MONTHLY ECONOMICS NEWSLETTER
M A R C H ,
2 0 1 5
I S S U E
MARKETS WAITING FOR CLEARER FED SIGNALS
Uncertain Fed Policy Remains A Source Of Volatility
“The global economy is looking better and recovery in the major economies appears to
be on track. However, what remains uncertain for now is when and how quickly the Fed
will raise its interest rates. Fed policy remains a key risk and therefore a continued
source of volatility for markets. Given this backdrop, it makes sense for investors to
tread cautiously for now. We continue to advocate dollar cost averaging for investors
who have minimal exposure to riskier assets like equities, and looking to gain exposure
to these assets to benefit from their medium-term potential.”
Lim Wyson, Head of Global Wealth Management, OCBC Bank
In This Issue
GLOBAL OUTLOOK
Rebound in Eurozone and Japan
P.2
HONG KONG / CHINA MARKET OUTLOOK
More stimuli needed
P.2
EQUITIES
Tread cautiously for now
P.3
BONDS
Fed to hike rates soon?
P.4
FX & COMMODITIES
U.S. dollar bullish cycle intact
P.5
SPECIALS
HKMA Tightens Mortgage Rules
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P.6
GLOBAL OUTLOOK
REBOUND IN EUROZONE AND JAPAN
“U.S. economic data, especially labour market data, has been strong. Wages are still
stable but workers and firms are expecting to see increases in the coming months, which
should boost consumption further. The outlook for the Eurozone and Japan are also
looking brighter, aided by accommodative monetary policies and weaker currencies.”
Richard Jerram, Chief Economist, Bank of Singapore
Key Points
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The buoyant U.S. economy is capturing most of the headlines, but a cyclical rebound is also building in the Eurozone and Japan. The
Eurozone’s 1.4 per cent economic growth in 4Q2014 was lower than the 2.2 per cent growth in both Japan and the U.S., but it still
marks a significant improvement.
The Eurozone’s February PMIs marked the third month of increase and imply that the boost from ECB easing will be a tail-wind to
an improving cycle. The business environment is already benefitting as fiscal austerity programmes come to an end, while the
weaker Euro and lower oil prices will also support growth.
The Eurozone has remained strikingly calm in the face of renewed uncertainty over the continued membership of Greece. A more
solid banking system and liquidity support from the ECB means that the region is not particularly vulnerable to events in Greece,
which also explains why the Eurozone can take such a tough line in negotiations. Greek exit still looks like a reasonable possibility
in the coming months, as it struggles to meet the terms of the bailout.
Like the Eurozone, the Japanese economy is also benefitting from a more favourable fiscal policy stance as well as the boost to
export competitiveness from the drop in Japanese yen after the BOJ’s recent policy easing. We expect the U.S. dollar to strengthen
further against the yen with the move coming from U.S. rate hikes, rather than BOJ easing.
On the wage-front in Japan, the focus for now is on the annual spring wage round where tight labour markets and strong corporate
profitability should produce a much better result than in recent years. A solid wage round would help to convince the BOJ that it
does not need to loosen policy further and it can sit and wait for prices to push higher.
Even with the slowdown in 4Q, U.S. growth in the second half of 2014 was still the strongest in a decade. Labour demand is booming,
with 1 million new jobs created in the past three months. So far, tight labour markets have not translated into a big pick-up in wages,
but normal time lags suggest that this should become a major feature of 2015.
Looking ahead, we are approaching a critical period for Fed policy. If the Fed is considering a June rate hike, as we expect, then it
needs to change the language in its policy statement at the 17-18 March policy meeting. Specifically, the Fed needs to stop saying it
will be “patient” in normalising policy, with Fed Chair Yellen hinting that this will happen.
HONG KONG / CHINA MARKET OUTLOOK
MORE STIMULI NEEDED
The latest PMI numbers have reiterated difficult conditions faced by the Chinese
economy over the recent months. Given this backdrop, we expect more easing measures to
be announced by the PBOC throughout the year. On the equities front, we expect stock
prices to be volatile as the earnings season in China kicks-off.
Key Points
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The latest PMI numbers out of China have reiterated difficult conditions faced by the economy over the recent months - both official
and HSBC PMIs went below the 50 mark. Exports fell 3.3% YoY in January, down significantly from 9.7% growth in December. Imports
also registered a 19.9% YoY contraction. Benign inflation adds to the sense of weakness in the economy, with latest CPI coming in at
0.8% YoY, the lowest reading since end-2009.
The RMB has hence effectively strengthened against the USD in real terms, compounding the woes of exporters already struggling
with cheaper rivals globally. In response, the PBOC has continued to ease monetary conditions domestically, following up with
separate moves in February to cut reserve requirement ratio by 50bps and lending and term deposit rates by 25bps. We expect more
easing measure to be announced throughout the year which would boost sentiment for Financials.
