Brief Macro: Hong Kong FX and more

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.