Macro

In this briefing:

1. India: Outlook on Capex Recovery Continues to Brighten
2. BoJ Steps in as ECB Exits
3. Fed Remains Unfazed by Recession Doomsayers, but Political Challenges Lurk on the Horizon
4. Japan: Upcycle Intact

1. India: Outlook on Capex Recovery Continues to Brighten

As per the CSO, gross fixed capital formation (GFCF) has grown above nominal GDP for 4 consecutive quarters now (latest data for September quarter). This, after GFCF grew slower than nominal GDP in 20 of the preceding 21 quarters. Capex cycle is thus picking up. And there are good reasons to expect this continue in the foreseeable future. Capacity utilisation is increasing in a broad-based manner. Liquidity conditions have improved, and cost of capital is likely to fall. Corporate profit cycle is no longer a headwind, although it is not yet a strong tailwind. The nascent signs of a recovery in the capex cycle are thus likely to get stronger in the months ahead.

2. BoJ Steps in as ECB Exits

By Shweta Singh, Managing Director Global Macro

• Global central banks turning dovish
• But BoJ maybe the only DM central bank ‘properly’ injecting liquidity this year
• European debt – including Italian BTPs – could benefit the most  

3. Fed Remains Unfazed by Recession Doomsayers, but Political Challenges Lurk on the Horizon

Following the release of the December US retail sales report, recession doomsayers have become much more vocal and their calls will invariably become louder as economic deceleration unfolds.

There are currently no major signs of excesses in important sectors of the US economy to unhinge the flat Phillips Curve, while structural shifts over time have made forecasting inflexion points in the business cycle much more difficult.

Meanwhile, although the Federal Open Market Committee (FOMC) is concerned about externally-sourced headwinds, members seem content with the current behaviour of the domestic economy, at least for the time being.

The Trump Administration will be keen to ease fiscal policy again to prevent a 2020 recession if growth slows significantly this year, while the Democrats would face a tricky task obstructing if there was a sizeable infrastructure spending component included as part of the measures.

Meanwhile, some Democratic politicians have been exploring deploying Modern Monetary Theory to facilitate the greater provision of free government services, but financial markets would baulk at this prospect, particularly bond market vigilantes.

The behaviour of the bond market vigilantes have highlighted the problems facing the Fed in trying to raise the policy rate significantly above zero, but they have at least provided the FOMC with an interest rate buffer to counter economic slowdown, something conspicuously absent in the Eurozone and Japan.

4. Japan: Upcycle Intact

Following 3Q’s contraction, economic activity rebounded in the final quarter of 2018 led  by investment spending. Global trade tensions and the planned increase in the consumption tax in 2019 are headwinds but we expect the Japanese economy to sail through. The investment upcycle remains intact underpinned by rising profits and consumption spending well supported by easy monetary and fiscal policy. We reiterate our overweight call on Japanese equities.

In this briefing:

1. FLASH: BoE Keeps Its Head Down in Mar-19
2. India Monthly Report Feb’19 – Mar’19
3. FLASH: UK Retail High as BoBs Ignore Brexit Lows
4. UK Inflation: Devilish Detail Extending Trends
5. Global Credit Cycle: Full-Blown Repeat of 2008 Crisis Unlikely…Contrary to Doomsayers

1. FLASH: BoE Keeps Its Head Down in Mar-19

• The MPC unsurprisingly voted unanimously for no policy change again in Mar-19.
• Recent news was deemed ‘mixed’ as soft surveys and global demand partly offset the otherwise good domestic news.
• How Brexit resolves remains crucial to the optimal policy response, which can be judged after seeing the reaction of other agents amid a high option value of delay.

2. India Monthly Report Feb’19 – Mar’19

Indian indices were the least performing among the select global indices with S&P BSE Sensex and Nifty 50 generating returns of negative 1.65% and negative 0.81% in domestic terms respectively. In Dollar terms, they fell by 0.81% and 0.09% respectively. Indian Rupee witnessed an appreciation of 0.85% during the period and has risen from 71.44 USD/ INR to 70.84 USD/ INR. Among the select indices, Dow Jones was the best performer with dollar returns of 3.4%.

