Macro

In this briefing:

1. Recession/Trade War/ Consumers/Shares/Perpetual Bonds
2. Resource Export Earnings Repatriated / Sulawesi Flood / BTP Free / Tax IT / MRT / Electoral Agencies
3. India Equity CY18 Update and Outlook for CY19
4. Migrant Workers and Employment
5. India: Unimpressive Data on Organised Sector Job Creation

1. Recession/Trade War/ Consumers/Shares/Perpetual Bonds

China News That Matters

• China´s weakest growth for 28 years 
• Talk to me; Liu He comes to town
• Consumers – still packing the engine room?
• Pork king stirs stocks as Nasdaq nears
• Perps. Billions of ‘em

2. Resource Export Earnings Repatriated / Sulawesi Flood / BTP Free / Tax IT / MRT / Electoral Agencies

Politics: Corruption moved to the fore of campaign sparring, as National Mandate Party (Pan) founder Amien Rais accused President Joko Widodo of “crimes of omission”.  The attack may reflect mounting grounds for concern about the poll position of Pan, which risks suffering exclusion from the next parliament.  Prabowo Subianto and his campaigners continue to issue vague insinuations, rather than highlighting the plain fact that four active investigations are embroiling Widodo‑government ministries (Page 2).  Basuki Purnama left prison and asked to be called ‘BPT’.  Megawati’s cool treatment of the former Jakarta governor reflects her diffidence about championing pluralism (p. 3).   

Disasters: Flooding has killed dozens and displaced thousands in 10 districts of South Sulawesi, including Makassar.  The governor faults past management of watersheds (p. 4). 

Electoral System: Yet again, the State Administrative Court (PTUN) has contradicted the General Election Commission (KPU), putting the latter at odds with the Election Oversight Agency (Bawaslu) in a case pertaining to Oesman Sapta Odang (OSO), the Hanura chair who is speaker of the Regional Representatives Assembly (DPD).  Although OSO is disreputable, Hanura is tiny and the DPD virtually powerless, the case nonetheless poses risks for the KPU’s prestige and effectiveness (p. 5). 

Justice: The spiritual leader of the former terrorist organization Jemaah Islamiyah (JI), Abubakar Baasyir, has not yet won release.  He must first issue a written statement declar­ing loyalty to the Republic of Indonesia and the pluralist state ideology Pancasila (p. 7).

Policy News: The president finally enacted a long-planned regulation to require natural-resource exporters to recycle their foreign-exchange earnings through domestic banks.  Some coal producers complain that the move conflicts with the terms of their offtake-and-financing agreements.  But the measure holds promise for rectifying the tight onshore dollar liquidity that has long rendered the rupiah highly volatile (p. 9).  A new tax IT system is undergoing procurement, with full deployment targeted for 2023 (p. 11).

Jakarta: The March opening of the MRT – and all 13 stations – is on schedule (p. 12).

3. India Equity CY18 Update and Outlook for CY19

Equity markets across emerging countries in 2018 faced significant headwinds primarily due to rising US Fed rates that led to a capital outflow as well as higher commodity prices including crude oil that affected the profitability of companies. India was no exception.

The corporate results in India were a mixed bag. While sales have finally recovered from the impact of demonetization and GST transition, the profitability was impacted due to high commodity prices and rising provisions due to higher bad loans for the banks.

On a positive note though, a number of  things seem to have fallen in place in 2018 like NCLT lead NPA resolution, bank management changes, increased capacity utilization, lower inflation, falling commodity prices. If the same trend were to continue in 2019, we are confident that macros will turn more favorable and improved corporate sales can translate into better earnings growth.  This we believe may augur well for Indian equities.

We examine all these factors in detail

4. Migrant Workers and Employment

Recently, we have profiled a spat of news items focusing on China’s employment numbers and efforts to better handle migrant workers. On Monday, some updated data on employment numbers and migrant workers was released. Much of the focus on Monday was on GDP, but there are some gems among the employment data that can shed light on the China’s employment numbers and the impact it could have on the wider economy.

5. India: Unimpressive Data on Organised Sector Job Creation

One of the important ongoing debates in the country has been on the topic of Job creation. In the absence of a official household survey, the government has been releasing data on new retirement accounts with EPFO as a proxy for formal sector job creation. That data though is subject to significant limitations and is most likely over-stating job creation currently due to the ongoing tax incentives. That said, even taken at face value, the EPFO data by itself is not suggestive of strong job creation in the economy. The EPFO data at best suggests a total of 8 million jobs being created in the organised sector when the total number of jobs required to be created outside Agriculture is probably 2x of that. Thus, unless a clear assessment of the performance of the unorganised sector can be made, any rigorous assessment of the labour market cannot be made. There is a urgent need for a formal, household survey to assess the labour market. And there is no reason why a country like India cannot commission and successfully execute a survey once a quarter.

