Money Matters 10th July 2018

Bank of England Governor Mark Carney delivered a rather upbeat view on the UK economy last week. In the Governor’s opinion, the economic softness observed in Q1 was mostly due to adverse weather conditions and economic momentum which picked up in Q2. He added that recent macroeconomic indicators are in line with the BoE’s forecast presented in the May Inflation Report and that the recuperation should persist thanks to accommodative monetary conditions. Further acceleration in growth, however, calls for tighter monetary conditions. The Governor therefore implied that the long-awaited second 25bp rate hike of the cycle might just be delivered in August thanks to this (perceived) improvement in the macroeconomic environment. The market agrees, with future contract pricing a strong probability of such an increase.
In contrast with the upbeat short-term assessment, Carney pointed out a wide variety of risks that could derail the UK’s economy in the long-run. Such risks are related to on-going global trade tensions and Brexit. Indeed, an example of these risks manifested as David Davis (the UK government’s Brexit secretary) resigned after being side-lined and in disagreement with Theresa May’s “soft” Brexit strategy. However, should the risks subside going forward, the upbeat mood of business leaders, which is reflected in the May PMI figures, together with ongoing weakness in the BP, could translate into additional economic output that could lead to further policy normalisation by the BoE.
S&P 2,760 +1.52%, 10yr Treasury 2.84% -3.84bps, HY Credit Index 345 -10bps, Vix 13.42 -2.72Vol
US equities rallied last week, albeit with defensive sectors outperforming. Although this was a shorter week than usual, since US investors were on holiday on Wednesday, there was a lot for markets to digest:
The Federal Reserve released the minutes of its monetary policy meeting held in June, when the FOMC delivered a 25bp rate hike to lift the Fed’s benchmark rate to the 1.75-2.00% range. In addition, the minutes gave a strong hint that the rate hike cycle will continue this year – especially if the FOMC’s upbeat macroeconomic assessment becomes reality.  Futures markets are already pricing an over 50% probability of two additional 25bp rate hikes for 2018 H2, one in September and one in Q4. As a result, the Fed funds rate could be as high as 2.25-2.50% by the end of this year. The Jerome Powell-led committee tweaked the language of the post-meeting communique, pointing out that global trade risks should not be neglected and as such calling for caution in the conduct of monetary policy.
The US dollar suffered from an underwhelming employment report and also the uncertainties stemming from on-going trade tensions. On Friday, tariff imposition on USD 34bn worth of Chinese imports to the US took effect, to which Chinese authorities immediately reacted by introducing an equal sum of tariffs on US products flowing to China. President Trump not only threatened China with additional, more severe tariffs, but upped the ante by claiming that he stood ready to levy tariffs on circa USD 500bn worth of Chinese goods. This value is equivalent to the total sum of Chinese exports to the US measured in 2017. It’s also equivalent to roughly equivalent to 2.5% of US GDP.
The June jobs report did not help the case of dollar strength either, as employment figures were not seen as convincing enough to serve as evidence for the US economy’s domestic resilience. NFP figures surpassed expectations by coming in at 213K, raising the 3m average to 211K. However, the unemployment rate increased by 0.2ppt to 4%. One could argue that this simply reflected a healthy increase in the labour force participation rate, but currency markets appeared to focus on the negative headline. Indeed, the dollar’s intraday weakness was amplified by continued underwhelming nominal wage growth, at 2.7% YoY.
Of course, June was not the first month when wage growth has disappointed. Indeed, as long as low unemployment does not translate into wage growth, markets may remain sceptical about the potential for inflation and therefore for higher interest rates over the long-term. Clearly, bond market vigilantes are not impressed by recent high-frequency data, which is reflected in the flatness of the yield curve. The 2s10s spread reached new 11-year lows by hitting 28bp on Friday, strongly implying that both the rate-hike cycle and the current economic cycle are nearing the end.