Among the sectoral indices, Nifty Media was the highest gainer with a 17.56% return in domestic terms and 18.56% in USD terms. The worst performer has been Nifty PSU Banks with a decrease of 5.82% in domestic terms and 5.02% in USD terms.

3. FLASH: UK Retail High as BoBs Ignore Brexit Lows

• UK retail sales rose again in Feb-19, contrary to Consensus expectations. Sales remain above their brisk trend and are supporting stronger GDP growth in 1Q19.
• Parliament continues to indulge in its political pantomime, but British consumers are Bored of Brexit (BoB) and more interested in spending their increasing real wage. Surveys remain bias to exaggerate the effect of uncertainty.

4. UK Inflation: Devilish Detail Extending Trends

• UK inflation was marginally stronger on the CPI and weaker on the PPI in Feb-19. Partially offsetting surprises lift my March forecast lightly before lowering it.
• Airfares and household energy prices are still set to significantly raise inflation to April before the latter unwinds enough in October to fall below target again.
• Annual updates to weightings extend trend changes in average rates and seasonality. The latter is likely to remain a source of surprise, while some market benchmarks might move almost 20bp further as they keep converging to reality.

5. Global Credit Cycle: Full-Blown Repeat of 2008 Crisis Unlikely…Contrary to Doomsayers

The slowing world economy has raised concerns in some quarters about an inflexion point in the global credit cycle that could provoke a repeat of the 2008 crisis due to higher levels of debt.

Governments have mainly contributed to the rise in global debt since 2008, particularly in advanced economies, while China has presided over debt expansion across all non-financial sectors of its economy.

Concerns about the US corporate bond market have centred around the significant growth of the BBB-rated segment since 2008, along with its ability to sustain liquidity given the looming satiation of investor mandates.

China’s corporate debt has risen aggressively and become increasingly risky since 2008, but a sovereign backstop and predominantly domestic funding sources limit any prospective cross-border fallout.

A full-blown repetition of the 2008 debt crisis is unlikely due to: 1) lower cross-border banking linkages, 2) a smaller role for banks in overall credit intermediation, and 3) far lower leverage in the US financial system.

In this briefing:

1. BoJ Steps in as ECB Exits
2. Fed Remains Unfazed by Recession Doomsayers, but Political Challenges Lurk on the Horizon
3. Japan: Upcycle Intact
4. Free Money Has Flown

1. BoJ Steps in as ECB Exits

By Shweta Singh, Managing Director Global Macro

• Global central banks turning dovish
• But BoJ maybe the only DM central bank ‘properly’ injecting liquidity this year
• European debt – including Italian BTPs – could benefit the most  

2. Fed Remains Unfazed by Recession Doomsayers, but Political Challenges Lurk on the Horizon

Following the release of the December US retail sales report, recession doomsayers have become much more vocal and their calls will invariably become louder as economic deceleration unfolds.

There are currently no major signs of excesses in important sectors of the US economy to unhinge the flat Phillips Curve, while structural shifts over time have made forecasting inflexion points in the business cycle much more difficult.

Meanwhile, although the Federal Open Market Committee (FOMC) is concerned about externally-sourced headwinds, members seem content with the current behaviour of the domestic economy, at least for the time being.

The Trump Administration will be keen to ease fiscal policy again to prevent a 2020 recession if growth slows significantly this year, while the Democrats would face a tricky task obstructing if there was a sizeable infrastructure spending component included as part of the measures.

Meanwhile, some Democratic politicians have been exploring deploying Modern Monetary Theory to facilitate the greater provision of free government services, but financial markets would baulk at this prospect, particularly bond market vigilantes.

The behaviour of the bond market vigilantes have highlighted the problems facing the Fed in trying to raise the policy rate significantly above zero, but they have at least provided the FOMC with an interest rate buffer to counter economic slowdown, something conspicuously absent in the Eurozone and Japan.

3. Japan: Upcycle Intact

Following 3Q’s contraction, economic activity rebounded in the final quarter of 2018 led  by investment spending. Global trade tensions and the planned increase in the consumption tax in 2019 are headwinds but we expect the Japanese economy to sail through. The investment upcycle remains intact underpinned by rising profits and consumption spending well supported by easy monetary and fiscal policy. We reiterate our overweight call on Japanese equities.

4. Free Money Has Flown

The world will soon discover that debt matters.