In this briefing:

1. Stimulus/Bond Index Products/China-US Tension/Huawei Denials/Military
2. FLASH: UK Retail Sales Normalise for End-2018
3. The Burden of Too Big Government
4. The Black Elephant Has Trumpeted

1. Stimulus/Bond Index Products/China-US Tension/Huawei Denials/Military

China News That Matters

• Pump it up, but don’t flood the place
• Roll up, roll up: China touts bonds
• Sino-US trade talks shift to Washington
• Trust me, I’m just a sesame seed
• No longer playing catch up? The “world-leading” PLA

2. FLASH: UK Retail Sales Normalise for End-2018

• UK retail sales retreated to their still-bullish trend level in Dec-18. A higher than usual share of consumption appears to have been pulled forward for Black Friday.
• The significantly weaker outcome for December trims my monthly GDP forecast to 0.0% but leaves 4Q18 at 0.3% q-o-q. The earlier reversion to trend removes that source of depression from growth in the new year.

3. The Burden of Too Big Government

From our very own “Austrian” Leigh Skene:

Wars in old times were made to get slaves. The modern implement of imposing slavery is debt. Ezra Pound

Governments used public sector balance sheets to bail out private financial institutions and assist private companies to emerge from bankruptcy in the GFC. These actions transferred credit risk from the private to the public sector, yet falling nominal interest rates minimised, and in some cases froze, the cost of servicing the mounting government debt until late 2016. Since then, many borrowers have paid rising  interest rates on increasing amounts of debt. Debt service charges are rising faster than nominal GDP in a growing number of nations as a result. It is estimated that the US federal funding requirement will rise from minus US$ 700bn to US$ 2tr in 2022.

4. The Black Elephant Has Trumpeted

In The United States: 2019 Set Fair but Then? we wrote that we do not expect another Fed rate hike until June 2019, at the earliest with an even stronger probability that the next move from the Fed in this cycle will be a cut in 2020. We expect on trend growth in the US over the next 12 months as the free money spigot continues to shut marginally. Sentiment towards Asian markets – once it is realised that Asia’s economic performance and growth in real economic activity will again surpass advanced economies by a wide margin – will change for the better this year. It’s about time. 

In this briefing:

1. Differing Sino-US Agendas Undermine Global Growth Outlook
2. FLASH: UK Inflation Falling Fast over 2018 Yearend

1. Differing Sino-US Agendas Undermine Global Growth Outlook

The fate of the global economy in 2019 will hinge on the willingness of China and the US to combat decelerating domestic growth via invoking appropriate policy support.

Given current fiscal backdrops, both China and the US have less capacity to ease policy to boost growth compared to the available monetary measures at their disposal.

Pressure is increasing on Beijing to aggressively cut taxes in March to stimulate growth, as well as structurally boosting consumption.

China’s consumers have become increasingly more discerning in their attitude towards foreign brands, partly due to the rise of credible local competitors.

The current economic and financial environment is somewhat reminiscent of 2016 when a deal between the Fed and China averted protracted economic and financial turbulence, but the current China-US nexus makes an accord in 2019 extremely unlikely.

China is unlikely to act again as buyer of last resort for the world economy courtesy of another credit binge, but policy will instead focus on stabilising growth at 6.0%-6.5%.

2. FLASH: UK Inflation Falling Fast over 2018 Yearend

• UK inflation disappointed consensus expectations for the RPI again in Dec-18 with its 0.5pp fall to 2.7% y-o-y (index at 285.6), while the CPI print was in line at 2.1%.
• Upside news in my CPI forecast was from food and airfares while the downside on the RPI was from the housing sector.

In this briefing:

1. Resource Export Earnings Repatriated / Sulawesi Flood / BTP Free / Tax IT / MRT / Electoral Agencies
2. India Equity CY18 Update and Outlook for CY19
3. Migrant Workers and Employment
4. India: Unimpressive Data on Organised Sector Job Creation
5. Vietnam: Still China Plus One?

1. Resource Export Earnings Repatriated / Sulawesi Flood / BTP Free / Tax IT / MRT / Electoral Agencies

Politics: Corruption moved to the fore of campaign sparring, as National Mandate Party (Pan) founder Amien Rais accused President Joko Widodo of “crimes of omission”.  The attack may reflect mounting grounds for concern about the poll position of Pan, which risks suffering exclusion from the next parliament.  Prabowo Subianto and his campaigners continue to issue vague insinuations, rather than highlighting the plain fact that four active investigations are embroiling Widodo‑government ministries (Page 2).  Basuki Purnama left prison and asked to be called ‘BPT’.  Megawati’s cool treatment of the former Jakarta governor reflects her diffidence about championing pluralism (p. 3).   

