International Trading

Asian growth momentum has lost some steam in the third quarter, but the extent of the slowdown is modest. Financial markets have been weighted down by rising global risk aversion.

Signs of moderation in growth, but pace is still briskSecond quarter GDP figures for the Philippines’s (7.9% y/y) and Thailand (9.1% y/y) were  brisk, beating beat expectations. However, July indicators point to some moderation. Taiwan’s
industrial output slowed (from 24.3% y/y in June to 20.7% y/y in July), as did. Singapore’s (from 26.1% in June to 9.9% in July). Export growth for July in Hong Kong and Japan also decelerated. On the inflation front, prices crept up slightly in Singapore (3.1% y/y) due to higher food and housing costs. On the contrary, Japan’s deflation worsened in July (-0.9% y/y vs.
previous -0.7%; -0.3% m/m sa), pointing to a weak domestic demand recovery.

The Bank of Thailand raises policy rates
The BoT raised its benchmark interest rate by 25 bps to 1.75% as expected, while the Central
Bank of the Philippines left rates unchanged.

In the coming week….
August PMI in China, August trade figures for Korea, 2Q GDP in Australia and India, and a host
of inflation data (Indonesia, Korea and Thailand). Malaysia and Indonesia have their monthly
monetary policy meetings, and both are expected to leave rates unchanged.

Growth concerns and European debt keep Asian markets down

Worse-than-expected US indicators (a sharp plunge in US home sales and lackluster durable good orders), coupled with S&P’s downgrade of Ireland's credit rating (from AA to AA-) deepened market worries and heightened global risk aversion. The negative news has overshadowed positive indicators from Europe (Germany's IFO and consumer confidence). In our view, global growth in the second half is slowing, but not collapsing. In Asia, 2Q GDP in the Philippines and Thailand beat market expectations. Thailand hiked rates by 25 bps, the second time since June, and widening interest rate differentials led the THB to become the third best performing currency after MYR and JPY in 2010. Other Asian currencies, especially the KRW and AUD, weakened in the midst of rising risk aversion.

JPY remained the best performing currency amidst high global risk premium. Strengthening pressure on JPY and bearishness in the stock market have accelerated since the government and BOJ failed to assure markets that they were committed to preventing currency appreciation and addressing the faltering economic recovery. JPY has broken the key resistance level of 85 and closed at 84.7 on Friday. Given the current risk aversion atmosphere the JPY could test support levels towards 82.5 against the dollar.

Global growth concerns along with a hung parliament in Australia after the federal election last weekend put downward pressure on AUD. In our view, the two leading parties share similar views on major macro policies, and there are no issues of policy discontinuity. Unlike the UK, Australia also does not have problems of high budget deficits for the new government to tackle. There are little uncertainties over the economic policies of the new government. We believe political risk is not a significant factor influencing the AUD. Rather, the global growth outlook and interest rate differentials are more important issues going forward.

The CNY stayed at around 6.8 against the dollar. Compared to the level when the policy of greater exchange rate flexibility was announced, the CNY has appreciated by only 0.5% gainst the dollar. Although EUR, JPY and Asian currencies have been volatile during this period, the CNY has remained relatively stable and has not shown any inclination to move in tandem. This would likely raise doubts over the importance of a basket of currencies in determining CNY’s levels. Given the large external surplus and the need to rebalance the economy towards domestic growth, we continue to see CNY to appreciate gradually, and the timing may be related to the rising international pressure ahead of US Congress Election in November.

Stock markets in Asia dropped last week, in line with global sentiment, as fears about Europe’s debt crisis re-emerged after Ireland’s downgrading and new disappointing indicators from the US. A still-strong JPY dragged Nikkei index to a 16-month low, while Taiwan were the worst performer (-2.6%). On the other hand, most of Southeast Asia’s stock markets recorded gains throughout the past week.

Highlights

China takes another step towards internationalization of its currency (II)
McDonalds Corp. this month became the first multinational non-financial company to issue RMB-denominated bonds in Hong Kong. The CNY200 million (USD29.4 million) in 3-year corporate bonds carried an annual interest rate of 3 percent in Hong Kong. According to the company, McDonalds intends to use the funds to expand its Chinese mainland operations. If the authorities allow the proceeds to be re-invested in China, as seems likely, it would signal the opening of another channel for offshore RMB to flow back, and thereby encourage the offshore usage of the RMB. The following table summarizes the recent measures which China has implemented to advance the internationalization of the RMB:



Further progress in internationalization of the RMB will require a considerable size of offshore RMB in circulation. Toward this end, the authorities are encouraging the development of an offshore market by increasing usage of the RMB in cross-board trade and developing Hong Kong as the RMB offshore center. However, offshore RMB today finds little investment use internationally, and consequently, market participants have little incentive to hold RMB deposits, other than to capitalize on expected further appreciation of the currency. The steps listed above are part of the authorities’ efforts to enhance the attractiveness of holding RMB deposits.

Australia’s elections leave a hung parliament
In the election on August 21, both the ruling Labor party and the Liberal-led opposition failed to reach the 76 seats majority, resulting in the first hung parliament since WWII. Both party leaders were now fighting over the backing of four independents and one green. Should the Liberal party convince three independent MPs to form a coalition government, Labor under the leadership of Julia Gillard would become the first since 1931 to fail to win a second term. Support for the Labor party has declined despite strong economic performance because of a number of policy bungles, including the government’s early proposal for a profits tax on mining resources. Nevertheless, it should be noted that on major policies, there are few significant differences between the Labor and Liberal parties. Both parties, for example, have vowed to bring the budget back into surplus by 2012-13. Therefore, the election is unlikely to have a material influence on economic policy.

Southeast Asian 2Q GDP growth is slowing, but still well above trendSoutheast Asian GDP continued to grow strongly in the second quarter, beating market expectations. After strong GDP outturns in Indonesia (6.2% y/y) and Malaysia (8.9% y/y) earlier this month, data releases this past week showed that Thailand’s and the Philippines’ GDP rose 9.1% y/y and 7.9% respectively, both ahead of market expectations. Although the growth pace has decelerated modestl in the second quarter, it remained well above historical trends. Sequentially, the deceleration in Thailand was more pronounced due to the political protests and violence in Bangkok in April. Macro indicators suggested that the disruption was one-off and growth resumed. That said, we believe that the slowdown is a transition back to trend after a sharp V-shape recovery.

As recoveries mature, Malaysia and Thailand have begun to withdraw monetary stimulus, and they have hiked rates since the beginning of the year. Malaysia has raised its benchmark rate for three times this year. Thailand, after the confirmation of continued recovery from 2Q GDP, raised rates by 25bp last week to 1.75%, the second time this year. We expect  Thailand to raise rates once more, by 25 bps, this year. Indonesia and Philippines have so far held rates unchanged. But with rising inflation expectations and growth gaining further traction, we expect their central banks to start hiking rates towards the end of this year.

What to watch

China: Purchasing Managers’ Index (August, September 1)
Forecast: 51.8
Consensus: 51.6
Previous: 51.2

Domestic demand is cooling on government efforts to restrain credit growt and cool the property market. In line with recent activity indicators pointing to an economic soft landing, we expect August manufacturing activity to come in at a similar pace as in recent months. However, due to seasonality, we expect China’s PMI to rise slightly in August. A weaker than expected reading, could trigger concerns of a hard landing, and renew worries about the sustainability of global growth.

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