KBank Multi Asset Strategies February 2019 Kobsidthi Silpachai, CFA [email protected]KResearch [email protected]KSecurities [email protected]FX market monitor page 1 Fixed income monitor page 6 Economic monitor page 15 Equity market monitor page 19 “KBank Multi Asset Strategies” can now be accessed on Bloomberg: KBCM <GO> Disclaimer: This report must be read with the Disclaimer on page 29 that forms part of it
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Concerns over growth outlook of the Eurozone economy is likely put pressure on euro. Eurozone economy has shown signs of slowdown, reflecting from consumer and business sentiment, as well as the effect more difficult external economic condition on exports. This could have implication on ECB’s accommodative policy, going forward. However, we do not expect the euro to be significantly lower than current level due to limited upside for the dollar sentiment as Fed continue to send more dovish signal and the impact of government shutdown is to be felt on US economy.
Bearish
JPY
The yen would be affected by global risk-off sentiment and Geopolitical concern. Monetary policy divergence between the BOJ and the Fed has been the factor weighing on the yen. However, the pressure is likely to ease over the short term as the Fed has been sending dovish signal about future rate increase. The global risk-off sentiment, especially from the weakening global growth, Brexit, and conflict between US and China also support the yen.
Bullish
GBP
GBP is likely to remain volatile as no agreement could lead to no-deal Brexit, while risk of Brexit delay second referendum could support GBP. The Brexit deal has been rejected by the UK parliament for the second time. The further amendment of the deal and Irish backstop could allow the UK parliament to accept the deal, but such deal will also have to be approved by the EU. GBP is likely to be trading around the sentiment over Brexit. GBP is to weaken in the wake of the risk of no-deal Brexit and to gain on the increased possibility of extension of Article 50, or second referendum.
Neutral
CNY
Impact of trade conflict between the US and China is likely to ease in the short term. This reflected from the agreement to cease fire for 90-day (until March 1). Some positive development from trade talk between both sides i.e. agreement not to raise tariffs on imports from China to 25%, is likely to support the yuan. However, in longer term, the yuan is likely to weaken from Chinese economic slowdown and the impact of trade tariff on China’s exports and investment.
Bullish
Asian currencies
Depreciation pressure on EM Asia currency is lessening, at least in the short term. Most Asian currencies that have suffered from the trade conflict between US and China, as well as rising Fed Fund rate are likely to see some gain, at least in short run. IDR, INR, and PHP are likely gain as the Fed pauses from rate hike. Also, easing tension on trade policy supports most
Asian currencies. In the longer term, slower global economic growth is to
keep downward pressure on EM Asian currencies.
Bullish
THB
Thai baht is expected to show strength in early 2019 on weakening dollar and stronger baht. Thai economic expansion supported by domestic demand, especially during Q1 2019, prior to the Thai general election. Also, inflows of foreign tourists during the high season in Q1 would raise demand for Thai baht. Meanwhile, slower Thai exports growth from weakening global demand and trade policy, as well as falling tourism revenue from Chinese tourist visitors are the key factors to weigh on the baht.
Bullish
6
Fixed Income Monitor: More pressure on Thai bond yields
The Thai bond yields are on a downside bias along with yields in
other regional countries due to concerns over a global economic
slowdown in a near-term
Lack of clarity on the US-Sino trade deals and uncertainty on the
US fiscal policies will weigh on global yields further at least until
early March
Greater downside risks in global markets at the beginning of the
year prompted us to adjust our outlook of the next Thai policy rate
hike to 2020 from the end of 2019
Bull flattening bias
Thai bond yields have been in a downward trend since November. Higher global
worries over overall economic growth outlook, and economic and political issues in
specific countries eroded investors’ confidence. The bond markets in almost every
country including Thai and Emerging Asia countries, thus, remain in demand to
hide/invest during high uncertainties (Fig.1) despite stock markets rebound upon
changed short-term market moods. Besides, investors still view Thailand as a safe-haven
asset within the emerging markets space due to favorable external stability conditions
such as low inflation, relative higher current account surplus, and low foreign currency
debt. The 98.9% correlation between 10-yr Thai and Japanese government bond yields
since November 2018 clearly explained the move, compared with the 90.8% correlation
with the 10-yr US Treasury yield. Thai bond yields exhibited a downward bias during
high-risk aversion periods. On the other hand, the short-term bond yields enjoyed support
from the Bank of Thailand’s Monetary Policy Committee, which decided to lift the rate
higher to 1.75% in December. This capped the magnitude fall in the 2-yr yield to only 3
bps versus a 6 bps drop in the 10-yr yields.