Disasters: Flooding has killed dozens and displaced thousands in 10 districts of South Sulawesi, including Makassar.  The governor faults past management of watersheds (p. 4). 

Electoral System: Yet again, the State Administrative Court (PTUN) has contradicted the General Election Commission (KPU), putting the latter at odds with the Election Oversight Agency (Bawaslu) in a case pertaining to Oesman Sapta Odang (OSO), the Hanura chair who is speaker of the Regional Representatives Assembly (DPD).  Although OSO is disreputable, Hanura is tiny and the DPD virtually powerless, the case nonetheless poses risks for the KPU’s prestige and effectiveness (p. 5). 

Justice: The spiritual leader of the former terrorist organization Jemaah Islamiyah (JI), Abubakar Baasyir, has not yet won release.  He must first issue a written statement declar­ing loyalty to the Republic of Indonesia and the pluralist state ideology Pancasila (p. 7).

Policy News: The president finally enacted a long-planned regulation to require natural-resource exporters to recycle their foreign-exchange earnings through domestic banks.  Some coal producers complain that the move conflicts with the terms of their offtake-and-financing agreements.  But the measure holds promise for rectifying the tight onshore dollar liquidity that has long rendered the rupiah highly volatile (p. 9).  A new tax IT system is undergoing procurement, with full deployment targeted for 2023 (p. 11).

Jakarta: The March opening of the MRT – and all 13 stations – is on schedule (p. 12).

2. India Equity CY18 Update and Outlook for CY19

Equity markets across emerging countries in 2018 faced significant headwinds primarily due to rising US Fed rates that led to a capital outflow as well as higher commodity prices including crude oil that affected the profitability of companies. India was no exception.

The corporate results in India were a mixed bag. While sales have finally recovered from the impact of demonetization and GST transition, the profitability was impacted due to high commodity prices and rising provisions due to higher bad loans for the banks.

On a positive note though, a number of  things seem to have fallen in place in 2018 like NCLT lead NPA resolution, bank management changes, increased capacity utilization, lower inflation, falling commodity prices. If the same trend were to continue in 2019, we are confident that macros will turn more favorable and improved corporate sales can translate into better earnings growth.  This we believe may augur well for Indian equities.

We examine all these factors in detail

3. Migrant Workers and Employment

Recently, we have profiled a spat of news items focusing on China’s employment numbers and efforts to better handle migrant workers. On Monday, some updated data on employment numbers and migrant workers was released. Much of the focus on Monday was on GDP, but there are some gems among the employment data that can shed light on the China’s employment numbers and the impact it could have on the wider economy.

4. India: Unimpressive Data on Organised Sector Job Creation

One of the important ongoing debates in the country has been on the topic of Job creation. In the absence of a official household survey, the government has been releasing data on new retirement accounts with EPFO as a proxy for formal sector job creation. That data though is subject to significant limitations and is most likely over-stating job creation currently due to the ongoing tax incentives. That said, even taken at face value, the EPFO data by itself is not suggestive of strong job creation in the economy. The EPFO data at best suggests a total of 8 million jobs being created in the organised sector when the total number of jobs required to be created outside Agriculture is probably 2x of that. Thus, unless a clear assessment of the performance of the unorganised sector can be made, any rigorous assessment of the labour market cannot be made. There is a urgent need for a formal, household survey to assess the labour market. And there is no reason why a country like India cannot commission and successfully execute a survey once a quarter.

5. Vietnam: Still China Plus One?

For the last few years people have been referring to China+1, the ‘one’ sometimes being Vietnam. Is it now time to be thinking of ‘The One’? There is certainly evidence that businesses are on the move. Admittedly, this is not new – low end footwear, clothing and toy companies have been moving to Vietnam for years. But the US-China trade dispute appears to be changing mind sets. The proof is in the pudding, see Vietnam: Economic Prestidigitation, where we noted Vietnam’s foreign direct investment boom. 

In this briefing:

1. FLASH: UK Inflation Falling Fast over 2018 Yearend
2. The United States: 2019 Set Fair but Then?
3. Philippines: The Hanjin Scare
4. FLASH: Brexit Deal Defeated by 230

1. FLASH: UK Inflation Falling Fast over 2018 Yearend

• UK inflation disappointed consensus expectations for the RPI again in Dec-18 with its 0.5pp fall to 2.7% y-o-y (index at 285.6), while the CPI print was in line at 2.1%.
• Upside news in my CPI forecast was from food and airfares while the downside on the RPI was from the housing sector.