Eurostoxx 3,460 +2.16%, German Bund 0.30% -1.00bps, Xover Credit Index 305 -14bps, USDEUR .850-0.57%
European equities moved higher last week, whilst fixed income markets were broadly unchanged.
ECB-related news dominated the European news flow last week: 

  • Monthly asset purchase (QE) figures released by the ECB revealed that the sovereign portion (PSPP) within the comprehensive programme increased to 83% in June. As asset purchases are phased out by the end of this year, this may see re-investment policy gain further importance and take the place of net asset purchases for the limelight.
  • ECB chief economist Praet delivered a speech in which he reiterated that interest rates should regain their prominent role as policy tools once QE ends. Sentiment is such, that this is unlikely to take place until the second half of the year based on the message delivered by President Draghi at the last press conference, when he emphasised that the policy rate should remain unchanged at least until the end of summer 2019.
  • Resurfacing rumours about the tension between Governing Council (GC) members about the timing of the first rate hike spurred the market to moderately reprice interest rate expectations.Due to the alleged concerns of some members about the lack of interest rate hike expectations, markets brought forward the date of the first expected rate hike from December 2019 to September 2019. These changes in market expectations could be viewed as negligible and do not overwrite the outlook for the Euro Area. Further market speculations about the ECB’s potential monetary policy measures citing that an ‘operation twist’-like programme may be initiated by the GC brought down long-dated sovereign bond yields.

Turkish CPI inflation substantially exceeded market expectations, as it soared to 15.4% YoY in June from May’s 12.15% YoY. Core inflation rose to 14.60% whilst producer price inflation was even more worrying, as June PPI edged up 23.70%, raising red flags about the prevailing inflationary pressure in Turkey.
The central bank of Turkey has to act very cautiously in such a fragile macro-environment. TRY weakness is yet to fully impact inflationary dynamics, and additionally Turkey has quite high gross external financing needs of around 25% of GDP. Consequently, in the context of tightening USD liquidity and global policy normalisation, the Turkish CB could  react by raising rates soon.
Even though inflation reached 5.4% YoY in May, the National Bank of Romania left the policy rate unchanged at 2.5%. The CB governor played down further inflationary risks and cited that the pace of rising consumer prices should slow going forward.
Depending on global market sentiment and domestic inflationary dynamics, the Romanian CB may deliver further rate hikes in the coming quarters. Should the intensity of inflation persist and/or capital outflows from the EM universe intensify, the CB may deliver a hike as soon as August.
HSCEI 10,798 -4.10%, Nikkei 22,052.18 -2.04%, 10yr JGB 0.04% 0bps, USDJPY 110.530 -0.28%
Asian markets continued to take pain last week on account of escalating Sino-US trade tensions with the implementation of Trump’s first round of 25% tariffs on $34bn of Chinese imports weighing on sentiment. The onshore Chinese A-share stock market fell -3.8% over the week, taking the market index below those levels last seen during the 2015-16 panic selloff. Hong Kong indices followed suit, with the HSCEI Index losing -4.1%.
The upcoming high-profile IPO of Chinese tech giant Xiaomi became collateral damage, with negativity on the Chinese market taking the expected valuation down almost 50% from its earlier touted levels of around $100bn. Thought to be trading at a 10% discount in the grey market, what was expected to be one of the stars of China’s ‘New Economy’ has now become a proxy for investor sentiment on the trade war with the US.
While the firing of Trump’s opening salvo on trade was well telegraphed, market sentiment became more negative following the announcement from the Whitehouse of a potential further round of tariffs affecting all $500bn of America’s imports from China. 
Retaliation, insulation and ultimate de-escalation are three possible elements that could allow the Chinese government to avoid an implicit submission to Trump’s accusations of foul play, maintain a domestic economic growth rate conducive to the current five-year plan, while at the same time support China’s attempts to integrate further with the global economic system and join the group of, historically western, voices advocating free trade and integration. 
A key aspect of this final point (gaining acceptance within the global community of major economies as a ‘team player’ within the international system) is the internationalisation of the RMB, for which a stable exchange rate is crucial. This is consistent with comments this week from the PBoC chairman, downplaying the possibility of weaponisation of the RMB. 