The concerns of the US economic outlook became more evident. President Trump
intentionally ignored American workers’ plight from the longest government shutdown and
insisted his stance toward the Southern border wall. Coupled with some weaker
sentiment indicators, such as purchasing manager and ISM indices, 10-yr US Treasury
yields slipped to the lowest level since early last year. Additionally, the Federal Reserves
(Fed) chairman Jerome Powell gave a more dovish message in a press conference after
announcing the monetary policy decision in January. The markets added more chance of
the Fed to keep its Fed Funds rate unchanged throughout the year with a market-implied
probability of a rate hike at 4.3% in the December-2019 from 8.0% measured on the
year-2018.
We expect this downside pressure on the long-term yields to continue at least until
early March. One of two key issues is the trade spat. The mid-level and higher-level
official meetings in January did not deliver material deal among counterparties as the
final decisions are spared only for the top of the administration. That is why both sides at
Among emerging markets Asia, Thailand is placed as the safest rank in term of low
financial vulnerability. The yield with discounting costs of inflation, political uncertainty,
and exchange rate gain/loss reveals that Thailand is the best performer (Fig. 4). This
made USD/THB to be an outperformer in the region since the beginning of the year.
However, this status made the BOT harder to increase an interest rate as a raising rate
will attract more capital inflows to Thai bonds.
However, there is an upside risk of the Thai policy rate. The MPC remains
preoccupied over search-for-yield behavior. Even though they decided to lift the rate
upward by 25 bps in December, yesterday’s meeting result suggests that they kept
mentioning this concern. The 2 members who voted for additional 25 bps hike to 2.00%
saw that the Thai economic growth was close to potential levels, which is justifiable for
the build-up for policy space and attempt to curb the financial stability risk. Given the
MPC’s view on the essence of keeping financial stability intact, the possibility of a rate
hike later this year should not be overlooked.
Investment strategy
Based on our short-term outlook, increasing the portfolio duration will be
appropriate with a bull flattening bias of the Thai bond yield curve. Given
the reference government portfolio duration at 8.66 years, we recommend buying
bonds with a maturity of more than 9 years or selling bonds with less-than-8-
years maturity. For securities selection, the Rich-Cheap model (Fig. 5) suggests
keeping holding LB326A with an entry level of 2.87%, an exit of 2.81%, a stop
loss level of 2.91% and an expected return of 6 bps over a 3-month horizon.
Barbell investment. As a curve is expected to flatten in a near-term, the implied
yield spreads between a combination of 2Y and 10Y less 5Y bonds will tighten
i.e. a negative butterfly. However, afterward, we found that investing in the 5Y
bond is expected to outperform investing in a combination of 2Y and 10Y bonds
as the curve shifts towards a “positive butterfly”.
9
KBank Deductions – Rate Insights
Policy Rates
Outlooks/Comments
Fed
A more dovish Fed. Overall US economic activities remained solid except a cooling housing market from rising
Fed Funds rate. The labor market remains tight while private consumption moderately expanded. Inflation is falling but close to the 2% target. However, benefits of tax reform in term of growth had faded and additional fiscal stimulus will be more difficult to pass into law as Democrats hold a majority in Congress. Trump’s inability to strike a deal with Democrats for a border wall with Mexico raises the risk of future government shutdowns. The US-China trade talks will probably drag on until the year-end.
ECB
Weakening growth across the region. Italy slipped into recession in Q4 due to problematic budget negotiation
between Rome and Brussels as Italy’s high public debt levels limit its borrowing capacity to support growth, dampening business confidence, driving up its borrowing costs. The BREXIT uncertainty also raised risk premium/ funding costs on the Eurozone economies. Besides, US trade protectionism had cut regional export revenues and productions, increasing the risk of more recessions within the Eurozone. Thus, we expect the ECB to remain on an easing bias via holding its key reference rates unchanged while maintaining sizeable liquidi ty in the market to support growth.
BOJ
Continuing its pace of monetary easing. A downturn cycle in global trade along with the US-China trade spat
will be unfavorable to Japanese exporters while its private consumption will be impacted by a VAT hike to 10% by October 2019. Besides, its aging population will be less responsive to stimulate domestic spending and marginally improve inflation. Its inflation outlook for the next 3 years remains tepid.
BOT
Long pause until next year. Expected prolonged US-Sino trade talk has impacted Thai exports and tourism,
slowing overall growth. Private consumption remains strong but might not drive inflation as global oil price could fall from the effect of oversupply. A more dovish Fed on rate normalization will loosen the BOT’s stress to bridge the interest rate gap. Even though the election schedule is clear, a continuation of policy implementation by the new government remains vague. While existing investment will be ongoing, political uncertainty could delay new investment projects going forward.