2. The United States: 2019 Set Fair but Then?

While Donald Trump amassed troops along the Mexican border in order to repel the migrant caravan from Honduras, it is really the caravan of policy problems lined up behind him that is more likely to disrupt his presidency. Fiscal promises relating to public-sector pensions, Medicaid and Medicare are set to grow exponentially over the coming years. And then there is the increase in nonfinancial corporate debt since 2010 which has been accumulated during a period of the most distorted capital-pricing in history. When the first wave of renewed economic problems hit all there will be to withstand them is, in the famous words of ex-Fed Chair Janet Yellen, “More of Plan A”. The next time around, and that time is coming soon, it is likely to prove to be a dud.

3. Philippines: The Hanjin Scare

• Knee-jerk market reaction to the disclosure last Friday (January 11, 2019) of Hanjin’s (Philippines) severe cash flow constraints including the local banks’ loan exposure, was understandable. However, the banks FCDU (foreign currency deposit unit) loan exposure of US$412mn (roughly Php21bn) to Hanjin was modest relative to the banking system’s FCDU (banks Hanjin loan exposure is about 1.1% of FCDU deposits), outstanding bank loans, capitalization ratios, etc. Officials of the big local banks have assured markets and investors of their financial ability to cover potential Hanjin loan losses. Banks consolidated NPL ratio is in the low, single-digit (1.8% in October 2018) that can easily absorb the FCDU hit.  

• Will the employment losses from Hanjin’s local subsidiary located in Subic bay, spawn regional demand-side risk particularly for Central Luzon—a key, emerging commercial/industrial hub in Luzon? Against recent regional GDP estimates (2016-17), we failed to detect any severe employment shock during the height of Hanjin’s job shedding. Down to 3,000 workers (peak of more than 30,000 in 2014-15), we have already been through the worst of the jobless impact of Hanjin’s business collapse. Central Luzon’s regional GDP grew by over 9% in real terms in 2017 and 2016 (vs national GDP growth of 6.9% in 2016 and 6.7% in 2017) despite the likelihood of Hanjin’s job losses. Central Luzon’s manufacturing output still managed to rise by 2-digit rates in 2016-17.On a per capita basis, Central Luzon’s per capita real GDP grew by close to 8% in 2016-17 despite perceived regional job market adjustments. Perhaps the fiscal stimulus programs including more infrastructure projects directed at the Central Luzon provinces allayed the worst of Hanjin’s macro shock.

• I believe the Hanjin event risk represents an opportunity to buy risk assets on any sustained adverse market reaction while safeguarding one’s liquidity position.

4. FLASH: Brexit Deal Defeated by 230

• The UK parliament rejected the Brexit deal by a historically substantial margin of 230 votes (432 vs 202). Presentation of a plan-B will probably occur on Monday.
• A vote of no confidence in the government will occur on 16 Jan. With eurosceptics and the DUP maintaining support, an early election should be avoided.
• Theresa May is signalling greater openness to opposition support, despite its unreliability, which the market has welcomed. A codicil that clearly clarifies the backstop’s non-permanence still looks like the most likely solution, in my view.

In this briefing:

1. FLASH: UK Retail Sales Normalise for End-2018
2. The Burden of Too Big Government
3. The Black Elephant Has Trumpeted
4. Debt Ratios Do Matter
5. Differing Sino-US Agendas Undermine Global Growth Outlook

1. FLASH: UK Retail Sales Normalise for End-2018

• UK retail sales retreated to their still-bullish trend level in Dec-18. A higher than usual share of consumption appears to have been pulled forward for Black Friday.
• The significantly weaker outcome for December trims my monthly GDP forecast to 0.0% but leaves 4Q18 at 0.3% q-o-q. The earlier reversion to trend removes that source of depression from growth in the new year.

2. The Burden of Too Big Government

From our very own “Austrian” Leigh Skene:

Wars in old times were made to get slaves. The modern implement of imposing slavery is debt. Ezra Pound

Governments used public sector balance sheets to bail out private financial institutions and assist private companies to emerge from bankruptcy in the GFC. These actions transferred credit risk from the private to the public sector, yet falling nominal interest rates minimised, and in some cases froze, the cost of servicing the mounting government debt until late 2016. Since then, many borrowers have paid rising  interest rates on increasing amounts of debt. Debt service charges are rising faster than nominal GDP in a growing number of nations as a result. It is estimated that the US federal funding requirement will rise from minus US$ 700bn to US$ 2tr in 2022.

