- 9/12/2023
#BQConversations | #BankofAmerica's Adarsh Sinha shares his insights on key indicators for Asian currencies, in a conversation with BQ Prime's Niraj Shah. #BQLive
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00:00 It is well known that the currency markets and the treasury markets give the first inkling
00:05 of what could happen to risk assets and it is never different.
00:09 So therefore it's very important at this point of time from an Indian market watchers perspective
00:13 as well as we are at those heady levels to try and understand what is it that the indications
00:19 from the currency and the bond markets are.
00:22 Adarsh Sinha, Co-Head of Asia FX and Rate Strategy at Bank of America is with us to
00:29 try and give his insights on the same.
00:31 Adarsh, great having you, thanks for taking the time out.
00:34 Thanks for having me.
00:36 The pleasure is ours.
00:38 Adarsh, a broad brush question, I mean when I look at the last couple of months and I'm
00:44 starting with the mother market and then the resultant impact on the others, the news around
00:50 US economy have been anything but bad.
00:54 They've largely been encouraging, even on the inflation front, at least the core inflation,
00:59 somehow after the initial burst of maybe a corrective move in yields and equity markets
01:05 as well but yields in particular, we've seen hardening of yields, we've seen the dollar
01:10 index strengthen as well.
01:12 What do you make of what a lot of people would call a dichotomy?
01:18 Yeah, sure.
01:20 Look, I think for the US definitely a lot of investors and a lot of analysts, ourselves
01:27 included, have been surprised by the resilience of the US economy.
01:31 You only have to look and see how many economists are changing their forecast from hard landing
01:36 to soft landing for the US economy.
01:38 It kind of tells you it has been a surprise.
01:40 What I would emphasize is specifically what has been the surprise in the US economy, what
01:44 is driving the resilience of the US economy?
01:47 It's the service sector.
01:49 Everything the central bank, the Federal Reserve cares about, the labor market, CPI inflation,
01:54 the consumer, if you look at the details, the resilience is being driven by the strength
01:58 of the services sector.
02:00 Just to give you an example, if you look at the latest jobs numbers in the US, 60% to
02:04 70% of jobs growth is being driven by services.
02:07 Therefore, I think as long as the service sector stays resilient, yields will remain
02:13 elevated and the dollar will remain strong.
02:15 The question is, when do you get signs of a turn in the service sector?
02:19 The latest leading indicator that we had, which was the ISM services last week, was
02:23 stronger than expected.
02:24 It's giving very little indication that the service sector is turning.
02:27 At some point, I think it will turn.
02:29 There are some tailwinds.
02:30 There is catch up hiring in the services sector.
02:32 There is obviously an excess savings dynamic in the US that hasn't ended yet.
02:36 At some point, these tailwinds will go away and the service sector will slow down.
02:40 To me, it seems more likely to happen in 2024 than in 2023.
02:44 That's part of the reason we think US yields, particularly at the front end, will remain
02:48 elevated, the dollar will remain strong.
02:51 Of course, the Federal Reserve, the central bank will continue to push back against any
02:55 suggestion or idea of rate cuts anytime soon.
02:58 Okay.
02:59 Riyu, you would believe this to be the base case even if the, I mean, we have CPI data
03:05 coming out this week from the US.
03:08 And if that data also shows a very contained core CPI inflation, and because that would
03:14 be the second or the third month in a row that I presume that happens, and if that continues,
03:18 even then your view remains that a larger portion of the action will only happen in
03:22 2024.
03:23 Yeah.
03:24 So, the first thing to say about this week's CPI, tonight's, this week's CPI inflation
03:29 number, we actually think there are upside risks to core CPI.
03:32 So, our forecast is 0.2, but we think a 0.3 is actually more likely than a 0.1, which
03:37 as you say, would be quite a big surprise because you had a few months where core CPI
03:40 has been soft.
03:42 Secondly, I think this CPI matters more around whether the Fed hikes rates once more or not.
03:48 I think everyone agrees the Fed is going to pause in September, and then they're going
03:51 to assess to see whether they need to hike again at the November meeting or the December
03:55 meeting.
03:56 So, I think this core CPI matters in terms of whether they hike once more or not.
04:01 But as far as 2024 is concerned, 2024 is less about another rate hike and more about whether
04:06 they cut rates.
04:07 And I think even if we see some deceleration in core CPI inflation over the coming months,
04:12 that's not going to be enough for them to say, okay, we may have to cut rates at some
04:16 point in the first half of next year.
04:18 I think the message from pretty much all Fed officials has been quite clear that they want
04:21 to keep rates higher for longer, which in my mind means they're unlikely to cut rates
04:26 in the first half of 2024.
