When did we ever start a new year without unfinished business, unsolved mysteries from the past year? In the non-exhaustive list below, most of the issues are obvious but the outcome is far from so.
1. US fiscal cliff. This should be renamed as the US fiscal rollercoaster which someone seemed to have forgottent to set a timer. Notwithtstanding the complexity of the US fiscal accounts and the ever-innovative US politicians, we can try to simplify the whole matter into two parts – sovereign credit risk vs recession risk. The crux of the matter is that the US government is incapable of reducing its debt stock under any circumstances in a short span of time. Hence, the decision to be made by the two political parties is how much the debt ceiling can be raised – for now – while working out a long-term – 10-year to be exact – plan that would progressively cut down on the government’ annual deficit so that it could return to a sustainable debt path, i.e. the debt stock can start coming down only at the end of this long-term/ 10-year plan. The sovereign credit threat comes of course from the three rating agencies which threatens that if the debt ceiling is NOT raised, then the US government IS surely to default. The Budget Control Act that President Obama signed back in August 2011 was that if the two parties cannot agree on a long-term/ 10-year plan, then there would be no increase in the debt ceiling which means that the federal government has to immediately start slashing spending and ending the carried over Bush tax cuts in order to “live within its means” – this is estimated to be equivalent to 10% of the US GDP, i.e. a 10% recession. At the end of 2011, the two sides couldn’t agree – the only thing they could agree was to give themselves another year to fix this after the Presidential election. So this is now.
Any which way you turn, the US economic growth is under threat of this “fiscal drag” i.e. deficit cut worth let’s say about 1% to 10% of GDP. Ben Bernanke is standing by to catch this by serialising QE. We are now in QE3.2. The conclusion on the USD is thus clear – it will be devalued by QE (because the US private sector is also running a deficit – the current account deficit, unlike Japan’s savings abundant private sector). The non-conclusive bit is the direction of the US treasury. Simplistically speaking, a sovereign credit threat should push up yields while a recession threat should push down yields. A sovereign credit threat may still occur even after a deal struck because the proof is always in the pudding. Have you heard of tax hikes working in a recession? Who pays taxes when income growth is negative? So for the whole of this year, be watchful of how this plan is going to work out. Don’t fall into complacency. I strongly suggest buying some CDS protection whenever it looks cheap enough if you prefer not to go short US treasury outright.
2. ECB and OMT. OMT = open market transactions. Greek C-rated sovereign debt is now accepted, said ECB. It’s slowly getting there. But will the ECB’s OMT goes up fast enough to overtake the Fed? This is an important question for the EURUSD. I don’t have an answer. I only know the Asia FX correlation to the EUR is a strong but sometimes asymmetrical one.
3. Dodd-Frank. I put this up here because us in banks are sternly warned about the don’ts of D-F which would prohibit any trades that have counterparty traced back to the US whether in person or by geographical location. Don’t believe the reports you read on how D-F can be circumvented by simplying relocating counterparties to outside the USA. The US law stipulates that as long as the ultimate beneficiary is US related, the DF applies. In the region, the MAS has said it would take a year to gather feedback before deciding whether to offer up our NDF FX to the the D-F spirit. It was quite clear that the MAS did not want to offer up the deliverable FX forward swaps for D-F coverage as that would expose the SGD business to a lot of scrutiny whereby… of course the MAS itself is a big market participant and its activities are justifiably to be kept opaque since these are intervention activities. On the fixed income side, this seems already cast in stone. Hong Kong is also dragging its feet. Taiwan has opted in. We’ll wait to hear more along the way and see how this might dampen activites, especially for markets such as CNY NDF.
4. China-Japan-Korea axis. All three held their national elections in Q4 2012. Japan’s PM-in-waiting Shinzo Abe is a second-time PM, first ruled in 2006 for less than a year. People with better memory might remember he wasn’t China-friendly. In the Sendoku Islands dispute, he made his point clear. Korea’s first female President Park Geun-hye was once upon a time the country’s de facto First Lady to her widowed father, President Park Chung-hee in the 1970s after her mother was assasinated. Park is a hardline rightist from the conservative Grand National Party. She hasn’t said much on foreign policies but I won’t hold my breath. China is more complex – this is like the Generation Z leaders – apparently the 7 politiburo members have very varied background but the tilt is towards conservatism. In any case, this is the default scenario if no consensus can be found. From an economic standpoint, we better be aware that the three economies have grown very close-knitted, forming a nice symbiosis through trade and investment that has actually gone to the State level. There are bilateral currency swap lines in their respective domestic currencies, three ways! I think there is unlikely to be direct confrontation that soon in the year… but it’s one of those red spots that warrants attention.
5. Japan – reflate or deflate. Heart is willing, flesh could be weak. BOJ is the heart, flesh is the economy. Governor Shirakawa’s job is at stake – he’s very willing to compromise.
6. China – reflate or deflate. Heart is weak, flesh is ever willing. PBOC is the heart, flesh is the economy. Governor Zhou’s term is already sealed, he has to step down by March – he’s determined not to backtrack on his hard-earned, 10-year track record as a reformer.
7. SGD. I have come to the tentative and non-consensus conclusion – keep the SGD FX policy. This is the best counter-strategy to QE because QE is ultimately a quantitive monetary policy and not an interest rate policy. The way the MAS operates the SGD policy is also pretty much a quantitative approach – buying quantums of USD according to how much it needs to keep the SGD stable rather than using interest rates. An interest rate policy in the current global QE world would not work. So yes, we continue to get cheap USD funding which the MAS can only continue to “moderate” but not cut off completely. These new measures on credit cards are unavoidable prudent measures which they should put more out.
8. Malaysia. In 2012, only Korea and Taiwan saw improvements in their trade/ current account positions which already started in surplus at the beginning of the year. On the other side, guess which country saw the biggest deterioration? Malaysia closely followed by India and Indonesia. The only reason why the ringgit has not suffered as much as the INR and IDR is because Malaysia came from a huge 20% of GDP current account surplus which has now fallen to single digit. Nothing is going right there – exports collapse with the collapsed of non-oil commodity prices, biggest being palm oil. Imports skyrocketed, thanks to the fiscal pump priming. Bank Negara says there is plenty more investment projects in the pipeline to drive growth. BNM is putting up a brave front. Fortunately, we don’t have to wait long to get over this guessing game. Election needs to be called by March 2013. If Barisan Nasional fails its super majority, there could be severe backlash on investments. I am very dovish MYR fixed income – I expect BNM to cut rates, a big non-consensus view.
9. Indonesia. 2013 is pre-election year. Lots of undercurrents in the political which seems to be following the recent conservatism vogue. I’m not bullish here.
10. India. 2013 is also a pre-election year here. The good thing is that this market has so under-performed in 2012 that its downside risk is now limited. I took a quick glance around the world – three markets stood up where its government bond markets failed to rally in 2012 – Spain, India and China. Indian politicians are trying to get their act together with the passage of the retail FDI bill and now on to the banking reform bill. But the recent win by the BJP in the state of Gujerat under Narendra Modi increases the risk of a contentious fight in the 2014 general elections, not that any Indian election is ever smooth-sailing or non-contentious.
Simplified conclusions – stay risk-on for now i.e. roll down the credit curve and long equities, buy some US sovereign protection, stay neutral EUR/USD, short JPY/Asia.