While further easing policies could come at the risk of sidelining the country’s reform agenda, consumption growth remains pivotal
to China shifting away from an investment growth-led model. Even as Consumer names are seeing lower demand from weak
consumer sentiment and the on-going anti-graft campaign, we see lower oil prices helping buffer profit margins for some companies.
Macau gaming stocks are also pricing in bear case scenarios and, in particular, we see certain stock as a recovery play. With earnings
season in China kicking-off, we expect stock prices to be volatile and would focus on companies in China’s new economy sectors
where we see favourable government policies providing tailwinds for stock prices.
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EQUITIES
TREAD CAUTIOUSLY FOR NOW
“Among equity markets, Europe is our favourite region. A combination of weaker
currency, easier credit, more relaxed fiscal policies and sharply lower commodity costs
means that the region is in a much better position for a sustained recovery. Although
short-term risk of a pullback on profit-taking remains, the medium-term outlook is
positive.”
Hou Wey Fook, Chief Investment Officer, Bank of Singapore
Key Points
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Eurozone equities surged in February on growing optimism over the effects of the ECB’s recently announced stimulus and the
region’s economic growth outlook. Greece’s 4-month bailout extension also removed immediate concerns about a run on Greek
banks, boosting investors’ confidence in Eurozone equities.
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The corporate earnings outlook for the Eurozone seems to be improving with the impact of a weaker Euro flowing through. Not
surprisingly, exporters continued to do well with Eurozone automobile companies for example, surging to multi-year highs.
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Given that the fundamental issues for the Eurozone remain unresolved, especially with impending elections, volatility is likely to
persist. While intermittent pullbacks and profit-taking cannot be discounted, we have turned more positive on Eurozone equities.
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Japanese equities also had a strong month in February, which we believe was driven by further public pension fund purchases.
Latest figures as of end-2014 released by the Government Pension Investment Fund (GPIF) in late February revealed that the GPIF
increased its holding of domestic stocks from 17 per cent to 21 per cent. The GPIF is targeting to raise the share of domestic stock
holdings to 25 per cent.
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The faster than expected move in 4Q2014 suggest that, in addition to the GPIF, other Japanese public pension funds are likely to
have started investing in domestic equities from the beginning of 2015.
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Longer-term, the efforts by Japan Inc. to improve on corporate governance and shareholder returns should boost equity market
performance.
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U.S. equities also did well last month, rebounding from the dismal performance in January, despite a mixed earnings result season.
Reflecting a turnaround in growth expectations, cyclical sectors such as Consumer Discretionary and Technology did well while the
more defensive Utilities and Consumer Staples lagged.
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The appreciating U.S. dollar and potentially higher wage cost represent further headwinds for U.S. corporate margins over the next
few quarters, even as the effect of lower energy costs flow through. Maintaining the view that the Fed is already behind the curve
and is paving the way for a rate hike this year, we continue to see the swings in focus between liquidity and growth driving market
volatility – at least until the Fed hikes rates.
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Asia Ex-Japan lagged their Developed Market peers in February, partly reversing the outperformance in January. Near-term, we
continue to see concerns over U.S. monetary policy driving volatility of Emerging Market equities.
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BONDS
FED TO HIKE RATES SOON?
“The Fed’s policy meetings in March and April may give more clues on its rate hike
schedule. While the Fed Chair made clear recently that no increase is imminent, she
suggested that the Fed might drop its pledge to be patient in deciding when to begin
tightening credit. We still see the first rate hike in June 2015, but the strong greenback
also makes September a possibility.”
Marc Van de Walle, Head of Group Wealth Products, OCBC Bank
Key Points
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We are concerned that the market is expecting a remarkably slow pace of rate hikes. In 1994 it took 13 months for rates to rise 3 per
cent. In 2004 rates rose 4 per cent in two years. The market is expecting just 1.75 per cent of rate increases by the end of 2017. It makes
sense for the Fed to tighten slowly to begin with, after going to such lengths to repair the economy and the financial system, but it
looks dangerous to keep policy loose for two years after the economy hits full employment.
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The timing of the first Fed rate hike still looks like a close call between June and September (we lean towards June). However, the
more important adjustment in market expectations relates to the pace and eventual scale of probable tightening. The market
expects Fed Funds to be below 2% at the end of 2017, so there will be focus on updated Fed projections after the mid-March meeting,
as it currently sees rates over 3.5% by end-2017.
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We are concerned that the market is badly underestimating the Fed’s intentions now that the economy has normalised. The Fed is
increasingly reminding us that it has a forward-looking approach to policy, which means that it should shift policy in anticipation
of the higher wage and price inflation that is a natural consequence of tight labour markets. Moreover, the Fed is explicit that it does
not regard the temporary drop in inflation due to lower oil prices as a reason to delay tightening.
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A steady flow of easing measures across the rest of the world held down yields elsewhere and also limited the rise in U.S. yields. At
this point, such low yields mean that investment grade bonds offer a poor risk-return profile even though abundant liquidity should
prevent a serious sell-off. We recommend an underweight position in investment grade bonds.