The announcement of each round of QE increased asset prices, but the effect on Treasury bond prices began to fade when central bank purchases began. This unexpected behaviour revealed a little-known fact: asset prices react more to the expectation of changes in liquidity than to the experience of greater liquidity in financial markets. By contrast, economic growth is subject to the fluctuating standards of commercial bank lending, which follow variations in the demand for credit. Consequently, financial markets lead the economy. Meanwhile, central banks focus on lagging indicators, so they’re followers, not leaders. Bond markets usually predict more accurately than stock markets. To work, central bank easing policies require real risk-adjusted interest rates. However, with those rates below zero in many countries, further reductions would penalise lenders without helping borrowers. Thus, only rising inflation can save stressed debtors.

In this briefing:

1. India Monthly Report Feb’19 – Mar’19
2. FLASH: UK Retail High as BoBs Ignore Brexit Lows
3. UK Inflation: Devilish Detail Extending Trends
4. Global Credit Cycle: Full-Blown Repeat of 2008 Crisis Unlikely…Contrary to Doomsayers
5. RBI Credibility at Stake

1. India Monthly Report Feb’19 – Mar’19

Indian indices were the least performing among the select global indices with S&P BSE Sensex and Nifty 50 generating returns of negative 1.65% and negative 0.81% in domestic terms respectively. In Dollar terms, they fell by 0.81% and 0.09% respectively. Indian Rupee witnessed an appreciation of 0.85% during the period and has risen from 71.44 USD/ INR to 70.84 USD/ INR. Among the select indices, Dow Jones was the best performer with dollar returns of 3.4%.

Among the sectoral indices, Nifty Media was the highest gainer with a 17.56% return in domestic terms and 18.56% in USD terms. The worst performer has been Nifty PSU Banks with a decrease of 5.82% in domestic terms and 5.02% in USD terms.

2. FLASH: UK Retail High as BoBs Ignore Brexit Lows

• UK retail sales rose again in Feb-19, contrary to Consensus expectations. Sales remain above their brisk trend and are supporting stronger GDP growth in 1Q19.
• Parliament continues to indulge in its political pantomime, but British consumers are Bored of Brexit (BoB) and more interested in spending their increasing real wage. Surveys remain bias to exaggerate the effect of uncertainty.

3. UK Inflation: Devilish Detail Extending Trends

• UK inflation was marginally stronger on the CPI and weaker on the PPI in Feb-19. Partially offsetting surprises lift my March forecast lightly before lowering it.
• Airfares and household energy prices are still set to significantly raise inflation to April before the latter unwinds enough in October to fall below target again.
• Annual updates to weightings extend trend changes in average rates and seasonality. The latter is likely to remain a source of surprise, while some market benchmarks might move almost 20bp further as they keep converging to reality.

4. Global Credit Cycle: Full-Blown Repeat of 2008 Crisis Unlikely…Contrary to Doomsayers

The slowing world economy has raised concerns in some quarters about an inflexion point in the global credit cycle that could provoke a repeat of the 2008 crisis due to higher levels of debt.

Governments have mainly contributed to the rise in global debt since 2008, particularly in advanced economies, while China has presided over debt expansion across all non-financial sectors of its economy.

Concerns about the US corporate bond market have centred around the significant growth of the BBB-rated segment since 2008, along with its ability to sustain liquidity given the looming satiation of investor mandates.

China’s corporate debt has risen aggressively and become increasingly risky since 2008, but a sovereign backstop and predominantly domestic funding sources limit any prospective cross-border fallout.

A full-blown repetition of the 2008 debt crisis is unlikely due to: 1) lower cross-border banking linkages, 2) a smaller role for banks in overall credit intermediation, and 3) far lower leverage in the US financial system.

5. RBI Credibility at Stake

By Shumita Deveshwar, Director, India research

The Reserve Bank of India’s approval of an interim dividend to the government from its surplus reserves is yet another example of the central bank conforming to the government’s wishes under the leadership of Governor Shaktikanta Das. While investors cheered the RBI’s softer monetary policy stance earlier this month, former RBI heads continue to warn against the government’s short-term bias and emphasize the need for RBI independence.

