Money Matters 13th February 2018

After the volatility explosion of the past 2 weeks, which came after 2 years of market calm and serenity, it would be easy to get carried away. However, the outlook can really be distilled to a single question:
Is enough inflation building to prompt a monetary tightening that will derail the (booming) global economy?
In a word, there is the argument for ‘no’. As Money Matters has repeated over the past few weeks, the US (where there is the greatest potential for higher rates) is in a later cycle than most peers and therefore not a fair proxy for the rest of the world. Indeed, even stateside inflation expectations remain relatively subdued (the 5Y5Y forward inflation swap roughly unchanged over 12 months at 2.39%). However, we should be equally clear that the market has entered a new, more volatile, regime. Central bank liquidity will now be biased to tighten, and every strong data print will have investors considering the negative implications of overheating and inflation. So for now, it could be argued that the build up of such headwinds will be modest and insufficient to stop growth in its tracks.
S&P 2,620 -5.16%, 10yr Treasury 2.88% +1.01bps, HY Credit Index 354 +52bps, Vix 29.06 +11.75Vol
US equities suffered their 2nd consecutive weekly loss and the worst for 2 years. After such extreme low volatility, it is perversely refreshing to report the narrow-focused Dow Jones Industrial Average registered declines of over 1,000 points for the 1st and 2nd time ever during the week, with Monday’s loss the 25th worst day on record. This led to multi-year highs in the VIX. From a sector perspective, no one was spared although energy fared worst given an almost 10% drop in the oil price (WTI trading below USD 60) as US production was reported to have topped 10 million barrels per day.
Despite the price action, fundamental data was extremely positive. At the macro level, the ISM non-manufacturing index reached its highest level in 10 years and weekly jobless claims fell to their lowest since 1973 (when the labour market was a fraction of its current size). Moreover, earnings season continues to progress better than expected; after 70% of the S&P 500 have reported, 81% have beaten expectations (more than normal) and aggregate earnings growth estimates have been upgraded to 14% (the 3rd quarter out of the last 4 with double-digit gains).
Market moves are because of rather than in spite of strong data. Even with safe-haven buying, the US 10-year appears to have settled in a new, higher yield, trading range and the probability of a FED rate hike next month (21st March) was little changed at 72% versus 76% a week ago and 67% a month back. The February employment report released during the first week of March now becomes critical. If average hourly earnings pop above 3%, the US 10 year could break 3% yield.
In the background, Jerome Powell was sworn in as chairman of the FED on Monday. His first major public appearance will be on the 28th February, when he appears before the House Financial Services Committee. Elsewhere in Washington, the House and Senate finally agreed a longer-term budget. After a 2-hour shutdown, a 2-year agreement was signed by President Trump.
Eurostoxx 3,334 -7.53%, German Bund 0.77% -2.20bps, Xover Credit Index 269 -28bps, EURUSD 1.226 +1.67%
In Germany, Angela Merkel finally concluded a new “grand coalition” between her CDU party and the left of centre Social Democrats. The deal is subject to approval by members of the SPD via a postal vote, which will take at least to the end of the month. A part of the deal, the SPD will control the finance, labour and foreign ministries. In addition, the treaty is seen as broadly pro-Europe, which may help French President Emmanuel Macron’s vision of an “ever closer union”.
In the UK, the Bank of England MPC voted unanimously to leave rates on hold at 0.50%. However, the accompanying inflation report was hawkish stating The Committee judges that, were the economy to evolve broadly in line with the February Inflation Report projections, monetary policy would need to be tightened somewhat earlier and by a somewhat greater extent” over the forecast period than anticipated at the time of the November Report, in order to return inflation sustainably to the target.” This raises the prospect of a 2nd rate hike by the end of the summer.
The BOE remains on the back foot, with stubborn inflation forcing a tightening bias. However, the economy is near the bottom of the global pile. This week, the services PMI came in at the lowest level in over a year (compared with a multi-year high in continental Europe).
The Central Bank of Russia cut rates by less than some expected (by 25bps to 7.50%) but struck a dovish tone. The National Bank of Poland left rates on hold at 1.50%.
HSCEI 1,189 -12.06%, Nikkei 2,138.00 -6.66%, 10yr JGB 0.07% 0bps, USDJPY 108.620 -1.20%
Asian markets continued to succumb to profit taking last week, with MSCI Asia Pac ex Japan falling -5.6%, taking the index in to negative territory for the year.
Global factors continue to drive volatility in Asia, with economic growth within the continent itself remaining firm and monetary policy remaining largely benign. The Reserve Bank of India, the only major central bank in Asia that had the potential to signal accelerated tightening in keeping with the Fed’s trajectory, opted for a pause last week.
Chinese H Shares saw the largest correction of any major market globally, with the HSCEI down -12.1%. After a narrow mega-cap rally in 2017, those same stocks took significant pain during the selloff. A Shares fared marginally better, with SHCOMP down -9.6%.
Switching focus from markets to fundamentals, Chinese economic data for 2018 continues to suggest that last year’s positive momentum is continuing, though seasonality effects should rightly dampen any over-excitement.
China’s import growth for January came in at 36.9% YOY, up from 4.5% in December. In 2017, however, Chinese New Year fell in January, whereas this year it falls in February, meaning that January 2018 had a higher number of working days than the corresponding month last year. Even adjusting for this, however, the underlying trend shows acceleration from the previous month, on the back of strong domestic demand. Exports grew 11.1% YOY, up from 10.9% YOY in December.
Inflation in China softened slightly in January. CPI fell from 1.8% YOY in December to 1.5%, while PPI slowed from 4.9% YOY to 4.3%.
The Reserve Bank of India left rates on hold at 6.0% last week.
Inflation accelerated in the Philippines in January, to 3.9% YOY, from 3.0% in December. Despite this, the central bank left rates on hold this week, citing the short term inflationary impact of new tax reform measures, though signaling vigilance in the face of further price pressure in the coming months.
MSCI Lat Am 2,952 -5.95%
Brazil’s central bank cut the SELIC rate by 25bps, taking it to 6.75%, a new historical low.
Since October 2016, the central bank brought the real interest rate from 6.9% to 2.8%, an easing cycle that is nearing the end (as the neutral rate of interest rate is estimated to be around 3% by the central bank).
Chile’s business confidence indicator returned to expansionary territory after almost 4 years, reaching 53.8 pts in January. The 9.8 points increase compared to the previous month is the biggest monthly advance in the index’s history. This publication was accompanied by a good retail sales print for December, coming in at 4.8% YOY in December (from 5.6% in November), above the market consensus.
Peru’s central bank decided to keep the benchmark interest rate on hold at 3.0% despite persistent declines in both headline and core inflation (both standing below the BCRP’s 2% target as of January) coupled with disappointing GDP growth in 4Q17.
Colombia January CPI came in at 3.68% YOY, within the target range of the central bank for the first time since September 2017. This came as a result of a favourable statistical base due to the VAT hike established a year ago, stronger currency and lower indexation mechanisms (like a more moderate increase in the minimum wage in 2018 compared to previous years).
The monetary policy committee may have acted pre-emptively, stating in its last communiqué that they had delivered the last cut of the easing cycle.
Mexico’s gross fixed investment fell another 4.5% YOY in November. The weakest component of domestic demand was dragged down by the fiscal consolidation and uncertainties associated to NAFTA renegotiation and presidential elections.
This confirms the late stage of the Mexican economic cycle, also concomitant with the US cycle. 
MSCI Africa 967 -4.44%
The political impasse in South Africa rumbled on for another week. The State of the Nation address scheduled for February 8 was postponed following 1) calls from factions within the ruling ANC party for President Zuma to step aside for Cyril Ramaphosa, and 2) opposition parties threatening to disrupt the address. In the background, Ramaphosa and the NEC continued engaging with Zuma to force a transition of power before Zuma’s term officially comes to an end next year.
Staying in South Africa, data prints were mixed:

  • Private-sector activity contracted in January for the sixth consecutive month. The rate of deterioration eased to 49.0 in January from 48.4 in December, however the index remained below the 50 mark that separates expansion from contraction.
  • Business confidence rose for a third month in a row in January to 99.7 from 96.4 in December, its highest since late 2015, on expectations that the new leadership of the ruling party will stabilise economic policy.

The outlook for the South African economy in the next 18 months will be driven by the outcome of the negotiations with Zuma. The Rand has advanced c.20% since Ramaphosa was elected president of the ANC in December, while other indicators, though weak, have been ticking up. An early end to Zuma’s tenure will see this positive trend continue, while a continuation till 2019 could see a reversal back to the lows of November 2017.
In Egypt, consumer price inflation fell to 17.1% YOY in January from 21.9% in December. On A MOM basis, inflation contracted 0.2%, while core inflation also fell to 14.4% YOY from 19.9% a month earlier.
Easing inflation is encouraging for the central bank, which has declared its intention to cut rates soon.
Moving on to Kenya, PMI came in at 52.9 points in January, little changed from December’s 12-month high of 53.0. Output rose to its highest reading since January 2016; 57.0 in January from 54.5 in December. This marks the second consecutive month of expansion and compares to the 34.4 reported in October 2017 amid political deadlock after a disputed election.
Lastly, Tunisia’s annual inflation rose to a 20-year high of 6.9% YOY in January from 6.4% in December.

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