3. The Black Elephant Has Trumpeted

In The United States: 2019 Set Fair but Then? we wrote that we do not expect another Fed rate hike until June 2019, at the earliest with an even stronger probability that the next move from the Fed in this cycle will be a cut in 2020. We expect on trend growth in the US over the next 12 months as the free money spigot continues to shut marginally. Sentiment towards Asian markets – once it is realised that Asia’s economic performance and growth in real economic activity will again surpass advanced economies by a wide margin – will change for the better this year. It’s about time. 

4. Debt Ratios Do Matter

Monetary diarrhoea has inflated the debt structure.

The death of the Bretton Woods monetary system in 1971 paved the way for unbridled money printing. The resulting Great Inflation inflicted huge negative real returns on bondholders and stockholders until 1982. Thereafter, many countries, especially EMs, linked their exchange rates to the dollar, resulting in the fastest ever-growth in global foreign exchange reserves. In addition, central bank puts and then extraordinary fiscal and monetary policies turned it into the most virulent asset bubble in history, despite monetary mayhem, exemplified by numerous banking crises and three big stock market drawdowns. 

5. Differing Sino-US Agendas Undermine Global Growth Outlook

The fate of the global economy in 2019 will hinge on the willingness of China and the US to combat decelerating domestic growth via invoking appropriate policy support.

Given current fiscal backdrops, both China and the US have less capacity to ease policy to boost growth compared to the available monetary measures at their disposal.

Pressure is increasing on Beijing to aggressively cut taxes in March to stimulate growth, as well as structurally boosting consumption.

China’s consumers have become increasingly more discerning in their attitude towards foreign brands, partly due to the rise of credible local competitors.

The current economic and financial environment is somewhat reminiscent of 2016 when a deal between the Fed and China averted protracted economic and financial turbulence, but the current China-US nexus makes an accord in 2019 extremely unlikely.

China is unlikely to act again as buyer of last resort for the world economy courtesy of another credit binge, but policy will instead focus on stabilising growth at 6.0%-6.5%.

In this briefing:

1. Wanted: A 21st Century Monetary Theory
2. Vietnam: Economic Prestidigitation
3. India Policy Rates – Case For A Cut Builds
4. Widodo Prevails in 1st Debate / Reform Discussed / BI Holds Rate / Poll Margins Steady / PSI Emerges
5. Stimulus/Bond Index Products/China-US Tension/Huawei Denials/Military

1. Wanted: A 21st Century Monetary Theory

The globe is facing more than an ordinary business cycle.

Joseph C. Sternberg, editorial-page editor and European political-economy columnist for the Wall Street Journal’s European edition, recently interviewed Claudio Borio, head of the Monetaryand Economic Department of the BIS. Mr. Borio said that politicians have relied far too much on central banks, which are constrained by economic theories that offer little meaningful guidance on how to sustain growth and financial stability. The only tool they have is an interest rate that can affect output in the short run but ends up affecting only inflation in the end.

2. Vietnam: Economic Prestidigitation

On Thursday 27 December 2018 the General Statistics Office (GSO) in Hanoi announced that Vietnam had grown by 7.08% (7.1% to us mere mortals) for full year 2018. Magically, this was exactly the same number as that forecast by the Asian Development Bank in April, long before the travails that affected the rest of the region in the second half of the year. It was also an outlier among economic forecasters (with the IMF in July projecting just 6.6% for last year). Even more magically, the GSO was able to produce this number just before the end of the year when, officially, money supply data were only available up to September and credit data to July. Hey presto, economic statistics are magic!

Truth be told, Vietnam is an object lesson in the worth of most macroeconomic statistics collected by governments at the insistence of the IMF: pinches of salt should be handed out with each release.

Economic data are manipulated around the world by governments. True economic conditions are apparent to anyone who is on the ground (which makes life difficult for fund managers who are not visiting countries they invest in regularly). And in Vietnam, after one day of meetings, we would conclude that, even if the 7.1% number is just pie-in-the-sky, economic growth and general economic conditions are very good.

3. India Policy Rates – Case For A Cut Builds

A cut in interest rates is coming. The case is compelling. Headline inflation is easing and is now running well below the RBI’s forecasts. System non-performing loans have peaked while the trade deficit is narrowing meaning the central can afford some largess. Given where real lending rates are and the fragility of the corporate profit cycle, lower policy rates would welcome and a positive of the India growth story. We reiterate our overweight Indian equities call.

