Macro Strategy: Liquidity peak for EM; firm USD
Credit: Greater differentiation as liquidity tide peaks
Markets have seemingly reached the end of the powerful lift from extraordinary central bank liquidity support. Two observations are prescriptive. First, we have pointed out that the Fed’s more recent dovish actions—namely its revision of the inflation-targeting framework and extension of zero rate guidance—have lost their “shock value” in term of stoking market gains. The problem is that markets have become so primed for easy policy that we are seeing diminishing returns to new dovish messaging. Indeed, the Fed’s policy settings are as dovish as they have ever been, but incremental inflows into asset markets have clearly dwindled, or even reversed.
Second, a tailing liquidity boom is typically accompanied by heightened cross-asset correlations in the face of new risks. Markets have become wary of US stimulus prospects and the election outcome. The response is a synchronous sell-off in assets as diverse as the S&P500, CSI300, IG and HY credit, AUD, JPY, gold, and even Bitcoin. Indeed, our country-by-country credit surveillance has previously flagged that USD credit spreads were widening in all Asian economies (see Macro Insights Weekly: Asian liquidity-driven rally sputters), a phenomenon that has not occurred since the depth of the pandemic sell-off in March. The unusual correlations spurred us to issue our first Asian spread widening call since the widespread injection of central bank liquidity, as we judge that credit inflows and liquidity have now turned.
Nevertheless, a peak in the liquidity cycle should not pose excessive concern as long as the real economic cycle continues to show improvement. There could then be a differentiated picture in Asian credit. Broadly held IG bonds are likely to see spreads widen as credit fund inflows ease, but less widely held HY bonds exposed to a sectoral recovery may benefit from specialized investors’ interest. In particular, Chinese HY bonds linked to local investment could be attractive, as infrastructure spending gets underway and the Chinese economy rebounds further in the coming quarter.
FX Daily: Tone remains firm for USD
DXY held above 94.3 for a second straight day with a firm tone. Major US stock indices gained 0.2-0.4% after a volatile session on Thursday. US 10Y treasury yield eased marginally to 0.666% from 0.672% while gold prices firmed modestly to USD1868/oz from USD1863. Investors were initially encouraged that US Treasury Secretary Steven Mnuchin and House Speaker Nancy Pelosi may be returning to the negotiating table but remained doubtful if a new economic aid package can be agreed before the US elections on 3 November. House Democrats want a stimulus package of USD2.4trn that is well above the USD1.5trn set by President Donald Trump.
On the data front, there was disappointment that US initial jobless claims did not fall to 840k but rose to 870k in the latest week ended 19 September; claims were also revised up to 866k from 860k in the previous week. This has dampened expectations for next week’s monthly US jobs report. Nonfarm payrolls are now expected to add fewer 865k jobs in September vs 1.37mn in the previous month. The DXY’s largest component, the EUR, is wary of more jawboning by European Central Bank President Christine Lagarde at her European Parliament Hearing next Monday. EU data next week will also show CPI inflation staying negative for a second straight month in August and the unemployment rate rising above 8% in September for the first time during the pandemic. GBP is nervous as EU-UK Brexit talks resume next week. UK is pushing ahead with the Internal Markets Bill which Brussels want withdrawn by 30 September.
CHF continued to depreciate to 0.9268 per USD, its highest level since 22 July. The next resistance is around 0.9343 or its 100D MA. The Swiss National Bank surprised at its policy meeting on Thursday. The SNB considered the CHF “highly valued” and signalled its willingness to “intervene more strongly in the foreign exchange market”. Foreign reserves surged to a record high of CHF840bn in August from CHF793bn in March. The SNB has also pledged to disclose its volume of interventions at the end of each quarter for the previous quarter. The sight deposit interest rate was left unchanged at -0.75%, the lowest policy rate in the world. Although the leading KOF indicator is pointing to a growth rebound in 3Q, CPI and inflation have been negative since February and March respectively.
The USD’s rebound reverberated across emerging Asia. According to the table above, the USD’s upside momentum was strongest against THB and IDR, with firm support at their 100D MAs. USDSGD has risen above 1.37, which has now become its support, in line with the greenback’s appreciation against its trade-weighted basket of currencies especially the G7 currencies. USDPHP, USDINR and USDMYR are likely to be supported at their 25D MAs with their eyes still set on testing their 50D MAs. The laggards are likely to be USDCNH and USDKRW which have bounced off their lows and are now closer to their 25D MAs.
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