High global economic and financial uncertainty to weigh on UST yields. As the US economy remains on a
solid footing (on consumption and labor markets) we view that the markets are overestimating the US economic weakness. We thus expect the market to rebalance their portfolios to riskier assets once expectations are readjusted. However, larger US fiscal deficits due to tax reform could uplift long-term bond yields. By contrast, the rising in yields could be limited by overall economic growth slowdown from the downturn of the trade cycle, BREXIT uncertainty, and artificial trade conflict initiated by the US itself. Lower 5Y5Y US inflation expectations and excessive market’s UST short positions should limit a yield upside.
End period 1y MoM bps 2y MoM bps 5y MoM bps 10y MoM bps 2-5 spread 2-10 spread Policy rate
Bear steepening curve by the end of the year. The long-term Thai bond yields will probably move in tandem
with long-term US Treasury yields. We expect the Fed to pause but not stop its monetary policy normalization as overall US economic development remains solid above its trend. Besides, high global financial volatility and uncertain trade talks will discourage foreign portfolio investments in the EM Asia space, supporting long-term yields to rise. The supply-side factor of higher planned government bond auctions also supports rising yields. As for the short-term yields, slowing growth and lower pressure of Fed normalization could delay the BOT rate hike to next year.
Note: The red dot is the spread between current and estimated bond yield in each sector. The green line is an average bond yield during the last 3 months. The vertical line represented the yield movement during the past 3 months. Investors who do not have a solid view on yield curve outlook may use this model for short-term investment by buying an undervalued bond, whose yield above the average (red dot above green line), and selling an overvalued bond, whose yield below average (red dot below). Under an assumption of mean reversion, we expect the current yields will convert their average value in the next 3 months. Source: KBank
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A quick thought on Fed’s QT
The recent FOMC meeting in January, more or less, confirmed that the US Federal
Reserve (Fed) would remain patient for the next move given a huge turmoil in the global
financial markets during late 2018. By contrast, it seems that the Committee is still
progressing through its balance sheet normalization, as dubbed quantitative tightening
(QT). It’s worth checking on a few charts that highlight the path of normalcy and how
such measure might have any implications on the markets.
To start with, let’s see how the global financial conditions change after the Fed has raised
its Fed Funds for 4 times in 2018 while the European Central Bank (ECB) has decided to
unwind its stimulus program. Fig. 1 clearly shows that the financial conditions have been
increasingly tightened albeit at a much lesser degree when compared to the period of
economic recession.
The key market concern is that would the Fed’s implementation of QT potentially lead to
a slump in asset prices. The logic is as follows: the old acronym quantitative easing (QE)
had once inflated asset prices; the unwinding of its stimulus packages through the
balance sheet reduction would cause trouble in the markets. As evidenced in Fig.2, it is
highly likely that EM stocks couldn’t avoid the impact of lower global liquidity as the Fed’s
carry on its plans for normalization forward.
Obviously, no one ever doubts how QE has solved problems during the period after the
financial disaster in 2008. However, it also created another big problem too. Easy and
cheap money have resulted in rising debt levels in many countries. And the opposite is
true, tightening financial conditions could also lead to decelerating bank lending whereby
affecting countries whose economic growth have been deeply relied on credit (Fig. 3).
From Econ 101, ceteris paribus, the lower the supply of a commodity, the higher is its
price. Fig. 4 clearly shows the relationship between the price of the greenback and
changes in balance sheet size. As a result, the Fed’s absorption of dollar liquidity would
likely trigger capital outflows from emerging countries which possess high dollar-
denominated debts (Fig. 5).
From another standpoint, gradually reducing the Fed’s holdings of US treasuries will
affect the yield movement. All else being constant, less bond reinvestment implies less
bond purchases, consequently push upward pressure on yield (Fig. 6). Nonetheless, we
still expect the upside to be limited as the economic outlook remains uncertain. According
to Fig. 7, the movement of the 10-yr treasury yield coincided with the adjusted US GDP
growth during the last couple of quarters. Given that the US economic growth is likely to
soften in 2019 as the impact of fiscal stimulus is expected to fade off, we think that slower
economic growth would prevent the 10-yr yield from overshooting.
Besides, it is also possible that it is the FOMC’s guidance itself that actually dictates the
movement of the 10-yr yield. As Fig. 8 shows, the 10-yr yield has been capped by the
Fed’s longer-run rate (rates of growth, inflation, unemployment, and federal funds rate to
which a policymaker expects the economy to converge over time in the absence of
further shocks and under appropriate monetary policy). Last but not least, the pace to
which the Fed reduces holdings of both the US treasury and the mortgage back
securities might not be as frightening as we previously expect as it would take several
years for the Fed balance sheet to return to normalcy.
