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MONTHLY ECONOMICS NEWSLETTER
A P R I L ,
2 0 1 5
I S S U E
MARKET VOLATILITY SET TO RISE
Fed Policy Remains A Key Source Of Uncertainty
“Last month’s Federal Reserve policy meeting was more dovish than expected.
Nevertheless, when the Fed will first hike its interest rates, and the pace of rate hikes,
remain a key concern for markets which will keep a close watch on upcoming U.S.
economic data to assess the outlook for Fed policy. This may result in greater volatility
in the short term as investors react to future U.S. data releases and Fed rhetoric as they
try to get a handle on what the Fed will do next.”
Lim Wyson, Head of Global Wealth Management, OCBC Bank
In This Issue
GLOBAL OUTLOOK
Sanguine about the outlook
P.2
HONG KONG / CHINA MARKET OUTLOOK
More concrete reforms needed
P.2
EQUITIES
Greater short-term volatility
P.3
BONDS
No Fed rate hike yet
P.4
FX & COMMODITIES
U.S. dollar to take a breather
P.5
SPECIALS
Macau - Economy Continues to be Dragged by
Weakening Gaming Industry
P.6
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GLOBAL OUTLOOK
SANGUINE ABOUT THE OUTLOOK
“The Eurozone and Japan are accelerating, while the U.S. has hit a softer patch, but we
are sanguine on the outlook for the global economy which we anticipate will grow by a
healthy 3.4 per cent this year. Delayed Fed tightening, looser monetary conditions
elsewhere and lower oil prices should help to boost global growth.”
Richard Jerram, Chief Economist, Bank of Singapore
Key Points
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The consequences of diverging monetary policy and exchange rate movements are evident in economic performances. The
Eurozone and Japan are accelerating, while the U.S. has hit a softer patch.
Despite the softer U.S. data, we should not expect the economy to deliver a constant pace of expansion in a cyclical upturn. Trade
data shows that the strong U.S. dollar is holding back growth, but the U.S. is a relatively closed economy – exports are only 13 per
cent of GDP – so this is unlikely to be enough to halt the recovery. The exchange rate is more of a threat to listed companies which
derive a substantial part of their earnings from abroad.
Cyclical recovery in Europe began well before the latest move from the ECB, but the shift to QE has given an extra boost. The
composite Eurozone PMI is at the highest level since early 2011, while consumer confidence is the best since the global financial
crisis began. It looks like consumers are enjoying the gains from lower energy prices.
Japanese firms seem to have greater confidence in the durability of the competitive exchange rate and it is notable that the latest
episode of yen weakness has produced more of an export improvement than before as domestic production expands. In the labour
market, the annual spring wage round has produced a marked improvement on last year. The vacancy rate is the best in over two
decades and firms realise that pay has to rise. In turn, this should push inflation higher and convince the BOJ that it does not need
to add to the current pace of liquidity injections.
Stronger growth in the developed markets should offer support to exports from emerging markets and this is already apparent in
trade with the United States. However, commodity exporters are suffering from lower prices and weaker demand from China,
which compounds the problems caused by external deficits. However, currencies have already moved a long way in anticipation of
higher U.S. interest rates and we do not expect Fed rate hikes to trigger systemic problems across emerging markets.
HONG KONG / CHINA MARKET OUTLOOK
MORE CONCRETE REFORMS NEEDED
The conclusion of the annual party congress saw the government adopting a more
pro-growth stance amid the weak domestic outlook. Key highlights include 7% GDP
target, expansionary fiscal policy, lower taxes for small businesses and flexible
monetary policy with likely more easing and interest rate/RRR cuts. However, structural
reforms and macro improvement would be the key to a sustained rally.
Key Points
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The conclusion of the annual party congress saw the government adopting a more pro-growth stance amid the weak domestic
outlook, promising to shore up growth should jobs or income be threatened. Infrastructure investments will be stepped up, with
significant increase in water conservation projects. Despite economic targets lower than previous years, these were well expected
with the “new normal” China. Key highlights include 7% GDP target (vs 7.5% in 2014), expansionary fiscal policy with larger projected
budget deficit, lower taxes for small businesses and flexible monetary policy with likely more easing and interest rate/RRR cuts.
Property stocks could benefit if property sales pick up on further loosening of mortgage restrictions.
