18 October 2018
Indonesian and Philippines central banks can afford to hit the pause button

Bank Indonesia (BI) and Bangko Sentral ng Pilipinas (BSP) can keep the powder dry as pressure on emerging markets eases in October

Relative calm affords some breathing room

Two of the busier Asian central banks this year have been the Bank Indonesia (BI) and the Bangko Sentral ng Pilipinas (BSP), both having hiked their policy rates by a cumulative 150 basis points in 2018.  BI has been aggressive in tightening monetary policy to provide financial market stability and to ensure “that the country’s financial markets remained attractive to investors”, according to Governor Warjiyo (pictured).  Meanwhile, the BSP has unleashed a flurry of rate hikes, with the last two policy actions being more forceful 50bp rate adjustments, as domestic inflation moved well-past their 2-4% target range.  

With risk sentiment improving somewhat in recent sessions despite elevated levels for oil and Treasury yields, we’ve witnessed both the Indonesian Rupiah (IDR) and Philippine Peso (PHP) strengthened over the past week.  Positive economic data has helped improve sentiments towards the two currencies. Indonesia’s trade balance swung to surplus in September from deficit in the previous month, while the government budget also improved to produce a smaller than target fiscal deficit this year. And in the Philippines, inflation slipped below market expectations in September.  Given these developments, the respective central banks are under less pressure to hike rates further, at least for their upcoming policy meetings, while still leaving the door open for respective 25 basis point rate hikes by the end of the year. 

European reform: ‘no sense of urgency… but it’s urgent’ 

Eurozone reform is once again overshadowed by Brexit and Thursday's Euro Summit was no exception. In the last two years, new reforms have been postponed again and again. The sense of urgency is still there, but disagreements among member states are unlikely to be bridged this year

Eurozone reform was on the agenda, but not top of mind

With Brexit and migration completely overshadowing this week's EU summit, you might not have noticed that monetary union reform was also on the agenda at the so-called Euro-summit, a lunch meeting at the end of almost two long days. As expected, no decisions were made but the plan to have further reform of the monetary union centre stage at the December summit was confirmed. In June, EU leaders decided they would revisit the reform agenda at the end of the year. Whether the December Summit will really bring a breakthrough is far from certain. Final words by European Council President Donald Tusk were not really encouraging as he stated that technical work had to be accelerated and that he hoped that today’s discussion would inspire the Eurogroup to act more dynamically. European language for “a lot has still to be done”.

Any breakthrough is far from certain

Thursday's meeting focused more on containing existing problems than on shaping the future. The economic uncertainty that the Eurozone faces was not lessened by the summit. As the Brexit negotiations will go down to the wire, downside risks to the outlook remain. Concerns about the Italian budget are also there, which was discussed just briefly at the Euro Summit as that remains a matter for the Commission and not European leaders for the moment.

While European Commission President Juncker said at the press conference that there is “no sense of urgency, but it’s urgent” about Eurozone reform, the question remains whether meaningful strengthening of the Eurozone can be achieved. More concrete steps towards completing the banking union still need to be taken, but President Juncker says that only a handful had been agreed so “there remains ample work until December”. The danger, of course, is that the December Summit could be overshadowed again by the Brexit debate, postponing Eurozone reforms to 2019.

ECB preview: Ending QE is not the biggest threat

The Federal Reserve may be President Trump’s “biggest threat” but in the eurozone, tighter ECB policy is way down the list of things to worry about    

What a difference six weeks can make

What a difference six weeks can make. If anything, the downside risks to the eurozone’s growth outlook have increased. Stock market turmoil, mixed hard data for the month of August and further tensions in emerging markets have added to what the ECB often calls global risks. At the same time, the never-ending Brexit saga, higher oil prices as well as the swelling conflict on the Italian budget all have the potential to weigh on what has been the eurozone’s biggest trump card so far: solid domestic demand.

Let’s be clear: up to now, the latest developments do not amount to additional risks, nothing has materialised yet and there is no guarantee it ever will. The eurozone recovery is still characterised by solid to strong domestic demand due to higher employment, falling unemployment and low interest rates. Meanwhile, exports have not been affected by trade tensions but rather have benefited from a weak euro and some moderate, though positive, fiscal stimulus.

Still, downside risks to the economic outlook have increased and the inflation outlook remains mixed. Headline inflation has been hovering around 2% in recent months, mainly due to higher energy prices. At the same time, core inflation is still not doing what the ECB expects it to do, namely, pick up. From the minutes of the September meeting, it is clear that the ECB still believes that supply-side constraints should translate into higher core inflation. However, evidence of this actually materialising remains very scarce. In this context, ECB President Mario Draghi will probably have to spend some time during the press conference explaining what he meant by a “relatively vigorous” pick-up in underlying inflation when he spoke at the European Parliament. We don’t expect him to repeat these words.

