India Set to Close in on China as Emerging-Market Stock Anchor

Economic

Summary:

India is poised to narrow the gap with China in MSCI Inc's gauge for developing nations...

India is poised to narrow the gap with China in MSCI Inc's gauge for developing nations.

Analysts from firms including Smartkarma and IIFL Securities Ltd expect India's weight in the MSCI Emerging Markets Index to rise by at least one percentage point following the index provider's review this week. This would bring the country almost on a par with China, which currently accounts for 22.33% of the benchmark. India lags at 19.99%.

A higher weighting for India will position it to become the new anchor for emerging-market equities, likely driving increased flows into the country. Fund managers say that India's rising heft may make the emerging-market gauge more appealing to global investors who have been wary due to China's sway over the index.

"It can make the emerging-market index more balanced, where secular growth stories like India receive higher allocation" compared with more cyclical markets like China and South Korea, said Vivek Dhawan, a portfolio manager at Candriam Belgian NV. India Set to Close in on China as Emerging-Market Stock Anchor_1

India Set to Close in on China as Emerging-Market Stock Anchor_1

This shift has a side effect, as index followers may be forced to allocate funds to India's already-expensive stocks at a time when crowded trades are taking a hit due to the turmoil in global markets.

India — long touted as the "next China" — has emerged as a favourite among investors, driven by its robust economic growth, a growing middle class and burgeoning manufacturing sector. Meanwhile, China is dealing with long-term economic challenges and increasingly strained relations with the West.

"Many global investors who didn't look at India as a stand-alone allocation in the past would now look at it more favourably," said Hiren Dasani, a co-head of emerging-market equity and lead portfolio manager of Indian equity strategies at Goldman Sachs Asset Management.

China's standing in emerging markets has shrunk in the past few years, while India's has steadily expanded. At its peak in 2020, China accounted for 40% of the MSCI EM Index, but that weighting has dropped amid Beijing's regulatory crackdowns and efforts to deleverage its indebted property sector.

India Set to Close in on China as Emerging-Market Stock Anchor_2

As of end of July, India's weight was just 2.34 percentage points away from China's in the MSCI Asia Pacific Index, a regional benchmark, a recurring pattern across most gauges from major index providers. MSCI didn't respond to an email seeking comment outside of regular business hours.

"With a rising equity market, increase in free float for companies and new large listings in India, the gap in the weightings should continue to narrow heading into year end," said Brian Freitas, an analyst at Smartkarma.

Meanwhile, Taiwan is competing fiercely with India in the race to replace China's top spot in emerging market equity portfolios. As of the end of July, Taiwan accounted for 18.39% of MSCI's emerging-market index.

While India has benefited from the infrastructure boom brought about by Prime Minister Narendra Modi's modernisation projects, Taiwan's rise has been supported by global interest in artificial intelligence chipmakers. It's home to the world's largest contract chipmaker, Taiwan Semiconductor Manufacturing Co (TSMC).

In its review, MSCI is likely to add six stocks to its key India index, including Samsung Electronics Co supplier Dixon Technologies (India) Ltd and property developer Oberoi Realty Ltd, according to Abhilash Pagaria, the head of alternative and quantitative analysis at Nuvama Wealth Management Ltd. HDFC Bank Ltd, India's largest by market value, may also see a gradual increase in its weighting, he wrote.

While Chinese stocks have struggled, India's NSE Nifty 50 Index has risen 12% this year, following Modi's third consecutive term in the office. The benchmark gauge is set for a ninth straight year of annual gains.

The contrasting trajectories highlights investors' preference for India even as China's equities remain very cheap. It also underscores Beijing's inability to stem the downtrend in its markets.

"We do look at India as a bit of a diversifier against some of China's weakness," said Seema Shah, the chief global strategist of Principal Asset Management. "A lot of the potential that people have been speaking about for years and years is now looking to be fulfilled."

Source: Bloomberg

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[Quick Facts]

1. Fed's Bowman makes hawkish remarks amid rising rate-cut expectations.

2. Israeli intelligence says Iran will attack Israel in days.

3. Nasdaq intends to weed out penny stocks.

4. Latest polls show Harris is leading Trump in key states.

[News Details]

Fed's Bowman makes hawkish remarks amid rising rate-cut expectations

Weak employment data in July suggests inflation is closer to the target level, which consolidates economists' and investors' expectations for a Fed rate cut in September. However, hawkish Fed Governor Bowman said U.S. fiscal policy, pressure from immigration on the housing market, and geopolitical risks are likely to exert upward pressure on inflation. The labor market continues to be strong, and the recent jump in the unemployment rate to 4.3% might have exaggerated the extent of the cooling of the labor market. Judging from what Bowman said, she may not be ready to support a rate cut at the next meeting in September.

Israeli intelligence says Iran will attack Israel in days

The Israeli intelligence assessed that Iran forces could be planning an attack on Israel within days, even before the August 15 Gaza hostage deal talks. Earlier, Qatar, Egypt, and the United States issued a joint statement, saying that the relevant mediators have reached a framework agreement on a ceasefire and exchange of hostages in the Gaza Strip, and only specific details remain to be finalized. The statement also called on Israel and Hamas to restart negotiations on August 15 in Cairo, Egypt, or Doha, Qatar, to determine the details.

Nasdaq intends to weed out penny stocks

The Nasdaq Stock Exchange is taking steps to purge dubious companies whose shares trade below $1 each, according to the latest filing posted on its website, following criticism that the exchange has become home to hundreds of risky penny stocks.

