Global Daily – More Abenomics expected

by: Maritza Cabezas , Roy Teo , Arjen van Dijkhuizen , Kim Liu

Japan economy – Japanese Prime Minister Shinzo Abe’s ruling coalition won a sweeping victory in the upper house, making it easier for policy makers to press ahead with plans to revise Japan’s constitution. This will likely give Prime Minister Abe more room to approve a larger fiscal stimulus package. Indeed, the Prime Minister mentioned that he would have to accelerate Abenomics to meet the public’s expectations. We think that given the post-Brexit impact on the yen and the underlying economic weakness of the Japanese economy, additional monetary and fiscal stimulus are needed. Reuters reported that former Fed chairman Bernanke had met with representatives of the BoJ and is due to meet Prime Minister Abe. This story added to market speculation that more innovative stimulus measures may be announced sooner than later. We expect that the BoJ will likely announce more measures at the upcoming monetary policy meeting, which is due on July 28/29. In anticipation of more stimulus, the Japanese yen already weakened by almost two yen to above 102.50 against the US dollar. In our view, current elevated long yen positions, as shown by CFTC data, are vulnerable to more stimulus measures which will reduce the attractiveness of the yen as real yields decline. Having said that, we expect the yen to find some support around 103.40 against the US dollar ahead of the BoJ monetary policy decision later this month (Maritza Cabezas, Roy Teo).

 

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China economy – The Chinese authorities have taken measures to reduce leverage in the corporate bond market. According to a Bloomberg report, China Securities Depository and Clearing Corporation cut the ratios that determine the room investors have for buying new corporate bonds when using holdings of exchange-traded company notes as collateral. This measure will likely drive up borrowing costs in the primary market and should be seen against the background of a rise in corporate credit events. We think that a rise in corporate bond defaults is as such not something to be overly concerned about, as China’s gradual move to more market orientation should go hand in hand with less government intervention. However, a rise of defaults could occasionally lead to the flaring up of investor concerns. All things considered, we think the move to tighten borrowing rules is a prudent one. It also fits within the broader need to put a halt to the ongoing rise of China’s already high overall corporate debt levels. Our main scenario is for an ongoing gradual slowdown of the Chinese economy. We expect that the country’s transition will remain bumpy given key risks stemming from high and rising debt levels and overcapacity issues. This week, a large set of macro-economic numbers from China will be released, including Q2 GDP, trade figures and monthly economic activity data. In our July China Watch, to be published at the end of this week/early next week, we will analyse these numbers and assess whether our scenario of an ongoing gradual slowdown is still holding up (Arjen van Dijkhuizen).

 

Eurozone government bonds – Yields on German bonds with a maturity of 2 years dropped intraday to -0.71%, which is 0.31% lower than the ECB deposit rate facility. Yields fell as fears for lower growth and inflation sparked a renewed flight to safe assets. Indeed, the 5y5y forward inflation swap, which is the ECB’s favored market based measure of inflation expectations, fell to 1.25%, which is the lowest level ever recorded. This drop has further increased speculation that the ECB needs to beef up its current stimulus package. The only question is how? Money market measures, like eonia forwards, are pricing in rate cuts, with a 10bps rate cut fully priced in for the October ECB Governing Council meeting. We think that the move in eonia forwards is misplaced. We do not expect rate cuts as this would harm the stability of the eurozone financial sector and see less added value since EUR/USD is already trading at around 1.10. We judge a step up and extension of the current QE programme more likely. However, under the current QE purchasing rules, the ECB will run out of eligible German bonds. This means that the ECB will need to tweak the rules again. Most likely options are raising the percentage per sovereign bond the ECB can buy, or removing the lower level at which the ECB can buy bonds. Discussions on fully deviating the ECB’s purchases from the capital key are still a bridge too far (Kim Liu).