A Brief on Global & Local Markets, Investment Strategy.

Week in Review | 11 – 15 September 2017

US inflation picks up alongside battered greenback

US inflation reading for the month of August came in above market expectation last week – as a jump in shelter and petrol prices saw CPI numbers rise by 0.4% from the prior month and 1.9% year-on-year.

Albeit surprising on the upside, markets are still a little bearish on the overall US inflation given several consecutive soft outings in the months before. The 10-year UST yield only went up by about 12bps to close the week at 2.2%. The 12bps move last week looks muted in that we should see higher yields should the Fed hike this year, which seems increasingly likely should inflation continue to surprise on the upside over the next 1-2 months.

Nonetheless, markets should be wary that the recent spike in the inflation reading could mean the start of a rolling snowball. Historically, inflation surprises (be it upside or downside) tend to have a serial correlation with recurring sequences; thus we could potentially witness a couple more upside surprises moving forward. While this does not mean that inflation will be excessively robust, it may turn out higher than what consensus expects.

On the currency side, the USD has managed to regain some traction in the past week amid the better inflation readings. In addition, President’s Trump recent agreement to extend the debt ceiling to focus on providing relief funding to those affected from the hurricanes has depicted his willingness to set aside differences in dire moments; thus somewhat helping the case for himself (and potentially his tax reform plans), as well as providing a temporary relief for the greenback.

Could this mean a more hawkish environment ahead?

The reversal in US inflation prompts the question on whether markets are actually underestimating the pace of the Fed’s rate hike cycle. Currently, markets are only pricing in 1 rate hike till end-2018 as opposed to 4 hikes guided by the US Fed. Should inflation continues to pick up in line with its historical trend, we could potentially see a rate hike happen as early as December 2017; alongside higher bond yields and a stronger USD.

Apart from the US, the Bank of England surprised markets last week with their sudden hawkish shift; citing that the Brexit aftermath may not weigh too significantly as initially expected. So markets are expecting a rate hike to come at the end of this year instead of 2018. The sudden repricing saw the Pound strengthen by about 3-4%. On a separate note, the Bank of Canada had also hiked its interest rates by 25bps (to 1.0%) earlier this month.

It is uncertain whether this is a short-term trend where global central bankers are turning to be more hawkish. Regardless, the US Fed’s decision will likely be dependent on upcoming CPI numbers and data points; so we intend to monitor on this closely.

China updates

A barrage of data was also released on the China front last Thursday; coming in slightly softer than expected. The August industrial production rose by 6.0% year-on-year while retail sales rose by 10.1% – missing economists’ estimates of 6.6% and 10.5% respectively. Albeit weaker than expected, we believe that the numbers are still fairly decent and the nation’s underlying fundaments are still relatively strong.

On the credit side, Chinese banks have extended RMB1.09 trillion in net new Yuan loans in August; well above the RMB900 billion forecast. The improvement was largely driven by the increase in household borrowings; which is quite supportive for the banking space. On the other hand, broad M2 money supply growth pace came in slower, at 8.9% year-on-year (vs. expectation of 9.1%). However, the slower M2 growth is due the government’s crackdown on risky shadow lending activities, which is in line with their plan to reduce the nation’s financial risks.

In currency news, the PBOC has also announced to scrap reserve requirements for banks establishing forward Yuan positions. Prior to this, banks are required to set aside 20% of the previous month’s Yuan forwards settlement amount as FX risk reserves; hence this reform would allow forward trading activities to be less costly. And given market’s expectation on RMB’s upward trajectory, we believe there could more room for China to introduce more reforms to further internationalise the RMB.

In summation, reforms would be the likely theme for China in the lead up to the National Party Congress coming November; and this should ultimately be positive for China as a whole.

Asian equity positioning

For the first time since the global financial crisis, the relative performance of emerging markets (“EM”) against developed markets (“DM”) has recovered. While the EM underperformance has been a long established theme since the 2008 crisis, EM stocks have been gradually recouping its underperformance since end-2016 and have considerably outperformed its DM counterparts for the year thus far.

Despite the slight rebound in USD, demand for EM stocks continues to be evident over the past week; with a total inflow of about USD2.1 billion – of which over USD500 million were shifted into Asian dedicated funds. The bulk of the inflow however was heavily focused on Korea and China, where valuations are still relatively attractive as compared to their respective historical averages, as well as regional peers.

Market performances in general was decent albeit being slightly narrow; mainly driven by names within the tech and e-commerce space. And despite the weaker than expected industrial production numbers from China, the underlying fundamentals of the country remain fairly supportive and we are expecting more positive reforms to be announced ahead of the National Party Congress.

In terms of positioning, our regional portfolios are currently quite heavily invested; reflecting our optimism for the Asian equity space. We have also increased our exposure into China over the past couple of weeks; namely into the insurance, banking and property space. As of now, the cash level for our Asian funds ranges from 3 to 5%.

Fixed income updates & positioning

Resilience within the Asian credit market continues to evident. Inflows into the region have been pretty robust throughout the year thus far, especially into the hard currency space. And despite the pullback in treasuries last week, inflows are still fairly healthy.

Attention will likely be focused on the FOMC meeting this week, as many are expecting the Fed to solidify its balance sheet reduction plan. Thus far, it has been announced that a maximum of USD6 billion worth of treasuries and USD4 billion of mortgage-backed securities will be rolled off the Fed’s sheet; the commencement of this however is yet to be revealed. In addition, we are also expecting the Fed to address the recent rebound in US inflation, as well as its rate hiking cycle.

As aforementioned, markets are currently under-pricing the number of rate hikes guided by the US central bank. Nonetheless, we intend to tread cautiously and will maintain our duration for our Asian portfolios at about 4.5 years.

On the Malaysian front, the fixed income space saw a slightly softer outing last week. Benchmark government bonds rose 1-3bps on the week, tracking the increase in UST yield.

Taking the August bond maturity as a gauge where some foreigners did not rollover their positions, similar trend can be expect on the recent large maturity (MYR12 billion) last Friday. Impact to the MYR and the bond market however, is expected to be fairly muted.

Currently, duration across our domestic portfolios are kept at 6 years.

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