Rising FFR Hike Expectations Underpinned USD Rally in October

2 November 2016

Rates & FX Markets Monthly Review

Rising FFR Hike Expectations Underpinned USD Rally in October

Highlights

¨   US & UK: US markets were driven by rising expectations of a December rate hike; FFR Futures indicated a probability of 71.4% vs. 59.3% a month before; GBP tanked sharply after PM May vowed to prioritise curbing immigrant flows over EU market access. As such, UST yields rose (2y: +7.9bps; 10y: + 23.1%) as well as the US Dollar with the DXY closing 3.12% higher. This scenario gained traction with upsides surprises coming from Markit Manufacturing PMI and 3Q16 GDP printing at 2.9% YoY. However we remain cognisant of a shallower rate trajectory in 2017 on softer growth prospects capping Treasury yields. In the UK, Gilt yields tracked UST yields higher, with 2/10y steepening by c.34bps m-o-m; robust data releases over the month also reduced the likelihood of further BoE easing over the near horizon. The GBPUSD pair fell almost 6% m-o-m after UK suggested triggering Article 50 in 1Q17, where concerns over a “hard Brexit” further exacerbate uncertainties, possibly weighing on UK credit strength.

¨   Eurozone: The fears of QE tapering were partially dismissed by the ECB which provided minimal dovish signals failing to stop the core EGBs rout with 10y German Bund yield navigating now over the course of October on average in positive territory for the first time since last June. The Euro lost ground on monetary policy discrepancy, closing down by -2.26% m-o-m. Portuguese bonds were the top DM performers since the decision by the Canadian credit rating agency DBRS to maintain the only Investment Grade rating left to the country came as a strong relief to market participants as it ensures the country’s eligibility under the ECB’s asset purchase program at a time rising yields were posing a threat to the country’s fiscal commitment and to the sustainability of the debt; 10y PGBs closed -1.1bps m-o-m.

¨   Japan & Australia: In the absence of strong onshore catalysts, the JPY weakened against the backdrop of a stronger USD; the USDJPY pair closed 3.42% higher. Amid the global bond selloff, JGBs were among the most resilient among developed countries, with PGBs and HKGBs, as 10y JGB closed 4.1bps higher. In Australia, ACGB yields climbed m-o-m on similar movements across the DM complex, while declines in AUD were largely attributed to USD strength. While September labour data was mildly disappointing, 3Q CPI came in stronger at 1.3% y-o-y (2Q: 1.0%); developments in Australia’s labour and housing markets are likely to receive greater focus under Governor Lowe.

¨   Developed AxJ: Narrowing SGS-UST spreads underpinned by an incrementally neutral MAS rhetoric; deteriorating economic and political outlook in South Korea places onus on BoK. Declining expectations for MAS to ease remained evident post MAS status quo decision, with spreads between SGS and USTs narrowing to a small margin over October. Separately, USDSGD surged higher by 2.05% m-o-m to 1.39, where weak 3Q GDP, NODX and labour market data in Singapore compounds on USD appreciation momentum. Elsewhere, South Korea faces a challenging month, with the President Park’s scandal exacerbating weak sentiment stemming from Hanjin and Samsung impact on economic woes. While the debate on accelerating household debt formation continue to bind BoK’s maneuverability, we opine for onus on support economic growth to remain on BoK, as the political stalemate alongside deteriorating political conditions is unlikely to yield a swift fiscal policy implement to stem the weakening economic growth outlook; yields on KTBs climbed 18-30bps while USDKRW surged higher by 3.87% to 1144 m-o-m amid the risk off sentiment. Meanwhile, risk off sentiment bolstered attractiveness for HKGBs, given the resilient HKD peg, with yields on HKGBs climbing by 0-7bps.

¨   Emerging AxJ: Fears of disorderly climb in USDCNY unfounded; persistently strong inflows into Thai bond market. Initial fears of disorderly movements on the USDCNY pair were quickly negated, as the pair treaded higher to 6.7758 (1.56% m-o-m) on the back of strengthening USD. China’s PPI edged into the positive territory in September, while disappoints from weak export data remained balanced by strong aggregate financing and PMI data, keeping PBoC rate cuts off the table and supporting a modest climb in CGB yields. Over in Thailand, bouts of political uncertainty undermined USDTHB, with the pair touching a high of 35.90 before retracing lower to 35.03 (+1.27% m-o-m) following the death of the Thai King. The pace of economic recovery in Thailand is likely to be tested given its impact on private consumption during the period of mourning, where the prospect of further BoT rate cuts underscored persistent inflows into the Thai bond market. In Malaysia, yields on 3y and 10y MGS climbed 7-13bps m-o-m, despite the softer-than-expected CPI (1.5% y-o-y; consensus: 1.8%) and IP (4.9% y-o-y; consensus: 5.4%) lending support to further BNM easing. The FY2017 budget was in line with broad market expectations, projecting a deficit of 3.0% of GDP (2016E: 3.1%) and continuing the slow and steady fiscal consolidation efforts. USDMYR surged towards the 4.20 handle, weighed by rising FFR hike odds alongside waning confidence in OPEC to cut supplies. Elsewhere, IndoGB yields tracked global yield movements higher, despite a relatively surprising 25bps BI rate cut aimed to bolster the Indonesian economy amid subdued gains in CPI growth. S&P declined to upgrade Indonesia’s BB+ rating at this juncture, citing corporate sector stress and external headwinds. In India, 10y Gsec yields and USDINR were surprisingly contained despite huge movements elsewhere, underpinned by RBI’s unanimous decision to cut policy rates by 25bps in its first meeting under the new regime; minutes due later in the month revealed that growth concerns and favourable CPI trends supported the decision. CPI data due after the meeting supported the easing stance (4.31% y-o-y; Aug: 5.05%).