Nasdaq has proposed two rule changes that would tighten regulations on stocks trading below $1, potentially speeding up the delisting process for non-compliant companies. Under one of the proposed changes, companies that reach the end of their second 180-day grace period wouldn't be able to postpone delisting by seeking an appeal. The second rule change would expedite the delisting process for companies that have recently undergone a reverse stock split.

Latest polls show Harris is leading Trump in key states

A poll released by The New York Times on Saturday reveals that Vice President Harris leading Trump with 50% support to his 46% in three key swing states - Wisconsin, Pennsylvania, and Michigan. Nationally, Harris also leads with 44% to Trump's 42%. The fluctuating support indicates a tight race, with the outcome of the election still highly uncertain.

[Today's Focus]

UTC+8 23:00 U.S. NY Fed 1-Year Ahead Inflation Expectations (Jul)

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TBD OPEC's Monthly Oil Market Report

Risk Warnings and Disclaimers

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Thomas

Bond

By now, last Monday's global market meltdown looks more like a brief tremor, a fleeting panic unleashed by a small policy shift from the Bank of Japan (BOJ) and resurgent fears of a US recession.

But the way it unfolded so rapidly — and just as quickly faded out — is exposing how vulnerable markets are to a strategy that hedge funds exploited to bankroll hundreds of billions of dollars of bets in virtually every corner of the world.

The yen carry trade, as it's known, was a sure-fire recipe for easy profits: Just borrow in Japan, the world's last haven of rock-bottom interest rates, then plough it into Mexican bonds yielding over 10%, Nvidia's soaring shares or even bitcoin. When the yen kept falling, the loans became even cheaper to repay, and the pay-offs turned that much bigger.

Then, seemingly all at once, investors bailed out of the trade, in turn helping to fuel a furious rebound in the yen and a swift exodus from equities and other currencies as traders dumped assets to meet margin calls. It roiled Japan's stock market, too, setting off the fiercest one-day sell-off since 1987 on concern the surge in the currency would hammer exporters.

“The yen carry trade remains the epicentre of everything in markets right now,” said David Lutz, the head of exchange-traded funds at JonesTrading.

The pressure had been building up for weeks as markets in carry-trade hot spots sputtered, the Nasdaq 100 Index slid off record highs and worries mounted that the Federal Reserve had kept monetary policy too tight for too long.

Then came the spark: an interest rate hike in Japan. The BOJ's benchmark is now still a mere 0.25%, the lowest in the industrial world, but the increase at the end of last month was large enough to force investors to rethink their long-held belief that Japanese borrowing costs would always remain pinned near zero.

Even though markets have steadied, the episode is raising alarms about how much leverage had built up around Japan as its central bank kept pumping out cash despite the post-pandemic inflation surge. That's left anxious traders trying to gauge whether the bulk of the unwinding is over — or whether it will continue rippling through markets in the weeks ahead.

Coming up with an answer is tricky because there are no official estimates for how much money is tied up in carry trades. According to GlobalData TS Lombard, there was some US$1.1 trillion (RM4.87 trillion) piled into the strategy, assuming all overseas borrowing in Japan since the end of 2022 was used to finance it and domestic investors used leverage for their foreign purchases.

After last week's dramatic unwinding, strategists at JPMorgan Chase & Co reckoned that three-quarters of global currency carry trades have now been closed out, while those at Citigroup Inc said the current level of positioning has taken markets out of the “danger zone”.

But others like BNY believe the unwind has further room to run, potentially driving the yen towards 100 to the US dollar — a fall of over 30% from where the currency pair ended last week.

“Further carry-trade unwinding seems likely but the most significant and destructive part of this bubble-burst is now behind us,” Steven Barrow, the head of Group of 10 strategy at Standard Bank in London, said in a note to clients last week.

The bubble, as Barrow called it, has decades-old roots. In the 1990s, with Japan's economy shadowed by a real estate crash, policymakers there slashed interest rates to zero. The trade has even been blamed by International Monetary Fund economists for playing a part in the 2008 financial crisis.

By 2016, the BOJ had nevertheless pushed rates into negative territory.

The incentive for speculators to borrow in Japan increased once other central banks started racing to contain the steep spike in inflation after the world reopened from the pandemic. As rates were lifted all around the world, the BOJ kept its benchmark beneath zero — widening the profits that could be made on carry trades.

The result was a wave of speculative cash that flowed out of Japan, putting downward pressure on the yen as traders sold the currency to buy those of the countries where they were investing the proceeds.

The impact was particularly stark in Latin America, which offered rates well above those in the US and Europe. In 2022 and 2023, currencies like the Brazilian real and the Mexican peso rose sharply, becoming some of the world's best performers.

By one measure, borrowing in the yen and investing in Mexico, for example, produced returns of 40% last year alone. The strategy continued to rack up gains, with yen-funded trades in a basket of eight emerging-market currencies returning just over 17% this year to early July.

“To go long the peso was such a no-brainer just a few months ago — but those days are definitely behind us,” said Alejandro Cuadrado, the head of global foreign exchange and Latin America strategy at Banco Bilbao Vizcaya Argentaria SA in New York.

When the yen started rebounding sharply from its weakest levels in decades, that created a feedback loop as traders unwound carry trades to lock in their gains — pushing the yen up further as investors purchased it to close out their loans. It accelerated after the BOJ hiked rates on July 31 for a second time this year and surprisingly weak US job figures fanned fears that the Fed had waited too long to reverse course.

