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2011-06-06 DBS Daily Breakfast Spread

2011-06-06 DBS Daily Breakfast Spread

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Daily Breakfast Spread, 6 June 2011
Daily Breakfast Spread
DBS Group Research6 June 2011
Monday’s The Week Ahead
Greater China, Korea
Market opinions are divided about the Bank of Korea’s rate decision this Friday.The economic data released last week appeared to be too weak to support the caseof a rate hike. Exports levelled off in May. Domestic demand indicators for Aprilhave softened broadly, ranging from equipment investment, constructioninvestment to private consumption. CPI inflation also stabilized at 4.1% in Maythanks to the correction in international oil and local food prices.The steady uptrend was seen in May core inflation (3.5%, up from 3.2% in April),suggesting that the cost passthrough from producers to consumers is still ongoing.This is because the accumulated cost pressures among upstream producers are stillhigh (PPI: 7.3%), as a result of the persistent surge in global commodity prices in thepast several quarters, in combination with a loose monetary stance as reflected in aweak won and low interest rates. The BOK has not boosted interest rates thus far in2Q. The current short-term rate level of 3.0% remains significantly lower than thelevel of inflation. The presence of negative real rates helps explain the weakness inthe won.Core inflation can ease eventually if growth in aggregate demand continuesslowing. A sustained downturn in global commodity prices could also help alleviatepressures on core inflation. However, there is currently no evidence showingformation of a trend of slowdown. Global oil prices have also stopped falling in thelater part of May. While the growth weakness in 2Q has obliged us to revise the full-year GDP forecast slightly to 4.1% from 4.5%, we continue to expect a growthrebound in 2H when global uncertainties dissipate and business confidence is rebuiltin Korea. For now, we think it remains appropriate for policymakers to considerclosing the rate gap with inflation to minimize the negative consequence ofnegative real interest rates. We maintain the forecast of a 25bps hike at this Friday’sMPC meeting, followed by modest tightening of 25bps per quarter in 2H.
Southeast Asia, India
: Industrial production index for Apr11 is on tap this week and a modest 3.3%YoY rise is expected, up from 2.3% in the previous month. Once again, base effect isat work which gives the illusion that industrial activity has been lackluster. As amatter of fact, absolute output level has improved significantly from the bottom ofthe cycle in February. Nonetheless, a modest month-on-month decline of about 2%nsa has been factored into our forecast to account for any possible production dipdue to electronics supply chain disruption arising from the calamity in Japan.However, April’s export data released last Friday saw exports to Japan increased byabout 35% YoY, due mainly to exports of LNG. It seems that the nuclear crisis inJapan has probably benefited fuel product exporters such as Malaysia as a result ofincreased demand for fossil fuel (i.e. fuel oil and natural gas) in Japan. This may tosome extent boost industrial activity and help mitigate any possible downside dragcoming from the other industries. Moreover, the subsequent rebuilding effort inJapan could well provide additional impetus to industrial output in the later part ofthe year.
Bank Indonesia is widely expected to keep the overnight reference rateunchanged at 6.75% when they meet this Thursday. May inflation data out lastweek have strengthened the case of no rate change this week. Headline CPIinflation has eased further to 6.0% YoY in May from 6.2% in April, thanks to thecontinued declines in food prices backed by local harvest. On the other hand,growth seems to be moderating in 2Q amid a less favourable global economic
US Fed expectations
Source: Bloomberg fed fundfuturesNotes: Given a FF target rate of0.25%, an implied FF rate of0.30 is interpreted roughly asthe market pricing in a 20%chance of a Fed hike to 0.50%from 0.25% (30 is 1/5th of thedistance to 50 from 25). DBSexpectations are presented indiscrete blocks of 25bps, i.e., theFed moves or it does not. Seealso “Policy rate forecasts”below.
Implied fed funds rateDec-11Mar-12Jun-12
Current0.170.230.311wk ago0.170.240.33
Daily Breakfast Spread, 6 June 2011
climate, which also means BI may prefer to take a cautious approach to monetarypolicy at this point. Owing to the supply chain disruption in Japan, motor vehiclesales in Indonesia have fallen significantly by -6.9% YoY in April. Exports remainedrobust at 37.3% as of April, but a slowdown is expected for May in line with thedownward correction in global commodity cycle.The faster-than-expected declines in food prices in 2Q obliged us to lower ourwhole-year inflation forecast slightly to 6.7% from 7.0%. But we still cautionagainst inflation risks in 2H. Note that consumers’ inflation expectations for thenext three months have jumped by 8 full points in May, based on the latestconsumer sentiment survey conduced by the central bank. Traditionally inflationexpectation index correlates well with the actual CPI (Chart). Indeed, thedownward trend in food prices has already slowed in May compared to in Mar-Apr,along with the local harvest passing the peak. A rebound in food prices is expectedfrom 3Q onwards, considering the end of the harvest season and the arrival of theRamadan festival. Meanwhile, despite the drop in global oil prices in May, there isno guarantee that oil prices will not rebound in 2H. As the gap between theunsubsidized and subsided fuel prices in Indonesia remains wide (comparable tothe gap in mid-2008), the government may still consider a fuel subsidy cut in 2H.The finance ministryplans to discuss thefuel subsidy policyduring the mid-yearbudget reviewscheduled in July.Besides food and oil,we also expect coreinflation to pick up in2H, mirroring apositive output gapand faster growth inmoney supply. Assuch, we maintainour view that BI willbe under pressure toresume tightening in2H. We continue toexpect a total of75bps rate hikes inthe remainder of thisyear.