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Fig 1. Global financial conditions index Fig 2. QT and EM stock performance
-2.0
-1.0
0.0
1.0
2.0
3.0
4.0
2002 2004 2006 2008 2010 2012 2014 2016 2018 2020
Chicago Fed Nationational Financial Condition Index (NFCI)
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
35%
10 11 12 13 14 15 16 17 18 19 20
-40%
-20%
0%
20%
40%
60%
80%
100%
120%
Sum of FED, ECB, ECB Balance Sheet MSCI EM
Source: Chicago Federal Reserve, KBank Source: Bloomberg, KBank
Fig 3. Credit intensity of GDP growth ratio Fig 4. Non-resident position in Thai bond market
0
2
4
6
8
10
12
CH KR IN MA TH ZA BR ID SG TR AR HK
Credit-intensity of GDP growth ratio
-60
-40
-20
0
20
40
60
80
100
120
04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19
65
70
75
80
85
90
95
100
US Federal Reserve Treasury Holdings (%YoY) US NEER
Source: ADB, Bloomberg, KBank
Note: The ratio of incremental aggregate debt to incremental output. High ratio means economic growth depends largely on credit.
Source: CEIC, KBank
Fig 5. USD and EUR denominated debt (% of total) Fig 6. Fed’s holdings of treasury and 10-yr yield
0
10
20
30
40
50
60
70
80
90
Chi
na
Kor
ea
Indi
a
Mal
aysi
a
Tha
iland
Sou
th A
fric
a
Bra
zil
Indo
nesi
a
Sin
gapo
re
Tur
key
Arg
entin
a
Hon
g K
ong
Non-financial corporate Financial corporate
0.0
0.5
1.0
1.5
2.0
2.5
3.0
2003 2005 2007 2009 2011 2013 2015 2017 2019
0.0
1.0
2.0
3.0
4.0
5.0
6.0
US Federal Reserve Holdings of Treasury (USD Trillion) 10-Yr Tresury Yield
Source: Bloomberg, KBank Source: Bloomberg, KBank
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Fig 7. US GDP growth and 10-yr yield (%) Fig 8. FOMC’s guidance on longer-run rate
Economic activities in December suggested a mediocre growth
December data came with a mixed bag. The domestic economy grew at a slower pace due partly to a high base effect of consumption and a decline in capital goods imports. Meanwhile, external sectors offered a glimpse of hope after the number of tourist arrivals edged higher, but exports slipped into a mild contraction amid intensifying negative feedback loops of the China-US trade war. In the absence of new economic catalysts, the GDP in 4Q2018 would expand on par with the pace in 3Q2018.
Fig 1. Key economic indicators
Source: BOT, OIE, KResearch
Private Consumption Index (PCI) grew 3.5 % YoY in December, versus the 3.8% YoY in the previous month. A slowdown in consumption was partly attributed to a high base effect, resulting from the government tax rebate scheme and the introduction of new car models in the late of 2017. Overall, the consumption performed in line with moderate economic growth. Consumption in non-durable expanded further, helped by a recuperation in farm income. Meanwhile, consumption of services saw some weaknesses as consumers adopt cautious stance on spending amid rising uncertainties over economic prospects.
Private Investment Index (PII) expanded at a slower pace of 1.8% YoY in December. It was dragged by sluggishness in construction sector because developers had already adopted a cautious stance to brace for the new mortgage-lending rules from Bank of Thailand. Moreover, heightened uncertainties over US-China trade war and a slowdown in global demand hurt demand for capital goods imports.
The number of foreign tourist arrivals to Thailand reported 7.7% YoY growth, thanked to a visa fee waiver program. The number of Chinese arrivals reported growth for a first time in 5 consecutive months. Also, the new routes, connecting Thailand to India and China, brought about a rise in foreign visitors. All in all, the number of tourist arrivals registered a new record high of 3.8 million. Government spending remained restricted in December. Overall budgetary disbursements contracted 6.5% YoY, led by a 12.2% YoY decline in investment budget disbursement. Meanwhile, the accumulative disbursement rate in Q1FY2019 was 29.8%, failing short of the target of 30.3%. On the external front, exports experienced a mild contraction for 2-consecutive months in December and finished the 2018 at 6.7%. The value of exports declined
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1.7% due to a sluggish demand from China and EU. Export to China experienced a declined of 7.3% YoY due to the negative feedbacks from US-China trade dispute. The affected product such as rubbers and computer and parts had a sharp drop of -45.6% YoY and -42.1% YoY, repectively. For EU, the export of Car and parts, computer and parts as well as ICs saw a decline. The export volume dropped of 2.4%, unchanged from the previous month. Going forward, KResearch anticipates that Thai exports may slowdown to 4.5% in 2018 due to the global slowdown as well as repurcassions from US-China trade dispute.