• Most policies that led to the spat between the RBI and the government spat have now been reversed
• The growth focus has translated into easier banking and regulatory norms
• A softer monetary policy puts the RBI’s hard-fought credibility at stake
• Outflows due to political uncertainty and global headwinds will prove tough for a less credible RBI to counter
• Loose fiscal and monetary policies put long-term macroeconomic stability at risk

In this briefing:

1. Fed Remains Unfazed by Recession Doomsayers, but Political Challenges Lurk on the Horizon
2. Japan: Upcycle Intact
3. Free Money Has Flown
4. UK Cycle: Bullish Trends Stretch Before Slowing

1. Fed Remains Unfazed by Recession Doomsayers, but Political Challenges Lurk on the Horizon

Following the release of the December US retail sales report, recession doomsayers have become much more vocal and their calls will invariably become louder as economic deceleration unfolds.

There are currently no major signs of excesses in important sectors of the US economy to unhinge the flat Phillips Curve, while structural shifts over time have made forecasting inflexion points in the business cycle much more difficult.

Meanwhile, although the Federal Open Market Committee (FOMC) is concerned about externally-sourced headwinds, members seem content with the current behaviour of the domestic economy, at least for the time being.

The Trump Administration will be keen to ease fiscal policy again to prevent a 2020 recession if growth slows significantly this year, while the Democrats would face a tricky task obstructing if there was a sizeable infrastructure spending component included as part of the measures.

Meanwhile, some Democratic politicians have been exploring deploying Modern Monetary Theory to facilitate the greater provision of free government services, but financial markets would baulk at this prospect, particularly bond market vigilantes.

The behaviour of the bond market vigilantes have highlighted the problems facing the Fed in trying to raise the policy rate significantly above zero, but they have at least provided the FOMC with an interest rate buffer to counter economic slowdown, something conspicuously absent in the Eurozone and Japan.

2. Japan: Upcycle Intact

Following 3Q’s contraction, economic activity rebounded in the final quarter of 2018 led  by investment spending. Global trade tensions and the planned increase in the consumption tax in 2019 are headwinds but we expect the Japanese economy to sail through. The investment upcycle remains intact underpinned by rising profits and consumption spending well supported by easy monetary and fiscal policy. We reiterate our overweight call on Japanese equities.

3. Free Money Has Flown

The world will soon discover that debt matters.

The announcement of each round of QE increased asset prices, but the effect on Treasury bond prices began to fade when central bank purchases began. This unexpected behaviour revealed a little-known fact: asset prices react more to the expectation of changes in liquidity than to the experience of greater liquidity in financial markets. By contrast, economic growth is subject to the fluctuating standards of commercial bank lending, which follow variations in the demand for credit. Consequently, financial markets lead the economy. Meanwhile, central banks focus on lagging indicators, so they’re followers, not leaders. Bond markets usually predict more accurately than stock markets. To work, central bank easing policies require real risk-adjusted interest rates. However, with those rates below zero in many countries, further reductions would penalise lenders without helping borrowers. Thus, only rising inflation can save stressed debtors.

4. UK Cycle: Bullish Trends Stretch Before Slowing

• UK employment growth increased further in Dec-18 despite GDP’s yearend weakness. Higher participation has bolstered the bullish trend but tends to be temporary.
• Slower employment growth need not prevent further falls in the unemployment rate, which looks to be creating an increasingly tight labour market.
• Wage growth is also likely to ease back in the new year, although the extent should be curtailed by an unwind of the depressed bonus share, in my view.

In this briefing:

1. FLASH: UK Retail High as BoBs Ignore Brexit Lows
2. UK Inflation: Devilish Detail Extending Trends
3. Global Credit Cycle: Full-Blown Repeat of 2008 Crisis Unlikely…Contrary to Doomsayers
4. RBI Credibility at Stake
5. Philippines: El Niño’s Comeback – How Bad?

1. FLASH: UK Retail High as BoBs Ignore Brexit Lows

• UK retail sales rose again in Feb-19, contrary to Consensus expectations. Sales remain above their brisk trend and are supporting stronger GDP growth in 1Q19.
• Parliament continues to indulge in its political pantomime, but British consumers are Bored of Brexit (BoB) and more interested in spending their increasing real wage. Surveys remain bias to exaggerate the effect of uncertainty.