After the unwind hit Japan's stock market on Aug 5, driving the Nikkei down 12%, BOJ deputy governor Shinichi Uchida stepped in to assure investors the central bank won't be raising rates as long as market instability persists. The markets steadied, with signs that hedge funds pulled back some bets that the yen would continue to gain.

The recent turn has, at least temporarily, likely tamped down the carry trade, with traders anticipating more volatility in foreign exchange markets this year.

“No trade lasts forever — and, the facts have changed,” said Jack McIntyre, a senior portfolio manager at Brandywine Global Investment Management. “The BOJ tightened and something broke — in this case the carry trade.”

Source: Bloomberg

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WELLS FARGO

Economic

U.S. Review

A Wild Week in a Data Desert

Last week's run of weak U.S. data, capped by a troubling rise in the unemployment rate and a slowdown in nonfarm payroll growth, helped spark a wild week in global markets.

It began Sunday night U.S. time when Asia markets opened and Japanese stocks fell a whopping 12%, propelled in part by an unwinding of the "yen carry trade" where traders borrow in a low-yielding currency and invest the proceeds in higher-yielding assets in a different currency. This financial market turbulence spilled over into the United States, and when paired with rising economic uncertainty, U.S. equities swung around sharply from days of steep losses to stretches of big gains. The VIX spiked to highs not seen since the pandemic (chart), and the 10-year Treasury yield traversed a range of 20 bps between Monday's lows and Thursday's highs.

The limited economic data we did receive this week provided a bit of optimism. The ISM services index bounced back to 51.4 in July from an unusually weak 48.8 reading in June, led by much stronger readings for business activity, new orders and employment. Initial jobless claims ticked lower in the week ended August 3, although continuing claims did not show the same improvement.

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Looking through the financial market volatility, we believe that the U.S. economy is losing momentum, and the risks of a recession in the next 12 months are on the rise. Nonfarm payrolls have risen by an average of 170K over the past three months. This is a solid pace of growth, but it marks a clear deceleration from the pace over the past year.

Furthermore, the breadth of job growth has narrowed considerably. The government and healthcare & social assistance industries have added 56% of the new jobs created over the past three months despite those industries accounting for just 29% of total employment. The unemployment rate has increased 0.9 of a percentage point from its low of 3.4% in April 2023 and triggered the "Sahm Rule" last month. In the survey data, more and more consumers are saying that jobs are "hard to get," while fewer are sayings jobs "are plentiful" (chart). Meanwhile, on the inflation side of the Federal Reserve's dual mandate, the core PCE deflator has risen just 2.6% over the past year and 2.3% (annualized) over the past three months.

This is not to say that the U.S. economy suddenly has fallen off a cliff. The U.S. economy likely is still expanding, albeit at a slower pace than the past couple of years. There are good reasons to think that the recent rise in the unemployment rate may be driven in part by Hurricane Beryl's effects and labor force re-entrants. But with the labor market weakening on trend and inflation nearly back to the central bank's target, the balance of risks for monetary policy is tilted toward being excessively tight.

Given this, we have made some changes to our forecast for the fed funds rate. We expect the FOMC to cut the fed funds rate by 50 bps at its September meeting, 50 bps at its November meeting and 25 bps at its December meeting for a cumulative 125 bps of easing through year-end. We look for another 75 bps of rate cuts through the first half of next year followed by a long pause from the FOMC as it assesses the impact from previous policy easing and feels its way to a neutral stance of monetary policy. If realized, we think a shift in U.S. monetary policy from restrictive to neutral can help sustain the U.S. economic expansion into 2025 and beyond.

Weekly Economic & Financial Commentary: A Wild Week in a Data Desert_2

CPI • Wednesday

The June CPI report was one of the most encouraging reports the FOMC had received since it began raising rates. Food and energy prices led the charge, with consumer prices declining 0.1% on the month. Excluding food and energy, core consumer prices rose a modest 0.1%, or the smallest such increase since early 2021.

Perhaps most encouraging in the report were core services prices, which increased only 0.1%, a marked improvement from the previous six-month average monthly gain of 0.4%. Core goods prices continued their deflationary streak for a fourth consecutive month, decreasing 0.1%. With core goods prices consistently coming down and the outlook for core services prices moderating through the rest of the year, the risks to the inflation and labor sides of the FOMC's dual mandate are in better balance.

We look for headline CPI to have advanced 0.2% in July, which would keep the year-over-year rate steady at more than a three-year low of 3.0%. The core CPI also looks set to advance 0.2% in July amid a rebound in some of the more volatile "super core" components. Looking beyond July, we expect inflation to continue to subside.

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Retail Sales • Thursday

Despite the flat headline retail sales number in June, retail spending still came in ahead of expectations and core retail spending held steady. Control group retail sales rose an impressive 0.9%, driven by a 1.9% surge in nonstore sales.

Strength was apparent elsewhere in the report, with building material store sales increasing 1.4% over the month, bucking the residential sector trend of sluggish home sales. Most of the weakness in the top-line number of last month's report was due to a 2.0% decline in auto sales and a 3.0% decline in gasoline sales. While June's retail sales was a show of consumer resilience, it is still consistent with a moderation from the swift pace of retail spending that followed the pandemic. Consider that of the nearly $180 billion growth in retail sales that has occurred over the past four years since the COVID recession, over 83% of that growth occurred in the first two years of that stretch.

