Assessing July

I’m back from my usual Ramadhan blogging break, and my, aren’t there lots of things to comment on. This will be a kind of omnibus blog post, covering some of the developments over the past month.

2Q2015 GDP Growth

A funny thing happened with the change in national accounts base year to 2010 – the economy all of a sudden got a lot harder to forecast. The usual indicators no longer seem to matter as much – for example, MIER’s confidence indices appear to have totally decoupled from GDP – which makes forecasting growth more than a little bit more difficult. IPI and trade remain good predictors, but their standard deviations have doubled and the forecasts are suggesting two completely different pictures of the economy.

In short, we’re seeing a lot more variability in growth, relative to the underlying numbers. I’m still reworking my forecast models but that’s going to take some time. My best guess at the moment is 2Q2015 growth will be around 5.0%, which is well above the consensus. We’ll find out if it’s as bad as people are expecting in three weeks time. My bet is that there will be an upside surprise.

Industrial Production

One of the my hypotheses for the year was that production and trade will diverge due to inventory rebuilding, and you can see from my comments on GDP growth above that that has seemingly come to pass. There’s some interesting things going on in the sub-indexes (log annual and monthly changes; seasonally adjusted):

Manufacturing growth is slowing, but still holding steady in its long term growth channel, but mining output has levelled up, while electricity output is on a slow decline. Both are puzzling, because export volumes of oil & gas are declining as well (keeping more in for our own use?), while a decline in electricity output (nee electricity demand) is indicative of slowing economic growth.

Another possibility is that with the gradual lifting of fuel subsidies (particularly those related to gas prices and electricity tariffs), consumers and businesses might be conserving more, in which case it a good sign. It’s the “on the one hand, on the other hand” dilemma of economic rationalisation.

Inflation

The June CPI report showed 2.5% y-o-y inflation, which was above my expectation, largely due to the change in fuel prices. July should see inflation accelerating once more, though based on the latest global oil prices, we should see pump prices climb down again come August. I’m expecting the peak for the year around September, but overall inflation will remain soft (<3.0%). The same can’t be said for next year though, as the low base will artificially raise the growth numbers (log annual and monthly changes):

Note however the elevated growth in core prices, which is largely being driven by GST in April. Looking at the index numbers however, seems to indicate that (minus the variability of petrol pump prices), inflation is already back to its long term trendline:

In which case, GST – as predicted – will have a one off only effect on prices, and future inflation will revert to the long term trend.

USDMYR

The big news of course is the breaching of the 3.80 per USD level. I’ve heard all kinds of doom stories on this, as well as BNM intervening to “hold the line”. It will certainly be interesting to see the FX reserve numbers for this period, though those won’t be out for another week or so. Then there’s that WSJ story on 1MDB…

But truth be told, I don’t think you can read that much into it. My benchmark for whether the Ringgit is moving unusually is to map against other large net energy exporters with free floating currencies, which would be Canada, Australia, and Mexico (MYR cross rates, up is appreciation):

Hmmm, over July, the Ringgit strengthened quite a bit against both CAD and AUD, and held the line against the MXP. In any case, the six month trading ranges against all of them is fairly small. What was that about political uncertainty driving down the Ringgit? A perfect example of a post hoc ergo propter hoc fallacy. It’s not just the media committing this error, but most of the analyst community as well.

I’m also getting tired of all the commentary about the Ringgit being the weakest in East Asia – the only reason why that’s true is because we’re the ONLY large net energy exporter in East Asia, and because Australia isn’t considered an Asian country. The market would have to be completely irrational not to sell down the Ringgit relative to other East Asian currencies, given the year long decline in oil prices and the more recent collapse in LNG contract prices. In other words, there are quite solid fundamental reasons for the relative decline in the Ringgit’s exchange value. Quit harping on it already, it’s a totally meaningless comparison.

One could certainly argue that it’s BNM intervention causing the recent Ringgit appreciation relative to its (real) peers, but that leaves out that it would have probably kept to its relative level absent such intervention. I would actually say that the change in the Fitch rating outlook was far more important for investors than anything to do with political stability or lack thereof.

For those who aren’t quite catching what I’m saying – it’s the USD that has been rising, not the Ringgit weakening. We’ll continue to see pressure on all other currencies (not just the Ringgit) until the Fed decides it’s time for lift off.

Apropos of that, the market for US Treasury futures isn’t fully pricing in the expected path that the FOMC is likely to take – comments from Board members indicate a preference for a rate hike every other meeting after the first. That’s twice as fast as the market is priced for. How I interpret this is – traders are going to take a hit on UST capital values when the Fed starts raising the Fed Funds Rate. And that would mean a pullback for the US Dollar bull. I’d be looking for a general reversal in USD strength about the time of the second or third hike i.e. by the end of 1Q2016, followed by a multi-year decline.

Greece

Plenty of drama in this Greek tragedy, from the lows of the breaking off of negotiations, to the highs of the referendum, and finally the capitulation to the troika (with a human sacrificial lamb in the form of Varoufakis to boot).

The worse part of it is – fundamentally nothing’s changed. The can’s just been kicked down the road, and we’ll be doing this again within the next six months. In the meantime, the Greek people will continue to suffer. Isn’t a six year depression enough already?