A Brief on Global & Local Markets, Investment Strategy.

Week in Review | 15 – 19 January 2018

US government shutdown short-lived; continuing resolution pushes through

The US federal government entered an abrupt shutdown last Friday; which however only lasted for a fleeting weekend – as the Senate voted to advance a short-term spending bill at the time of writing to end the brief impasse; paving the way for a quick reopening of the government.

The shutdown came into place following a dispute between Republicans and Democrats of the Senate; centred on the protection of undocumented young immigrants in the US – in which many of whom were in danger of deportation following the abolishment of the Action for Childhood Arrivals (“DACA”) programme in September 2017.

The Democrats were quick to yield and agreed to a continuing resolution on Monday – which will fund the US government till 8 February 2018 – following a firm pledge by the Republicans to pursue for a bipartisan immigration bill in February.

Historically, impact on financial markets during such government shutdowns are benign. During the 2-week shutdown in September 2013 concerning the Obamacare bill, the S&P500 fell slightly before rebounding going into the end-2013. Considering the much swifter resolution this time around, market impact will likely be muted.

This however only spells for a temporary pause on the current deadlock, as Trump and his administration will still have to commit to an immigration deal. Should the deal be left unattended, the stalemate will likely put more downward pressure on the USD in the longer-term. Nonetheless, Trump and his administration would want to be more accommodative to solidify their position in the mid-term US elections coming November.

UST yield marches higher

Treasury yields continued to move higher last week as the 10-year UST closed the week at 2.66%; breaking above its key technical level of 2.64% seen during Trump’s election win in 2016.

According to reports, Japanese bond investors are seemingly shifting out of treasuries to purchase more European debt due to increasingly unfavourable FX hedging costs. After accounting for FX hedging costs, Japanese investors only get a net carry of 0.60% on the 10-year UST as compared to 0.90% last year. Given that French government bonds net of hedging can provide Japanese investors about 0.85% to 0.90% carry; this could mean that treasuries might have to sell-off approximately 20-30bps from its current level to become attractive to Japanese investors again.

While we’re looking at the 2.40% to 2.70% range for the 10-year UST in 1Q2018, the possibility for the benchmark treasury yield to overshoot to the 2.80-2.90% level cannot be ruled out given the current market sentiment on strong global growth and the potential revival of global inflation.

3.00% will be the key level to look at for the 10-year UST – which is the point where it breaks above the equity earnings yield (inverse P/E ratio), and may potentially dampen the risk-on sentiment. Nonetheless, with the current environment of a robust US economy and synchronised global expansion, risk assets will likely remain well supported for the near term.

ECB expected to hold interest rate guidance in upcoming meeting

In central bank news, the ECB draws closer to its first policy meeting of the year which is set to happen this Thursday.

For this meeting however, we do not expect to see any drastic changes on its current QE unwinding – from 60 billion Euros to 30 billion Euros per month – as well as its interest rate guidance. This is because there are still concerns on the overly-strong Euro; and soft inflation remains to be a hurdle for the ECB to further fortify its hawkish stance prematurely.

The European inflation rate for December reportedly stood at 1.4%; which is 0.1% lower from November figures. Core inflation rate was also stuck at 0.9% for its third consecutive month. With its current pace, inflation on the Europe front is likely to remain soft in the interim; and the ECB is only expected to turn more hawkish during its meeting in March – should economic and inflation data improve.

Equity update & positioning

Asian equities continued its ascent, as it looks poised to extend gains on the back of a still fairly bullish environment and optimism derived from the decent 4Q2017 earnings reported in the US. The HK/ China space paced gains in regional indices, with the Hang Seng Index up by 4.1% YTD hitting all-time high. The MSCI Asia ex Japan Index is also up 2.5% YTD (in MYR terms) – driven by strong performances in Hong Kong and China, which constitutes a large weight in the index.

Ongoing supply-side reforms in China continues to bode well for the commodity and material sector, whilst rising household consumption and increased urbanisation through strong wage increases will be positive for consumer discretionary and staples; and also place the planks for a long growth runway for its new economy play.

On our Asian portfolios, we have reduced some exposure in the tech-hardware space including names from Korea and Taiwan – where suppliers are facing increasing cost pressures arising from higher commodity and crude oil prices. Both the Korean Won and Taiwan Dollar have also appreciated markedly this year, leading to FX loss translation when converting exports denominated in USD back to the respective local currency.

Closer to home, the Malaysian equity market mirrored the performance of its regional peers, as the FBMKLCI gained 0.3% to close at 1,828 points last Friday. Invest Malaysia 2018 set to kick-off this week could see several deals and infrastructure announcements coming through; potentially more stimulus to boost the local economy.

As tailwind continues to blow in favour for the domestic equity space, we look to maintain our high equity exposure of about 90.0% to leverage on the positive momentum in this pre-election period.

Fixed income update & positioning

The regional fixed income space has been somewhat dovish amid treasury yields that are trending higher. Technical wise, we are still seeing strong inflows into EM and Asian funds; but most managers and investors have opted to remain side-lined in the interim awaiting for evident stability in treasury yields.

While the reversal of the “lower for longer” sentiment is expected to be challenging for the bond market, we believe that a gradual and accommodative normalisation of interest rates alongside bond yields would still be manageable. And from a longer term perspective, better coupons and income derived from higher rates would still be quintessential for investors.

In terms of positioning, while our focus is tilted towards IG bonds, we have been selectively participating in the AT1 space for some of our funds – especially in European names, and Chinese AT1s which have shorter calls – given that they are less sensitive to interest rate movements. Nonetheless, we will be holding a cautious approach, and duration across our regional portfolios will be kept short at about 3-3.5 years for at least 1Q2018.

On the domestic front, sentiment is also turning cautious due to the rising treasury yields – as the 10-year MGS yield followed suit to edge higher by 11bps week-on-week. The yield curve continues to bear flatten as yields for the short term and medium term bonds increased higher as compared to the longer term papers.

We expect this trend to continue, and MGS yields will likely remain under pressure going into BNM’s Monetary Policy Committee (“MPC”) meeting that is scheduled for this Thursday. Attention will be centred on BNM’s guidance for the Malaysian economic outlook as well as the central bank’s policy stance. In the interim, we intend to remain defensive behind the expectation that MGS yields will rise; and will await for clarity from the MPC meeting.

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