We expect a continuation of the recent moderate pace of growth in July data, with headline retail sales rising 0.3% amid a rebound in auto sales. Furthermore, we expect that retail sales ex-auto sales to rise a more modest 0.1%. The outlook for retail sales through the rest of the year is constrained by a slowdown in the labor market and slower real income growth. Weekly Economic & Financial Commentary: A Wild Week in a Data Desert_4

Weekly Economic & Financial Commentary: A Wild Week in a Data Desert_4

Industrial Production • Thursday

The Industrial Production Index reached a new cycle high in June, after notching the largest back-to-back monthly gains since 2021. A solid 0.4% gain in manufacturing production along with a 2.8% increase in utilities production led the charge.

On an industry level, chemicals and food & beverages both modestly added to June industrial production. Even so, industrial production has still not surpassed its prior peak reached in September 2018. The impact of higher rates in the industrial sector has been consequential. Take, for example, that the quarterly CAGR for industrial production did not surpass 1.5% for the nearly two years between Q2-2022 and Q2-2024, aligning with the beginning of the tightening cycle of the FOMC. Before the marked rise in interest rates, industrial production expanded at an average 3.9% annualized rate over Q1-2021 through Q2-2022.

We expect industrial production to decline 0.2% in July, as still high interest rates remain a formidable barrier to sustaining the recent strength in the sector. We forecast capacity utilization to decline a touch to 78.6%. The start of FOMC easing should provide the industrial sector with some breathing room, but a full recovery remains some ways off. Weekly Economic & Financial Commentary: A Wild Week in a Data Desert_5

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International Review

A Mixed Week for Foreign Central Banks, International Data

This week's central bank activity saw monetary policy announcements from Australia, Mexico and India. The Reserve Bank of Australia (RBA) held its Cash Rate steady at 4.35%, while its accompanying statement leaned hawkish in tone. The central bank said that inflation is proving persistent, and that the process of returning inflation to target is proving slow and bumpy.

Indeed, in its updated economic projections, the RBA forecasted a slightly slower return of inflation to target than previously. The central bank envisages inflation returning to the 2%-3% target late in 2025, and approaching the midpoint in 2026. The RBA noted resilience in the labor market and said that wage growth is still elevated considering the trend of productivity growth, while also noting weakness in the broader economy.

The RBA indicated that policy will need to be sufficiently restrictive until it is confident inflation is moving sustainably towards the target range, and in the post-meeting press conference Governor Bullock suggested it might not reach that judgement before the end of this year. As a result and despite recent market volatility, our view remains that an initial 25 bps RBA rate cut will come in February 2025.

This week's Reserve Bank of India (RBI) monetary policy announcement also leaned hawkish in tone. The central bank held its repurchase rate at 6.50%, while also repeating that it would continue to focus on the withdrawal of policy accommodation. The central bank highlighted "stubborn" food inflation, which Governor Das said could not be ignored.

Meanwhile, deputy governor Patra said that considering a higher potential economic growth rate, the neutral interest rate has risen, and that the current level of the policy rate is probably exactly right. Even though two policymakers voted to lower interest rates (versus four policymakers who voted to hold rates steady), the hawkish comments mean we do not expect an imminent reduction in India's policy interest rates. An initial RBI policy rate cut may not come until late in Q4, or beyond.

Leaning in the other direction, Mexico's central bank—Banxico—cut its policy rate by 25 bps to 10.75% at this week's monetary policy announcement. The decision to lower interest rates was finely balanced, both in terms of analyst forecasts as well as Banxico policymakers, who voted 3-2 to reduce the policy rate.

In terms of a rationale behind the easing as well as the possibility of further rate cuts to come, Banxico said it would consider the effects of weakness in economic activity, and said that growth risks were biased to the downside. The rate cut came even as the central bank raised its near-term headline inflation forecasts on the back of supply shocks, including higher food prices and a weaker peso, while leaving its core inflation forecasts broadly unchanged. Still, even after this week's rate cut, we expect Banxico to pursue a relatively gradual pace of monetary easing going forward, in view of some remaining upside risks to inflation, as well as the volatility of the Mexican currency.

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In this week's data, Japanese wage growth showed some further firming in June, potentially supporting the case for further Bank of Japan tightening if and when a sense of calm returns to global financial markets. June labor cash earnings rose 4.5% year-over-year, far exceeding the consensus forecast for a 2.4% gain. Given the large increase in wages, real—or inflation-adjusted—cash earnings were positive for the first time in 27 months, rising 1.1%.

To be sure, the pay gain was driven by one-off payments, likely reflecting bonuses, or back pay of the base salary increases agreed to earlier this year. That said, underlying wage growth also appears to be on a firming trend. Ordinary time earnings rose 2.3%, the largest increase since 1994, while measured on a same-sample basis, regular pay for full-time workers rose 2.7%. While we view firming wage growth and elevated inflation as important elements of any potential further Bank of Japan tightening, when and whether the central bank delivers further rate hikes will also likely be dependent on a stabilization in global financial markets.

In New Zealand, the second quarter labor market report was a bit firmer than expected. Q2 employment unexpectedly rose 0.4% quarter-over-quarter, while the jobless rate rose less than expected to 4.6%. That said, the employment gain was not as strong as it appears at first glance—the increase was driven entirely by part-time jobs, with full-time jobs and hours worked both down during the quarter.

