Macro

In this briefing:

1. Trade War/China Strategy/Credit Growth/Bonds/Taiwan
2. Widodo Withstands Prabowo’s Debate Pressure / BI Hints at Lower 1Q CAD / Gerindra Prepares Dispute
3. A Solid U.S. Employment Report For March
4. Hong Kong FX
5. Fed Policy Independence: Facing the Biggest Challenges in Decades

1. Trade War/China Strategy/Credit Growth/Bonds/Taiwan

China News That Matters

• Praying the US-China end-game is near
• What to do about China?
• Stability, phew. Or just a false dawn?
• OTC bonds sell like hot cakes 
• Even worse than a trade war…

2. Widodo Withstands Prabowo’s Debate Pressure / BI Hints at Lower 1Q CAD / Gerindra Prepares Dispute

Prabowo performed forcefully in the 30 March presidential debate, but Widodo remained unflustered and debunked the Gerindra chair’s particularly dark realpolitik vision.  Prabowo fell ill later in the week but apparently recovered, and a major rally will occur in Jakarta on 7 April.  But virtually all polls show Widodo maintaining his large lead through mid-March and no developments seem likely to alter the standings.  But if Widodo’s 17 April margin of victory is unexpectedly narrow, Prabowo campaign officials seem certain to allege fraud and contest the outcome.  This scenario would present prolonged tension and uncertainty through 8 August. 

Politics: Gerindra Chair Prabowo Subianto missed three successive campaign appearances due to an unspecified malady (Page 2).  Supporters of Prabowo – namely, his brother Hashim Djojohadikusumo and the National Mandate Party (Pan) founder Amien Rais – warned of potential electoral fraud and threatened to mobilize “people power” after election day.  This highlights the importance of Widodo winning by a wide margin, lest a narrow victory lends credence to claims of fraud (p. 2).  Prabowo pressured President Joko Widodo more aggressively in the fourth presidential debate on 30 March, but he also lost his temper and appeared condescending – while Widodo coolly parried incessant jabs.  Prabowo sought to portray Widodo as being innocently out of touch with harsh realities in security, diplomacy and governance.  He depicted foreigners – including diplomats, journalists and investors – as duplicitous, disrespectful and untrustworthy.  For his part, Widodo chided Prabowo for being fearful and lacking confidence in Indonesian institutions, especially the military.  Prabowo insisted that willful leadership is essential to make Indonesia strong, prosperous and self‑sufficient.  He closed by reiterating his pledge to end food imports.  While his display of mettle may help his appeal among some voters, his bluster – debunked with effect by Widodo – may have alienated others (p. 3).  While scrutinizing the Golkar parliamentarian Bowo Pangarso regarding dealings with a state fertilizer firm, personnel from the Anti-Corruption Commission (KPK) discovered Rp8 billion in his company’s basement – neatly sorted in 400,000 envelopes.  He was allegedly preparing a vote‑buying operation in his Central Java electoral district (p. 13). 

Surveys: Indobarometer corroborated findings from other polls and measured Widodo’s lead at 18 percentage points as of mid‑March (p. 14). 

Security: Counter‑terror police apprehended a figure in West Java whom they suspect is a leader of the formidable Jemaah Ansharut Daulah (JAD) terrorist group (p. 15). 

Economics: A Bank Indonesia (BI) deputy governor cited the possibility of a significantly lower current account deficit for the first quarter of 2019, but warned that it could widen again in the second quarter (p. 16).  Oil production fell short of the government’s target again (p. 16).  

Jakarta: The public works minister openly rebuked Governor Anies Baswedan for making no progress on a ‘naturalization’ project to rectify drainage in the Ciliwung River.  Baswedan has refused to evict riverbank squatters who obstruct the work (p. 16). 

3. A Solid U.S. Employment Report For March

The U.S. employment report for March was solid and should be viewed as reassuring about the state of the economy in the first quarter of 2019.  Nonfarm payrolls rose 196,000 in March and t he unemployment rate held at 3.8%.

4. Hong Kong FX

We will be the first to admit some of our best ideas for reports come from subscribers. That is the story of today’s report on Hong Kong FX. Regular readers know we write extensively on China FX, but rarely touch on Hong Kong. To that end we got a request to look into FX currency and to a less extent rates in Hong Kong. At this point in history, while the HKD is tied directly to the USD, it more accurately reflects the CNY leaving the whole thing in a bit of a bind.

5. Fed Policy Independence: Facing the Biggest Challenges in Decades

Low inflationary expectations have finally forced the Federal Open Market Committee (FOMC) to become even more dovish at its last policy meeting due their inherent stickiness.

Although benign inflationary expectations have lowered the bar for cutting the federal funds rate, incoming economic data will ultimately determine whether any reductions actually come into fruition.

Since the beginning of 2018, the Fed has been encountering rising political pressure from the Trump Administration that has ultimately forced Chair Powell, despite his attempt to display policy autonomy, onto the back foot.

The Fed is facing rising risks to its independence via overt political appointments onto the Board of Governors, while Modern Monetary Theory (MMT) has supporters on both sides of the US political divide.