Brexit blog: What the latest impasse means for the UK economy

As Brexit negotiations stall, the ever-increasing uncertainty surrounding 'no deal' could see businesses take more concrete action and consumers turn even more cautious. For the Bank of England, this makes a rate hike unlikely before March 2019

As another crunch EU Council meeting comes and goes without agreement, the critical issue of the Irish backstop - the insurance policy that would kick in in the event of the UK leaving the single market and customs union - remains unresolved.

Two weeks ago, we discussed how a possible compromise appeared to be in the offing, which would see the UK government accept the EU's backstop proposal, if Brussels kept the door open to Britain remaining in a customs union as a whole. In other words, this plan, which has been rather clunkily labelled the "backstop to the backstop", would eliminate customs checks between Northern Ireland and the rest of Britain in the event the backstop kicked in, but would require goods to be checked against EU rules.

Over the past few days, there have also been indications from both sides that the door could be left open to extending the transition period beyond December 2020. In theory, this would allow more time to find a more workable solution to the Irish border challenge - and in any case, the length of the transition period as it stands is unlikely to be long enough to agree upon the overall future trading relationship.

As ever, the challenge has been to conjure up a 'wording' that will convince enough UK lawmakers to approve this fudge - and recent reports suggest that even the most creative choice of policy wording may not be enough to reassure MPs from the Democratic Unionist Party or Conservative Brexiteers. The DUP has long been concerned about the spectre of regulatory checks between Northern Ireland and the rest of the UK, while Brexiteers within the Conservative Party worry the mooted customs compromise could effectively see Britain tied to the EU for long after the transition period ends.

We are unlikely to know for sure whether 'no deal' has been averted until much closer to the UK's scheduled exit date

Nobody really knows exactly how many of these MPs could ultimately reject the deal when it comes to Parliament. But with no obvious way of squaring the circle, it looks increasingly likely that the UK government is going to play for time. The later the Prime Minister can leave agreeing a deal with Brussels, the later the Parliamentary vote will be held. This would mean the choice MPs face would become a much more binary decision between PM May's agreement, and an economically-risky 'no deal' scenario.

If this is indeed the tactic, it looks increasingly likely that a deal won't be settled until the December EU Council meeting. Given that this summit comes just days before MPs leave for the Christmas recess, it seems likely that the 'meaningful vote' would then follow in mid-to-late January. The government is obliged to give lawmakers a say by 21 January.

In short, we are unlikely to know for sure whether 'no deal' has been averted until much closer to the UK's scheduled exit date in March.

For the economy, this could see growth momentum slow again over the winter as uncertainty rises - and there are two key factors in particular that we think will be worth keeping an eye on:

Opportunities and threats for EU firms in the US-China trade war

The hot topic at Thursday’s Asia Europe (ASEM) meeting will no doubt be the China-America trade conflict. There are opportunities here for European firms, but potential harm too

Why we are where we are

In the first week of September, the US announced another round of increased tariffs targeting a group of import products from China worth some $200bn. Shortly after, China announced its retaliation, raising tariffs on 60 billion dollars-worth of US products. Currently, the trade flows covered by both countries' tariffs add up to approximately 2% of world trade. An escalation of trade tensions between the EU and the US is on hold after President Trump and the EU's Jean Claude Juncker started trade negotiations in July, but this does not mean the EU remains unaffected by the conflict between the US and China.

Russia: Weaker consumer activity - a challenge to budget conservatism?

Retail trade growth decelerated to 2.2% year-on-year in September, below expectations, despite unemployment dropping to a new low of 4.5% and real salaries growing more than the expected rate of 7.2% YoY. The apparent higher preference for savings suggests that households are bracing themselves for a possible deterioration in the economy

The official reading of September retail trade growth was 2.2% YoY, below the 2.4% consensus and our 2.3% forecast. It also marks a deceleration from the 2.8% YoY rate seen in August. We think this is a case of deteriorating expectations, rather than an actual erosion of fundamental income trends. The unemployment rate declined to a new record low of 4.5% vs. the market expectation of an increase to 4.7%, and real salary growth surprisingly accelerated to 7.2% YoY, higher than the 6.0-6.5% YoY expectations and the August reading of 6.8% YoY.

The persistent strength in income growth fundamentals (we disregard the real disposable income metric due to its inherent statistical imperfections) suggests that the deterioration of consumption reflects a higher preference for savings, which is a standard defensive reaction from Russian households amid growing uncertainties. Indeed, the recent polls ordered by the Bank of Russia show a noticeable drop in consumer sentiment since May this year. Possible reasons include higher geopolitical uncertainties as well as local factors such as the end of the electoral cycle, the decision to increase the retirement age, the VAT rate increase and tighter monetary policy signals.

