>ASIA MACRO & STRATEGY OUTLOOK (CITI)

When it Rains, it Pours

■ The sharp rally in Asian assets is accompanied by both a rapid expansion of domestic liquidity and optimism about Asia prospects “relative” to the rest of the world. While relative growth optimism about the region is valid — strong fiscal, bank and household balance sheets are supportive — lingering risks need to be factored in. A sub-par recovery path in G2 on top of still significant inventory overhang would stall re-stocking momentum, and China’s investment-driven growth engine could worsen excess capacity.

■ Recent data confirm that economies are bottoming in the region. The growth rate bottomed in 4Q08, but even for countries still experiencing sharp contraction in 1Q09, like HK, SG and TW, we expect growth to turn sharply positive on a SAAR basis by 2Q09.

■ We remain fundamentally bullish on Asia FX over the medium to longer term. While we could see a near-term pull-back after a sustained run, we expect the longer-term appreciation story to remain intact on external flows, further anchored by CNY’s growing undervaluation as the dollar weakens. Our most aggressive FX appreciation expectations vs. spot in 12 months are in KRW, IDR and MYR.

■ Forces of “inflation” are currently winning over “deflation” – While we don’t foresee any monetary tightening in the near-term, we remain biased to pay rates (MY, TW) or steepeners (SG, TH) with the exception of IDR bonds, where we like being long on improving IDR sentiment, carry and BI accommodation.

■ Sovereign credit spreads are now close to or even tighter than pre-Lehman levels, so we see little value in going outright short protection on Asia CDS. We see more relative value opportunities with the Indonesia-Philippines CDS spread gap narrowing to 80-100bps and going long cash to play the negative basis.

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