SINGAPORE (June 26): Despite a rise in US equities on Thursday, DBS Research Group analysts Phillip Wee and Chang Wei Liang are warning that this Wall Street bullishness is nothing but a head fake. With the US economy remaining fundamentally weak and Covid-19 showing no sign of dissipating, they predict that July will see a downward correction for currencies next month. 

“The rally that came in the final hour of trading was narrow, driven mainly by financials from recommendations to ease restrictions on US banks from the Volcker Rule. These gains were reversed in after-hours trading after the Fed told big banks to limit dividend payments and suspend share buybacks in 3Q,” say the analysts. They warn that the Fed is encouraging US banks to maintain capital stocks to absorb the economic fallout should a prolonged pandemic result in loan defaults from corporates and households. 
 
After falling from April to May, unemployment levels seem to have plateaued in June. Millions of Americans are at risk once the US government’s US$600 unemployment benefit expires at the end of July, with small firms under pressure to retrench once government relief dries up. “In the end, a jobless recovery (not U, V or W) is what Americans worry most about,” note the analysts sombrely. 
 
With bad news around, markets remained mired in doom and gloom as fears of a second wave of Covid-19 have caused the modest return of optimism of recent months to dissipate. Blue-chip tech firm Apple has closed 10% of US outlets while Disney has further delayed the screening of its much-awaited Mulan film to 24 July from 27 March. Mistimed comments from Trump aide Peter Navarro that the US-China Phase 1 trade deal was over only further served to sow confusion and volatility into the markets. Pension funds will likely pursue an equity sell-off in the coming weeks after a strong 2Q20 rally. 
 
Wee and Chang see a sharp correction in July for strong forex performers for June and Q2, particularly the Indonesian Rupiah (IDR), Australian Dollar (AUD) and New Zealand Dollar (NZD). The Euro is likely to have more scope for a lower correction than Sterling while the Swiss National Bank has promised to defend the Swiss Franc (CHF) should it fall close to its perceived floor of around EURCHF1.05. 
 
Back in Asia, the analysts have agreed with the Thai government’s prognosis that the Thai Bhat is overbought relative to the Kingdom’s weaker fundamentals. The Philippine Peso is currently holding at a resistance level of PHP50 to the US Dollar. Export-driven currencies like the Korean Won and Singapore Dollar will probably face downward pressures should the NASDAQ fall to sub 10,000 points. Fortunately, presently stable currencies are likely to remain in consolidation. 
 
Despite credit spreads tightening in China since peak panic in March, recovery remains uneven. While investment-grade credit among Chinese USD bond issues has recovered quickly -- 2Q20 issuance has returned to 2Q19 volumes -- high yield USD issuance has not rallied as swiftly following a stagnant April. High yield bond issuance has been concentrated in real estate, implying second-degree segmentation between property firms and the rest of the market. 
 
Weaker Chinese firms are likely to come under pressure as markets remain unreceptive to non-property Chinese high-yield credit -- especially in industries badly hit by Covid-19. An oil field equipment and services provider, for instance, had to default on repayments for maturing USD bonds as it failed to refinance its debt or secured creditor support for a debt swap.   
 
The firm has complained that despite possessing enough cash to repay the debt onshore, they were unable to obtain SAFE approval to remit RMB to repay its USD bond for reasons unknown. DBS suspects that this was because the offering memorandum stated that the money was for offshore rather than onshore use, potentially creating a precedent for a firm to default on offshore bonds and remain current on onshore obligations, calling into question the dictum that China offers better protection to foreign investors than local creditors. 
 
Another potential reason for this reluctance to approve the remission was due to the fear of unchecked RMB outflows from the Chinese market at a time of economic uncertainty, since debtors are likely to remit RMB in large numbers to service high-yield USD bonds with difficult refinancing prospects. The need for financial stability has therefore trumped the desire of individual firms to avoid defaults and even legal action for firms.