Meanwhile, President Trump has significantly lowered the bar in selecting candidates for Fed Governor vacancies, notably Stephen Moore, while also ignoring the historic convention of respecting Fed independence to pursue their dual mandate.

The Fed’s decision to hike the federal funds rate last December could prove very costly, both economically and politically, particularly if the US economy enters recession later this year or in 2020.

In this briefing:

1. Understanding the Widening of the U.S. Trade Deficit

1. Understanding the Widening of the U.S. Trade Deficit

• The widening of the U.S. merchandise trade deficit to a record $891 billion in 2018 received considerable attention in the financial press this week but the criticisms that this widening represented either weakness in the U.S. economy or a failure of U.S. economic policy are misplaced.
• We expected a widening of the trade deficit in 2018 as a consequence of the tax cut and stronger economic growth.  Higher investment spending and a wider fiscal deficit were all but certain to lead to a larger trade gap.
• The dollar has firmed as the trade gap has widened over the last four years, which suggests the net overseas demand for U.S. assets has been rising faster than the current account deficit.

In this briefing:

1. Understanding the Widening of the U.S. Trade Deficit
2. Weak February Payrolls But U.S. Labor Market Is Still Tightening

1. Understanding the Widening of the U.S. Trade Deficit

• The widening of the U.S. merchandise trade deficit to a record $891 billion in 2018 received considerable attention in the financial press this week but the criticisms that this widening represented either weakness in the U.S. economy or a failure of U.S. economic policy are misplaced.
• We expected a widening of the trade deficit in 2018 as a consequence of the tax cut and stronger economic growth.  Higher investment spending and a wider fiscal deficit were all but certain to lead to a larger trade gap.
• The dollar has firmed as the trade gap has widened over the last four years, which suggests the net overseas demand for U.S. assets has been rising faster than the current account deficit.

2. Weak February Payrolls But U.S. Labor Market Is Still Tightening

Nonfarm payrolls rose only 20,000 in February but the unemployment rate declined to 3.8% from 4.0%.  Average hourly earnings increased 0.4% and year-over-year wage growth picked up.  Monthly payroll changes are highly volatile and the three-month average of payroll growth is 186,000, which is still solid.  Also, most metrics show that the labor market tightened in February.

In this briefing:

1. Understanding the Widening of the U.S. Trade Deficit
2. Weak February Payrolls But U.S. Labor Market Is Still Tightening
3. Philippines: February Inflation Eases Back to BSP’s Inflation Target Range

1. Understanding the Widening of the U.S. Trade Deficit

• The widening of the U.S. merchandise trade deficit to a record $891 billion in 2018 received considerable attention in the financial press this week but the criticisms that this widening represented either weakness in the U.S. economy or a failure of U.S. economic policy are misplaced.
• We expected a widening of the trade deficit in 2018 as a consequence of the tax cut and stronger economic growth.  Higher investment spending and a wider fiscal deficit were all but certain to lead to a larger trade gap.
• The dollar has firmed as the trade gap has widened over the last four years, which suggests the net overseas demand for U.S. assets has been rising faster than the current account deficit.

2. Weak February Payrolls But U.S. Labor Market Is Still Tightening

Nonfarm payrolls rose only 20,000 in February but the unemployment rate declined to 3.8% from 4.0%.  Average hourly earnings increased 0.4% and year-over-year wage growth picked up.  Monthly payroll changes are highly volatile and the three-month average of payroll growth is 186,000, which is still solid.  Also, most metrics show that the labor market tightened in February.

3. Philippines: February Inflation Eases Back to BSP’s Inflation Target Range

• Better-than-expected February inflation of 3.8%YoY wasn’t just a ‘base effect’ result. Broad food and transport CPI readings probably benefited from a year-ago, statistical high. It’s not the same for most of the non-food CPI items like rental & household utilities, and restaurant & miscellaneous goods & services that comprise discretionary expenditures. Lacking the base effect, inflation within this group seemed to have shed off last year’s price catalysts led by TRAIN’s excise hikes, high oil prices and supply shocks. 

• Based on the PSA’s seasonally adjusted data, headline inflation’s annualized pace was a benign 1.2%.

• Our updated monthly time series extrapolation showed headline inflation bottoming out at 1.3%YoY-1.4%YoY in September-October this year.

• Sustained liquidity tightness amid inflation’s benign pace with a trajectory settling in the BSP’s target range could facilitate a staggered bank reserve ratio cut of 2% starting 2Q19.   

• With the pro-growth bias of newly appointed BSP chief Benjamin Diokno (former Budget Secretary), the likelihood of a 25bp policy rate cut has been elevated in 3Q19 when inflation this year is expected to hit rock bottom and the ensuing size of positive, real interest rates could risk threatening growth.
• Considering potential macro upsides this year, e.g., inflation bottoming out alongside consumption recovery, buying risk assets on dips is still the norm.

