Daily Macro: UK Wrap: Politically Fragmented Outlook and more

In this briefing:

1. UK Wrap: Politically Fragmented Outlook
2. Ten Years On – Asia Outperforms Advanced Economies
3. Beto’s Emergence: Pragmatic Policymaking Suddenly Seems Possible (Just 24 Short Months From Now)
4. Growing Pains & PBoC Cut/US-China Clash/Railways & Airports & Bonds/More Babies Please/Moon Landing
5. Philippines: Time to Mull over the Risks of the ‘twin Deficit’ Syndrome

1. UK Wrap: Politically Fragmented Outlook

• Brexit: Agreement with the EU was concluded before reaching the required reassurances for parliament. A soft Brexit remains most likely, before breaking harder, but the politics is fragmenting the outlook.
• Economy: The post-referendum growth trend pace has re-established at 0.15% m-o-m, which appears to be above-potential. Inflation should temporarily slow below target despite domestic pressure building.
• Monetary policy: The BoE delivered its second rate hike in August to 0.75%. Bullish economic trends mean I expect the next hike in May-19, assuming a smooth transition becomes assured soon.

2. Ten Years On – Asia Outperforms Advanced Economies

You might be surprised to learn that in the ten years to 2017 Asia has outperformed advanced economies. Despite extraordinary monetary and fiscal stimulus and the damaging dollar-demand deflationary policies of the ECB, BoJ and BoE, the region is 188% larger in US dollar terms compared with 2007 while US dollar GDP per capita income is 170% higher. The parallel numbers for the advanced countries – the US, euro-area and Japan combined- are 19% and 13%. Asian stock markets have underperformed since 2010 but we believe that investors are still to fully acknowledge Asia’s strong growth fundamentals. Combined with cheap valuations there is significant upside for Asian equity markets.

3. Beto’s Emergence: Pragmatic Policymaking Suddenly Seems Possible (Just 24 Short Months From Now)

As market scrutiny focuses on the short-term effects of current trends – i.e., slowing global growth, the US government shutdown and the Trump ‘trade war’ – an overlooked longer-term prospect is that the US political outlook may finally be improving. 

Since Hillary Clinton’s sensational loss in 2016, the Democrat Party has been in disarray about whom to nominate for president in 2020, and this in turn has fostered the specter of President Donald Trump serving through 2024.  However, new polls now show that the Democrats may already be uniting behind a potential nominee who is not only vetted and viable, but also reasonably centrist (especially on economics).  This is the former three-term congressman from El Paso, Texas: Beto O’Rourke (no relation to this insight writer). 

O’Rourke’s emergence is significant because it can reduce perceptions of risk surrounding the 2020 election and, more importantly, offer prospects for sounder policymaking and international re‑engagement starting 24 months from now.  In particular, O’Rourke (like Obama) supports free trade and he voted for the Trans Pacific Partnership (TPP).  In contrast to redressing perceived grievances through ruinous tariffs, the TPP offered hope for bringing about equitable economic relations through positive inducements.  If the pact were to develop and expand with US participation, benefits to membership might become clear – which might eventually elicit interest from China and achieve the cooperation that Trump has fitfully pursued through coercive means.  In any event, the prospect of less US protectionism post‑2020 suggests that the recent downturn for exporters (e.g., Apple) may be, in the grand scheme, a blip – not the start of a secular decline.   

4. Growing Pains & PBoC Cut/US-China Clash/Railways & Airports & Bonds/More Babies Please/Moon Landing

China News That Matters

• PBoC responds to disappointing start to another year of slowing growth
• Talks planned but US-China “clash of civilisations” deepens
• Ever faster trains, new airports from Beijing to Antarctica – and more debt
• Two-child policy fails to avert demographic crisis
• Beijing nails first ever landing on moon’s far side

5. Philippines: Time to Mull over the Risks of the ‘twin Deficit’ Syndrome

• We remain upbeat on 2019 growth prospects (6.5%-6.6%) amid fading inflation risk. However, we don’t see a return to the ‘sweet spot’ with the risks of swelling macro imbalances as highlighted in our macro strategy piece recently. Domestic demand, which will underpin growth prospects, has a larger impact on the trade shortfall rather than oil price fluctuations.

• Anticipated costs from a hefty current account gap would be the sustained compression of official reserves with a corresponding peso liquidity drain. Managing the hefty current account deficit likely to probe more than 3% of GDP as investment- driven growth persists, would require the combination of a weaker PHP and positive, real interest rates. Aside from attracting portfolio flows, real interest rates would encourage private sector savings in our twin deficit situation. Positive real rates could also curb the private sector’s strong debt appetite. A staggered 2% bank reserve cut anticipated this year when monthly inflation is closer to 5% or less, would provide partial relief to peso liquidity loss arising from the BSP’s net dollar sales in the inter-bank FX market.

• Fiscal deficit has to be kept in check and within the range of 3% of GDP. Public sector credit risk has been buoyed by the implementation of the 2nd phase of excise hikes on diesel and gasoline products this year amid low oil prices. More fiscal reforms are pending in Congress that could be delayed by the mid-term elections. 

• Against a backdrop of hefty fiscal and external gaps, it’s premature to contemplate lower policy rates with receding inflation risk. The full impact (or pass-through) of the cumulative 175bp hike in lowering inflation expectations to within the BSP’s inflation target range of 2-4%, has yet to be seen. While BSP’s policy bias may ‘sound’ dovish in the new year, maintaining its policy rate at 4.75% amid receding inflation, would signal policy focus on lingering macro stability issues.

• PHP may revisit historic highs of 55-56 on the back of swelling macro imbalances in the near-term although correction to the 54-55 range would depend much on the US Fed finally declaring an end to its rate tightening cycle and thus, terminate the strong USD episode, with BSP sticking to its current policy rate.

• We continue to like ‘steepeners’ in the long end as debt supply from the government and private corporate debts to fund ambitious investment plans would likely persist. The expected backdrop of upbeat growth prospects coupled with our view of the BSP ending its monetary tightening cycle (ahead of the Fed) amid waning inflation risk, bode well for local equities and short-duration bonds.