Ahead Today
G3: US ADP Weekly Employment Change
Asia: Reserve Bank of Australia, Bank Indonesia
Market Highlights
It’s a tough job for central banks both globally and in Asia amidst the uncertainty around the Iran conflict, and today we kick it off with the Reserve Bank of Australia and Bank Indonesia, followed by a whole host of key policy meetings from BOE, ECB, BOJ, CBC, and not least the Fed. Certainly one common thread for all central banks is the scenarios around oil prices, and importantly also how prolonged the Strait of Hormuz closure will be and the resultant impact on both growth and inflation. Beyond the common threads there are three distinguishing factors which we think could result in divergence across central banks. First, the starting point of macro conditions including whether inflation is already a concern and growth is above trend. Second, issues around sovereign credit risks and fiscal settings. Third, the linkages of each market to the Strait of Hormuz and how vulnerable they are to a prolonged crisis.
Taking the Reserve Bank of Australia for instance, existing inflation rates are somewhat above comfort levels to begin with, and with both RBA Deputy Governor Hauser and Governor Bullock already putting out hawkish signs saying that the March policy meeting is live with inflation too high, the Middle East crisis likely puts some fuel to the fire in terms of the possibility of inflation rising above the RBA’s forecasts. Nonetheless, we note that the AUD OIS markets are currently pricing in for around 65% probability for a hike this meeting, and also importantly around 3 hikes by December 2026. In a tail risk event of a prolonged Middle East crisis and sharply higher oil prices, the high-beta nature of AUD and concerns around growth may then start to dominate both AUD yield differentials and higher commodity prices, even as AUD may outperform DXY and other G10 FX trends modestly.
In sharp contrast, Asian central banks face a very tough trade-off in this crisis given just how exposed our region is to the Strait of Hormuz closure. 90% of the energy passing through the Strait of Hormuz goes to Asia, while from Asia’s perspective, close to 60% of crude oil imports, 20% of refined petroleum and natural gas, and around 40 to 50% of hydrocarbon gas liquids such as propane and naphtha come from the Middle East. In addition, the data on refined petroleum understates Asia’s linkages to the Middle East, given that 60% of Asia’s refined petroleum product imports are largely from regional refiners such as South Korea, Singapore, Malaysia and China – feedstock which ultimately derives from crude oil dependent on the Middle East.
So in short, it’s really not just about oil prices for Asian economies, but the increasingly risks of energy shortages the longer this crisis drags on.
For Bank Indonesia, the good news is that Indonesia is a net commodity exporter, and so even though it does import oil and gas, if commodity prices including palm and coal were to rise more generally it could benefit. Nonetheless, the key is that the starting point of macro conditions including sovereign credit risk and fiscal sustainability for Indonesia is not ideal, and with higher oil prices likely raising pressure on fuel subsidies to increase the 3% of GDP budget deficit limit could become more difficult to maintain in a tail risk event of sustained oil price spikes.
We see BI keeping rates on hold in this meeting, but the bias is still a dovish one for BI, and as such from a FX and rates perspective we think that both IDR FX and bonds are biased to underperform in the midst of the SoH crisis.