Editor’s Note: Below is a Q&A with Rob Rennie, Global Head of Market Strategy at Australia’sWestpac.This Q&A went out to subscribers of our “10 Things You Need To Know Before The Opening Bell” newsletter on Monday morning.Sign up hereto get the newsletter and more of these interviews in your inbox every day.
BUSINESS INSIDER: What is the most underreported story in Asian markets?
ROB RENNIE: To be perfectly honest I think the most over-reported stories have been the impact of Fed taper and China’s supposed ‘Lehman moment’ on Asia. If you had followed the hype, then you would have been forgiven for thinking that capital flight from Asia was the prevailing theme. Clearly this would have been false – bar a short period of nerves in Feb, the underlying trend has been one of continued equity investment into the region, led by India in March and quickly followed by Korea in April.
BI: When it comes to China in particular, what might markets have failed to
price in so far?
RR: While the financial press has spent a great deal of time writing about China’s ‘Lehman moment’ we have been surprised by the limited move to price this in various asset markets in China. Our financial stress index is based on IMF methodology and is a composite index which attempts to identify periods of financial stress by using high frequency Chinese market based variables.
Specifically there are 7 variables in the index – namely bank sector beta, the ‘Ted’ spread, the yield curve (inverted), corporate bond spread (we use Sovereign CDS here for China), stock returns, time varying stock volatility and time varying exchange rate volatility. Each variable is adjusted by its own mean and standard deviation to reduce the impact on the index of the more volatile variables. The FSI is then constructed as an average of these 7 scores. The chart below notes that while financial stress is rising, it is certainly not suggesting that we are yet anywhere near to ‘break-out’ or ‘Lehman moment’ levels for China.
BI: You recently wrote that certain sectors like shipping have proven resilient in the face of flagging Chinese trade. How have they done this?
RR: Part of the story has been the very sharp rise in supply coming on stream in Australian iron ore where current growth is best described as ‘exponential’. Part of the story is driven by continued expansion in steel production in China helped, in turn, by expectations of front loaded railway investment. Part of the story is Asia showing signs of trading more within Asia as we move towards increased bilateral central bank swap lines/ increased invoicing in local currency and bilateral free trade agreements. While East/ West trade has not improved much, Asia is showing signs of increased trade within the region. China’s imports from Asia ex Japan over the last 3 months are up 11% year-over-year, which suggests a solid start to the year and a positive sign in my view.
BI: At the same time, you’ve also said U.S. demand has proven surprisingly weak. Are you “team weather,” as we’ve been saying here, and expect any kind of snapback?
RR: I am not really expecting a sharp snap-back in terms of US demand outside of short term weather related story. The key constraint I see for US demand is a constrained household. Gains in U.S. employment have failed to beat population growth meaning household income has only seen negligible growth over the past two years, circa 0.7%yr. It is hard to see a material lift in US demand in this environment, without a material lift in household income.
BI: What has been the view from the Pacific region on Yellen so far?
RR: There is a keen sense that Yellen communicates well with the market. September last year was seen as a communications debacle. Yellen has been able to deliver two ‘tapers’ with the prospect of more to come and make it feel as if little has really changed. She has developed a clear knack of delivering bad news in a positive way.