On the wage front, the private sector labor cost index rose 0.9% quarter-over-quarter, a bit more than expected, but eased to 3.6% year-over-year. While the mixed details of the report should pave the way for the Reserve Bank of New Zealand to lower interest rates in the months ahead, we don't view it as soft enough to trigger an immediate rate cut. We expect the central bank to hold its policy rate steady at 5.50% at next week's monetary policy announcement.

Canada's July labor market report was mixed but, we think, still consistent with another rate cut and the Bank of Canada's next announcement in September. Employment unexpectedly fell by 2.8K, although that reflected a large drop in part-time jobs as full-time jobs rose sharply. The unemployment rate was lower than forecast, holding steady at 6.4%, while hourly wages for permanent employees slowed but by less than the forecasted 5.2% year-over-year.

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U.K. CPI • Wednesday

A swath of economic data from the United Kingdom coming out next week will provide market participants with insight into how the Bank of England’s (BoE) monetary easing efforts could evolve in the coming months. In its decision to deliver an initial 25 bps policy rate cut last week, BoE policymakers signaled that they would be taking a cautious approach to rate cuts, given that risks around the inflation outlook remain. Policymakers forecast headline CPI inflation to rebound to 2.8% in the second half of this year before returning closer to target in the medium term.

In terms of next week’s CPI inflation data for July, consensus economists expect the headline CPI to quicken to 2.3% but for a slight moderation in the core CPI to 3.4% and the services CPI to 5.5%. Other economic data coming out next week for the U.K. include second quarter GDP and June wage growth. Consensus economists expect the economy to grow 0.6% quarter-over-quarter, which would confirm the U.K. recovery is gathering momentum. Average weekly earnings are expected to decelerate to 4.6% in the three months to June as compared to the same period last year.

In terms of our own monetary policy outlook for the BoE, we believe central bank officials will wait until November to deliver another 25 bps policy rate cut, which would be consistent with its plan for a gradual pace of monetary easing. If next week’s inflation and wage growth data were to surprise to the downside, an earlier rate cut (in September) could potentially be in play.

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Japan GDP • Thursday

Next week will see the release of Japan's GDP figures for the second quarter. After contracting at a 2.9% quarterly annualized pace in the first three months of 2024, the Japanese economy is expected to grow at a 2.4% pace in Q2. Some of the underlying details of the GDP report are expected to be somewhat encouraging, too. Private consumption growth and business spending growth are both expected to turn positive, rising 0.6% and 0.8% quarter-over-quarter (not annualized) respectively.

The question on everyone’s mind will be: What implications do these data have for the Bank of Japan’s (BoJ) monetary policy normalization efforts? In our view, if economic growth can recover and remain steady, and wage growth can also remain sturdy, additional BoJ rate hikes remain possible. In a recent report following the BoJ's July tightening, we laid out a path for further rate hikes in October 2024 and January 2025. With that being said, the past week has seen much turmoil in global markets. If this environment continues, or intensifies, this could impact whether, or to what extent, the BoJ follows through with additional rate increases. Weekly Economic & Financial Commentary: A Wild Week in a Data Desert_9

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China Industrial Production and Retail Sales • Thursday

Next week, China’s industrial production and retail sales data for July will provide market participants with insight into how the economy performed at the start of the third quarter. Consensus forecasts for the July activity data are mixed, with industrial production growth forecast to ease to 5.2% year-over-year and retail sales growth is forecast to pick up to 2.6%. If these consensus forecasts are realized, the pace of growth would still not be that impressive by recent or historical standards for China. We also note that both measures of activity have surprised to the downside several times in recent months.

In the bigger picture, Chinese economic data have been generally underwhelming as of late. Second quarter GDP growth missed the official growth target of “around 5%” with a 4.7% year-over-year reading. The manufacturing PMI has spent five of the past seven months below the 50 “breakeven” level, and its non-manufacturing counterpart has slid lately. All in all, it is not the most encouraging picture for the economic superpower. As we wrote in a recent report, we expect economic growth to continue to underwhelm and slow in the medium term. We look for overall GDP growth of 4.8% in 2024 and 4.5% in 2025. Weekly Economic & Financial Commentary: A Wild Week in a Data Desert_10

Weekly Economic & Financial Commentary: A Wild Week in a Data Desert_10

Credit Market Insights

Households Are Feeling the Pinch

The Federal Reserve Bank of New York released its Q2 Household Debt and Credit Report this week. The report provides context into the dynamics and flows of national household debt. This week's report showed total debt reached $17.8 trillion (+$109 billion from the last quarter)—the highest in the report's history. Even as households continue to borrow, household debt has increased at a slower rate in recent quarters, suggesting consumers may be feeling the pinch of higher rates.

Concern over delinquency rates has continued to persist, given the high rate environment. While the report highlighted aggregate delinquency rates held steady at 3.2% for the quarter, the transition for certain debt balances, namely credit cards and auto loans, have become elevated. These severely delinquent loans (90+ days past due) for households have increased to 4.4% for auto loans and 10.9% for credit cards. These growing rates suggest that many households are struggling to manage their debt obligations in current market conditions.

Households are also turning to other sources of borrowing. With homeowners holding a near-record share of equity in their homes today and many refinancing at low rates throughout the pandemic, mortgage delinquencies remain low. These trends are further extrapolated through other metrics as well. Households have, however, increasingly tapped HELOCs to leverage that equity by using their homes as collateral. Such balances have increased by 20% since 2021. With the Federal Reserve having held the fed funds rate at 5.25%–5.50% since July 2023, refinancing activity has plummeted as many homeowners locked in previously low mortgage rates, shifting households to seek HELOCs as an alternative instrument to access liquidity in the short term.