While reforms had been patchy thus far with more talk than action, local government debt resolution could potentially be a turning
point, if executed well. The Finance Ministry raised 2015 municipal bond issuance quota to RMB600bn from RMB400bn in 2014 and
more importantly, approved an initial RMB1tn debt swap to refinance maturing LGFV debts. While this sparked QE talk which the
central bank denied and rising local government debt could still be a market risk when the latest audit is completed, swapping into
medium-term notes at lower yields along with assigning clear responsibilities for debts could lower interest costs for local
governments and reduce the moral hazard. Banks could see a net benefit from receding bad debts concerns offsetting potential
lower fee income and loan demand. We expect more local governments will be allowed to issue municipal bonds with the amended
Budget Law effective from Jan 2015.
Near-term, while detailed plans released post the party congress and further rate cuts remain positive for sentiment, structural
reforms and macro improvement would be the key to a sustained rally. With rising valuations, investors should remain tactical and
selective given the ongoing policy dilemma between supporting growth and controlling credit. We recommend taking profits on
stocks that have outperformed.
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EQUITIES
GREATER SHORT-TERM VOLATILITY
“We believe equities will encounter greater volatility in the short term ahead of
the quarterly earnings results as well as on news of Fed rate hike. We continue to
prefer developed markets over Asia in particular European equities. Asia, being a
small market in terms of capitalisation as compared to U.S., Europe and Japan is
more exposed to capital repatriation when U.S. rates rise.”
Hou Wey Fook, Chief Investment Officer, Bank of Singapore
Key Points
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Historically we have seen more equity volatility surrounding the first Fed rate hike in previous tightening cycles. Therefore, equities
may only gain a firmer footing once volatility over the Fed rate hikes subsides and earnings growth improves.
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In the U.S., corporate earnings will continue to remain under pressure in the near-term with a stronger U.S. dollar. In addition to the
challenge of an appreciating U.S. dollar, potentially higher labour cost represent further headwind for U.S. corporate margins over
the next few quarters, even as the effect of lower energy costs flow through.
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Within global equities, our preference for Europe has played out nicely with the boost from the ECB’s sovereign QE announcement.
While there may be near-term profit-taking on the back of more expensive valuations and more crowded fund manager positioning,
we remain positive on Europe in the medium-term. Notably, we are starting to see more signs of Eurozone growth picking up, and
we expect forward earnings growth to be supported by the weaker Euro and lower oil prices.
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Japanese equities had another strong month in March, as the strong momentum, particularly driven by public pension fund
purchases, drove foreign inflows. Notwithstanding the strong domestic support, a pullback and some profit-taking in the short
term cannot be discounted. Longer-term, we continue to see effects of efforts by Japan Inc. to improve on corporate governance and
shareholder returns boosting equity market performance.
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On Asia, we continue to be cautious on this region as we see potential for capital repatriation outflows that can result from the
initial Fed rate hikes and stronger U.S. dollar. This is especially the case, given that Asian equity markets are small in comparison to
developed markets.
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BONDS
NO FED RATE HIKE YET
“The strong U.S. dollar seems to have convinced the Fed to delay the first interest rate
hike to September. This makes sense – exchange rate appreciation has a similar effect
to higher interest rates. However, financial markets still seem to be underestimating
the potential for interest rate increases as tight labour markets push up wages and
inflation.”
Marc Van de Walle, Head of Group Wealth Products, OCBC Bank
Key Points
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The March Fed policy meeting outcome was more dovish than expected. The timing of the first rate hike will still be datadependent - September would be the most likely lift-off date. However, June could not be ruled out, if there was further
acceleration in the labour market recovery.
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The Fed seems to be more concerned about the strong U.S. dollar impact on growth (via weaker exports) and inflation. Last month,
it revised downwards both its growth and inflation forecasts. The dot plot (which shows the FOMC’s expectations about interest
rates) was also lowered by around 50 to 62.5 basis points over the next three years, and is now in closer alignment with market
expectations.
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However, we continue to caution that the pace of interest rate hikes may be faster than what the market is expecting, given rising
wage inflation pressures. Surveys show that firms and employees realise that bargaining power has shifted, so it is only a matter of
time before that translates into wage growth, even though it is muted at the moment.
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In the short term, a stronger U.S. dollar may have a positive impact on bonds. Bonds benefit for two reasons. Firstly a stronger
greenback will push out the timing of the Fed rate hikes. This lower-for-longer interest rate environment will help to support bond
prices in the near-term. Second, a stronger U.S. dollar will lead to a fall in imported inflation. This increases deflationary risk, and
lead to lower longer-term bond yields.
