USD Recovery Underscored by Increasingly Hawkish FOMC Expectations

2 September 2016

Rates & FX Market Update

USD Recovery Underscored by Increasingly Hawkish FOMC Expectations

Highlights

¨   US & UK: USTs fell in August amid the hawkish Fed; BoE delivered further monetary easing after downgrading economic forecasts. Fedspeak at the Jackson Hole Symposium reinforced comfort towards improvements in US economy, particularly within the labour market, which supports a rate increase in 2016 (FFR Futures indicated 60% hike probability in 2016 vs. 36% in July); DXY climbed 0.52% m-o-m. In the UK, BoE oversaw a 25bps rate cut, a GBP 70bn increase in its QE program, as well as a new Term Funding Scheme with a c.GBP100bn capacity; measures likely exceeded market expectations. Unsurprisingly, the Gilts curve bull flattened in August, while GBPUSD dipped 0.7% m-o-m, although the pair briefly trades under the 1.30 handle in mid-August.

¨   Eurozone: Uncertainties over Italian banking system and ongoing electoral deadlock in Spain increase political risks in the block. Data-wise, macroeconomic numbers were mixed: 2Q16 GDP printed as expected at 0.3% QoQ and inflation remains weak with core CPI at 0.8% (exp 0.9%). As such it provided little clues ahead of the next ECB Governing Council held on September 8^th. EURUSD lost -0.14% m-o-m against the backdrop of stronger USD. Core EGBs tracked global bonds while PGBs fell on speculation the country could lose its investment grade ratings; 10y PGB yield rose by 11bps m-o-m.

¨   Japan & Australia: Economic prospects remain weak in Japan. Economic growth stagnation alongside further contractions in IP exacerbated Japan’s deflationary woes, with worse than expected core CPI printing at -0.5% YoY (exp -0.4%). USDJPY tested the psychological 100 support on several occasions before the JPY weakened as the broad USD benefitted from a hawkish Fed posting a 1.34% monthly gain. Over to Australia, RBA delivered another 25bps rate cut following the poor 2Q16 CPI reading, although both the statement and the minutes revealed little with regards to future policy actions. ACGB yields were lower m-o-m amid higher UST yields, while the AUDUSD declined c.1% m-o-m on the stronger dollars.

¨   Developed AxJ: SGS-UST spreads narrowed despite softer SGD; expansionary 2017 South Korean budget to bolster growth. SGS-UST spreads narrowed m-o-m despite weaker SGD (-1.69% m-o-m); SGS curve bull steepened. Singapore’s economic data painted a weak growth outlook, prompting a revision for 2016 GDP target to 1.0-2.0% (previous: 1.0-3.0%). Elsewhere, heightening political noise ahead of Hong Kong’s Legco elections remains overshadowed, where HKGB investors took directional cues from UST; HKGB curve flattened m-o-m, with yields on 10y declining back below 1.0%. In South Korea, yields on KTBs tracked USTs higher, rising by 5-12bps m-o-m; 3/10y KTB spreads remained tight at c.16bps, offering opportunities for investors to add steepener positions. Separately, South Korea released its draft fiscal budget, which is expected to increase fiscal expenditure by 3.7% to KRW400.7trn, while projecting for GDP to expand by 2.9%; net KTB issuances are expected to be reduced further for 2017 to KRW37.7trn (-17.9%).

¨   Emerging AxJ: Strong gains for CGBs contrasted AxJ bond movements. In China, increasingly hawkish FOMC expectations spurred an uneasy climb in USDCNY to 6.679 (+0.67% m-o-m), ahead of the G20 Summit. Despite so, strong demand was seen for both onshore and offshore CGBs, buoyed by corporate default concerns and tighter regulations from WMPs, driving yields on 2y CGBs and 3y CNH CGBs lower to 2.34% and 2.76%, partially offset by PBoC’s approach to discourage the utilisation of cheap short term funding to fuel the credit and bond market rally. In Thailand, ThaiGB curve bear steepened m-o-m, with yields rising by 2-20bps as support for Thai Constitution Referendum dulled near term expectations for a BoT rate cut while sustained robust public spending elevated concerns of heavy ThaiGB issuances; THB remained resilient, appreciating by 0.43% to 34.63/USD. In Malaysia, 2Q16 GDP printed within consensus expectations at 4% y-o-y, while IP, trade data and foreign reserves improved m-o-m; July CPI print remain lacklustre at 1.1% y-o-y. MGS/GII yields remained anchored after JP Morgan decided to add GIIs into its EMBI indices, while oil prices remain a significant driver of MYR movements. Elsewhere, BI lowered the lending facility rate by 100bps to facilitate a symmetrical and narrow rate corridor at ±75bps, as the bank moves to formally adopt the new 7D RRR as its new policy rate. IndoGBs and the IDR underperformed on market jitters amid mixed FOMC expectations among investors, while the progress of the tax amnesty program remains to be seen (1.9% of target as of end-Aug). In India, 2Q16 GDP disappointed at 7.1% y-o-y (consensus: 7.6%) with weakness appearing broad-based, piling pressure on the new RBI governor Mr Urjit Patel amid constrained fiscal policy leeway and rising headline prices. India made progress towards the much-awaited GST bill, with the Upper House of Parliament giving the green light and 15 states ratifying the bill already, driving Indian reform optimism; INR remained resilient despite USD strength.