We ultimately expect some reprieve is on the horizon for households and look for the Fed to begin easing policy in September with a 50 bps cut followed with further cuts through mid-2025. While these anticipated rate cuts should provide relief, it will take some time for more accommodative conditions to reach households.

Furthermore, the Federal Reserve's Consumer Credit report indicated an $8.9 billion increase in June, roughly $5 billion less than the increase in May. But all of that gain was due to nonrevolving credit (like auto and student loans), while revolving credit dropped by $1.7 billion, which is not only the second drop in three months, but also only the second drop since April 2021. This suggests consumers are feeling the pinch of tighter monetary policy.

Looking ahead, these recent data underscore the balance and management households must maintain in this volatile and high interest environment. Rising debt levels along with continued delinquencies emphasize household situations with increasing concern for financial costs in the near- to mid-term. While rate easing is expected soon, the burden of previous debts coupled with economic uncertainty certainly places pressure on the shoulders of consumers.

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Topic of the Week

Have Lower Bond Yields Started the Easing Process Early?

As we noted in the U.S. Domestic Review, it was a roller coaster ride this week in financial markets. The volatility was partially owed to a string of weak economic data, which sparked concerns that a more substantial reduction in the federal funds target rate range would be needed in order to prevent a recession in the United States.

As of this writing, markets were priced for about 100 bps of easing for the remainder of 2024, a dramatic change from 50 bps priced just one month earlier. A decline in interest rates across the yield curve has accompanied the change in monetary policy expectations, with the two-year Treasury yield falling 57 bps to 4.0% and the 10-year Treasury yield falling 29 bps to 4.0% over the past month. Our view is roughly in line with current market expectations for an easing to cycle to begin with a 50 bps cut at the September 17-18 FOMC meeting.

But with the meeting still more than five weeks out on the calendar, could the recent move lower in bond yields already be helping foster improvement in the sectors of the economy most affected by high interest rates? One way that decreased long-term rates may be giving the economy an early lift is through the housing market.

According to Freddie Mac, the average 30-year mortgage rate declined to 6.47% during the week ended August 8, the lowest in more than a year and 75 bps below this year's peak of 7.22% hit back in early May. Lower mortgage rates typically boost the residential sector through increased home sales and higher home prices. What's more, declining financing costs can lift home builder confidence and foster growth in single-family construction. Consumer spending can also benefit, as categories of spending related to housing, such as spending at building material and furniture stores, increase alongside the pickup in residential activity.

So far, there has been little evidence that the relatively sharp pullback in mortgage rates has resulted in a noticeable improvement in the housing sector. Despite inching up in the week ended August 2, mortgage applications for purchase fell during July as a whole. Zooming out, the purchase applications index is still not far from the cycle low hit in October 2023 when mortgage rates were close to 8%.

Lower financing costs should eventually bring about a stronger improvement, but the lethargic response so far looks partially owed to the softening in the labor market that has occurred this year, which has resulted in a higher unemployment rate and more tepid income growth for prospective buyers. It is also a reminder that a drop in rates is not likely to be a panacea for a housing market still constrained by adverse affordability issues stemming from a structural shortage of available homes.

That said, the decrease in rates has led to an upturn in refinancing activity. Refinance applications are still low, yet are up almost 59% on a year-to-year basis at the end of last week. The uptick means some relief is on the way for those with high monthly mortgage payments. It is also a potential sign that homeowners are dipping further into the deep pool of equity accumulated over the past several years.

All told, a monetary policy pivot is almost certainly forthcoming; however, mortgage demand largely has been unresponsive so far despite a fairly significant dip in mortgage rates. This development serves as a reminder of the unique challenges the Federal Reserve is sure to encounter as they seek to dial back restriction on the economy. Weekly Economic & Financial Commentary: A Wild Week in a Data Desert_12

Weekly Economic & Financial Commentary: A Wild Week in a Data Desert_12

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Thomas

Economic

Bond

China's bond market, the world's second largest, is on edge following a turbulent week in which the central bank started intervening heavily to stem a plunge in yields even as the economy is struggling.

But die-hard investors say the bull market in government bonds still has legs, citing China's wobbly economy, deflationary pressures and low investor appetite for riskier assets.

"We remain actively bullish," said a bond fund manager, undeterred by unprecedented government moves to cool the sizzling treasury market and arrest a plunge in yields, which move inversely to prices.

"We don't see a rosy economic picture ... and we're under peer pressure to generate returns," said the Beijing-based manager who asked to be anonymous due to sensitivity of the topic.

Even those who have turned bearish appear half-hearted. Treasury futures investor Wang Hongfei said he chose to be "opportunistic" in the short term, trading quickly in skirmishes as the market tussle with regulators intensifies.

China's central bank has repeatedly warned of potentially destabilising bubble risksas investors chase government bonds and scurry away from volatile stocks and a sinking property market, while banks cut deposit rates. Falling yields also complicate the People's Bank of China's (PBOC) efforts to stabilise the weakening yuan.

But with the PBOC now turning threats into action to tame bond bulls, authorities have opened a new battle front - following wars of attrition long fought against speculators and unwelcome price moves in the country's stock and currency markets.

Unlike the West, "China's financial markets, including the bond market, are subject to top-down regulation," said Ryan Yonk, economist with the American Institute for Economic Research.