In this briefing:

1. Understanding the Widening of the U.S. Trade Deficit
2. Weak February Payrolls But U.S. Labor Market Is Still Tightening
3. Philippines: February Inflation Eases Back to BSP’s Inflation Target Range
4. Japan – Chinese Flu

1. Understanding the Widening of the U.S. Trade Deficit

• The widening of the U.S. merchandise trade deficit to a record $891 billion in 2018 received considerable attention in the financial press this week but the criticisms that this widening represented either weakness in the U.S. economy or a failure of U.S. economic policy are misplaced.
• We expected a widening of the trade deficit in 2018 as a consequence of the tax cut and stronger economic growth.  Higher investment spending and a wider fiscal deficit were all but certain to lead to a larger trade gap.
• The dollar has firmed as the trade gap has widened over the last four years, which suggests the net overseas demand for U.S. assets has been rising faster than the current account deficit.

2. Weak February Payrolls But U.S. Labor Market Is Still Tightening

Nonfarm payrolls rose only 20,000 in February but the unemployment rate declined to 3.8% from 4.0%.  Average hourly earnings increased 0.4% and year-over-year wage growth picked up.  Monthly payroll changes are highly volatile and the three-month average of payroll growth is 186,000, which is still solid.  Also, most metrics show that the labor market tightened in February.

3. Philippines: February Inflation Eases Back to BSP’s Inflation Target Range

• Better-than-expected February inflation of 3.8%YoY wasn’t just a ‘base effect’ result. Broad food and transport CPI readings probably benefited from a year-ago, statistical high. It’s not the same for most of the non-food CPI items like rental & household utilities, and restaurant & miscellaneous goods & services that comprise discretionary expenditures. Lacking the base effect, inflation within this group seemed to have shed off last year’s price catalysts led by TRAIN’s excise hikes, high oil prices and supply shocks. 

• Based on the PSA’s seasonally adjusted data, headline inflation’s annualized pace was a benign 1.2%.

• Our updated monthly time series extrapolation showed headline inflation bottoming out at 1.3%YoY-1.4%YoY in September-October this year.

• Sustained liquidity tightness amid inflation’s benign pace with a trajectory settling in the BSP’s target range could facilitate a staggered bank reserve ratio cut of 2% starting 2Q19.   

• With the pro-growth bias of newly appointed BSP chief Benjamin Diokno (former Budget Secretary), the likelihood of a 25bp policy rate cut has been elevated in 3Q19 when inflation this year is expected to hit rock bottom and the ensuing size of positive, real interest rates could risk threatening growth.
• Considering potential macro upsides this year, e.g., inflation bottoming out alongside consumption recovery, buying risk assets on dips is still the norm.

4. Japan – Chinese Flu

By Konstantinos Venetis, Senior Economist

• Japan skirts recession but near-term prospects remain weak
• Deflationary headwinds to persist in H1, threatening business spending
• Recovery likely in late 2019 as world trade finds a firmer footing

In this briefing:

1. Widodo Withstands Prabowo’s Debate Pressure / BI Hints at Lower 1Q CAD / Gerindra Prepares Dispute
2. A Solid U.S. Employment Report For March
3. Hong Kong FX
4. Fed Policy Independence: Facing the Biggest Challenges in Decades
5. RBI to Unwind Its Policy Error, but Not Fast Enough; External Sector to Lead Rebound

1. Widodo Withstands Prabowo’s Debate Pressure / BI Hints at Lower 1Q CAD / Gerindra Prepares Dispute

Prabowo performed forcefully in the 30 March presidential debate, but Widodo remained unflustered and debunked the Gerindra chair’s particularly dark realpolitik vision.  Prabowo fell ill later in the week but apparently recovered, and a major rally will occur in Jakarta on 7 April.  But virtually all polls show Widodo maintaining his large lead through mid-March and no developments seem likely to alter the standings.  But if Widodo’s 17 April margin of victory is unexpectedly narrow, Prabowo campaign officials seem certain to allege fraud and contest the outcome.  This scenario would present prolonged tension and uncertainty through 8 August. 

Politics: Gerindra Chair Prabowo Subianto missed three successive campaign appearances due to an unspecified malady (Page 2).  Supporters of Prabowo – namely, his brother Hashim Djojohadikusumo and the National Mandate Party (Pan) founder Amien Rais – warned of potential electoral fraud and threatened to mobilize “people power” after election day.  This highlights the importance of Widodo winning by a wide margin, lest a narrow victory lends credence to claims of fraud (p. 2).  Prabowo pressured President Joko Widodo more aggressively in the fourth presidential debate on 30 March, but he also lost his temper and appeared condescending – while Widodo coolly parried incessant jabs.  Prabowo sought to portray Widodo as being innocently out of touch with harsh realities in security, diplomacy and governance.  He depicted foreigners – including diplomats, journalists and investors – as duplicitous, disrespectful and untrustworthy.  For his part, Widodo chided Prabowo for being fearful and lacking confidence in Indonesian institutions, especially the military.  Prabowo insisted that willful leadership is essential to make Indonesia strong, prosperous and self‑sufficient.  He closed by reiterating his pledge to end food imports.  While his display of mettle may help his appeal among some voters, his bluster – debunked with effect by Widodo – may have alienated others (p. 3).  While scrutinizing the Golkar parliamentarian Bowo Pangarso regarding dealings with a state fertilizer firm, personnel from the Anti-Corruption Commission (KPK) discovered Rp8 billion in his company’s basement – neatly sorted in 400,000 envelopes.  He was allegedly preparing a vote‑buying operation in his Central Java electoral district (p. 13). 

