Money Matters 16th January 2018

The second week of 2018 started where the first left off – with a different flavour of equity market rally. Specifically, with investors increasingly attuned to the risk of interest rate tightening and inflation (oil is now up 50% since June), fixed income sold off to leave bond yields near their highest levels in recent years.
For now, yields remain at very low levels, with the magnitude of recent moves contained. They key factor, will be inflation data, which although suggesting an increased pace of price rises, is still well short of target for most major central banks. Still, the market is at least waking up to the idea that the “perfect calm” cannot last forever.
US markets were closed Monday for Martin Luther King Day.
S&P 2,786 +1.57%, 10yr Treasury 2.54% +6.99bps, HY Credit Index 297 +2bps, Vix 10.16 +0.94Vol
After a 4.2% increase in 10 trading days, the S&P 500 is enjoying its best start since 2003 and closed on Friday at a new all-time trading high. Indeed, last week the US 2-year topped 2% yield for the first time since the GFC and, aside from brief spikes in December 2016 and March 2017, the US 10-year touched its highest yield since September 2014. Looking at rates markets more closely, media reports on Wednesday suggested that China (the largest foreign holder of Treasuries) would slow or halt purchases of US government debt. The State Administration of Foreign Exchange (SAFE) however dismissed these rumours, calling them “fake information”. Nonetheless, the probability of a FED hike in March rose to near 75% after CPI inflation for December came in higher than expectations (2.1% headline and 1.8% core YOY). Retail sales were also better than expected, with the fastest rate of sales growth since 2014.
On Friday, Q4 corporate earnings season kicked off with JP Morgan, BlackRock (beating) and Wells Fargo (disappointing). Next week 28 companies deliver updates and, in aggregate, it is expected to be a quarter of positive momentum with between a 10-12% gain in earnings and every sector reporting profit growth for the first time since 2011. Also next week, Congress must pass a spending bill to avoid a government shutdown.
Eurostoxx 3,613 +0.87%, German Bund 0.58% +14.20bps, Xover Credit Index 228 -7bps, EURUSD 1.222 1.41%
In Germany, a preliminary 28-page agreement between Chancellor Angela Merkel’s CDU and the SPD was announced. This includes tax reform, a commitment to strengthen the EU (as per French President Macron’s proposals) and a cap on refugees to between 180-200k per year. The SPD will now put this plan for a “Grand Coalition” to its membership; first at an extraordinary party conference on the 21st January and then at a referendum (expected sometime in February).
European economic data was mostly positive; industrial production for November accelerating, with German and French numbers both beating expectations, but Italy lagging. As the FT reported on Thursday, the Italian property market is the only one in the EU where prices are still contracting (and have been since 2007). Of greater focus, were minutes to the December ECB meeting, which confirmed a growing consensus across the governing council that growth and inflation are improving. This prompted decent moves in bonds (German Bund yield some 14bps higher over the week).
Whilst the pace of monetary policy change in Europe is likely to be moderate, markets are now starting to price an end to QE in September. This helped push the Euro to a 3-year high against the USD and even prompted the Swiss 10-year yield into positive territory for the first time since October.
Central banks in Israel and Poland left rates on hold at 0.10% and 1.50% respectively.
HSCEI 1,247 +2.05%, Nikkei 2,371.00 +1.47%, 10yr JGB 0.08% 0bps, USDJPY 110.730 -1.70%
Reports emerged last week that The People’s Bank of China instructed local banks to reduce the ‘counter-cyclical factor’ used to calculate their daily contributions for the RMB fixing rate.
The counter-cyclical factor (CCF) permits banks, under the supervision of the PBOC, to embed their views on FX market conditions and broader fundamentals in their submissions to the central bank. Reducing the prominence of the CCF, therefore, is an implicit show of faith from the central bank in the value of the RMB.
Elsewhere, another set of media reports suggested that Chinese policymakers are considering reducing or halting purchases of US treasuries. As above, no credible source was provided for the reports, which were later denied by China’s State Administration of Foreign Exchange.
Consumer price inflation rose moderately in China, up from 1.7% YOY in November to 1.8% in December, with an uptick in food prices contributing to the slight increase. PPI inflation dropped 90bps to 4.8% in December, largely on account of base effects.
Trade growth remained strong in China, with December’s exports and imports growing 12.0% and 16.0% YOY respectively, though both softened slightly from November’s levels. M2 growth came down slightly, from 9.1% YOY in November to 9.0% in December.
Consumer price inflation rose further in India, from 4.9% YOY in November to 5.2% in December. The increase was in line with market expectations and driven by stubbornly high food prices as well as adverse base effects.