As the economy sputters, "Chinese officials will face increasing difficulty in maintaining such tightly controlled financial markets, and additional interventions are likely, and may signal the very instability Chinese officials are seeking to avoid."

First Shot

The first shot was fired last Monday, when China's long-dated yields hit record lows amid a global rout that drove money into safe havens such as treasuries.

State banks were seen selling large amounts of 10-year and 30-year treasuries after treasury futures jumped to record highs.

Debt dumping by state banks - confirmed by data and traders - continued throughout the week, mirroring how the central bank uses big banks as agents at times to influence the yuan currency market, traders said.

Late on Friday, the central bank said it will gradually increase the purchase and sale of treasury bonds in its open market operations.

PBOC Governor Pan Gongsheng was previously head of China's foreign currency regulator, so "it appears to be the same playbook," said a Shanghai-based fund manager.

In another warning shot to bond buyers, the PBOC ceased providing cash through open market operations on Wednesday for the first time since 2020, contributing to the biggest weekly cash withdrawal in four months in support of yields.

Dealing a further blow to market sentiment, China's interbank watchdog said it would investigate four rural commercial banks for suspected bond market manipulation, and would report several misbehaving financial institutions to the PBOC for penalty.

The PBOC did not reply to a Reuters request for comment.

'Sword of Damocles'

To be sure, the flurry of measures have made some investors cautious. Both China's 10-year and 30-year treasury futures posted their first weekly fall in a month.

"Taking all factors into account, it would be prudent to exercise additional caution regarding China duration risk," Kiyong Seong, lead Asia macro strategist at Societe Generale said, referring to the risk of holding long-dated bonds.

"While the scale of any selloff in China bonds may not be substantial in the medium and long term due to the fragile growth momentum in China, chasing duration returns in China does not seem appropriate in our view."

Tan Yiming, analyst at Minsheng Securities, wrote in a note: "The sword of Damocles is falling."

But in a so-called "asset famine" environment where high-yielding assets are in short supply, "the bond bull remains alive," Tan said.

The Shanghai-based fund manager said there's no reason to throw in the towel without seeing clear signs of economic improvement, and his strategy is to "buy on the dip".

"You cannot change market direction using technical tools, just as you cannot change the temperature by adjusting the thermometer," he said.

The PBOC moves could change the tempo of bond price rises, but not the uptrend, he said. "If you hold long enough, you will make money."

However, rising volatility shows the central bank is at least making some progress in giving investors pause for thought.

Chun Lai Wu, head of Asia Asset Allocation at UBS Global Wealth Management, cautioned that expected support to Chinese bonds from any monetary easing will likely be offset somewhat by stepped-up government bond issuance.

China's 30-year treasury yield is currently around 2.37%, compared with 3% a year ago.

"Over the long term, we could see the ... yield drift higher, maybe towards 2.5%, if indeed we see the economic recovery continue and inflation begin to return."

($1 = 7.1715 Chinese yuan renminbi)

Source: Reuters

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Economic

U.S. – Bumps in the Road

After last Friday’s disappointing payrolls report sent equities tumbling and bonds flying, markets have taken a bit of a breather this week. The U.S. 10-year treasury yield is back to 3.9%, within basis points of where it was last Thursday, while equities have retraced roughly half of their losses since Friday – although they are still well off their mid-July highs

The payrolls data set off alarm bells and traders piled into bets of impending rate cuts and a steep slowdown in economic activity. Fed funds futures are pricing 100 basis points of rate cuts from the Fed through the end of 2024. Importantly, with only three meetings to go, this suggests a 50-basis point cut could come as early as September.

We think this is a tad overdone. To be sure, rate relief is on the way, however our expectation is that the Fed will deliver three more cuts through December. The difference is slight but reflects the fact that we still see an economy that’s gradually gearing down, rather than one where the bottom is falling out.

For instance, take last week’s jobs report. Job growth slowed sharply to 114k jobs from 179k the month prior, with the services sector kicking its smallest addition of the post-pandemic recovery. On the face of it, the second consecutive month of decelerating job growth reflects waning momentum. However, job growth needed to cool to tame inflation and from this lens, the average of 170k jobs gained over the past three months, combined with a cooling in inflation, is a pace the Fed would be happy to accept.

Beyond the labor market, there are signs that economic activity is holding up. This week the ISM services index surprised to the upside, showing the sector regained some momentum to continue expanding. The details of the report were solid with new orders, overall activity and even employment all showing gains (Chart 1). The Weekly Bottom Line: Bumps in the Road_1

The Weekly Bottom Line: Bumps in the Road_1

Moreover, falling bond yields are helping ease financial conditions. Thirty-year mortgage rates are down below 6.5%, from 6.9% a month ago (Chart 2). Data from the National Association of Realtors showed June’s pending home sales up nearly 5% month-on-month (m/m), and with a further drawdown in financing costs in July, further recovery in actual sales could be in the offing. The Weekly Bottom Line: Bumps in the Road_2

The Weekly Bottom Line: Bumps in the Road_2

These indicators suggest an economy that continues to mosey along, slower than before, but not yet hitting a wall. And remember, the Fed remains data dependent, so for a sense of how the Fed will respond in September, two upcoming events will be in focus. First up, next week’s release of July’s Consumer Price Index (CPI). We are looking for a firming in core CPI (ex. food and energy) to 0.2% month-on-month. While this implies an annual figure of 3.2%, it would sink the three- and six-month percent changes in core CPI to roughly 1.6% and 2.9% annualized, respectively, comfortably extending the cooling in price gains.