04:27 Okay.
04:28 Now, I've read a few of your notes that you've authored in the last, whatever, a fortnight,
04:36 if you will.
04:37 What comes out from there and something that you referred to in the first answer as well,
04:41 that you seem to be constructive the US dollar.
04:44 At the same time, I believe in one of the notes you said that a lot of it would be centered
04:49 around actions that happen in China on the stimulus front.
04:53 Can you take us through your thesis and what happens either or if there is a proper stimulus
04:59 given by China or if there isn't, because frankly, it's a bit of a guesstimate as to
05:04 what China does these days?
05:06 Absolutely.
05:07 Look, I mean, just taking a step back, when we talk about the US dollar, I think most
05:12 people talk about what we spoke about so far, which is the US, US interest rates, Fed policy.
05:17 But I've done quite a bit of work to show basically the dollar move since 2022.
05:21 Yes, a large part of it is down to Fed policy and interest rate differentials, but an equally
05:27 large part of it is just down to the China economic slowdown, and particularly the disappointment
05:32 around growth after the reopening.
05:34 I won't go into the details, but I would say around 30% to 40% of dollar appreciation since
05:38 the beginning of 2022 is simply down to China.
05:41 My point for a long time has been you cannot have a sustainable dollar downtrend without
05:47 a China recovery.
05:48 And I think we all recognize you cannot have a China recovery unless and until you see
05:53 some meaningful big bank stimulus.
05:55 Now, I get this question a lot.
05:56 What do you mean by big bank stimulus?
05:58 Because China has been cutting rates.
05:59 They have been providing support for the property sector.
06:01 They have been providing some support for local government.
06:03 So what do you mean by big bank stimulus?
06:05 It's quite simple.
06:06 You need central government balance sheet expansion to support the consumer, to support
06:11 the property sector, to support local governments.
06:14 And we haven't seen that yet.
06:15 Since the Politburo in July, we've seen a lot of easing measures, but we haven't seen
06:19 kind of this big bank policy stimulus.
06:21 When we survey our clients, expectations are quite low.
06:24 I think in our latest survey, 49% of clients thought that we'd only get piecemeal stimulus
06:29 measures as opposed to big bank stimulus.
06:32 So that's what you need for recovery in China.
06:34 And as you say, it's very, very difficult to tell because these days, decision making
06:38 in China is very centralized in President Xi's office.
06:41 So there's very little visibility on when that stimulus might come.
06:45 It's the same thing as the reopening.
06:47 The reason the reopening came as a surprise is people had no visibility last year on when
06:51 that decision would be made.
06:53 So the best way I can put it is that China sentiment is very, very negative right now.
06:58 People are very bearish.
06:59 So the hurdle for a positive surprise is perhaps quite low.
07:03 But it's not clear if and when you get that big bank central government driven stimulus,
07:08 which would lead to some bottoming in growth expectations, which is what everyone's looking
07:12 for right now.
07:13 Should it not be a big bank one?
07:15 And should it be a piecemeal, small token things because there is prosperity for all?
07:20 And we've seen some actions which don't inspire confidence about necessarily a big bank stimulus.
07:26 What's the resultant impact on the US dollar and what would be your thoughts about what
07:31 happens for the rest of the calendar to that, assuming that there is no big Chinese action
07:36 that comes about?
07:37 Yeah.
07:38 So firstly, I think we have to think about in the context of China's growth target.
07:42 So China set a growth target of 5% for the current year in March of this year.
07:46 At that time, people thought, why such a conservative growth target?
07:50 But that's what the growth target was.
07:52 And I think having missed that growth target for a couple of years now, the incentive to
07:55 meet that growth target would be quite high.
07:57 So right now, our growth forecast for China for this year is 5.1%.
08:00 I think the consensus is around 5%.
08:02 But I think if you see another couple of months of weak data, and it looks like they're going
08:06 to undershoot that growth target, then that might be the trigger for them to do something.
08:09 But to answer your question, what if they don't?
08:11 What if they continue down this sort of road of piecemeal stimulus measures?
08:14 Growth generally remains weak.
08:16 I think the dollar has to strengthen.
08:19 We think euro dollar goes to 105.
08:21 Dollar yen probably goes to 150.
08:23 Dollar CNY goes to 7.4.
08:26 And the idea here is very simple.
08:27 If China's import impulse is weak, that's a lot worse for countries like Japan, Germany,
08:32 a lot of countries in Asia, than it is for the US.
08:35 The US export exposure to China is actually very low as a percentage of GDP.
08:40 So in relative terms, the US dollar looks a lot better when China is slowing down.
08:44 Got it.