Surveys: Indobarometer corroborated findings from other polls and measured Widodo’s lead at 18 percentage points as of mid‑March (p. 14). 

Security: Counter‑terror police apprehended a figure in West Java whom they suspect is a leader of the formidable Jemaah Ansharut Daulah (JAD) terrorist group (p. 15). 

Economics: A Bank Indonesia (BI) deputy governor cited the possibility of a significantly lower current account deficit for the first quarter of 2019, but warned that it could widen again in the second quarter (p. 16).  Oil production fell short of the government’s target again (p. 16).  

Jakarta: The public works minister openly rebuked Governor Anies Baswedan for making no progress on a ‘naturalization’ project to rectify drainage in the Ciliwung River.  Baswedan has refused to evict riverbank squatters who obstruct the work (p. 16). 

2. A Solid U.S. Employment Report For March

The U.S. employment report for March was solid and should be viewed as reassuring about the state of the economy in the first quarter of 2019.  Nonfarm payrolls rose 196,000 in March and t he unemployment rate held at 3.8%.

3. Hong Kong FX

We will be the first to admit some of our best ideas for reports come from subscribers. That is the story of today’s report on Hong Kong FX. Regular readers know we write extensively on China FX, but rarely touch on Hong Kong. To that end we got a request to look into FX currency and to a less extent rates in Hong Kong. At this point in history, while the HKD is tied directly to the USD, it more accurately reflects the CNY leaving the whole thing in a bit of a bind.

4. Fed Policy Independence: Facing the Biggest Challenges in Decades

Low inflationary expectations have finally forced the Federal Open Market Committee (FOMC) to become even more dovish at its last policy meeting due their inherent stickiness.

Although benign inflationary expectations have lowered the bar for cutting the federal funds rate, incoming economic data will ultimately determine whether any reductions actually come into fruition.

Since the beginning of 2018, the Fed has been encountering rising political pressure from the Trump Administration that has ultimately forced Chair Powell, despite his attempt to display policy autonomy, onto the back foot.

The Fed is facing rising risks to its independence via overt political appointments onto the Board of Governors, while Modern Monetary Theory (MMT) has supporters on both sides of the US political divide.

Meanwhile, President Trump has significantly lowered the bar in selecting candidates for Fed Governor vacancies, notably Stephen Moore, while also ignoring the historic convention of respecting Fed independence to pursue their dual mandate.

The Fed’s decision to hike the federal funds rate last December could prove very costly, both economically and politically, particularly if the US economy enters recession later this year or in 2020.

5. RBI to Unwind Its Policy Error, but Not Fast Enough; External Sector to Lead Rebound

We expect the RBI’s MPC to cut the policy (repo) rate by 25bp on 4th April, thereby unwinding the policy error it made last year by raising the repo rate by 50bp — on the basis of an utterly erroneous inflation forecast. (Our view was: RBI Raises Rates, but Will Likely Look Foolish when Inflation Moderates). Between November 2018 and January 2019, India’s real policy rate was consequently well above +4%. Even after tomorrow’s rate cut, India’s real interest rate will be among the highest in the world — and so the appropriate cut on 4th April would have been 50bp. Real GDP has decelerated to 6.6% and is set to decelerate further in the Jan-Mar19 quarter, and the decline in imports over the past 3 months provides additional evidence for the slowdown. 

However, India’s external sector is likely to lead the recovery over the next few quarters. FDI inflows averaged US$33.63bn annually in the first 4 years of NDA2 (the Modi administration), up from US$18.19bn in the previous 4 years. In April-December 2018, FDI inflows have risen to US$44.7bn. Meanwhile, the current account deficit was 2.4% of GDP in 2018 (calendar year), the largest during the Modi years, but is likely to shrink to 1% of GDP in January-March 2019. (During UPA2, the current account deficit was consistently above 2.6% of GDP, peaking at above 5% of GDP in 2012). The improved basic balance will lay the basis for a modestly stronger rupee that allows the RBI to pursue more aggressive monetary easing over the next few meetings. 

India’s exports grew 12.7% in 2017, 10% in 2018 and are up 3.1% YoY in Jan-Feb 2019. The latter seems unremarkable, except for the fact that Indonesia, South Korea, Taiwan and Singapore are all seeing their exports decline at a double-digit YoY pace over the past 4 months (and China’s exports are down 5.3% YoY in the latest 3 months) amid a renewed slump in global trade. In fact, India’s goods exports have grown faster than China’s for the past 3 years. In the last 3 months, India’s electronics exports (albeit only 3.3% of total goods exports) were up more than 50% YoY (amid a cyclical decline in global electronics demand!). Something big is beginning to stir in India, and it is not just the momentum in the election rallies!  