In line with the ‘gradual but certain’ thesis on Indian economic recovery post demonetisation and GST implementation, industrial production growth accelerated to a robust 8.4% YOY in December. Versus consensus expectations of 6.0%, the data serves to further degrade any lingering notions that Prime Minister Modi’s reforms irreparably slowed the Indian economy, allowing investors to focus on the transformational impact Modi’s work is having on shaping the long-term path that India will follow.
MSCI Lat Am 2,987 +0.60%
Argentina’s central bank cut its benchmark rate by 75bps to 28%, less than the 150bps consensus estimate and CPI inflation closed the year at 24.8%. After failing to reach its 2017 target (17%) by a wide margin, Argentina’s central bank still lacks credibility, as inflation expectations for 2018 are way above its upwardly revised 15% target. Its high real interest rates failed to offset tariff adjustments (regulated prices increased by 9.8% MOM in December alone, while energy prices increased by 51.6% YOY in 2017).
Chile’s economy grew 3.2% YOY in November, from 2.9% the month prior and inflation remained low and well under control at 2.3%. Moreover, the country recorded a USD 6.9Bn trade surplus in 2017 (from 5.3 in 2016), driven by mining and industrial exports. Last, consumer confidence (53.1pts) returned to expansionary level in December, for the 1st time in more than 3 years.
Better copper prices and a favourable external environment supported the economy during 2017. Chile remains the most stable and advanced economy in Latin America. It is also a country with one of the most mature governance frameworks in EM.
Mexico’s inflation came in at 6.77% in 2017, well above Banxico’s 2-4% target range and surprising once again to the upside. This was mainly explained by the spike of the oil and gas prices and its spill overs at the start of 2017 and the 10.4% minimum wage increase in December 2017. Mexico’s industrial production fell 1.5% YOY in November. 
S&P downgraded Brazil’s sovereign rating from BB to BB-, as progress on the pension reform slows.
Market reaction was subdued, the downgrade was somewhat priced in and “risk-on” assets remain en vogue.
Brazil’s industrial production increased 0.2% MOM in November and 4.7% YOY, beating market expectations, once again. Retail sales were up 1.1% (TTM), in the same month.
The strength of the industrial cycle recovery has been consistently overlooked by market participants in 2017. On the contrary, the rebound in consumption has been consistently overestimated.
Brazil’s inflation closed the year at 2.95%, breaching the lower limit of the tolerance band, explained by the sharpest decline in food inflation since 1989 from +16.8% YOY in August 2016 to -4.85% in December 2017.
Colombia’s 2017 inflation came in 4.09%, above the central bank’s 2-4% target range for the 3rd consecutive year.
The negative output gap and the strong performance of the COP should aid an inflation slowdown ahead, providing an opportunity for easing to support economic activity.
MSCI Africa 1,004 -1.33%
South Africa’s business confidence rose for the second consecutive month in December to 96.3 (vs. 95.1 in November) driven by the outcome of the ANC elective conference which was widely received as business friendly and positive for necessary economic reforms.
Elsewhere in South Africa, it was reported that an early exit of President Jacob Zuma was not discussed at the first meeting of the newly elected ANC NEC. The market was looking to this meeting for evidence of a change in the balance of power within the ruling ANC party, and change in policy direction. The inaction saw the rand weaken by as much as 1.7% midday on Wednesday to 12.53/USD though it closed the week stronger at 12.41/USD.
In Egypt, headline inflation fell sharply to 21.9% YOY in December from 26% in November and 30.8% in October, driven by a decline in food inflation (25.2% vs. 32.3% in November) and non-food items (18.7% vs. 20.1% in November). Core inflation also fell sharply to 19.9% from 25.5% in the previous month.
Staying in Egypt, Presidential elections will be held on 26 – 28 March and the winner announced on 2 April. The official list of candidates is set to be announced on 23 February, however the incumbent President Abdel Fattah Al-Sisi, who won the backing of over three-quarters of parliamentarians for a second term on Tuesday, is expected to win easily.
Moving on to Sponsored Stories Nigeria, Presidential and parliamentary elections will be held on 16 February 2019. Political parties must select their candidates by 7 October while official campaigns will begin on 18 November. The current president, Muhammadu Buhari who took office in May 2015 on an anti-corruption mandate and has spent half of his tenure in a London hospital, has not announced whether he will run, but will most likely be pressured to stand.
In Morocco, a more flexible exchange rate system will be introduced for the dirham. The fluctuation band in which the dirham is traded against hard currencies will be widened from 0.3% either side of the previous day’s close to 2.5%, giving a 5% range in total.
Last, Tunisian annual inflation rose to 6.4% YOY in December, its highest rate since July 2014, from 6.3% in November.

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