By Emily Lai
The market was mixed last week with focuses mainly on Central Banks’ actions and the Chinese CCP 5th Plenary Session. The market was optimistic in the first half of the week with the PBoC cutting interest rates but turned cautious later with disappointing US growth data and decision from the Bank of Japan. Samuel Mann, Managing Director and Head of Solutions APAC at Franklin Templeton Investments, shares with BENCHMARK in an exclusive interview their views on future central bank actions.
The PBoC cut the policy rate by 25bps and the reserve ratio by 50bps on 23 October. The reserve ratio for small-medium sized enterprises (SMEs) and rural-focused banks was cut by an additional 50bps as well.
Mann believes the IMF is likely to include the yuan in the basket of reserve currencies known as the Special Drawing Rights (SDR) in early November. The market consensus believes that further monetary policy easing is forthcoming after official confirmation that the IMF will include the yuan in the SDR. The yuan’s inclusion in the basket of reserve currencies enables the PBoC to be more flexible and provide further monetary stimulus this year.
Discussions on China are often polarized between two extremes: the doomsday view of the hard-core skeptics and the unconditional optimism of the perma-bulls. Mann has a balanced view on China’s economy seeing both good and bad signs.
Contraction in three key areas will continue to curb growth, including the traditional manufacturing sector, real estate and construction, and local government financing. These had been China’s traditional growth engines but they have all stalled at the same time. Traditional manufacturing has lost competitiveness due to rising wage pressure triggered by a significant slowdown in labor force growth; however, the slower growth also means that the rising service sector should be able to maintain full employment. Together with rising wages, this drives the increase in consumption needed to rebalance the economy. The development of a high-tech and high-value-added manufacturing sector will support this shift.
Meanwhile, state-owned enterprise reform, capital account liberalization and exchange rate stability strengthen long-term prospects. A number of planned domestic and cross-border infrastructure projects could also promote significant growth as the economy continues to rebalance.
The disinflationary trend around the world persists and it appears that Australia is no exception. Australia’s CPI release was on the low side of market expectations and brings the likelihood of a potential RBA rate cut. Mann believes it will come sometime in the next six months – to a close call; but not at the meeting this week.
Mann says as the RBA has demonstrated in the past that it can look through transitory drivers of economic activity and inflation, remaining more focused on its medium to long-term outlook. “Recent Reserve Bank commentary and speeches have expressed a level of contentment around the Australian economy in general, employment, stability of the system and the level of the Aussie dollar,” he says.
Current rates market pricing reflects a probability of around 50% that the RBA will cut interest rates next week and almost two rate cuts by the middle of 2016. Mann feels greater opportunity for return existing in the potential decline of the Aussie below the psychologically important 70-cent level.
Mann sees Fed policy normalization as forthcoming given the generally improving economic fundamentals in the United States. “What we believe to be the market lagging the FOMC’s expectations for the pace of Fed rate hikes. Inflation remains below the Fed’s 2% objective, and in the near term, we believe inflation will likely be held down by current low energy prices,” says Mann. “However, we believe employees should be able to negotiate higher wages as the labor market tightens, and inflation should improve.”
As of September, unemployment rate had trended down to 5.1%, private employment was at a record high level, and the gap between the unemployment rate and the Congressional Budget Office’s estimate of the nonaccelerating inflation rate of unemployment had significantly narrowed. While the labor force participation rate has fallen and the long-term unemployment rate has remained elevated, much of the decline in the participation rate since 2007 may be structural, according to published Fed research.
Mann expects the Bank of Japan (BoJ) to continue to be aggressive with its central bank policy, buying 80 trillion JPY annually of government bonds and risky assets. “Current market consensus does not expect any additional quantitative easing (QE) for the remainder of the year, and the existing BoJ QE program is consistent with the ECB QE program. However, the recent move by China has intensified regional currency competition. The trading range for the JPY will likely stay closer to 120 moving forward,” he says.
Mann holds a favorable view of global equities versus fixed income due to supportive global monetary policy, attractive relative valuations, and developed market labor improvements that can benefit global economic fundamentals. BM
- neutral in on developed market (DM), sees opportunities in developed EMU equities hedged to the US dollar (USD) due to ECB QE, EMU economic indicators supporting cyclical recovery, and an encouraging EMU EPS outlook given euro weakness
- favour Japanese Equities hedged to the USD given improving corporate fundamentals, supportive monetary policy, and attractive valuation; however, reduced the conviction of our positive view on Japanese equities recently due to the lack of catalysts such as no additional QE from the BoJ expected in 2015.
- upgraded our view to neutral of (for?) equities in Canada, UK, and Australia, all hedged to USD, due to a more neutral outlook on equities in commodity exporting countries and a more constructive view on direct commodities within our cross asset strategy.
- Favor cash and US TIPs over 5-year US Treasuries due to Fed policy normalization, improving US economic and employment indicators, and the market lagging Fed expectations for the first rate hike, resulting in mispricings
- Fed policy normalization should support USD strength relative to DM and EM currencies. The difference in interest rates is a major driver of exchange rates in developed markets, while macroeconomic growth differentials are most strongly impacting exchange rates in EM. For example, ECB and BoJ QE in contrast to Fed policy tightening should continue to support USD strength.
- Expected further PBoC easing or depreciation of the currency will lead to further weakness in EM Asia currencies relative to USD given that EM Asia will need a weaker currency to remain competitive. Furthermore, countries in EM Asia are experiencing “current account illusions”, in which they are experiencing surplus in their current account, but this is actually due to a greater decrease in imports compared to exports rather than a true increase in demand
- Low commodity prices and political instability in specific countries will also contribute to USD strength relative to EM EMEA and EM Latin America currencies
- Favor commodities over cash given falling US oil production and attractive valuations
- Position on commodities has evolved from an negative view at the beginning of 2015 to a more positive outlook over the next 3 – 6 months