Lowering our Asia bond yield forecasts; taking stock of Fed views

Asia yield forecasts revised lower. Taking stock of Fed views.
Duncan Tan, Philip Wee23 Aug 2019
    Photo credit: AFP Photo

    Rates: Declining DM yields pushing down Asian EM yields

    Earlier this week, we had brought down our G3 bond yields forecast to reflect our lower for longer broad view (link). We now see 10Y US Treasury yields around 1.75% at end-2019 and 2.20% at end-2020. In line with our G3 revisions, we are also lowering some of our forecast across Asia, specifically for Malaysia, Thailand, the Philippines, and South Korea. We think bond yields are presently slightly rich and could trough by early-2020 on the back of some stabilization in the global growth outlook. Thereafter, yields could grind higher towards end-2020 as the demand for safe assets like government bonds fade. Volatility in interest rates could stay elevated and looking ahead, there is likely a fair amount of uncertainty/margin of error around our forecast.

    The front-end of most Asia curves are already pricing in a large amount of central bank easing, approximately 25-50bps over the next 12 months for each of the 4 countries. Relative to market pricings, our policy rates forecast do appear to be slightly hawkish. In our view, we believe markets are assigning overly large probabilities to severe future economic scenarios and consequently, a faster pace and larger amount of monetary easing. At the same time, possible events that would weaken the case for easing, e.g. upside surprises in inflation, are being under-priced.
    In the current environment where global investors are reaching for yields but are wary of rising macro risks, Asia's mid-yielders like Malaysia and Philippines bonds could be in a sweet spot. Their yields are much higher than low-yielders such as South Korea and Thailand. Mid-yielders are also less sensitive to external risks and global risk sentiments when compared to high-yielders like Indonesia. To global investors, mid-yielders offer an attractive balance between yields and risks.
    FX: No big bets into Jackson Hole

    Global currencies have not taken strong positions into the Fed’s Jackson Hole Symposium in Kansas. Opinions remain divided amongst the FOMC members on the need and urgency for more rate cuts. The two Fed Presidents who dissented against the Fed cut in July, Esther George (Kansas) and Eric Rosengren (Boston), have not changed their minds. Neither subscribed to the recession fears inferred from the inverted yield curve. George blamed the inversion on the Fed’s balance sheet. Rosengren prefers to rely on hard data instead of market sentiment.

    Fed Governor Lael Brainard, however, has been paying close attention to financial markets and their implications for the outlook. Brainard was a former Undersecretary of the Treasury for International Affairs who helped steer Washington’s response during the Eurozone crisis. Fed Chairman Powell, Vice Chairman Richard Clarida and James William (New York) also subscribed to the need for “insurance cuts” to help buffet the economy from global headwinds.

    Leading Fed dove James Bullard (St Louis) has not abandoned his view for another cut this year. But he saw no urgency to deliver one or the need for a larger reduction. Not surprisingly, Charles Evans (Chicago) wants more accommodation. The MNI Chicago Business Barometer has fallen sharply to 44.4 in July 64.7 in February. Overall, the Fed will attempt to balance its message that while data has supported cautious optimism for the US economy, the Fed will not ignore the headwinds implied by financial markets, and when needed, is ready to respond to sustain the expansion.

    Duncan Tan

    FX and Rates Strategist - Asean

    Philip Wee

    FX Strategist - G3 & Asia

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