With many of USD-Asia pairs at multi-year lows, Asian central banks will likely have to hike more, especially since many regional central banks have already expended a fair amount of FX reserves. In terms of curbing imported inflation, efficacy is in doubt as Asia central banks that have hiked more have not necessarily seen more resilient currencies (think BOK vs BI). Export competitiveness considerations would in fact argue for hiking less, as recent CNY and JPY depreciations have been larger relative to the region (dovish PBOC and BOJ). However, the argument to hike more could be valid for containing financial stability/outflow risks by improving policy differentials and looking less behind-the-curve. In this regard, Asia equity and bond markets where foreign ownership levels are relatively high would likely be more concerned about outflow risks.
CNY Rates - August trade balance came in at USD79.4bn vs survey USD92.7bn and July USD101.3bn. Though the trade balance stays elevated, it may not provide much support to the outlook for CGB returns. Proxy measures suggest that conversion rate of export proceeds are low and is unlikely to rebound until growth sentiments significantly improve. Many market participants hold a curve flattening view on expectations that normalization of liquidity from flush levels would push up the 1Y and 2Y, while the slower growth recovery would weigh on the 5Y. We are sceptical as we think liquidity could stay flush and 7D repo fixing could stay low for an extended period of time, and there is the risks that larger CGB/LGB/PBB issuances on the back of greater policy support could bring some steepening pressures.
INR Rates - GSec yields are expected to stay relatively resilient against core rates vol, due to index inclusion optimism. Positioning for a positive outcome via long GSec pay OIS is likely building - We are seeing larger-than-usual foreign inflows into FAR bonds. Compared to the region, RBI appears to be closer to the end of its hiking cycle. Therefore, OISs are unlikely to make it back above 7%, instead likely to trade in a 6.1-6.7% range.
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