2. UK Inflation: Devilish Detail Extending Trends

• UK inflation was marginally stronger on the CPI and weaker on the PPI in Feb-19. Partially offsetting surprises lift my March forecast lightly before lowering it.
• Airfares and household energy prices are still set to significantly raise inflation to April before the latter unwinds enough in October to fall below target again.
• Annual updates to weightings extend trend changes in average rates and seasonality. The latter is likely to remain a source of surprise, while some market benchmarks might move almost 20bp further as they keep converging to reality.

3. Global Credit Cycle: Full-Blown Repeat of 2008 Crisis Unlikely…Contrary to Doomsayers

The slowing world economy has raised concerns in some quarters about an inflexion point in the global credit cycle that could provoke a repeat of the 2008 crisis due to higher levels of debt.

Governments have mainly contributed to the rise in global debt since 2008, particularly in advanced economies, while China has presided over debt expansion across all non-financial sectors of its economy.

Concerns about the US corporate bond market have centred around the significant growth of the BBB-rated segment since 2008, along with its ability to sustain liquidity given the looming satiation of investor mandates.

China’s corporate debt has risen aggressively and become increasingly risky since 2008, but a sovereign backstop and predominantly domestic funding sources limit any prospective cross-border fallout.

A full-blown repetition of the 2008 debt crisis is unlikely due to: 1) lower cross-border banking linkages, 2) a smaller role for banks in overall credit intermediation, and 3) far lower leverage in the US financial system.

4. RBI Credibility at Stake

By Shumita Deveshwar, Director, India research

The Reserve Bank of India’s approval of an interim dividend to the government from its surplus reserves is yet another example of the central bank conforming to the government’s wishes under the leadership of Governor Shaktikanta Das. While investors cheered the RBI’s softer monetary policy stance earlier this month, former RBI heads continue to warn against the government’s short-term bias and emphasize the need for RBI independence.

• Most policies that led to the spat between the RBI and the government spat have now been reversed
• The growth focus has translated into easier banking and regulatory norms
• A softer monetary policy puts the RBI’s hard-fought credibility at stake
• Outflows due to political uncertainty and global headwinds will prove tough for a less credible RBI to counter
• Loose fiscal and monetary policies put long-term macroeconomic stability at risk

5. Philippines: El Niño’s Comeback – How Bad?

• With SST (sea surface temperature) in the Pacific past 26^oC, El Niño’s comeback is highly likely. Past occurrences of severe El Niño was isolated in the farm sector with upside risks to food prices. While another round of contraction in farm output and employment would be expected, the liberal rice import policy would entice imports to plug the gap between demand-supply in 1H19 and ease potential rice/food price upticks. 

• The El Niño supply shock would coincide with the global macro slowdown and fiscal spending delays that spawn downside risks to growth. With a legally handicapped fiscal budget, monetary policy may have to step up to ease likelihood of severe, near-term constraints to growth. We believe monetary adjustments would be the appropriate responses to the macro challenges as inflation winds down. Sequencing and appropriate timing of monetary reaction remains key to credible policy responses starting with the bank reserve ratio cut in 2Q19 (staggered cuts for a maximum of 3% this year) followed by policy rate cuts commencing in 3Q19 (cumulative -50bp in 2H19) when inflation hits rock bottom of less than 2%.

• Buy bonds with preference for the curve’s belly to short-duration.

In this briefing:

1. Japan: Upcycle Intact
2. Free Money Has Flown
3. UK Cycle: Bullish Trends Stretch Before Slowing

1. Japan: Upcycle Intact

Following 3Q’s contraction, economic activity rebounded in the final quarter of 2018 led  by investment spending. Global trade tensions and the planned increase in the consumption tax in 2019 are headwinds but we expect the Japanese economy to sail through. The investment upcycle remains intact underpinned by rising profits and consumption spending well supported by easy monetary and fiscal policy. We reiterate our overweight call on Japanese equities.

2. Free Money Has Flown

The world will soon discover that debt matters.