4. Widodo Prevails in 1st Debate / Reform Discussed / BI Holds Rate / Poll Margins Steady / PSI Emerges

BI held its benchmark rate steady due to current account concerns; in any event, bank credit growth suggests that the economy has considerable momentum despite international headwinds and the 2018 rate hikes.  Widodo did enough to surpass Prabowo in the 1st of 5 presidential debates, although Prabowo avoided gaffes and both candidates lacked energy.  Dubbed a ‘dud’ in headlines, it at least featured constructive discussion of bureaucratic reform.  Widodo also promised a National Legislative Center to rectify conflicting and excessive regulation.   A Charta Politik poll shows steady margins for Widodo and PDI-P as of late December and the sole reform-minded party, the new PSI, finally registered support of 1.5%.  Planners remain at odds over a location for a downtown terminus of Jakarta’s elevated LRT — a project crucial for complementing the imminent MRT. 

Politics: Despite a critical domestic press reaction and a lack of sensational moments, the first presidential debate produced the most detailed high‑level discussion of bureaucratic reform in more than a decade.  Overall, President Joko Widodo fared better than his challenger, Gerindra Chair Prabowo Subianto, but both seemed lacking in energy.  Both also succeeded in avoiding pitfalls: Widodo’s running mate, the aging cleric Mar’uf Amin, caused no major embarrassment for the ticket; and Prabowo maintained an even temper with no unseemly rants.  The candidates traded barbs: Prabowo hit home by questioning Widodo’s decision to appoint a “top law enforcement official” (i.e., the attorney general) who is a party representative; and Widodo twice inflicted damage by citing Gerindra’s lack of women in its leadership and its nomination of corruption convicts for legislative offices.  Widodo unveiled a plan for a National Legislative Center (Puslegnas).  The debate, translated in full by Ref Wkly, seems unlikely to alter the candidates’ poll positions (Page 2).  The president approved the release of the 80‑year‑old icon of terrorist groups, Abu Bakar Basyir (p. 15).  Widodo visited a fair for businesses run by impoverished households and, oddly, purchased 100,000 1‑liter bottles of dishsoap from one vendor.  At best, the episode may indicate a preoccupation with his family’s catering business; at worst, it shows haphazard handling of his personal finances (p. 16). 

Surveys: Charta Politik measured President Joko Widodo’s margin as being virtually unchanged at 19 percentage  points in late December.  It also confirmed that PDI‑P’s nomination of Widodo is a major reason for its popular support.  The pro‑reform Solidarity Party (PSI) finally registered detectable support of 1.5 percent (p. 17). 

Infrastructure: Differences between the central and provincial government persist over where to locate the terminus of the Light Rail Train (LRT) in downtown Jakarta.   A large land plot south of Landmark Tower has been vacant for decades – but the central government prefers a less central location (p. 19).   

Economics: The rupiah has partially rebounded amid easier external financing conditions in recent weeks, but Bank Indonesia (BI) nonetheless decided this week to maintain its benchmark rate at 6.0 percent – due to a persistently high current account deficit.  In part, the deficit reflects Indonesia’s considerable economic momentum.  Nonetheless, rising fuel imports and falling oil production signal continued current account pressure ahead, necessitating vigilance from BI (p. 20). 

5. Stimulus/Bond Index Products/China-US Tension/Huawei Denials/Military

China News That Matters

• Pump it up, but don’t flood the place
• Roll up, roll up: China touts bonds
• Sino-US trade talks shift to Washington
• Trust me, I’m just a sesame seed
• No longer playing catch up? The “world-leading” PLA

In this briefing:

1. China’s December GDP
2. The Bull Case for 2019: If Household Spending Stands Out (And Funding Finally Flows In)
3. UK Cycle: BoE Should See a Tightening Labour Market
4. Fed Policy Outlook Gets Even More Complex Due to Multiple Factors
5. 2019 Equity Market Outlook

1. China’s December GDP

China’s quarterly numbers are in and China’s economic growth decreased to 6.4%. We are reviewing the most recent numbers and examining some inconsistencies.We believe there are pronounced weak spots in China’s GDP growth and expect to see that downward pressure in the Chinese economy going forward.

2. The Bull Case for 2019: If Household Spending Stands Out (And Funding Finally Flows In)

There is a certain scenario in which the Indonesian market in 2019 could outperform on relative basis.  If global growth slows while the resilient household sector holds up, capital inflows coud prove sufficient to cover the current account and avert yet more depreciation. 

An adverse policy framework is depressing key sectors and hampering investment – at a time when the current account deficit (Cad) is jeopardizing stability.  The administration of President Joko Widodo, who is cruising to re-election, shows little urgency about rectifying recent declines in Foreign Direct Investment (FDI).  These concerns have underpinned our bearish outlook for the market in 2019 (see Indonesia: The Year of Dithering Dangerously).  But in the event of a sharp global slowdown this year, Indonesia has potential – on a relative basis – to outperform. 

