

Good MornING Asia - 28 September 2018

The outlook for Asian currencies is in large part a function of the strength of the USD, and the US currency shows few signs that it is willing to capitulate. 

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