The announcement of each round of QE increased asset prices, but the effect on Treasury bond prices began to fade when central bank purchases began. This unexpected behaviour revealed a little-known fact: asset prices react more to the expectation of changes in liquidity than to the experience of greater liquidity in financial markets. By contrast, economic growth is subject to the fluctuating standards of commercial bank lending, which follow variations in the demand for credit. Consequently, financial markets lead the economy. Meanwhile, central banks focus on lagging indicators, so they’re followers, not leaders. Bond markets usually predict more accurately than stock markets. To work, central bank easing policies require real risk-adjusted interest rates. However, with those rates below zero in many countries, further reductions would penalise lenders without helping borrowers. Thus, only rising inflation can save stressed debtors.

3. UK Cycle: Bullish Trends Stretch Before Slowing

• UK employment growth increased further in Dec-18 despite GDP’s yearend weakness. Higher participation has bolstered the bullish trend but tends to be temporary.
• Slower employment growth need not prevent further falls in the unemployment rate, which looks to be creating an increasingly tight labour market.
• Wage growth is also likely to ease back in the new year, although the extent should be curtailed by an unwind of the depressed bonus share, in my view.

In this briefing:

1. Japan: Upcycle Intact
2. Free Money Has Flown
3. UK Cycle: Bullish Trends Stretch Before Slowing
4. Uzbekistan Is a Promising Latecomer, but Investors Need to Watch Out and Stay on Top of Data

1. Japan: Upcycle Intact

Following 3Q’s contraction, economic activity rebounded in the final quarter of 2018 led  by investment spending. Global trade tensions and the planned increase in the consumption tax in 2019 are headwinds but we expect the Japanese economy to sail through. The investment upcycle remains intact underpinned by rising profits and consumption spending well supported by easy monetary and fiscal policy. We reiterate our overweight call on Japanese equities.

2. Free Money Has Flown

The world will soon discover that debt matters.

The announcement of each round of QE increased asset prices, but the effect on Treasury bond prices began to fade when central bank purchases began. This unexpected behaviour revealed a little-known fact: asset prices react more to the expectation of changes in liquidity than to the experience of greater liquidity in financial markets. By contrast, economic growth is subject to the fluctuating standards of commercial bank lending, which follow variations in the demand for credit. Consequently, financial markets lead the economy. Meanwhile, central banks focus on lagging indicators, so they’re followers, not leaders. Bond markets usually predict more accurately than stock markets. To work, central bank easing policies require real risk-adjusted interest rates. However, with those rates below zero in many countries, further reductions would penalise lenders without helping borrowers. Thus, only rising inflation can save stressed debtors.

3. UK Cycle: Bullish Trends Stretch Before Slowing

• UK employment growth increased further in Dec-18 despite GDP’s yearend weakness. Higher participation has bolstered the bullish trend but tends to be temporary.
• Slower employment growth need not prevent further falls in the unemployment rate, which looks to be creating an increasingly tight labour market.
• Wage growth is also likely to ease back in the new year, although the extent should be curtailed by an unwind of the depressed bonus share, in my view.

4. Uzbekistan Is a Promising Latecomer, but Investors Need to Watch Out and Stay on Top of Data

In this briefing:

1. UK Inflation: Devilish Detail Extending Trends
2. Global Credit Cycle: Full-Blown Repeat of 2008 Crisis Unlikely…Contrary to Doomsayers
3. RBI Credibility at Stake
4. Philippines: El Niño’s Comeback – How Bad?
5. FLASH: UK Labour Market Melt-Up into 2019

1. UK Inflation: Devilish Detail Extending Trends

• UK inflation was marginally stronger on the CPI and weaker on the PPI in Feb-19. Partially offsetting surprises lift my March forecast lightly before lowering it.
• Airfares and household energy prices are still set to significantly raise inflation to April before the latter unwinds enough in October to fall below target again.
• Annual updates to weightings extend trend changes in average rates and seasonality. The latter is likely to remain a source of surprise, while some market benchmarks might move almost 20bp further as they keep converging to reality.

2. Global Credit Cycle: Full-Blown Repeat of 2008 Crisis Unlikely…Contrary to Doomsayers

The slowing world economy has raised concerns in some quarters about an inflexion point in the global credit cycle that could provoke a repeat of the 2008 crisis due to higher levels of debt.

Governments have mainly contributed to the rise in global debt since 2008, particularly in advanced economies, while China has presided over debt expansion across all non-financial sectors of its economy.

Concerns about the US corporate bond market have centred around the significant growth of the BBB-rated segment since 2008, along with its ability to sustain liquidity given the looming satiation of investor mandates.

