Asia FX Talk FOMC Talk is cheap, sharp sell off in long end US yields

Asia FX Talk Asia FX Talk MICHAEL WAN Senior Currency Analyst FOMC - Talk is cheap, sharp sell-off in Global Markets Research Global Markets Division for Asia long-end US yields and risk sentiment T: E:

Market Highlights The Federal Reserve kept rates on hold in its July FOMC meeting in Fed Chair Kevin Warsh’s second meeting, but this came with three dissents for a rate hike from the FOMC Committee (Lorie Logan, Beth Hammack and Neel Kashkari).

The much bigger market action came during Kevin Warsh’s press conference.

Longer-end US Treasury yields sold off sharply, US inflation expectations rose, while risk sentiment fell with equities lower. The Dollar also weakened on the impact of likely positioning adjustments and also with US front-end yields MUFG Bank, Ltd. coming off. In particular, both the US 10-year and 30-year rose sharply by close to A member of MUFG, a global financial group 10bps with the 10-year rising closer to 4.67%. This was also combined with a sharp rise in inflation expectations as proxied by US breakeven inflation rate rising closer to 2.27%, relatively unchanged US real yields, while the S&P500 dropped by 1.7%.

CHART 1: US 10-YEAR BOND YIELDS ROSE SHARPLY POST THE FOMC MEETING AND KEVIN WARSH’S PRESS CONFERENCE

Ahead Today G3: US PCE Inflation, US Initial Jobless claims

Asia: Philippines Trade Deficit

Source: Bloomberg, CEIC, MUFG GMR

We think the market is ultimately telling us (and Kevin Warsh) that talk is cheap with the combination of these moves, and that it is not enough to just say and proclaim that price stability is paramount for the FOMC. In other words, the Fed

has to eventually walk the talk on inflation under this new regime. During his press conference, Kevin Warsh spoke about using many alternative sets of measures of inflation beyond the official target of core PCE to gauge underlying inflation pressures, together with how the Fed was inferring aggregate supply while fine-tuning demand. Ultimately, this seemed to be taken by the market as being a confusing mental model and framework, and also lacking a clear anchor for inflation in his reaction function.

As we highlighted previously, our inclination with Kevin Warsh is that he could bring about greater rates market volatility due to his proclivity to avoid guiding the market and stay away from forward guidance, and together with a potentially steeper yield curve due to his inclination to reduce the Fed’s balance sheet. Today he delivered both but without even truly acting or touching on the subject on the Fed’s balance sheet yet.

While the Dollar initially sold off, for emerging market currencies including here in Asia we are concerned that if these market moves continue meaningfully, it could ultimately be bad for risk sentiment and weigh on EM Asia FX and rates.

From a Asia FX perspective, we are as such inclined to be somewhat more cautious on the current account deficit currencies in Asia such as IDR and PHP in the near-term, and to some extent INR. The likes of CNY may still outperform driven by local drivers.

FOREIGN EXCHANGE Asia % Chg London close 6pm New York close 5pm Close % Chg USDJPY INDU EURJPY NKY EURUSD DAX GBPUSD UKX USDSGD STI USDTHB SET Closed USDMYR 4.0905 -0.03 OTHER INDICATORS KLCI USDIDR 18055 -0.07 DXY Curncy 100.886 JCI USDPHP 61.388 -0.39 PSEi USDINR GT2 Govt 4.274 SENSEX USDKRW GT10 Govt 4.679 KOSPI USDTWD 32.375 -0.08 GTJPY2Y Govt 1.473 TWSE AUDUSD 0.6943 -0.43 GTJPY10Y Govt 2.751 AS USDHKD 7.8434 0.02 GTDEM10Y Govt 3.160 HSI USDCNY 6.7655 -0.03 CO1 Comdty 90.74 SHCOMP USDVND 26323 -0.05 XAU Curncy 4067.56 VNINDEX

FX estimated closing. % Chg & bps chg indicate daily changes versus prior trading day. Sources: Bloomberg * As of 4:30pm, Beijing Time