Headline inflation was rather bleak at the begining of 2019. The headline inflation rose marely of 0.27% YoY, weighted down by a decline in energy prices. Meanwhile core CPI rose 0.69% YoY. Going forword, the impact of high-base effect in energy price shoud dissipate and adjustment of transporation costs should provide some support for headlline inflation.Therefore, KResearch expects that the headline inflation may gradually increase to the average of 0.8% in 2019.
Global Economic Update
Global economy experiences a significant slowdown in 2019, the risk
toward global recession should contain.
Global economy started the year of the pig with a dismal outlook, PMIs in major economies except the US have drifted from moderate expansion to weak expansion and mild contraction. Monetary policy no longer supports the economic expansion after many central banks pursued the path back to “normal”. Unfortunately, some economies may have fiscal constraints that could limit their ability to respond to economic weakness, while rising financial costs may double down the situation. Regarding risk to global growth, the EU and China may become a potential risk event. Eurozone is in the mire of problems. Eurozone economic growth remained soft at the end of 2018. Global slowdown pose risk to the growth of the bloc. Real GDP in the Eurozone rose just 0.2%QoQ in 4Q2018. Meanwhile, Italy faced two consecutive drop in real GDP, suggesting the economy fell into a technical recession in the second half of 2018. Amidst dismal economic performance, Italy may face grave challenges. A recession and unstable political situation may cause a significant worsening in the Italian fiscal situation. This may result in a resurgence of financial turbulence in the Eurozone, unless the situation will improve in the near term. Apart from Italy, Brexit is an elephant in the room. Although Brexit could still be averted at the last minute, Brexit uncertainty remains. A disorderly Brexit could trigger an event risk and send UK into a recession, which the negative spillovers could reverberate into Eurozone economy.
A sharper-than-expected slowdown in the Chinese economy is another event to consider. The Chinese economy grew at the slowest pace in 28 years of 6.4% in 4Q2018, with retail sales in particular weakening. PMIs slipped into sub-50 level, a demarcation line between an expantion and a contraction, for 2-consecutive months. Meanwhile, the effectiveness of monetary policy to ward off economic risk from China-US trade war is in the question. A series of RRR reductions and massive liquidity injection failed to lift the corporate sentiment.The falling M1 in China to the multiple year low of 1.5% in December 2018 suggested that China corporate may refrain from making a credit or face some restrictions to do so. This might be signs of stress on balance sheets and faltering business confidence.
Chinese economic growth is expected to slow going forward, but stable consumer sentiment, particularly in the services sector, as well as initiatives from the Chinese government to reduce tax for consumers may support overall economic activies in the coming quarters. Therefore, a collapse in activity or a hard landing could be avoided.
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Although the global economy experiences a significant slowdown in 2019, the risk toward
global recession should contain. A listless inflationary pressure could keep interest rates
lower for longer. Given a counitinuity of job creation in major ecomomies, the underlying
economy should withstand the headwinds in the near to medium term. Although there are
limited foreseeable risks that could bring global economy into recession, an escalation of
trade war out of control may result in the lower-than-expected global economic growth.
19
Market risk is well compensated
We maintain our positive view of the Thai equity market with a 12-
month forward SET Index target of 1,750, implying a total return of
13%. As we discussed in our previous monthly strategy note “Less
is more,” dated November 27, 2018, we expect the key
macroeconomic drivers and global events to be benign and develop
in a more positive direction in 2019.
We believe our market return analysis provides a useful investor
tool and that investors, at this index level, would be well
compensated by a cycle-high market EPS risk return. Key
conclusions of our analysis are: 1) the implied non-market EPS
return is most volatile; 2) low market EPS risk return coincides with
bad years; 3) the market performed badly when the 1-year yield was
more volatile; and 4) invest when the “1-year forward expected”
market EPS risk return is high.
Key risks to our call are the return of a very hawkish US Fed from a
global point of view and major political turmoil after the upcoming
Thai election in 2019, the probability of which is low, in our view.
These two key factors could significantly increase market volatility
beyond the normal cycles we observed since 2012.
Market risk is well compensated
12-month forward SET Index target is 1,750
As we discussed in our previous monthly strategy note “Less is more,” dated November
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