In this briefing:

1. Weak February Payrolls But U.S. Labor Market Is Still Tightening
2. Philippines: February Inflation Eases Back to BSP’s Inflation Target Range
3. Japan – Chinese Flu
4. Widodo Leads 59-31 / IA-Cepa Holds Promise / Online Permitting Progresses / Rights Activist Arrested

1. Weak February Payrolls But U.S. Labor Market Is Still Tightening

Nonfarm payrolls rose only 20,000 in February but the unemployment rate declined to 3.8% from 4.0%.  Average hourly earnings increased 0.4% and year-over-year wage growth picked up.  Monthly payroll changes are highly volatile and the three-month average of payroll growth is 186,000, which is still solid.  Also, most metrics show that the labor market tightened in February.

2. Philippines: February Inflation Eases Back to BSP’s Inflation Target Range

• Better-than-expected February inflation of 3.8%YoY wasn’t just a ‘base effect’ result. Broad food and transport CPI readings probably benefited from a year-ago, statistical high. It’s not the same for most of the non-food CPI items like rental & household utilities, and restaurant & miscellaneous goods & services that comprise discretionary expenditures. Lacking the base effect, inflation within this group seemed to have shed off last year’s price catalysts led by TRAIN’s excise hikes, high oil prices and supply shocks. 

• Based on the PSA’s seasonally adjusted data, headline inflation’s annualized pace was a benign 1.2%.

• Our updated monthly time series extrapolation showed headline inflation bottoming out at 1.3%YoY-1.4%YoY in September-October this year.

• Sustained liquidity tightness amid inflation’s benign pace with a trajectory settling in the BSP’s target range could facilitate a staggered bank reserve ratio cut of 2% starting 2Q19.   

• With the pro-growth bias of newly appointed BSP chief Benjamin Diokno (former Budget Secretary), the likelihood of a 25bp policy rate cut has been elevated in 3Q19 when inflation this year is expected to hit rock bottom and the ensuing size of positive, real interest rates could risk threatening growth.
• Considering potential macro upsides this year, e.g., inflation bottoming out alongside consumption recovery, buying risk assets on dips is still the norm.

3. Japan – Chinese Flu

By Konstantinos Venetis, Senior Economist

• Japan skirts recession but near-term prospects remain weak
• Deflationary headwinds to persist in H1, threatening business spending
• Recovery likely in late 2019 as world trade finds a firmer footing

4. Widodo Leads 59-31 / IA-Cepa Holds Promise / Online Permitting Progresses / Rights Activist Arrested

A credible poll — the first new trustworthy data in a month — shows Widodo having expanded his lead to 59 percent, versus 31 percent for Prabowo.  The latter’s prospects are dim.  Indonesia’s Comprehensive Partnership (Cepa) with Australia will bring myriad import prices down — although, contrary to a spate of international press reports, it does not raise ownership ceilings for Australian investors.  A senior activist with Amnesty International Indonesia suffered arrest for critizing the military’s plan to place hundreds of active officers in civilian posts.  The BKPM’s OSS system for online permiting is making progress, although its smooth functioning remains a distanct prospect.

Politics: President Joko Widodo proposed monthly income support for graduates of vocational programs who lack immediate employment and need to search for jobs.  He did not specify an amount per recipient.  The proposal has some merit – but simple regulatory changes to facilitate investment and job‑creation would obviate its need.  Politically, the concept will likely prove popular, further boosting Widodo (Page 2).  A prominent Partai Demokrat official, Andi Arief, left the party to undergo drug rehabilitation.  This marks yet another blow for a party that had been Indonesia’s largest only five years ago (p. 3).  A human rights activist and lecturer suffered arrest for allegedly defaming the military (p. 4). 

Surveys: In the first new poll data to emerge in over a month, the Survey Network (LSI) showed that, as of late February, nationwide support for Widodo stood at 59 percent, versus 31 percent for Gerindra Chair Prabowo Subianto.  The findings, which are credible, suggest that Widodo strengthened during February, perhaps due to the two televised debates – and despite Prabowo’s emphatic attempts to provoke various economic fears.  The data portray Prabowo’s prospects as distinctly remote.  A Widodo landslide would further reduce the likelihood of disruption or unrest, as Prabowo‑camp claims of fraud or manipulation would lack credence.  Meanwhile, Widodo would emerge with an unequivocal mandate and particularly strong political capital.  Parties that defy him would jeopardize their own image.  But whether he would use this strength effectively is questionable (p. 5).  Findings from Polmark, a somewhat obscure firm employed by the National Mandate Party (Pan), claim that Widodo’s margin over Prabowo is only 15 percentage points – but the poll is old, it has a large error margin and it featured a 34 percent level of undecided respondents.  As a percen­tage of decided respondents, Widodo’s support is comparable to other (and better) polls (p. 6). 

Justice: In the first verdicts in Lippo’s Meikarta scandal, four Lippo personnel including Billy Sindoro received sentences ranging from 1.5‑3.5 years each.  This is Sindoro’s second conviction from the Anti-Corruption Commission (KPK) (p. 8).

Policy News: A new phase of implementation is underway for online permitting (p. 8).

International: During an election that features strident economic critiques, the govern­ment concluded the Comprehensive Economic Partnership with Australia (IA‑Cepa).  Parties may yet posture when it comes due for ratifi­cation, but other trade agreements have managed to pass.  The IA-Cepa reduces tariffs on myriad Australian goods from five percent to zero, while higher tariffs on certain foods will fall precipitously.  Contrary to reports, it sets no new foreign ownership ceilings (p. 8). 

