An unhealthy correction

The ongoing market sell-off does not represent a healthy cleaning out of positions. Market uncertainty will persist, in our view.
Taimur Baig, Duncan Tan12 Oct 2018
  • Factors like oil, China-US trade war, USD liquidity, and interest rates won’t get resolved soon
  • The mood at the ongoing IMF meetings is grim, as multilateralism is being challenged worldwide
  • The IMF has revised down global growth forecast modestly
  • The potential for upside surprise has diminished in a tightening environment
Photo credit: AFP Photo

The market correction is unlikely to force the Fed’s hand

Rising rates, China-US trade friction, and geopolitical unease have broken the market’s back for now. We are in the middle of worldwide selloff that is sharp enough to warrant a scrutiny of our views on various asset classes and the key economies of Asia, with this publication providing a comprehensive rundown.

As a general point, the ongoing market sell-off hardly represents a healthy cleaning out of positions. For value to emerge, many uncertainties need to be resolved (oil, China-US trade war, USD liquidity, interest rates), something we don’t envision any time soon.

Moreover, the idea that a Fed relent is around the corner if financial markets correct sharply is unlikely to materialise, in our view. Inflation may not surprise on the upside, but given the tightness of the US labour market, as well as US policy-induced pressure on trade and oil, the Fed will have to continue on its path toward normalisation.

The latest wrinkle in this narrative is the strong criticism of the Fed by US President Trump, which can only backfire, in our view. To ensure that its credibility as an independent monetary authority is maintained, the Fed will now have to take measures that shows its resolve, which certainly can’t include being amenable to presidential exhortations.

Indeed, other than the market correction, there is little reason for the Fed to relent. Strong fundamentals that have propelled growth to well above the potential rate, pipeline wage demand, and emerging inflation risks support continuation of a rate hike cycle. Unless some systemic risk emerges, this will continue, as signalled for long by the US monetary authorities.

The November mid-term election in the US is a major source political uncertainty. If the Democratic party takes control of the House, the ability of the US government to inject further fiscal stimulus may well be constrained, which could push up the probability of sharp slowdown (if not an outright recession) in US growth in 2020. At the same time, some restraint on unilateralism will be welcome.

Brief take from the IMF meetings

The mood at the ongoing IMF meetings in Bali is grim, independent of market developments. Multilateralism is being challenged worldwide; the erosion of a rules-based system to settle disputes is concerning. Initiatives on environmental sustainability, inclusive growth, market and economic integration and regulation, all are under the shadow of a disruptive US.

The IMF has revised down global growth forecast modestly, noting that the economic expansion has become less balanced and growth may have peaked in some major economies. The IMF also sees the potential for upside surprise diminishing in an environment of tightening monetary and financial conditions.

The policy prescription is straight-forward, avoid protectionist tendencies, find cooperative solutions, rebuild fiscal buffers to protect against a future downturn, focus on inclusive growth, and prepare financial institutions to deal with a continuation of asset market volatility and exchange rate overshoot. The reality however is few economies are in a position to heed this line of advice.

Of course, not everything is about the macroeconomics. These meetings highlight that promising developments in the areas of financial technology and financial inclusion are energising developing economies, frontier markets in South Asia, Eastern Europe, and Africa continue to forge ahead, and despite the doom-and-gloom around trade wars, large parts of the world remain open for business. Interesting work has been presented on human development index, underscoring the need to invest in health and education.

We are keen to see if the remainder of the IMF meetings offer new insights on China’s policy direction, macro risk mitigation measures (we welcome yesterday’s announcement that the monetary authorities of Singapore are deliberating a USD10bn swap/repo line for Bank Indonesia), progress with the IMF’s capital buffer increase, and initiatives on climate change.
Taimur Baig

Highlights of the week:

Thailand chart book – Asia’s safe haven
Hong Kong chart book - HKD rates are sensitive to rising USD rates
South Korea: Policy debate heating up
China chart book - Weakening policy transmission
SGD Policy: Play it again, MAS
China: Monetary policy tilts toward loosening

To read the full report, click here to Download the PDF.

Taimur Baig, Ph.D.

Chief Economist - G3 & Asia

Duncan Tan

FX and Rates Strategist - Asean

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