Indonesia’s economy is poorly integrated with the international arena, and this ‘decoupling’ can offer insulation from global turbulence under certain conditions.  And the key driver of GDP is household consumption, which has shown resiliency by sustaining a 4.9‑5.1 percent pace of annual growth over the past five years.  As global growth deteriorates, Indonesia’s stalwart consumer‑growth engine may stand out and garner attention; if so, this may attract the capital inflows needed to cover the Cad. 

However, risks remain high due to a background context that features policy flaws and institutional dysfunctions.  Reforms to address the investment climate could bring about a substantial upward re‑rating – but prospects for Widodo to move assertively in this direction seem poor.  In the continued absence of meaningful reforms, macro-economic stability will remain fragile, vulnerable to abrupt reversals in short‑term portfolio flows.  Given Indonesia’s weak export performance and growing dependence on imported oil, the currency would face renewed pressure in the event of excessive Federal Reserve hikes or global shocks.  However, in a scenario of global deceleration without undue turbulence, Indonesia has potential to outperform. 

3. UK Cycle: BoE Should See a Tightening Labour Market

• Faster employment growth lowered the unemployment rate to 4.0% in Nov-18, contrary to expectations. The labour market still looks to be tightening.
• The BoE will provide its annual update of supply-side conditions in its 7-Feb Inflation Report. I expect it to maintain its 4.25% NAIRU estimate.
• Stronger wage growth suggests an effective tightening of the labour market. Excess demand and inflation provide hawkish pressure, albeit neutered by Brexit.

4. Fed Policy Outlook Gets Even More Complex Due to Multiple Factors

The Fed’s new patient approach to raising the federal funds rate will hinge critically on co-operative incoming economic data, notably subdued inflation signals.

Measures of US inflationary expectations remain well-anchored, thereby providing the Federal Open Market Committee (FOMC) with policy breathing space, while labour market conditions will continue to be closely monitored for overheating risks.

US monetary policy requires both nimbleness and flexibility, analogous to the conduct of the 1990s, although the advanced age of the current cycle raises the risks of a policy mistake.

The Fed has effectively been forced by excessive financial market volatility to return to issuing forward guidance, as investors struggle to envisage the return to a normal environment where short-term interest rate volatility is higher compared to long-term yields.

Fed policy adjustment is being complicated by further declines in the term premium demanded by bond investors that simultaneously boosts financial accommodation, supports the real economy and flattens the yield curve.

5. 2019 Equity Market Outlook

• The equity market in the fourth quarter of 2018 was throwing off recession-like signals with the 19.8% drop in equity prices from the S&P 500’s all-time high through the near-term trough of December 24, 2018.  We see the decline as a correction from an overvalued position in late September rather than as point to an impending recession.
• Key to the outlook for equities and the economy are economy-wide profit margins (share of nonfinancial corporate profits in output).  It appears the balance between price increases and productivity-adjusted labor costs has improved as productivity has accelerated despite a pickup in the growth of labor compensation.  The corporate tax cut has spurred post-tax margins close to record highs.
• We expect nonfinancial corporate profit growth of 7% on average over the next two years, which should support equity prices.   However, the scope for a strong further rebound in equity prices is challenged by our outlook for rising corporate bond yields (our valuation model suggests rising profits and higher yields roughly cancel each other out in our valuation model). 

In this briefing:

1. Much Ado About Credit
2. Ten Years On – Asia’s Time Is Coming, Don’t Miss The Boat
3. UK Preview: Disinflationary Date for Dec-18

1. Much Ado About Credit

• Global financing conditions could tighten further
• Credit demand is deteriorating; credit risks are rising; Eurodollar costs are edging higher
• A de-escalation in trade tensions and a Fed pause could ease the pain
• Will Fed recently turning more dovish (possible shift to slower QT & Fed rate cut in 2019?) + concomitant USD drift provide sufficient respite to put a floor under risk assets?

2. Ten Years On – Asia’s Time Is Coming, Don’t Miss The Boat

We noted in   Ten Years On – Asia Outperforms Advanced Economies Asia’s economies and companies have outperformed advanced country peers in the ten years to 2017.  Growing by 6.8%, real, through the crisis the region is 188% larger in US dollar terms while US dollar per capita incomes 170% higher compared with 2007. In this note we argue even though Asian stock markets have underperformed since 2010 and the bulk of global capital flows have gone to advanced countries, Asia’s time is coming. Valuations are cheap. Growth fundamentals strong. There are few external or internal imbalances. Macroeconomic management has been better than in advanced economies and the scope to ease policy to ward off headwinds in 2019 is greater. China has already started.