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In the bond space, we generally prefer high yield to investment grade bonds. Following the recent correction due to lower oil prices,
U.S. high yield bonds are starting to look attractive. With oil prices finding a bottom, U.S. high yield bonds are now looking attractive
on a risk-reward basis, with a decent carry and credit spread that can buffer against both a sell-off in U.S. Treasury bonds and
expected defaults this year.
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Although we are positive on U.S. high yield bonds in the short term, we still encourage investors to adopt a diversified approach
towards the high yield fixed income sector. We also continue to advise investors to hold bonds with shorter tenures as such bonds
tend to be less sensitive to increases in interest rates.
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FX & COMMODITIES
U.S. DOLLAR BULLISH CYCLE INTACT
“We are of the view that medium-term U.S. dollar bullish cycle remains in place. We
think we are only halfway through the strong U.S. dollar trend. Growth and monetary
policy differentials are likely to work in favour of the greenback, and the fundamental
drivers of the currency’s strength have not changed.”
Michael Tan, Senior Investment Counsellor, OCBC Bank
Key Points
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Compared to an unusually forceful phase of U.S. dollar strength in January, a more consolidative picture for the U.S. dollar emerged
in February. This is despite monetary policy being eased in a significant number of countries (e.g. Australia and Indonesia).
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Green shoots of recovery in Europe along with some weakening in U.S. economic data despite the strong January payrolls figure,
prompted investors to take profit on long U.S. dollar positions as growth divergences narrow. The rally in oil prices has also taken the
heat off commodity currencies like the Australian dollar. Market participants appear disinclined to put on aggressive new positions,
waiting for clearer signals from the March Fed policy meeting.
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While the U.S. dollar may take a breather from time to time, we still believe that the greenback has more room to head higher given
the divergent monetary policies between the Fed and other major central banks like the ECB, BOJ and RBA. Central banks in
emerging markets have also been easing policy due to concerns about growth and deflation.
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Amongst the European currencies, the Pound is our preferred proxy to play for better European data. Political uncertainty ahead of
the 7 May U.K. election is potentially negative for the Pound but much of the concerns appear to be already in the price. The
improved tone in U.K. data and a more upbeat BOE Inflation Report have contributed to a more stable Pound.
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Growing signs of supply responding to the recent price shock, increases confidence that the worst is over. The U.S. rig count is down
by almost one-third, while firms are announcing aggressive cuts to capital spending plans. Prices should stabilise as high-cost
producers are pushed out of the market, followed by a moderate rebound as supply continues to contract.
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We have a 12-month target for WTI of US$60 per barrel and Brent of US$65 per barrel. A recovery to neutral levels of US$70 to US$80
per barrel will be a slow process unless we see a geopolitical negative supply shock or a sudden OPEC deal.
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The safe haven appeal of gold has waned further after Greece and Eurozone leaders reached a deal to extend Greece’s bailout by
four months (i.e. through June). Stronger U.S. growth should sustain upside risks for U.S. real interest rates and downside risks for
the gold price. We remain in the bear camp on the medium-term gold outlook with a 12-month price target at US$1,050 per ounce.
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SPECIALS
HKMA TIGHTENS MORTGAGE RULES
“The new rules would deter end-user demand from both the first home buyers and the
upgraders. Supply in the secondary market from the upgraders would also reduce.
Transaction volumes would therefore stay at very low levels and residential property
prices would likely see moderate correction in the coming months. We expect more
downward pressure on residential property prices from 2H 2015 due to the expected
rate hike in the U.S.”
Iris Pang, Chief Economist, OCBC Wing Hang Bank
Key Points
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HKMA tightened maximum loan-to-value ratio from 70% to 60% for self-use residential units priced below HK$7 million on 27th
February. Meanwhile, on 2nd March, the HKMA lowered maximum debt servicing ratio (DSR) for mortgage applicants who seek
additional mortgage financing from whatever source that results in total loan-to-value (LTV) ratio exceeding the normal ceilings by
more than 20 percentage points.
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As such, we expect transaction volumes to stay at very low levels and residential property prices to see moderate correction in the
coming months. We expect more downward pressure on residential property prices from 2H 2015 due to the expected rate hike in
the U.S.
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For the FY 2015 budget, though the government expects the surplus to continue through FY2019, it reiterated that structural deficits
will surface within ten years due to the aging population. This may pave the way for the government to propose tax reforms such
as the introduction of sales tax to broaden the tax base in the coming years.
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Despite all the measures in the Budget to support the tourism sector, the retail sector is unlikely to revive in 2015 amid the
anti-corruption campaign in the Mainland. Relief measures in the Budget would only partially compensate for the loss in retail
sales due to weak tourism activities. Money allocated for all relief measures represents 7% of retail sales value in 2014, of which tax
reductions on salaries accounts for 3%.
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