CITI Asia Macro and Strategy Outlook

Balancing Act after the Rebound

Asia’s growth is expected to rebound quite sharply in the 2Q 2009 then taper off gradually in the second half. Recessionary forces in the developed world are easing as policy efforts are gaining traction, while aggressive monetary and fiscal policies across Asia and strengthening momentum in China are supporting the region’s upturn.

We think the export momentum in Asia will shift between tech and non-tech exporters. We think the tech-driven re-stocking effect supporting the export rebound in Korea, Taiwan and Singapore NODX will lose momentum, while exports of laggards like China, Malaysia and Thailand should pick up gradually alongside global growth.

Inflation in Asia has largely bottomed and we expect some central banks will shift their language by this year and policy rate next year ahead of the US. Headline inflation should remain very benign in the coming months on base effect but is expected to notably reverse by year-end for India and China, alongside growing concerns on the lagged impact of loose liquidity conditions feeding into asset prices and inflationary expectations. From historically very low levels, we expect BOK will be the first to hike rates (1Q 2010F), followed by RBI (2Q 2010F), BI (mid-2010F) and PBOC (2H 2010F).

We remain fundamentally bullish Asia FX over the medium to longer term but expect more range-bound trend in the short-term. We expect some consolidation of short-term risk appetite, but longer-term appreciation story remain intact on stronger growth prospects, robust external positions and CNY undervaluation anchor. Our most aggressive FX appreciation forecast vs. spot in 12 months are in KRW, IDR, INR and MYR.

We maintain our steepening bias on local rates. We would look to pay longer end rates in CNY and INR where growth momentum is strong as well as TWD where rates sell-off have considerably lagged. Front-end sell off looks overdone – rate hikes are neither imminent nor sizeable and carry and roll to receiving looks attractive in INR, KRW and THB. We would also look to go long shorter-end IDR bonds on pull-backs.

Citigroup - Asia Macro and Strategy Outlook

Citigroup - Asia Macro and Strategy Outlook: Searching For “A” Bottom (Not “The” Bottom)

We see tentative bottoming signs in recent data releases — Growth declines are moderating for most countries with month-on-month rebounds in Korea and Singapore. China data is mixed with fiscally-driven growth in full swing while trade data is weakening. However, our bleak outlook for G3, and uncertainty on the path of recovery, mean it is too early to call for "a" bottom, let alone “the” bottom.

Expectations on economic data are catching up with reality — Negative data surprises have narrowed significantly. We make no changes to our growth forecasts this month after significantly downgrading in February.

Policy responses: Rate cuts now slowing, intervention much less than US — While we are seeing additional fiscal stimulus (Korea and Malaysia), rate cuts are now slowing with China, Taiwan and Malaysia expected to pause (no ZIRP here), and only RBI pursuing limited QE.

FX reserves may have peaked in EM as a whole, but remain on the rise in some Asian economies — FX reserves in Hong Kong, Philippines, Taiwan and Thailand are still rising, helped by terms of trade improvement. China will likely resume its ascent after the recent reported recent dip.

We think Asia FX is at a turning point — Economic weakness, prompting Asia FX depreciation pressures, need to be counter-balanced by more aggressive monetary/quantitative and fiscal easing in the US, which would weigh on the US dollar. We remain residually bearish on the SGD and MYR but more bullish on INR and IDR. We remain wary of chasing sharp moves in the KRW, which has outperformed significantly.

With CB policy easing slowing, but bond supply concerns rising, we are more neutral on Asian rates — We would offset some selective long positions in the front-end of Indonesia, India and Singapore with paying on the back-end of Korea, Malaysia and Taiwan.