In this briefing:

1. A Solid U.S. Employment Report For March
2. Hong Kong FX
3. Fed Policy Independence: Facing the Biggest Challenges in Decades
4. RBI to Unwind Its Policy Error, but Not Fast Enough; External Sector to Lead Rebound
5. UK: PMIs Diverge as Bias Intensifies in Mar-19

1. A Solid U.S. Employment Report For March

The U.S. employment report for March was solid and should be viewed as reassuring about the state of the economy in the first quarter of 2019.  Nonfarm payrolls rose 196,000 in March and t he unemployment rate held at 3.8%.

2. Hong Kong FX

We will be the first to admit some of our best ideas for reports come from subscribers. That is the story of today’s report on Hong Kong FX. Regular readers know we write extensively on China FX, but rarely touch on Hong Kong. To that end we got a request to look into FX currency and to a less extent rates in Hong Kong. At this point in history, while the HKD is tied directly to the USD, it more accurately reflects the CNY leaving the whole thing in a bit of a bind.

3. Fed Policy Independence: Facing the Biggest Challenges in Decades

Low inflationary expectations have finally forced the Federal Open Market Committee (FOMC) to become even more dovish at its last policy meeting due their inherent stickiness.

Although benign inflationary expectations have lowered the bar for cutting the federal funds rate, incoming economic data will ultimately determine whether any reductions actually come into fruition.

Since the beginning of 2018, the Fed has been encountering rising political pressure from the Trump Administration that has ultimately forced Chair Powell, despite his attempt to display policy autonomy, onto the back foot.

The Fed is facing rising risks to its independence via overt political appointments onto the Board of Governors, while Modern Monetary Theory (MMT) has supporters on both sides of the US political divide.

Meanwhile, President Trump has significantly lowered the bar in selecting candidates for Fed Governor vacancies, notably Stephen Moore, while also ignoring the historic convention of respecting Fed independence to pursue their dual mandate.

The Fed’s decision to hike the federal funds rate last December could prove very costly, both economically and politically, particularly if the US economy enters recession later this year or in 2020.

4. RBI to Unwind Its Policy Error, but Not Fast Enough; External Sector to Lead Rebound

We expect the RBI’s MPC to cut the policy (repo) rate by 25bp on 4th April, thereby unwinding the policy error it made last year by raising the repo rate by 50bp — on the basis of an utterly erroneous inflation forecast. (Our view was: RBI Raises Rates, but Will Likely Look Foolish when Inflation Moderates). Between November 2018 and January 2019, India’s real policy rate was consequently well above +4%. Even after tomorrow’s rate cut, India’s real interest rate will be among the highest in the world — and so the appropriate cut on 4th April would have been 50bp. Real GDP has decelerated to 6.6% and is set to decelerate further in the Jan-Mar19 quarter, and the decline in imports over the past 3 months provides additional evidence for the slowdown. 

However, India’s external sector is likely to lead the recovery over the next few quarters. FDI inflows averaged US$33.63bn annually in the first 4 years of NDA2 (the Modi administration), up from US$18.19bn in the previous 4 years. In April-December 2018, FDI inflows have risen to US$44.7bn. Meanwhile, the current account deficit was 2.4% of GDP in 2018 (calendar year), the largest during the Modi years, but is likely to shrink to 1% of GDP in January-March 2019. (During UPA2, the current account deficit was consistently above 2.6% of GDP, peaking at above 5% of GDP in 2012). The improved basic balance will lay the basis for a modestly stronger rupee that allows the RBI to pursue more aggressive monetary easing over the next few meetings. 

India’s exports grew 12.7% in 2017, 10% in 2018 and are up 3.1% YoY in Jan-Feb 2019. The latter seems unremarkable, except for the fact that Indonesia, South Korea, Taiwan and Singapore are all seeing their exports decline at a double-digit YoY pace over the past 4 months (and China’s exports are down 5.3% YoY in the latest 3 months) amid a renewed slump in global trade. In fact, India’s goods exports have grown faster than China’s for the past 3 years. In the last 3 months, India’s electronics exports (albeit only 3.3% of total goods exports) were up more than 50% YoY (amid a cyclical decline in global electronics demand!). Something big is beginning to stir in India, and it is not just the momentum in the election rallies!  

5. UK: PMIs Diverge as Bias Intensifies in Mar-19

• The pace of activity growth implied by the UK services PMI collapsed again in Mar-19 as the index fell by 2.4 points to 48.9. It is biased to overstate the effect of uncertainty, which has intensified recently amid political gridlock.
• A slight slowing in comparable sectors remains likely, but I maintain my relatively bullish forecast for 1Q19 GDP growth of 0.4% q-o-q, with 0.0% m-o-m in Feb-19.

