Reality check after last week's burst of optimism

MAS eases. Reality check after last week’s burst of optimism. Fed does QE-lite.
Philip Wee, Eugene Leow14 Oct 2019
    Photo credit: AFP Photo

    FX: MAS eases; reality check after last week’s burst of excessive optimism

    The decisions at this morning’s SGD policy review were broadly in line with expectations. As expected, the Monetary Authority of Singapore slightly flattened the slope of the SGD nominal effective exchange rate (NEER) policy band and kept its width and centre unchanged. According to our model, the band should start appreciating at a pace of 0.5%/year vs 1% previously. The central bank has kept the door for another easing should the already weak growth/inflation outlook deteriorate significantly.

    In our view, the SGD NEER is still considered strong in the upper half of its policy band. In USDSGD terms, the downside is constrained by the band’s limit at 1.36 and should be closer to the mid-point around 1.39. The recent fall in USDSGD to 1.37 from 1.3850 in early October was attributed to the temporary rollback in trade war and Brexit fears. A reality check is likely to set in this week after the burst of optimism last Thursday-Friday. Our forecast remains for USDSGD to rise above 1.40 by end-year.

    The partial China-US trade deal has suspended the US tariffs that is scheduled to increase tomorrow to 30% from 25% on USD250bn of Chinese goods. This has simply temporarily halted the escalation in China-US trade tensions. Longer term concerns remain that the trade war may widen from tariffs towards impeding investment flows between the two countries. The temporary truce between China and US could also see the Trump administration turning its tariff war towards the Eurozone.

    The Brexit deal that Prime Minister Boris Johnson is trying to put together with the EU is already considered worse than his predecessor’s withdrawal agreement. Without the consent of the House of Commons for the UK to exit the EU with or without a deal by October 19, PM Johnson is still required to request this Saturday the EU for a Brexit extension to January 2020. Brussels is keen to avert a no-deal Brexit on October 31 and would prefer a longer extension to June 2020 if UK supports new elections or another referendum. Unfortunately, the fragmented UK House of Commons has only agreed to disagree on all issues.

    Rates: Fading of excessive pessimism in the bond market; Fed announces QE-lite   

    We had thought USD interest rates were overly low when 10Y yields were hovering around 1.50%. That has since played out as 10Y yields climbed above 1.70% on the back of a scaled down China-US trade deal (at the October round of tariffs got suspended) and fresh hopes of a Brexit deal. To be sure, the bond market has been the most pessimistic amongst the asset classes amid increasing uncertainties and increasing signs that even the US economy (which has been resilient through the global cyclical downturn) may be slowing. However, this rendered the market vulnerable to any bit of good news that has been in shortfall for much of the year. We reiterate our 10Y yield forecasts at 1.75% for end-2019.

    Meanwhile, the Fed announced a series of steps to address funding concerns (see here). The steps taken are aggressive – buying USD60bn of T bills through at least 2Q20 and the conducting of overnight and term repo operations through January. We had estimated that the Fed needs to expand its balance sheet by around USD150-200bn (see here) but the Fed indicated that it would buy at least USD400bn (if the programme stops in April). Liquidity should become flush by early 2020 and we suspect that the private sector’s use of the repo facilities should start to taper accordingly. We think that the Fed should have done enough to assuage concerns on funding. Beyond 2Q, we think that the pace of bill buying should slow into the USD10-20bn per month range.

    Philip Wee

    FX Strategist - G3 & Asia

    Eugene Leow

    Rates Strategist - G3 & Asia

    The information herein is published by DBS Bank Ltd and PT Bank DBS Indonesia (collectively, the “DBS Group”). It is based on information obtained from sources believed to be reliable, but the Group does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation & the particular needs of any specific addressee. The information herein is published for the information of addressees only & is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Group, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Group or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Group & its associates, their directors, officers and/or employees may have positions or other interests in, & may effect transactions in securities mentioned herein & may also perform or seek to perform broking, investment banking & other banking or finan­cial services for these companies. The information herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Sources for all charts & tables are CEIC & Bloomberg unless otherwise specified.

    DBS Bank Ltd., 12 Marina Blvd, Marina Bay Financial Center Tower 3, Singapore 018982. Tel: 65-6878-8888. Company Registration No. 196800306E. DBS Bank Ltd., Hong Kong Branch, a company incorporated in Singapore with limited liability. 18th Floor, The Center, 99 Queen’s Road Central, Central, Hong Kong.

    PT Bank DBS Indonesia, DBS Bank Tower, 33rd floor, Ciputra World 1, Jalan Prof. Dr. Satrio Kav 3-5, Jakarta, 12940, Indonesia. Tel: 62-21-2988-4000. Company Registration No.