China’s corporate debt has risen aggressively and become increasingly risky since 2008, but a sovereign backstop and predominantly domestic funding sources limit any prospective cross-border fallout.

A full-blown repetition of the 2008 debt crisis is unlikely due to: 1) lower cross-border banking linkages, 2) a smaller role for banks in overall credit intermediation, and 3) far lower leverage in the US financial system.

3. RBI Credibility at Stake

By Shumita Deveshwar, Director, India research

The Reserve Bank of India’s approval of an interim dividend to the government from its surplus reserves is yet another example of the central bank conforming to the government’s wishes under the leadership of Governor Shaktikanta Das. While investors cheered the RBI’s softer monetary policy stance earlier this month, former RBI heads continue to warn against the government’s short-term bias and emphasize the need for RBI independence.

• Most policies that led to the spat between the RBI and the government spat have now been reversed
• The growth focus has translated into easier banking and regulatory norms
• A softer monetary policy puts the RBI’s hard-fought credibility at stake
• Outflows due to political uncertainty and global headwinds will prove tough for a less credible RBI to counter
• Loose fiscal and monetary policies put long-term macroeconomic stability at risk

4. Philippines: El Niño’s Comeback – How Bad?

• With SST (sea surface temperature) in the Pacific past 26^oC, El Niño’s comeback is highly likely. Past occurrences of severe El Niño was isolated in the farm sector with upside risks to food prices. While another round of contraction in farm output and employment would be expected, the liberal rice import policy would entice imports to plug the gap between demand-supply in 1H19 and ease potential rice/food price upticks. 

• The El Niño supply shock would coincide with the global macro slowdown and fiscal spending delays that spawn downside risks to growth. With a legally handicapped fiscal budget, monetary policy may have to step up to ease likelihood of severe, near-term constraints to growth. We believe monetary adjustments would be the appropriate responses to the macro challenges as inflation winds down. Sequencing and appropriate timing of monetary reaction remains key to credible policy responses starting with the bank reserve ratio cut in 2Q19 (staggered cuts for a maximum of 3% this year) followed by policy rate cuts commencing in 3Q19 (cumulative -50bp in 2H19) when inflation hits rock bottom of less than 2%.

• Buy bonds with preference for the curve’s belly to short-duration.

5. FLASH: UK Labour Market Melt-Up into 2019

• The LFS unemployment rate fell to 3.9% on rapid wage growth of 222k. Unusually elevated participation is temporarily exaggerating strength, and its correction could cause a sharper slowdown in the data, irrespective of Brexit.
• Wage growth also exceeded expectations owing to revisions. The increasingly tight labour market appears to have melted-up at the start of 2019.

In this briefing:

1. Free Money Has Flown
2. UK Cycle: Bullish Trends Stretch Before Slowing
3. Uzbekistan Is a Promising Latecomer, but Investors Need to Watch Out and Stay on Top of Data

1. Free Money Has Flown

The world will soon discover that debt matters.

The announcement of each round of QE increased asset prices, but the effect on Treasury bond prices began to fade when central bank purchases began. This unexpected behaviour revealed a little-known fact: asset prices react more to the expectation of changes in liquidity than to the experience of greater liquidity in financial markets. By contrast, economic growth is subject to the fluctuating standards of commercial bank lending, which follow variations in the demand for credit. Consequently, financial markets lead the economy. Meanwhile, central banks focus on lagging indicators, so they’re followers, not leaders. Bond markets usually predict more accurately than stock markets. To work, central bank easing policies require real risk-adjusted interest rates. However, with those rates below zero in many countries, further reductions would penalise lenders without helping borrowers. Thus, only rising inflation can save stressed debtors.

2. UK Cycle: Bullish Trends Stretch Before Slowing

• UK employment growth increased further in Dec-18 despite GDP’s yearend weakness. Higher participation has bolstered the bullish trend but tends to be temporary.
• Slower employment growth need not prevent further falls in the unemployment rate, which looks to be creating an increasingly tight labour market.
• Wage growth is also likely to ease back in the new year, although the extent should be curtailed by an unwind of the depressed bonus share, in my view.

3. Uzbekistan Is a Promising Latecomer, but Investors Need to Watch Out and Stay on Top of Data