RINGING THE CHANGES
At the beginning of this year, consensus expected a re-acceleration in US growth led by Trump tax reform and fiscal stimulus. As such, many predicted fixed income would deliver a negative return and that the USD would strengthen (hurting emerging markets). Moreover, there was a fear of inflation due to tightening labour markets.
The reality has been quite different. Economic data has consistently disappointed in the US, versus broadly improving elsewhere. Meanwhile, inflation has remained subdued everywhere. As a consequence, the US 10-year has fallen from 2.45% to 2.05% yield (despite 2 rate hikes) and the USD has lost over 10% of its value on a trade weighted basis.
Whilst equity valuations remain full, markets can now be considered to have priced out any acceleration in growth. Indeed, the outlook for monetary policy is as uncertain as it has been at any time over the last 12 months. Last week, Vice Chair Stanley Fischer tendered his resignation from the FOMC (effective mid-October, having been due to leave in 2020). He stated this was for “personal reasons” but it came less than a month after he called efforts to loosen constraints on banks “dangerous and extremely short-sighted”. There were already 3 out of 8 seats on the Board of Governors vacant and it is thought extremely unlikely that Janet Yellen will be reappointed in February (since Donald Trump openly attacked her on the campaign trail). Therefore, we will likely see a very different FED over the next few years. The exact mix of replacements will be significant for policy. Moreover, investors should reflect as to whether there is increasing evidence that Trump’s fractious leadership is impairing decision-making and, ultimately, growth.
S&P 2,461 -0.61%, 10yr Treasury 2.08% -11.50bps, HY Credit Index 337 +11bps, Vix 11.29 +1.99Vol
Last week, the yield on the US 10-year touched its lowest level since before the November 2016 Presidential elections. This came after 2 of the biggest doves on the FOMC questioned the need for further hikes – Minneapolis Federal Reserve Bank President Neel Kashkari saying that recent Fed rate hikes have been detrimental to the U.S. economy and Governor Lael Brainard commenting “My own view is that we should be cautious about tightening policy further until we are confident inflation is on track to achieve our target.”
After Hurricane Harvey wreaked havoc across the Gulf Coast of Texas, Hurricane Irma, the Category 5 storm that caused unprecedented damage in the Caribbean, made landfall in Florida on Sunday. Despite the largest mass evacuation in US history, 3 million people are said to be without electricity. However, the worst case was probably averted as the eye of the storm missed Miami. US 3rd quarter GDP will be negatively impacted by this severe Hurricane season. However, the twin disasters did help avoid a government shutdown as President Trump struck a deal with congressional Democrats to extend the debt ceiling for 3 months – in part to provide disaster relief.
The Bank of Canada raised rates for the 2nd consecutive meeting (to 1%), prompting a sharp move higher in the CAD. The move was only priced at a 40% probability and comes on the back of consistent economic outperformance, with a surging housing market and unemployment at the lowest rate since 2008 (6.2%).
Eurostoxx 3,476 +1.53%, German Bund 0.33% -6.70bps, Xover Credit Index 230 -0bps, EURUSD 1.201 -1.47%
At last week’s ECB meeting, the ECB left policy unchanged but (as expected) confirmed that QE will be “recalibrated” in October. In practice, this is likely to mean a reduction in monthly purchases and perhaps some technical changes to the buying mix. Most notably, Mario Draghi’s statement and Q&A focused on the exchange rate (the EUR is 12.6% higher against the USD this year):
- “The recent volatility in the exchange rate represents a source of uncertainty which requires monitoring with regard to its possible implications for the medium-term outlook for price stability.”
- “The exchange rate is not a policy target. But it’s also – it’s very – it’s important and very important for growth and inflation.”
Despite these comments, the EUR finished higher on the week. Moreover, due in part to currency strength, the ECB downgraded its inflation forecast for the full year to 1.2% (from 1.3%).
Catalonia officially set the 1st October as the date for their independence referendum. This has caused much anger in Madrid, with Prime Minister Mariano Rajoy vowing to “stop at nothing” to derail the vote and Spain’s Constitutional Court suspending the referendum law. The Mayor of Barcelona has also refused to allow use of its voting centres.
This week, there is an MPC meeting in the UK at which no change in policy is expected but the committee could make hawkish comments given Sterling’s continued depreciation and the associated risk of higher inflation. There are also central bank meetings in Russia and Turkey. Last week, the National Bank of Poland left rates on hold at 1.50%.
HSCEI 1,122 -1.02%, Nikkei 1,954.00 +0.07%, 10yr JGB 0.01% +0bps, USDJPY 108.440 -2.20%
Having run close to a 10% YOY growth rate for much of the first half of the year, China’s exports slowed in August to +5.5% YOY (below consensus of 6.0%) from July’s growth rate of 6.8%. Within the overall figure, exports to G3 nations decelerated notably from 9.1% YOY in July to 6.1% in August. Appreciation of the RMB (up 4% against the dollar since July) and high base effects exacerbated the trend.
China’s Imports grew faster than the market had expected in August, at 13.3% vs consensus forecasts of 10.0%. In addition to stronger domestic demand, the higher value of commodity imports was a key factor, with the value of imported coal and copper rising 43.3% and 26.5% YOY respectively, driven more by price rises than volume.
The resultant trade balance for China in August came in at US$42bn, lower than consensus of US$48bn, and down from the $47bn surplus recorded in July.
China’s foreign reserves rose US$11bn in August to $3.09trn. What was the zeitgeist data point for much of 2016, the fact that the market now pays very little attention to China’s monthly foreign reserves demonstrates the amount of confidence the central bank and broader set of government policymakers have been able to restore in the RMB. The weak dollar, admittedly, has played a significant helping hand in this process.