Furthermore, Europe has become an interesting chess piece as a result. With Donald Tusk and Jean-Claude Junker both set to visit Beijing next week, China will be hoping to bring Europe onside so as to create a united front against the disruptive force of President Trump.
Philippines inflation rose more than expected in June, with the CPI index hitting 5.2% YOY. At the current rate of price rises, there is potential for a 50bps rate hike from the BSP at the next meeting.
In Malaysia, following the shocking electoral victory of an opposition party for the first time since the country’s independence, former Prime Minister Najib Razak was arrested on corruption charges in relation to the 1MDB scandal.
With over a decade of alleged corruption to unravel at 1MDB, this development is expected to be only the tip of the iceberg in the new government’s anti-corruption campaign. 
India’s Nikkei Manufacturing PMI strengthen in June, to 53.1 versus 51.2 the previous month.
MSCI Lat Am 2,523 +1.85%
Chile’s data for the month of May confirmed the robustness of this cycle. Industrial production and retail sales grew 3.6% and 3.0% YOY respectively. The Business Confidence indicator was 55.1 pts, comfortably in expansionary territory. In the first 5 months of 2018, GDP grew 4.9% YOY, boosted by low inflation, positive external tailwinds and a boost of confidence following Pinera’s election last December.
Peru’s CPI inflation came in at 1.4% YOY in June, coming back within the central bank’s target range (1-3%). Core inflation accelerated to 2.2% YOY due to an increase in excise tax. Peru’s GDP grew above 5% YOY in May, according to the President of the Central Bank.
Absent any major shock, the central bank should keep the benchmark rate on hold at 2.75% for the rest of the year.  
Brazil’s trade surplus reached USD 5.9bn in June, slightly below expectations due the truck drivers’ stoppage in the beginning of the month.  However, industrial production fell 10.9% MOM and 6.7% YOY in May. Activity was heavily impacted by the truck drivers’ strike, which paralyzed the whole country for 10 days.
MSCI Africa 870 +1.33%
South Africa’s private sector activity expanded in June after two months of stagnation. The Standard Bank PMI inched up to 50.9 in June from 50.0 in May.
Elsewhere in SA, domestic vehicle sales figures exceeded industry expectations, growing 3% in June to 46,678 units (June 2017: 45,332). Notably, new car sales improved 4.4% YOY and car rentals recovered 15.1% on the back of fleeting replenishment.
Activity has stalled in recent months with disappointing sets of data including a Q1 GDP contraction stifling some of the optimism generated by Cyril Ramaphosa’s rise to the presidency. The better than expected data on car sales and private sector activity improvement, suggests the slump was temporary and likely signals a return of momentum for the economy.
Egypt recorded a full-year primary budget surplus for first time in 15 years in FY2017-18, achieving a 0.2% primary budget surplus, worth EGP 4mn (USD 223mn). Building on this, the government is aiming for a 2% primary surplus in the current fiscal year, July 2018 to June 2019.
Economic indicators in Egypt ar encouraging; unemployment fell to 10.6% in Q1 2018, GDP growth crossed the 5% threshold and balance of payments recorded to surplus in the last print. The overall budget deficit is expected to come in at around 9.8% in the FY2017-18 fiscal year. This is still too high, but the country is moving in the right direction after an economic crisis in 2016. 
Kenya’s private sector activity grew at a slower pace in June, hit by slower expansion in output and new businesses, with higher food and fuel prices posing a challenge to consumers. The Markit Stanbic Bank Kenya PMI fell to 55.0 in June from 55.4 in May.
Tunisia’s annual inflation rate rose to 7.8% in June from 7.7% in May. Tunisia’s central bank last month raised its key interest rate by 100 basis points to 6.8%, for the second hike in three months to tackle inflation. Government officials expect inflation to reach to about 9% by the end of this year.
This week’s global market outlook is powered by Alquity


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