We also note that the deceleration in retail trade was attributable mostly to the food segment, while non-food retail growth totalled 4.1% YoY, which is very close to the August level of 4.2% YoY. This might be an indication that the deterioration in sentiment is concentrated among the lower income groups. Meanwhile, the continued acceleration in retail loan growth to 22% suggests that the higher income strata (as the income threshold for consumer loans and mortgages is quite high in Russia) are less affected.

Regardless of the reasons for the slowdown in consumption, it suggests that GDP growth- having already decelerated from 1.9% YoY in 2Q18 to 1.3% YoY in 3Q18, as reported by the Ministry of Economic development just now- will remain under pressure in the coming quarters. While neutral for monetary policy, which has to remain moderately hawkish because of the heightened inflationary risks, this weakening consumer activity amid declining approval rates for the country's political leadership, might become a challenge to the conservative budget policy implemented so far. An easing in the budget rule and calls for extra social spending to be incorporated into the 2019-21 budget draft would be the major factors to watch.

The dollar year-end buying effect comes earlier than you might expect

There’s evidence of much more collective dollar buying in FX markets in November rather than December so don't be caught out by the 'year-end' effect 

When it comes to year-end USD demand, November appears to be the onset of action

  • Amid the noise around dollar funding difficulties, we take a quick look at year-end seasonality trends and find that November is typically a strong month in terms of both performance and positioning for the broad USD index. The Bloomberg Dollar Index (BBDXY) has posted average returns of +1.6% and 1.8% over the last 5 and 10 years respectively in the month of November (see first graphic below). In contrast, our calculations show inconsistent returns for the BBDXY index in the month of December (see the second graphic). However, we would caveat that 2017 was an anomaly - which saw the BBDXY index fall 1.46% in November (and -0.35% in December)
  • Looking at individual currency pairs, we find USD/JPY to be most vulnerable to potential year-end USD demand effects; the pair has posted a normalised average return of +1.07% over the past five Novembers. G10 dollar-bloc FX (CAD, AUD and NZD) also appear to underperform against the USD in November. As for EUR/USD, we find some evidence of a downside bias in November - although the lower statistical significance over the past five years hints at possible waning effects. 
  • As for EM currency blocs, LATAM FX looks most vulnerable to year-end USD seasonality trends - with both November and December seeing heavy losses for the overall LATAM FX index. Asian currencies (ADXY index) broadly to move lower in November - but as with the G10 currencies, there is no consistent evidence for December being a bad month for the region.
  • Scandi currencies to some extend buck the above pattern - with December being a relatively more difficult month for NOK and SEK (against the EUR). This is somewhat consistent with our bearish outlook for SEK into year-end as the resolution fund related decline in interbank rates should weigh on the currency. However, it's worth noting that we find EUR/NOK to have the more statistically significant year-end effects. 
  • All of this can be somewhat corroborated when we look at monthly positioning trends across G10 currencies (see third graphic below). Broadly speaking, we have seen strong USD buying by speculative investors in November - followed by a selling theme in December.
  • Bottom line: For those investors concerned about year-end USD demand impact, we find greater evidence of 'USD buying' in spot FX price action and speculative positioning in the month of November - as opposed to December.

[Disclaimer: These observations are largely factual and we make no attempt to add a fundamental overlay to understanding these trends]

Time to ditch the 9 to 5 and embrace the 4-day week?

Smart management of flexible working may ensure productivity and performance aren’t reduced if we want to cut the working week

What a way to make a living

Dolly Parton was on to something when she bemoaned that working 9-5 would drive you crazy if you let it. The way many people work today is changing, and it's not just about going part-time or hot-desking. The shared office space company, WeWork now occupies more office space in Manhattan than any other company as it responds to different demands from workers and companies. And there are increasing calls to reduce the length of the working week, not least in the UK. Recently, the Trades Union Congress claimed that eight out of ten British workers want to reduce working time in the future, with nearly half opting for a four-day working week, without loss of pay, with the TUC suggesting new technology will make work more efficient and profitable.

And while people embrace working from different locations, behavioural studies suggest remote working won’t necessarily stifle innovation and productivity if you manage it correctly. Creativity in how people manage their contributions to organisations is open for continued exploration.

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In case you missed it: A sense of urgency, perhaps

An impasse in Brexit talks and growing tension over Italy's budget deficit have forced the European Union to focus on containing existing problems rather than shaping the future of the bloc. Bold reforms will have to wait. But for how long and at what cost? Plus, why November is a key month to watch for the dollar and is it time to ditch the 9 to 5? 

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