After a presidential impeachment, the sacking of the head of the central bank and seemingly unstoppable bleeding of foreign reserves, Pakistan’s economic situation took another turn for the worse when the official data showed that the government has been running a much higher fiscal deficit than forecast, at 5.8% of GDP for the last 12 months versus the initial 3.4% target.
Inflation in the Philippines ticked up to 3.1% YOY in August from 2.8% in July.
In Indonesia, inflation came off slightly, dropping from 3.9% in July to 3.8% in August.
The central bank of Malaysia left interest rates on hold at 3.0% in line with expectations. The accompanying statement was bullish on the prospects for the economy while downplaying inflation risks.
MSCI Lat Am 2,942 +1.02%
Brazil’s GDP grew 0.3% YoY in 2Q17, the first positive variation since 1Q14. This performance was led by consumption which benefited not only from lower interest rates and labour market stabilisation, but also from the one-off effect of the release of inactive FGTS accounts (injecting approximately BRL 44Bn into the economy). The trade balance contributed positively to growth again. QOQ GDP growth (0.2%) decelerated from 1.0% in 1Q17 mainly because the agricultural sector was not able to repeat its stellar performance and remained unchanged after surging 11.5% QOQ in 1Q17.
Last week brought a set of new development in the political and judicial saga in Brazil:
- New evidence was handed to the Prosecutor General, that shows omissions in the previous recordings, obstruction to justice and corruptions of several judges by the Batista’s brothers. The Batista’s plea bargain could be revoked and the case against President Temer is weakened.
- The Prosecutor’s office submitted charges to Supreme Court against politicians linked to the PT party, including former presidents Luiz Inacio Lula da Silva and Dilma Rousseff, accused of participating in a corruption scheme at state-owned company Petrobras.
Brazil’s central bank cut the SELIC overnight rate by 100bps to 8.25%, in a unanimous vote. The communiqué suggests the plan is now to slow down the pace of easing moderately. Consensus is for a 75bps next meeting and the SELIC rate reaching 7% by the end of the year.
Brazil’s falling inflation and set of structural reforms triggered the sharpest fall in real and nominal interest rates (600bps so far) of any large country in the world in the past 12 months.
Brazil’s August inflation declined to 2.46% YOY (vs. July 2.71%), the lowest print since February 1999.
Brazil’s Industrial production is sharply rebounding, posting another rise of 0.8% MOM in July, bringing the YOY growth to 0.9% in 7M17. On a YOY basis, industrial production grew 2.5%, as capital goods jumped 8.8% and durable consumer goods increased 8.1% YoY.
Chile’s Business Confidence edged up to 43.2 in August. Although this is the 41st consecutive month in pessimistic territory (below 50), we observe sequential improvements. The indicator gained 3pp from the prior month (42.4) and from a year ago (40.2). This was the 6th consecutive month of YOY improvement.
Colombia’s annual inflation accelerated to 3.87% in August, still within the central bank’s target range (2-4%), after reaching a minimum of 3.4% in July.
Mexico’s annual inflation cranked up again at 6.66% YOY in August, up from 6.4% in July. However, CPI inflation should stabilise in the coming months as the MOM inflation is slowly declining.
A major 8.1-magnitude earthquake hit Mexico’s southern coast on Friday and killed at least 5 people. It was the biggest in a century to hit the country. The full extent of human casualties is still unknown. Its impact on the economy and markets is still uncertain.
MSCI Africa 896 -2.07%
South Africa exits recession – the economy grew 2.5% in 2Q17 (1.1% YOY) following a 0.6% contraction in 1Q17, and marginally beat expectations (c.2.3%). The main positive contributions came from agriculture which grew 33.6% (following a good maize harvest) and contributed 0.7% to GDP growth, and finance, real estate and business services which grew by 2.5% and contributed 0.5%. In contrast, general government services decreased by 0.6% and made a 0.1% negative contribution to GDP growth.
Other data prints suggest that the recovery is fragile; private sector activity contracted (49.8 in August compared to 50.1 in July), business confidence fell to a 30 year low (89.6 in August vs. 95.3 in July), and industrial output fell for a third consecutive month, dropping 1.4% YOY in July (vs. consensus of a 0.35 percent contraction).
Nigeria exits recession – after five consecutive quarters of contraction (1.58% total contraction in 2016), the Nigerian economy grew 0.55% YOY in 2Q17, 1.46% higher than the preceding quarter (revised to –0.91% from –0.52%), but c.1% lower than expectations. The oil sector, Nigeria’s largest growth driver, grew 1.64% on the back of increased production (9.1% YOY growth in oil production to 1.68 million barrels per day), while the non-oil sector grew 0.45%, 0.38% YOY increase but -0.28% lower than Q1 2017.
In Egypt, CPI fell to 31.9% YOY in August from 33.0% in July. Core inflation decreased to 34.9% percent from 35.3%. Also, non-oil private business activity’s contraction narrowed to 48.9 in August (vs. 48.6 in July) on the back of a pick-up in export orders which reached a record high in August, the Central Bank has cleared its multibillion dollar foreign currency backlog and is now meeting new requests without delay, while tourism revenues rose 170% YOY in 7M17 to USD3.5bn and the number of tourists rose 54% YOY in the same period to 4.3 million (though well below the 14.7 million peak in 2010).
In Kenya, the electoral commission has set October 17th 2017 as the date for the repeat presidential elections. Business conditions have however deteriorated on the back of the electoral uncertainty; private sector activity slid to 42.0 points in August from 48.1 in July, the lowest level since the series began in 2014.
Source: Alquity Global Market Update www.alquity.com