Deficits be damned

Yellen to call for more stimulus to bolster economy

The Financial Times reports that Treasury Secretary Nominee Janet Yellen, the Federal Reserve’s former head, will state that the US risks a more prolonged recession and long-term scarring if it does not inject more government spending into the economy. The prepared remarks obtained by the FT ahead of Ms Yellen’s testimony today outlined that Ms Yellen feels that with interest rates at historical lows, now was the time to “act big,” with the benefits outweighing the challenges of a larger deficit.

With US markets mostly closed for a public holiday, Asian markets appear to have seized on Ms Yellen’s remarks as further vindication for President-elect Biden’s USD1.90 trillion stimulus package. And as we know from 2020, any mention of stimulus is usually good for asset prices. That seems to be the case in Asia, with most equity markets across the region opening up much stronger.

I can’t argue with Ms Yellen’s premise. The US government can issue 10-year debt at 1.10%, and 30-year debt at 1.80%. Despite the hand wringing of the inflationistas as 10-year yields climbed back through 1.0% (it’s a strange world we live in when 1.0% borrowing costs worry people), that is still effectively free money. If inflation and interest rates were to rise notably in the years ahead, the US government could repurchase the debt cheaper than originally issued (bond prices fall as yields go higher). What’s not to like?

Of course, the Senate Republicans, and possibly some more centrist Democrat ones, as well as the Byrd Rule, are likely to have something to say about that. But with one eye on deteriorating US employment and domestic consumption data, the Senate may not be as inclined to slim down the package as they would have been previously. The concerns over the presidential inauguration tomorrow, which weighed on sentiments yesterday, have receded with fiscal stimulus business as usual regaining ascendancy.

That has yet to flow through to US dollar weakness though, with the CFTC Commitment of Traders data showing multi-year highs in speculative short dollar positioning in currency futures markets. The data is released a week in arrears, and I suspect some of that positioning was dialled back last week. Nevertheless, having spent all of 2020 selling the US dollar, markets remain heavily short. If it can withstand stimulus talk and debt issuance speculation, the short squeeze is likely to continue into early February. If Senate Republicans indicate early hostility to the programme and some of Mr Biden’s wish list requires a Byrd Rule/Reconciliation 60-vote pass, the squeeze could get quite messy.

Today’s calendar in Asia is literally a bare cupboard, with only German inflation to break the monotony this afternoon. China’s Loan Prime Rate and Bank Negara interest rate decisions are released tomorrow. Of the two, Bank Negara will be the more interesting. As one of the few regional central banks with anything left in the rate cut tank, tomorrow could see another cut after a 6-month hiatus to support growth which is suffering under a resurgent Covid-19. That should be positive for Malaysian equities although the ringgit’s direction driven by the US dollar and the Asian bloc as a whole. The ringgit may weaken in the short term though.

The Bank of Japan and Bank Indonesia both release their latest decisions on Thursday along with the European Central Bank (ECB). Much of the Japanese yen’s recent strength has been due to a spike in JGB yields with speculation rife in Tokyo that the BOJ may adjust their yield curve control programme. I am not sure why the BOJ would do that in all honesty at this time, and no change from the BOJ should see yen weakness return. Bank Indonesia is likely to sit this one out, as will the ECB, which has many moving parts to monitor Europe and the United States before contemplating its next move.

That is a very long way of saying that Asian markets will continue to trade the US fiscal stimulus trade winds, but that headline risk dominates the potential causes of short-term volatility spikes. I couldn’t have put it better myself.

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