08:45 Adarsh, there was this survey that you guys did, right, which is the FX and rates sentiment
08:50 survey.
08:51 And there's a bunch of takeaways there.
08:54 What I'm trying to understand is, where would you as an expert who looks at this space so
08:59 closely differ materially from what the sentiment across a large set of respondents was and
09:08 why?
09:09 Yeah.
09:10 So look, I think one of the main takeaways from this FX and rates sentiment survey is
09:14 that global asset managers are very long duration.
09:19 In other words, they're long bonds, government bonds across countries.
09:23 And by the way, this is part of the reason yields have kept moving higher, because this
09:28 asset manager real money community has been trying to buy bonds as yields have been moving
09:33 higher, and positioning is very long.
09:35 And so the price action has been quite against that.
09:38 Positioning is usually a contrarian indicator.
09:41 So I think that's one of the main takeaways we've taken from the survey over the past
09:44 few months is yields are moving higher.
09:46 Yes, fundamentals is one thing, but positioning is wrong way.
09:49 And that's why yields have been moving higher.
09:50 I think for that to change, we wouldn't necessarily disagree with this longer term view that eventually
09:55 long term bond yields, 10 year treasury yields should move lower, maybe back towards 4% by
10:01 sometime early next year.
10:02 But I think we need to see clearer signs of a slowdown in the US economy, which goes back
10:07 to the first point.
10:08 We need to see a service sector slowdown, if not a service sector recession, to be confident
10:14 that 10 year yields across countries in the US, Europe, and elsewhere will start to move
10:18 lower.
10:19 And of course, right now there are no signs of that, but maybe by sometime next year we
10:22 see more signs.
10:24 And then the clients are right, investors are right, and it makes sense to be long duration.
10:30 OK.
10:34 The other aspect is an indicator, I believe, that you have, or a measure.
10:39 I've written this down.
10:41 I think in the 10th September note that you wrote, you mentioned that the point of view
10:48 is that the export weakness was actually a major headwind for Asia FX, but your export
10:54 data surprise measure recently turned positive.
10:57 Now, what is the implication of something like this?
11:00 Because you mentioned that the signals are unlikely to be indicative of some early signs
11:04 of a recovery as well.
11:05 Yeah, look, I mean, we've seen this for India as well, but it's not just India.
11:11 Across countries within the region, you see tentative signs of trade numbers surprising
11:16 to the upside, and particularly export numbers have been surprising to the upside.
11:20 Still very weak, still falling in year over year terms, but expectations are so low that
11:24 you're seeing these positive surprises.
11:26 So usually when this happens, people say, OK, this should be good for Asian currencies.
11:30 Currency should strengthen because export numbers are surprising to the upside.
11:34 And the point I make in that note is when you look at some of the lead indicators for
11:38 Asia's export cycle, so you look at new export orders, you look at shipment to inventory,
11:43 you look at the tech cycle, it's far from clear that this is going to be the big bottom
11:48 or the big recovery in export numbers for the region.
11:51 And that's why I make the point that this is perhaps not the right time to be long Asian
11:56 currencies.
11:57 India is a bit of an exception, though.
11:58 We all know that India export exposure to China is a lot more limited.
12:03 India exposure to tech exports is limited.
12:06 And we know the resilience in India's exports is being driven by service sector exports
12:10 and service sector exports to countries like the US.
12:13 So I think India's export dynamic is a little bit different because it's being driven by
12:17 service sector resilience that we were talking about earlier in the US and other countries.
12:21 But for the rest of Asia, I think it's a lot more about China.
12:23 It's a lot more about tech.
12:25 And the leading indicators for this kind of stuff is not that encouraging yet.
12:30 One final question, and a slightly maybe both encompassing both the short and the medium
12:37 term, India specific.
12:41 Service exports, as you mentioned, continue to stay strong.
12:45 Commentary from IT companies seems to suggest that, for example, if not in 2023, then you
12:50 might see a beginning of a bit of an uptick, say, 2024, assuming that that happens.
12:55 That's part one.
12:56 Part two, a bunch of global companies setting up shop in India to manufacture for India
13:02 and for the world.
13:03 And we've seen some green shoots there in mobile phone exports.
13:07 So on and so forth as well.
13:08 And three, the third part is that with the kind of reserves that the central bank is
13:13 sitting on and the interventions that we've seen, they're kind of maintaining the rupee
13:18 a bit more steady as opposed to some of the other currencies.
13:22 So one might argue that we actually had a very sharp depreciation move in the preceding
13:27 12 months than what's happened in the last six.
13:30 But my question is, do you reckon that the Indian rupee could fare a bit better because
13:37 of these and some other factors as opposed to some of the other currencies?