: In line with the downside risks to GDP growth and upside risks to inflationflagged in this space over the past couple of months, we are revising our GDP andinflation forecasts. We expect GDP growth to ease to 7.5% in FY2011/12 (ends Mar)and in 2012/13, lower than the 8% expected earlier. Inflation, factoring in a 10%hike in diesel and LPG prices, is expected to average 8% in 2011/12 and 7% in 2012/ 13.The main worry relates to inflation and the large fiscal gap. The continued upsidesurprises in inflation despite significant tightening in monetary policy point to alarger structural component in inflation. In addition to the lagging and weakinfrastructure, possible reasons for this include the deterioration in the investmentclimate and investment and the simultaneous support to consumption from severalgovernment policies (direct income tax reduction, NREGA, fuel subsidies). At thesame time, growth in food production (2%) is significantly lagging growth in realper capita GDP (6%) and thus food demand. This means, even if GDP growth is lessdependent on agriculture and less sensitive to monsoon than before, agriculturestill indirectly can and does impact overall economy – via higher food inflation thatultimately leads to higher overall inflation and thus interest rates (and slowergrowth). There are two major worries over the inflation outlook ahead. First, thegap between food production and demand — the likely cause for rising foodinflation — is unlikely to close, implying a real risk that expectations for foodinflation to return to pre-2008 trends (5% annual rise) remain just that. Second, abig gap has emerged between domestic fuel prices and global crude oil prices. Weestimate that retail fuel prices (excluding freely floating fuels which constitute 20%of mineral oil component of WPI) are priced on average for Brent crude of USD 75 / bbl. At the minimum, further rises in oil prices have to be passed on entirely to
CPI (LHS)Inflation expectation: consumers
ID: Inflation & inflation expectation
% YoYLatest: May11point
Daily Breakfast Spread, 6 June 2011
consumers and more likely, given what we think is a precarious fiscal position,regular upward adjustments to retail fuel prices are in order (probably over thenext several years) to trim the fiscal deficit. Thus, even after this upward revision toinflation, we still judge inflation risks to lie to the upside. This means inflation andinterest rates are likely to be well supported in 2011 and 2012, dragging growthwell below recent trend rate of 8%. While the investment climate can be improvedwith a more pro-business stance by the government, it always takes much morethan a few quarters or a year to see the effect on actual supply. Thus, it is difficultto envisage the economy escaping some ‘pain’ in the short-run.
: Job growth has slumped back to January levels; a bit lower in fact. Worse,investors may recall that January was an awful month weather wise, so even thatcomparison is kind to the May outcome reported Friday: payrolls expanded by 54k,the least since Sep10 (when they fell by 29k).Markets would have reacted more dramatically had it not been for the servicesector ISM, which rose by more than 2 points. Thank heaven for small favors. Infact, it’s a bigger favor than it seems: not only did the ISM go up, but the servicesector is sort of the supply-side equivalent of consumption: it’s big and slow-moving and carries a lot of weight and momentum. So a two point rise in such alarge mass is good news indeed – especially when it was driven by an orderscomponent which rose by 4 points (to 56.8) and an employment component whichrose by 2 points (to 54).There’s absolutely nothing on the data calendar this week, save for the joblessclaims that appear every week. They’ll be interesting but not that interesting. Theyhave started returning to the good side of things, after having taken a 6-weekdetour in the wrong direction. Last week they fell to 422k (sa), some 50k betterthan one month ago but remain a far cry from the 375k-390k reading thatprevailed in February and March. Only a decisive move below 410k this weekwould raise any favorable eyebrows. The thing is, even a small improvement won’tcome easy what with labor markets so prone to sentiment and the latter moving inthe wrong direction right now.There’s a load of Fed speeches on tap, though, and they will be interesting indeed.Plosser, Fisher, Hoenig, Lockart, Dudley and (chairman) Bernanke himself are allscheduled to opine on matters that will pale in comparison to the Q&A sessionsthat will follow their speeches where reporters will, to a woman, all zero in onwhether the Fed still intends to put QE2 to bed or whether it might be putting QE3into the oven instead. Officials so far have been stunningly silent about the slide inthe data over the past 6-8 weeks. No doubt they’re in an awkward situation: nosooner had they intimated (at the last FOMC meeting on 27Apr) that QE2 would bethe end of QE period when things started to go downhill. The poor data reached acrescendo last week and the Fed now has no choice but to speak or let everyoneand their sister do their speaking for them.The interesting question, or one of them anyway, will be whether the Fed speaks asone or as many. Two months ago, there was a lot of democratic disagreement overwhether the Fed was being too slow in ending QE2. Bernanke prevailed (inextending it to its natural end) and he sure looks good now. The question remainsas to what “the Fed” now thinks about the drop in the data since the last FOMCand what it means for policy. A lot of democratic discourse might not be good formarkets just now, given that 10Y Treasury yields are down by 60bps since April (to2.99%) and the SPX has fallen for five straight weeks. But a United Front, whateverthat might mean in terms of content and policy projection, seems impossible at this juncture. All we know for sure is that officials will repeat what they have alwaysrepeated since the start of the crisis back in August 2007: the Fed will do whateveris necessary to support the recovery. Good to hear. For the 25
We no longer expect the Vietnamese dong to devalue this year, and see USD/ VND stable at 20500 in the medium-term. The market is telling us two things aboutthe dong. First, the unofficial exchange rate, which has led past devaluations, isencouraged that the dong is stabilizing from the government’s efforts to improve

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