3. UK Preview: Disinflationary Date for Dec-18

• UK inflation has tended to disappoint expectations, and another 0.1pp downside surprise looks likely in the Dec-18 data. I forecast CPI inflation to slow by 0.3pp to 2.0% and for a 40bp loss in RPI inflation to 2.8% (index print at 285.8).
• The ONS is likely to use 11 Dec for its index day, which would mean it is using cheaper seasonal travel dates in its airfares survey. The Consensus tends to miss this effect and be surprised by it. My proprietary food price data were soft too.

In this briefing:

1. China’s Household Consumption in a Slowing Economy
2. China’s December GDP
3. The Bull Case for 2019: If Household Spending Stands Out (And Funding Finally Flows In)
4. UK Cycle: BoE Should See a Tightening Labour Market
5. Fed Policy Outlook Gets Even More Complex Due to Multiple Factors

1. China’s Household Consumption in a Slowing Economy

Now that we know China’s GDP posted the lowest growth rate in decades in December 2018, a lot of attention has turned to stimulus. A key outlier of stimulus is getting consumers to spend, so today we take a look at consumer spending and household consumption overall. Yet, first we need to take a look at disposable income and just where it is coming from.

2. China’s December GDP

China’s quarterly numbers are in and China’s economic growth decreased to 6.4%. We are reviewing the most recent numbers and examining some inconsistencies.We believe there are pronounced weak spots in China’s GDP growth and expect to see that downward pressure in the Chinese economy going forward.

3. The Bull Case for 2019: If Household Spending Stands Out (And Funding Finally Flows In)

There is a certain scenario in which the Indonesian market in 2019 could outperform on relative basis.  If global growth slows while the resilient household sector holds up, capital inflows coud prove sufficient to cover the current account and avert yet more depreciation. 

An adverse policy framework is depressing key sectors and hampering investment – at a time when the current account deficit (Cad) is jeopardizing stability.  The administration of President Joko Widodo, who is cruising to re-election, shows little urgency about rectifying recent declines in Foreign Direct Investment (FDI).  These concerns have underpinned our bearish outlook for the market in 2019 (see Indonesia: The Year of Dithering Dangerously).  But in the event of a sharp global slowdown this year, Indonesia has potential – on a relative basis – to outperform. 

Indonesia’s economy is poorly integrated with the international arena, and this ‘decoupling’ can offer insulation from global turbulence under certain conditions.  And the key driver of GDP is household consumption, which has shown resiliency by sustaining a 4.9‑5.1 percent pace of annual growth over the past five years.  As global growth deteriorates, Indonesia’s stalwart consumer‑growth engine may stand out and garner attention; if so, this may attract the capital inflows needed to cover the Cad. 

However, risks remain high due to a background context that features policy flaws and institutional dysfunctions.  Reforms to address the investment climate could bring about a substantial upward re‑rating – but prospects for Widodo to move assertively in this direction seem poor.  In the continued absence of meaningful reforms, macro-economic stability will remain fragile, vulnerable to abrupt reversals in short‑term portfolio flows.  Given Indonesia’s weak export performance and growing dependence on imported oil, the currency would face renewed pressure in the event of excessive Federal Reserve hikes or global shocks.  However, in a scenario of global deceleration without undue turbulence, Indonesia has potential to outperform. 

4. UK Cycle: BoE Should See a Tightening Labour Market

• Faster employment growth lowered the unemployment rate to 4.0% in Nov-18, contrary to expectations. The labour market still looks to be tightening.
• The BoE will provide its annual update of supply-side conditions in its 7-Feb Inflation Report. I expect it to maintain its 4.25% NAIRU estimate.
• Stronger wage growth suggests an effective tightening of the labour market. Excess demand and inflation provide hawkish pressure, albeit neutered by Brexit.

5. Fed Policy Outlook Gets Even More Complex Due to Multiple Factors

The Fed’s new patient approach to raising the federal funds rate will hinge critically on co-operative incoming economic data, notably subdued inflation signals.

Measures of US inflationary expectations remain well-anchored, thereby providing the Federal Open Market Committee (FOMC) with policy breathing space, while labour market conditions will continue to be closely monitored for overheating risks.

US monetary policy requires both nimbleness and flexibility, analogous to the conduct of the 1990s, although the advanced age of the current cycle raises the risks of a policy mistake.

The Fed has effectively been forced by excessive financial market volatility to return to issuing forward guidance, as investors struggle to envisage the return to a normal environment where short-term interest rate volatility is higher compared to long-term yields.

Fed policy adjustment is being complicated by further declines in the term premium demanded by bond investors that simultaneously boosts financial accommodation, supports the real economy and flattens the yield curve.