13:42 Should there be a general strengthening of the US dollar index over the course of the
13:47 next 12 months?
13:48 Yeah, good question.
13:49 Look, I completely agree with you that the balance of payments backdrop for India is
13:55 quite good.
13:56 You know, we estimate account deficit of about 1.2 percent of GDP, which is very good.
14:01 I mean, that can be easily funded by FDI and FDI inflows.
14:05 You talk about the manufacturing cycle.
14:07 Actually, FDI inflows have disappointed a little bit in the current fiscal year.
14:10 But of course, that could start to pick up.
14:12 There's, of course, talk of potential bond inclusion, which could add to some inflows
14:16 on the debt side and actually inflows have been quite resilient anyway.
14:19 So we are forecasting a BOP surplus for the current fiscal year, which generally should
14:24 be good for the rupee.
14:25 And as you say, the Reserve Bank of India's FX reserves are, you know, they built up their
14:29 FX reserves to a reasonably adequate level.
14:32 Definitely, FX reserve levels are not a concern.
14:34 I think the issue here is, as you say, you know, the dollar is strong.
14:38 The way the Reserve Bank manages the currency is obviously they would accommodate a higher
14:42 dollar rupee if the dollar is strengthening versus everything else.
14:45 So, you know, whereas the dollar rupee range has been 81, 83 so far, maybe it shifts to
14:50 a range of 82, 84 if the dollar continues to strengthen against all of the currencies.
14:54 However, to your point, if you think about it in relative terms against other Asian currencies
14:59 or against some of the other G10 currencies, yes, I think there is a case to be made that
15:03 the rupee should do relatively better than other currencies.
15:07 And that's the way we sort of we have been expressing this to our clients, which is maybe
15:11 you don't necessarily want to be short US dollars versus the rupee because the dollar
15:15 is still strong.
15:16 But in relative terms, the rupee should do better given the balance of payment spectrum.
15:20 Okay, sorry, I rephrase.
15:21 This is my last question now.
15:22 Should you have the time?
15:23 Just one more slightly longer term question.
15:26 Traditionally, we've always or usually seen circa 4% CAGR depreciation for the rupee,
15:34 I mean, a year or there notwithstanding, but that's been the average.
15:38 Should we become CAD neutral?
15:42 I don't know if it happens, but there's a lot of talk of that happening and multiple
15:47 levers to that as well.
15:48 But should that happen in the next couple of years, if you will?
15:51 Can the Indian rupee, can the Indian interest rate sensitivity be materially different for
15:57 the rest of the decade than what it has been for a better part of India's history?
16:01 Yeah, it's a good question.
16:05 I mean, as you say, the other way of putting this is dollar rupee has always tracked the
16:08 FX forwards.
16:09 So it's been very hard to beat the forward market in dollar rupee, which just sort of
16:14 compensates for the interest rate differential.
16:17 Does that change?
16:18 I think depends on two things.
16:19 It does depend on structurally where's the current account over time.
16:23 I'm not sure India can manage a sustainable neutral current account for a long period
16:29 of time, just because of the demographic profile.
16:32 Usually when you have a young population, the equilibrium current account tends to be
16:36 a deficit rather than a surplus because that's the nature of the savings investment balance.
16:42 But yes, I think if there's a smaller current account over time than what we've observed
16:47 before, maybe the rupee can outperform the interest rate differential a little bit more
16:51 than it has over the past 10 years.
16:53 But I think the other important element here is, again, how the Reserve Bank of India manages
16:57 the currency.
16:58 Like, if you talk about India's motivation to be a manufacturing powerhouse, kind of
17:02 keeping the currency structurally weak makes sense.
17:06 So if that's the policy, the FX policy reaction function that the Reserve Bank and policymakers
17:12 in India want to have, then it's a bit harder to say whether the rupee can necessarily benefit
17:16 a lot from this transition.
17:18 So yeah, an interesting long-term question.
17:19 I think the relationship will be a bit different over the next five to 10 years, over the long
17:23 term.
17:24 But does it necessarily mean that the rupee appreciates a lot as a consequence?
17:28 That's not as clear to me.
17:30 Okay.
17:31 Fair call.
17:32 Lovely talking to you, Adarsh.
17:33 Thank you so much for taking the time out.
17:34 This is the first time that we've spoken.
17:36 We hope that we can get you more often on the platform.
17:38 Great.
17:39 Thanks, Neeraj, and thanks for inviting me.
17:42 The pleasure was ours.
17:43 Viewers, thanks for tuning in to this very special conversation.
17:53 [BLANK_AUDIO]
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