Dollar Lifted by Reflation Hopes, Higher March Rate Hike Odds

2 March 2017

Rates & FX Markets Monthly Review

Dollar Lifted by Reflation Hopes, Higher March Rate Hike Odds

Highlights

¨   US & UK: Reflation theme kept alive by reform and spending hope. The US Dollar recovered over the course of February, rising by 1.62% m-o-m. Despite no further details provided on future US policies, markets continued to capitalize on hopes for pro-growth measures bolstered by strong economic data. As such, the probability for a March rate hike climbed to 52% at the end of the month from 14.5% at the beginning; 2y UST yield rose by 5.6bps while 10y UST yield dropped by -6.3bps highlighting that uncertainties linger which is supportive of safer assets; a thematic that we expect to protract in 2017. Over in the UK, 10y Gilt yields tanked c.27bps lower m-o-m on a combination of catalysts, including: i) BoE signalled a lower inclination towards rate hikes over the medium term; ii) poor CPI and wage data, despite relatively robust employment numbers; iii) European political woes dragging down German yields, subsequently impacting Gilt yields to some extent. The GBPUSD pair was also dragged down (-1.58% m-o-m) by a resilient dollar and emergent threats of a 2^nd Scottish independence referendum.

¨   Eurozone: ECB willing to continue its accommodative policies in view of weak growth prospects. Although the political risk is rising in Europe ahead of the upcoming Dutch and French elections (March 15^th, and April/June respectively), European Government Bonds performed well in February as market participants took comfort with ECB’s minutes suggesting little appetite to curb its stimulus of aggressive bond purchases. The ECB acknowledged that the recent rise in inflation could only be temporary, against the backdrop of weak growth prospects, opening the door to more stimulus if needed. On the currency side however the Euro dropped because of the worrying possible outlook of the elections, monetary policies discrepancy and the trumpflation trade supportive of the USD.

¨   Japan & Australia: AUD dynamics stable amid resilient commodity prices. As expected, Japanese assets took cues from global markets. Although closing flat (USDJPY -0.03% m-o-m), the JPY remains the most sensitive currency to USD gyrations with a 3-month beta standing at 1.18. 10y JGB yield briefly spiked up above 0.105 before closing around 0.05% helped by BoJ yield curve control which is expected to anchor the yield around 0%. In Australia, 2y and 10y ACGB yields were marginally higher m-o-m as the Australian economic outlook remains resilient, with the AUD gaining ground despite the stronger dollars as the terms of trade outlook continues to improve on stabilising commodity prices. Australian labour data painted a mixed picture, while Capex trends appear pessimistic.

¨   Developed AxJ: Expansionary FY17 fiscal budget in Singapore further diminished prospects of MAS easing. Singapore’s FY17 budget remained expansionary, registering a narrower fiscal surplus of SGD1.9bn (0.4% of GDP), targeting long term productivity gains while providing short term support for households and corporates impacted by the economic cycle. SGS curve bull steepened m-o-m amid diminishing prospects for MAS easing this year while USDSGD broke its major support at 1.4150, treading lower even as debates on FOMC March rate hike intensifies. Elsewhere, the South Korean government unveiled plans to promote consumer spending following BoK’s decision to remain on hold for the month of February. Better risk sentiment sent the KRW surging by 2.67% m-o-m to 1,130/USD, with investors shrugging off impact from North Korea’s missile test launch; yields on KTBs held steady m-o-m.

¨   Emerging AxJ: Tighter liquidity condition in China; Yields on Gsecs climbed as RBI refrained from further easing measures. In China, we saw a volatile month for CGBs, with yields on 10y reaching an intra-month high of 3.48%, before retracing lower to 3.31%. Tight grip on domestic liquidity remained evident as PBoC stayed away from the reverse repo market for the first 3 weeks, as stabilizing economic growth fuels China’s commitment to advance its reforms agenda of curbing excessive credit growth; USDCNY held firm to the 6.87 handle over February. Turning to Thailand, upside surprise in export demand buoyed strong expectations towards a firmer economic recovery, with Finance Ministry revising the 2017 GDP forecast higher to 3.6% (previous: 3.4%). Yields on ThaiGBs edged lower by 4-11bps m-o-m amid improving risk appetite, while robust external balances continue to bolster strength in the THB, supporting an appreciation of 0.46% m-o-m against the strengthening USD. Malaysian 10y yields tightened c.9bps m-o-m on lower global yields, although the latest BNM data revealed that foreign ownership of MGS dipped further in January to 46.0%. While 4Q16 GDP print surprised on the upside (4.5% y-o-y; consensus: 4.4%) alongside inflation ticking upwards, sentiment towards the MYR remains weak (USDMYR +0.27% m-o-m) as foreign investors adopt a wait-and-see approach. Elsewhere, IndoGB yields tightened c.3-10bps m-o-m bolstered by foreign inflows, despite an uptick in inflation alongside BI’s cautiousness towards further monetary easing over the near term; the bank held benchmark rates at 4.75%. IDR was resilient over the month against the USD despite planned protests against the incumbent Jakarta governor, although the election process itself went largely unhindered. Indian assets were largely driven by local catalysts, with RBI’s decision to refrain from a widely expected rate cut drove 10y Gsec yields c.46bps higher m-o-m, although the move also bolstered the INR on foreign inflows and domestic buying; USDINR fell 1.73% m-o-m. Although Indian CPI came in softer than expectations, WPI unexpectedly surged 5.25% y-o-y due to higher commodity prices, while 4Q16 GDP printed much stronger than expectations (7.0% y-o-y; consensus: 6.1%) despite the surprise demonetisation effort.

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