Macro Strategy: Post mid-term check on Trump’s unilateralism to support EM sentiment

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Eugene Leow, Rates Strategist

Radhika Rao, Economist

DBS Group Research

Rates: Election uncertainties fade

Overnight, the market piled back into risk, driving the Dow up by 545pts, as uncertainties over the US mid-term election got lifted. In line with improved sentiment,the US dollar weakened while yields ended the day modestly higher.To recap, the elections ended with a split Congress (the lower house went to the Democrats while the Republicans held on to the Senate) was in line with what polls had been suggesting. This dampens the risk of an even more expansionary fiscal stance and should allay concerns that the supply of USTs could drive longer-tenor yields much higher over coming few years. Indeed, USTs initially rallied in Asia trading hours before giving up the gains as the rally in risky assets overwhelms.

The improved sentiment should filter into Asia trading today. The combination of higher US equity indices and a weaker USD should drive increased risk taking, allowing equities and local government bonds to extend their fledging rally after a volatile October. While it is tempting to extrapolate the risk rally through to the end of the year, it must be noted that a split Congress should have no bearing on how Trump intends to handle the US-China trade war. On this front, market participants are hoping that Trump will be able to cut a deal with Xi, with further meetings planned for the G20 summit at the end of the month.

India: INR bond markets enjoy a reprieve

In this holiday-shortened week, INR government bonds are likely to witness some reprieve, with 10Y yields closing at 7.79% earlier this week, down 40bp from the year’s high. Global cues, with strong correlation to INR bonds, have turned supportive. The USD eased yesterday as Democrats secured a majority in the Lower House in Tuesday’s mid-term elections, perceived as a hurdle for the US government’s fiscal and tax policies. Oil prices continue to slide, with Brent down ~15% from late-September highs.

Domestically, the Reserve Bank of India’s proactive approach to liquidity management continues to support bond markets. After unveiling plans of INR400bn bond buybacks through open market operations (OMOs) this month, the first tranche of INR100bn was conducted on Tuesday. With more planned in the weeks ahead, plans are to offset the drain on total systemic liquidity through higher currency in circulation and FX intervention. Banking liquidity deficit has eased up in recent sessions, averaged INR 500bn in this month, from INR1trn+ in late-October. Some let-up in the deficit is underway as a rupee bounce has reduced the need for an aggressive FX intervention stance and festive-related currency leakage fades. Further out, as end-year elections near, currency in circulation levels will be back in focus.

For the short-term, 10Y bond yields are likely to hover within 7.70-7.85%. Debt FPIs have taken a breather into November after USD2.7bn outflows in the last two months. At the short-end of the curve, markets are no longer pricing in rate hikes in December, pushing 2Y yields to sub-7.5%, three-month low. Renewed selling pressure could surface on any bounce in oil prices or as markets turn attention to the December’s state elections and fiscal worries return. The latter also ties into the ongoing RBI-government tussle, as government seeks a large one-off transfer of the RBI’s reserves to boost fiscal revenues, while the central bank has resisted the move.

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