Singapore’s final Q2’GDP report released this morning was unchanged from the advance report of just 0.1% yoy. The contraction in the manufacturing sector was revised -3.1% yoy vs -3.8% previously but this was offset by weaker numbers for services and the construction sector. This implies just 0.6% growth in H1’2019 and the big picture is that the government downgraded the outlook for this year for the second time to just 0-1% vs 1.5-2.5% previously. It expects growth to be around the mid-point of this range, around 0.5% which implies -0.6% to 1.4% growth in H2’2019. We could see another quarterly contraction in Q3 following -3.3% QoQ annualized in Q2. This will imply a technical recession and first since 2008.
The downturn is unlikely to be as severe as in 2008 when growth contracted nearly 8% yoy in Q1’2009 but at the same time, the rebound is also unlikely to be robust. The outlook is challenging even into 2020 given the continued correction in the electronics sector, lingering trade tensions, and the uncertain regional outlook.
MAS easing risks have risen noticeably in recent weeks. A simple comparison of where macro variables sit now compared to previous easing cycles shows the hurdle to shift policy at the October meeting is arguably not that high to clear.
Short SGD NEER trade and pay SGD-USD spread:
From an FX standpoint, we have been reluctant to play SGD from the short side in 2019, given Singapore’s strong external balances and safe-haven characteristics. However, with MAS easing risks rising our bias has shifted.
Markets have started to price this in but we would stress that the reaction in both the SGD NEER and USD/SGD to date is still well short of what we have typically seen in previous cycles.
Our preferred expression is to be short SGD via the NEER. The risk/reward around short SGD NEER positions has certainly improved compared to 3-4 months ago when the risks for easier policy were more geared towards 2020 rather than this year.
Applying “interest rate parity” and considering the various caveats remains our preferred framework to analyze SGD interest rates. This is because over the medium term, turns in MAS policy have reliably and consistently explained the turning points in SGD interest rate versus trading partner interest rates.
Under such a framework, a reduction in the slope of S$NEER appreciation to 0.5% per year because of a lower 2020 core inflation forecast, is supportive for SGD interest rates to underperform USD rates.
The observation that SGD points/SGD-USD IRS spread has already moved north YTD is not an oddity as “markets moving in advance of a central bank” has always been the case in Singapore.
Strategy: In FX, we enter into a short SGD NEER trade, with an entry-level of 127.05 based off the JPM S$NEER estimate. The carry for the NEER is around flat and we target a move back to slightly below the mid-point of the band in the next 3 months. We currently are +113bp above the mid-point of the band. In rates, we look to pay the SGD-USD spread, either through front-end, SGD-USD IRS spread or 6x12 SGD forward points, on dips. Courtesy: JPM