In this briefing:

1. Philippines: February Inflation Eases Back to BSP’s Inflation Target Range
2. Japan – Chinese Flu
3. Widodo Leads 59-31 / IA-Cepa Holds Promise / Online Permitting Progresses / Rights Activist Arrested
4. Futures and Spot Opportunities

1. Philippines: February Inflation Eases Back to BSP’s Inflation Target Range

• Better-than-expected February inflation of 3.8%YoY wasn’t just a ‘base effect’ result. Broad food and transport CPI readings probably benefited from a year-ago, statistical high. It’s not the same for most of the non-food CPI items like rental & household utilities, and restaurant & miscellaneous goods & services that comprise discretionary expenditures. Lacking the base effect, inflation within this group seemed to have shed off last year’s price catalysts led by TRAIN’s excise hikes, high oil prices and supply shocks. 

• Based on the PSA’s seasonally adjusted data, headline inflation’s annualized pace was a benign 1.2%.

• Our updated monthly time series extrapolation showed headline inflation bottoming out at 1.3%YoY-1.4%YoY in September-October this year.

• Sustained liquidity tightness amid inflation’s benign pace with a trajectory settling in the BSP’s target range could facilitate a staggered bank reserve ratio cut of 2% starting 2Q19.   

• With the pro-growth bias of newly appointed BSP chief Benjamin Diokno (former Budget Secretary), the likelihood of a 25bp policy rate cut has been elevated in 3Q19 when inflation this year is expected to hit rock bottom and the ensuing size of positive, real interest rates could risk threatening growth.
• Considering potential macro upsides this year, e.g., inflation bottoming out alongside consumption recovery, buying risk assets on dips is still the norm.

2. Japan – Chinese Flu

By Konstantinos Venetis, Senior Economist

• Japan skirts recession but near-term prospects remain weak
• Deflationary headwinds to persist in H1, threatening business spending
• Recovery likely in late 2019 as world trade finds a firmer footing

3. Widodo Leads 59-31 / IA-Cepa Holds Promise / Online Permitting Progresses / Rights Activist Arrested

A credible poll — the first new trustworthy data in a month — shows Widodo having expanded his lead to 59 percent, versus 31 percent for Prabowo.  The latter’s prospects are dim.  Indonesia’s Comprehensive Partnership (Cepa) with Australia will bring myriad import prices down — although, contrary to a spate of international press reports, it does not raise ownership ceilings for Australian investors.  A senior activist with Amnesty International Indonesia suffered arrest for critizing the military’s plan to place hundreds of active officers in civilian posts.  The BKPM’s OSS system for online permiting is making progress, although its smooth functioning remains a distanct prospect.

Politics: President Joko Widodo proposed monthly income support for graduates of vocational programs who lack immediate employment and need to search for jobs.  He did not specify an amount per recipient.  The proposal has some merit – but simple regulatory changes to facilitate investment and job‑creation would obviate its need.  Politically, the concept will likely prove popular, further boosting Widodo (Page 2).  A prominent Partai Demokrat official, Andi Arief, left the party to undergo drug rehabilitation.  This marks yet another blow for a party that had been Indonesia’s largest only five years ago (p. 3).  A human rights activist and lecturer suffered arrest for allegedly defaming the military (p. 4). 

Surveys: In the first new poll data to emerge in over a month, the Survey Network (LSI) showed that, as of late February, nationwide support for Widodo stood at 59 percent, versus 31 percent for Gerindra Chair Prabowo Subianto.  The findings, which are credible, suggest that Widodo strengthened during February, perhaps due to the two televised debates – and despite Prabowo’s emphatic attempts to provoke various economic fears.  The data portray Prabowo’s prospects as distinctly remote.  A Widodo landslide would further reduce the likelihood of disruption or unrest, as Prabowo‑camp claims of fraud or manipulation would lack credence.  Meanwhile, Widodo would emerge with an unequivocal mandate and particularly strong political capital.  Parties that defy him would jeopardize their own image.  But whether he would use this strength effectively is questionable (p. 5).  Findings from Polmark, a somewhat obscure firm employed by the National Mandate Party (Pan), claim that Widodo’s margin over Prabowo is only 15 percentage points – but the poll is old, it has a large error margin and it featured a 34 percent level of undecided respondents.  As a percen­tage of decided respondents, Widodo’s support is comparable to other (and better) polls (p. 6). 

Justice: In the first verdicts in Lippo’s Meikarta scandal, four Lippo personnel including Billy Sindoro received sentences ranging from 1.5‑3.5 years each.  This is Sindoro’s second conviction from the Anti-Corruption Commission (KPK) (p. 8).

Policy News: A new phase of implementation is underway for online permitting (p. 8).

International: During an election that features strident economic critiques, the govern­ment concluded the Comprehensive Economic Partnership with Australia (IA‑Cepa).  Parties may yet posture when it comes due for ratifi­cation, but other trade agreements have managed to pass.  The IA-Cepa reduces tariffs on myriad Australian goods from five percent to zero, while higher tariffs on certain foods will fall precipitously.  Contrary to reports, it sets no new foreign ownership ceilings (p. 8). 

4. Futures and Spot Opportunities

Liquidity is driving the futures market to push up iron ore. We know futures trading is very active. This tells us we are not the only ones who noticed the divergence and are looking to capitalize.The fundamental issue is that we expect the futures and spot are back together after being seeing a gap. 