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In the bond space, we generally prefer high yield to investment grade bonds. Refinancing needs remain modest till 2017, and default
rates are expected to be low this year. As a result, we see U.S. high yield bonds as having a decent carry and credit spread buffer
against both a sell-off in U.S. Treasury bonds and expected defaults.
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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 TO TAKE A BREATHER
“We believe the U.S. dollar uptrend is not over, but dovish comments from the Fed and
soft U.S. data mean that the greenback could consolidate and retrace over the next few
weeks after a strong run over the past few months. We retain a strategic pro-U.S. dollar
bias, especially against Euro and Yen given that U.S. rates are still headed higher over
the medium-term.”
Michael Tan, Senior Investment Counsellor, OCBC Bank
Key Points
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The U.S. dollar’s uptrend, particularly versus the Euro and Yen, remains intact but the road towards a stronger greenback will be
bumpier and less impulsive than before given the dovish Fed meeting outcome last month.
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Stronger Eurozone data and positioning unwinds may extend the Euro’s upside versus the U.S. dollar for a while but a trend reversal
is unlikely given the ECB’s QE and concerns about Greece.
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The Pound could see further near-term weakness as the 7 May U.K. election build-up begins to gather pace. But we think the
resilience of the U.K. macro data will dominate election concerns over the medium-term. We prefer thee Pound among European
currencies and we could see a resumption of the Pound’s outperformance against the Euro in due course.
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The dovish Fed meeting outcome provides some near-term support for emerging market currencies. But we expect the relief for
these currencies to prove transitory. Even if an eventual Fed exit is more gradual than markets expected, the direction for U.S. rates
is likely to be higher and would undermine yield seeking flows into emerging market currencies.
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On the commodities front, potential rate hikes by the Fed and the possibility of a stronger U.S. dollar increases the downside risks
for gold, making it less appealing to investors. Interest rate hikes reduces the allure of gold which offer no yield. A stronger U.S. dollar
also make gold more expensive and reduces demand for the metal. We are bearish on gold and have a 12-month price target at
US$1,050 per ounce for the metal.
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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. We have a 12-month price
target of US$60-65 per barrel for oil prices.
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SPECIALS
MACAU - ECONOMY CONTINUES TO BE DRAGGED
BY WEAKENING GAMING INDUSTRY
“The Macau economy is expected to see another full year contraction in 2015. Gaming
revenue continued to drop in Q1 2015. This points to further headwinds in the retail
sector and residential property market.”
Iris Pang, Chief Economist, OCBC Wing Hang
Key Points
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We expect Macau’s GDP growth to see another full year contraction in 2015. The Macau government has cut its forecast of average
monthly gaming revenue in 2015 to MOP20 billion, 31.7% lower than the actual figure of MOP29.3 billion in 2014. In 2014, gaming
revenue dropped 2.6% YoY, leading to a 0.4% economic contraction. This was the first contraction observed since data became
available in 2002. The government’s latest gaming revenue forecast suggests that the Macau economy may face a deeper contraction in 2015 relative to 2014.
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Gaming revenue recorded the tenth straight negative growth of 39.4% YoY in March (-36.6% YoY in Q1) amid the continued
anti-corruption campaign on the Mainland. As the Macau economy is highly dependent on the gaming sector, falling gaming
revenue will result in continued slower wage growth, lower retail sales and weaker residential property market.
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The latest data shows that the average wage in the gaming sector slowed to 6.3% YoY in Q4 from 13.3% YoY in Q3. Overall wages
increased by 13.8% YoY in Q4 from 8.3% YoY in Q3, mainly driven by the utility and construction sector. However, we expect slower
overall wage growth in 2015 in part due to the continued decline in gaming revenue.
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We expect growth in retail sales to continue to be weak in 2015 because of lacklustre tourist spending on luxury items. Meanwhile,
lower wage growth also means less support to retail sales from domestic demand. Retails sales fell for the second quarter by 7.7%
YoY in Q4, of which sales of watches and jewelry dropped by 21.0% YoY.
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We expect the residential property market to remain under pressure amid the weakening gaming sector and falling income from
junkets. We expect average residential property prices to continue to record quarter-on quarter drops, at least in 1H 2015. Also, on a
year-on-year basis, we expect the increase in prices to turn negative. The downward trend in residential property prices may
continue into 2H 2015 if the worsening trend in the gaming sector does not stabilize. Average residential property prices dropped
5% QoQ to MOP94,788 per square meter in Q4, after a drop of 10% QoQ in Q3. On a year-on-year basis, average residential property
prices slowed to 10% YoY gains in Q4 from 49% YoY gains in Q3.
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