The update on inflation then lays the groundwork for the next big event, the Fed’s Jackson Hole Economic Symposium on August 22-24th. Chairman Powell is slated to speak, so markets will be closely parsing his statements for any insights into the Fed’s read of recent events.

Canada – Keep Calm, Carry On

Canadian markets spent the holiday-shortened week digesting the rapid shift in market sentiment stemming from growth worries south of the border. Recent events in the U.S. and Japan have created volatile market conditions that have spilt over to Canadian markets. Yields whipsawed, with front-end yields rising 15 basis points, partially reversing the 30 bps rally the week prior. The Canadian dollar also caught a bid, up just over a tenth of a cent to 0.728/USD. Despite the external noise, we’d argue the economic outlook for Canada is stable and there isn’t a need to ring the alarm bells just yet.

With a soft U.S. payrolls print last week spurring knee-jerk reactions, Canada’s job market updates were being watched with an even closer eye. Like our southern counterparts, Canada disappointed against expectations, with virtually no job growth recorded in July. But unlike the past several months, labour force growth pulled back which helped keep the unemployment rate steady at 6.4%.Meanwhile, wages as measured by the Labour Force Survey are still growing at 5.0%, which will continue to be on the Bank of Canada’s (BoC) radar (Chart 1). The labour market has no doubt lost steam, but it is holding up relatively well and is evolving roughly in line with what we’d expect from past economic cycles. The Weekly Bottom Line: Bumps in the Road_3

The Weekly Bottom Line: Bumps in the Road_3

The Bank of Canada will use the labour data as a marker in their next policy decision. The Bank has firmly entered their rate easing cycle and so the question becomes how the path for policy rates looks over the rest of the year. Governor Macklem’s dovish tilt at last month’s meeting had markets re-jigging their rate cut expectations for the remaining three announcements this year, to now see Canada’s policy rate at 3.75% at year-end (Chart 2). This aligns with our thinking as it keeps interest rates on a slowly declining path and balances the objectives of supporting growth without reigniting inflation. The Weekly Bottom Line: Bumps in the Road_4

The Weekly Bottom Line: Bumps in the Road_4

The BoC’s Summary of Deliberations also released this week reiterated an important shift in the BoC’s thinking from last meeting. New in their messaging was the emphasis on the downside risks to inflation via excess supply and how it has taken on an increased weight in monetary policy discussions. This is an important shift in sentiment, as it’s indicative of a central bank concerned that the still high level of the policy rate may be exerting too much slowing in the economy.

Economic growth in Canada’s economy is by no means advancing at breakneck speed, but we don’t foresee a deterioration–or a recession–on the horizon. Domestically, the Canadian consumer bounced back in the first quarter of this year with contributions from spending expected to remain in coming quarters. Further, Canada’s trade picture is firming up as the recently operational Trans Mountain Pipeline expansion boosts energy exports, a theme we expect to persist of the coming months. At this stage, the BoC has enough confidence to gradually deliver rate relief to the economy with a soft-landing scenario still being the likely outcome.

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Samantha Luan

Economic

A week is not just a long time in politics.

Seven days ago a huge unwind in the yen carry trade and selloff in megacap U.S. tech triggered a wave of volatility that sent global markets reeling and investors running for the safety of U.S. Treasuries.

As the new trading week gets underway in Asia on Monday, that seems a long time ago - many assets have recovered much of these losses, volatility has subsided, and traders have heavily scaled back their rate cut expectations.

The question now is whether that momentum can be sustained. Some investors will seize upon lower equity volatility to push up risky assets again; others will be wary of potential aftershocks in any corner of the market, especially in mid-August when liquidity is much thinner than usual.

Monday's Asian calendar is light. Indian consumer price inflation is the main event, leaving markets at the mercy of global forces.

If that's the case, Monday should be relatively calm. Wall Street rose on Friday, meaning the Nasdaq and S&P 500 ended last week essentially flat. Treasury yields fell on Friday but registered their biggest weekly rise in months.

Stronger-than-expected U.S. economic data suggesting recession fears are overblown, and a couple of poorly-received U.S. debt auctions, pushed yields higher. No bad thing, perhaps, if you think the previous week's plunge was excessive.

Asian markets' rebound last week was pretty impressive. After the Nikkei registered its second biggest fall on record and its third largest ever rise in the space of 24 hours, the index ended the week down only 2.5%.

Other benchmark indices fared even better - the MSCI Asia ex-Japan and MSCI World index both ended flat, and the MSCI Emerging Market index rose 0.2%.

In currencies, U.S. futures market data on Friday showed that hedge funds slashed their net short yen position in the week to Aug. 6 by 62,000 contracts. That is the biggest yen-bullish weekly swing since the Fukushima disaster in February 2011, and third biggest since comparable data started in 1986.

If this is representative of the broader FX market, the short yen 'carry trade' has been mostly wiped out. Do traders begin shorting the yen and putting on carry trades again, or not?

Indian inflation is the main data point in Asia and comes after the Reserve Bank of India last week kept its key interest rate unchanged at 6.50%, dismissing the market turbulence and focusing on getting inflation down to its 4% medium term target.

The consensus in a Reuters poll is for annual consumer inflation in July to fall to 3.65% from 5.08% in June. That would be the first time in five years below the RBI's medium-term target.

Here are key developments that could provide more direction to Asian markets on Monday:

- India interest rate decision

- India industrial production (June)

- Germany wholesale inflation (July)