In this briefing:

1. Hong Kong FX
2. Fed Policy Independence: Facing the Biggest Challenges in Decades
3. RBI to Unwind Its Policy Error, but Not Fast Enough; External Sector to Lead Rebound
4. UK: PMIs Diverge as Bias Intensifies in Mar-19
5. What Next in the Inflation / Deflation Debate and What Does It Mean for Asset Prices?

1. Hong Kong FX

We will be the first to admit some of our best ideas for reports come from subscribers. That is the story of today’s report on Hong Kong FX. Regular readers know we write extensively on China FX, but rarely touch on Hong Kong. To that end we got a request to look into FX currency and to a less extent rates in Hong Kong. At this point in history, while the HKD is tied directly to the USD, it more accurately reflects the CNY leaving the whole thing in a bit of a bind.

2. Fed Policy Independence: Facing the Biggest Challenges in Decades

Low inflationary expectations have finally forced the Federal Open Market Committee (FOMC) to become even more dovish at its last policy meeting due their inherent stickiness.

Although benign inflationary expectations have lowered the bar for cutting the federal funds rate, incoming economic data will ultimately determine whether any reductions actually come into fruition.

Since the beginning of 2018, the Fed has been encountering rising political pressure from the Trump Administration that has ultimately forced Chair Powell, despite his attempt to display policy autonomy, onto the back foot.

The Fed is facing rising risks to its independence via overt political appointments onto the Board of Governors, while Modern Monetary Theory (MMT) has supporters on both sides of the US political divide.

Meanwhile, President Trump has significantly lowered the bar in selecting candidates for Fed Governor vacancies, notably Stephen Moore, while also ignoring the historic convention of respecting Fed independence to pursue their dual mandate.

The Fed’s decision to hike the federal funds rate last December could prove very costly, both economically and politically, particularly if the US economy enters recession later this year or in 2020.

3. RBI to Unwind Its Policy Error, but Not Fast Enough; External Sector to Lead Rebound

We expect the RBI’s MPC to cut the policy (repo) rate by 25bp on 4th April, thereby unwinding the policy error it made last year by raising the repo rate by 50bp — on the basis of an utterly erroneous inflation forecast. (Our view was: RBI Raises Rates, but Will Likely Look Foolish when Inflation Moderates). Between November 2018 and January 2019, India’s real policy rate was consequently well above +4%. Even after tomorrow’s rate cut, India’s real interest rate will be among the highest in the world — and so the appropriate cut on 4th April would have been 50bp. Real GDP has decelerated to 6.6% and is set to decelerate further in the Jan-Mar19 quarter, and the decline in imports over the past 3 months provides additional evidence for the slowdown. 

However, India’s external sector is likely to lead the recovery over the next few quarters. FDI inflows averaged US$33.63bn annually in the first 4 years of NDA2 (the Modi administration), up from US$18.19bn in the previous 4 years. In April-December 2018, FDI inflows have risen to US$44.7bn. Meanwhile, the current account deficit was 2.4% of GDP in 2018 (calendar year), the largest during the Modi years, but is likely to shrink to 1% of GDP in January-March 2019. (During UPA2, the current account deficit was consistently above 2.6% of GDP, peaking at above 5% of GDP in 2012). The improved basic balance will lay the basis for a modestly stronger rupee that allows the RBI to pursue more aggressive monetary easing over the next few meetings. 

India’s exports grew 12.7% in 2017, 10% in 2018 and are up 3.1% YoY in Jan-Feb 2019. The latter seems unremarkable, except for the fact that Indonesia, South Korea, Taiwan and Singapore are all seeing their exports decline at a double-digit YoY pace over the past 4 months (and China’s exports are down 5.3% YoY in the latest 3 months) amid a renewed slump in global trade. In fact, India’s goods exports have grown faster than China’s for the past 3 years. In the last 3 months, India’s electronics exports (albeit only 3.3% of total goods exports) were up more than 50% YoY (amid a cyclical decline in global electronics demand!). Something big is beginning to stir in India, and it is not just the momentum in the election rallies!  

4. UK: PMIs Diverge as Bias Intensifies in Mar-19

• The pace of activity growth implied by the UK services PMI collapsed again in Mar-19 as the index fell by 2.4 points to 48.9. It is biased to overstate the effect of uncertainty, which has intensified recently amid political gridlock.
• A slight slowing in comparable sectors remains likely, but I maintain my relatively bullish forecast for 1Q19 GDP growth of 0.4% q-o-q, with 0.0% m-o-m in Feb-19.

5. What Next in the Inflation / Deflation Debate and What Does It Mean for Asset Prices?

Despite some signs of stabilization in China’s factory gauges the primary trend is still weakness and it might be rash for investors to read too much into the recent data given the apparent weakness in the Eurozone and the moderation form a high level of growth in the United States.  Quantitative tightening is on hold in the United States but a sharp “U-turn” to easing has not happened yet and is politically embarrassing. As inflation falls real rates are rising. Housing markets are showing signs of price weakness. Investors need to watch for signs of credit quality decay that could be an indicator of the next period of severe financial distress.