Money Matters 17th April 2018

After a vicious rally and equally potent sell-off at the start of this year, equity markets have oscillated uneasily with no clear direction. The economic cycle has matured, with the US late cycle, and although some emerging countries remain in a “sweet spot”, the general picture is now of higher volatility and a more classical inverse relationship between bonds and equities. Of course, every period of history has its own peculiarities. Today, the unorthodox and tweet-based interventions of the US president represent such a variable, with the ability to shape market direction over a daily time window. In this sense, last week was a good representation of the paradigm markets are in; equities rising over the week, bonds modestly lower and the overall direction punctuated by political sound bites. Actually, there was a more sinister tone to the news flow with tensions building between the US and Europe on one side and Russia on the other over an alleged chemical weapons attack by the Assad government in Syria. This led to an allied response of more than 100 missiles on government facilities in the early hours of Saturday morning. Whilst Russia condemned the attacks, it stopped short of using its air defenses or threatening retaliation.
Elsewhere, oil prices posted a strong rally, (best weekly performance in 8 months) rising to their highest level since 2014. Latest gains came amid the rising geopolitical tensions in the Middle East and an IEA report that estimated global inventories have fallen back to their 5-year average. However, they were in spite of US crude production touching a record high, with output now greater than that of Saudi Arabia, and the US rig count still rising.
S&P 2,656 +1.99%, 10yr Treasury 2.85% +5.32bps, HY Credit Index 339 -13bps, Vix 17.41 -4.08Vol
Amid continued higher volatility, US equities rallied, bonds ended lower and the yield curve flattened.
From a trade perspective, Donald Trump appeared to soften his stance over the weekend, tweeting “President Xi and I will always be friends, no matter what happens with our dispute on trade. China will take down its Trade Barriers because it is the right thing to do. Taxes will become reciprocal & a deal will be made on Intellectual Property. Great future for both countries!” However, he followed up on Monday with more sabre rattling: “When a car is sent to the United States from China, there is a Tariff to be paid of 2 1/2%. When a car is sent to China from the United States, there is a Tariff to be paid of 25%. Does that sound like free or fair trade. No, it sounds like STUPID TRADE – going on for years!”. At the Boao forum on Tuesday, his Chinese counterpart was more conciliatory promising to ease access to a number of sectors and to protect intellectual property in a “new phase of opening up.” Later in the week, Trump suggested he would be open to re-joining the Trans-Pacific-Partnership, an agreement he previously called a “rape of our country”. This was met by a cool response from its members.
On Friday, Q1 earnings season kicked off in earnest with a number of major US banks reporting. For the quarter overall, analysts expect an extremely buoyant 17.1% YOY increase in earnings with recent tax cuts temporarily boosting profit growth. As it pertains to Friday’s numbers, JP Morgan, Wells Fargo and Citigroup all beat estimates, but traded lower on the day. This was because exceptional items and capital markets masked weakness in loan growth and net interest margins. Next week, Bank of America will report, alongside tech stalwart Netflix. We also have retail sales for March.
Eurostoxx 3,451 +1.71%, German Bund 0.54% +1.40bps, Xover Credit Index 276 -10bps, USDEUR .811 -0.41%
Equities rose and bonds modestly sold off across core European markets. This was despite industrial production numbers that confirmed a slow start to the year (-0.8% MOM for the Eurozone and 0.1% MOM for the UK for February).
Elsewhere, Russian equities and the Rouble sold off precipitously after the US imposed further sanctions. Indeed, the Rouble traded at its weakest level against the USD since 2016, whilst Rusal, the second largest aluminium producer in the world, lost over a third of its value. If currency weakness persists, it is likely to spur inflation and put the country back in the uncomfortable situation of “stagflation”. On Sunday, the US ambassador to the UN suggested that yet another round of sanctions will be announced within the next 48 hours. Relatedly, and also because of concerns over the independence of the central bank, the Turkish Lira hit all-time lows for 5 days in a row to Wednesday in what president Erdogan called an economic attack by enemies of the state. The government is currently pursuing a “high growth at any cost” policy, which is creating an unsustainable inflation and current account position. To retain some credibility, the central bank needs to raise rates, but the government is extremely resistant, and the corporate sector is leveraged and susceptible to a rate rise.
HSCEI 11,965 +2.43%, Nikkei 21,835.53 +0.71%, 10yr JGB 0.05% 0bps, USDJPY 107.260 +0.40%
China’s President Xi calmed markets with a speech at the Boao Forum, using the platform to discuss further opening up of the Chinese economy, rather than trade tensions with the US.
The speech was fairly light on specifics, other than the pledge to liberalise foreign investment in the auto sector by the end of 2018. Otherwise, this was largely a reiteration of previously established big picture objectives, including opening up the financial services industry, greater enforcement of intellectual property rights and to make China a generally more attractive destination for foreign investment.
The calming effect of the speech came from both the actual content as well as which issues were ignored. The fact that Xi simultaneously reiterated China’s intentions towards further trade liberalisation, whilst also choosing not to add further heat to the US trade dispute, proved to be a powerful combination for propping up sentiment.  
On the data front, the Chinese economy had mixed performance in March. Import growth accelerated from 10.0% YoY last month to 14.4%, while exports flipped from an 11.0% growth rate to a decline of 2.7%, with weaker external demand the only significant factor. M2 growth slowed more than expected, from 8.8% YoY to 8.2%, with central bank officials highlighting the decline as being purely a seasonal phenomenon, rather than being symptomatic of a deliberate policy tightening initiative. Inflation decelerated more than the market expected, with CPI declining from 2.9% to 2.1%.
India’s headline inflation rate fell in March, though core inflation rose. The headline CPI inflation rate fell from 4.4% in February to 4.3% in March, hitting a five-month low. Core inflation, however, increased from 5.2% to 5.4%,  with the services sub-index creating upward pressure. Our outlook for a data dependent RBI with a neutral to tightening bias remains unchanged. 
A weaker mining sector dragged India’s industrial production growth rate down slightly in March, to 7.1% YoY from a revised 7.5% in February.
Bank of Korea left rates on hold at 1.50%, in line with expectations.
MSCI Lat Am 3,027 -0.08%
Last week was rich in inflation data across Latin America, with a confirmation of disinflationary trends mostly explained by
negative output gaps in most of the region excluding Mexico and Argentina:

  • Chile’s inflation decelerated further to 1.8% in March, below the central bank’s 2%-4% target range. Inflationary pressures remain contained as the stronger CLP keeps tradable inflation low while the negative output gap (spare capacity in the economy) and indexation lead to low non-tradable price increases.

Rates should remain stable in the foreseeable future despite the economic acceleration.

  • Colombia’s inflation slowed to 3.14% YOY in March from 3.37% in February, coming in well below expectations
  • Brazil’s inflation slowed to 2.68% YOY in March
  • Mexico’s inflation continued decreasing in March to 5.04% YOY and core inflation decreased to 4.02%, due to a stronger MXN and the fading impact of the gasolinazo, last year’s tax levy on energy products

Although inflation data points to an end of Mexico’s hiking cycle, monetary policy will depend on the outcome of NAFTA negotiations and the presidential elections, due to their potential impact on the MXN and therefore on inflation.

  • Argentina’s inflation remains excessive at 25.4%, continuing to surprise on the upside and far from their targeted 15% rate for 2018

Chile recorded the largest trade surplus in a first quarter since 2011 with a USD 3.2bn surplus. Mining exports were the main driver of Chile’s strong Q1, however it was strongly supported by agriculture and industrial exports.
Brazil’s presidential campaign officially started last week with the deadline to register as a candidate for the Presidential race resulting in the following individuals leaving their executive positions to join parties:

  • Henrique Meirelles joined the MDB (former PMDB) and stepped down as Finance Minister
  • Former Supreme Court President Joaquim Barbosa, who became well-known by the general public in Brazil when he was rapporteur of the “mensalão” political scandal of 2006, joined the PSB
  • Geraldo Alckmin and Joao Dória (PSDB) resigned from São Paulo governor and mayor position, respectively
  • Lula (PT) is in jail and his arrest has been confirmed by several Courts now, making it almost impossible for him to run for President
  • Jair Bolsonaro, a former military and extreme right candidate, will also be an important protagonist of this campaign
  • TV presenter Luciano Huck did not join a political party, therefore will not run

The only uncertainty is around the participation of President Temer, as he is not forced to step down 6 months before the election like other candidates.
MSCI Africa 966 -0.21%
Egypt’s headline inflation eased to the lowest rate in almost 2 years. Annual urban consumer price inflation in March fell to 13.3% YOY from 14.4% in February and a record high of 33% in July 2017. Core inflation fell to 11.6% YOY in March from 11.9% in February.
Inflation falling within the central bank’s target range of 13% +/- 3 percentage points increases the probability of a rate cut. However, with demand expected to pick up before Ramadan and further subsidy cuts in the pipeline, the central bank is likely to wait till the second half of the year to continue the easing cycle, which has already seen a 200bps decline in rates. 
Nigeria annual inflation slowed for the 14th consecutive month, by 100bps to 13.3% in March. Food inflation fell to 16.1% from 17.6% and core inflation fell to 11.2% from 11.7%.
South African mining production increased 3.1% YOY in February beating consensus expectations of 2.6%. The main contributors to growth were the 42.9% increase in diamond production, contributing 2 percentage points, the 10.5% increase in iron-ore output, which contributed 1.5 percentage points and the 24.3% growth in manganese ore production, adding 1 percentage point. Seasonally adjusted mining production increased 0.9% MOM in February from January, following MOM changes of 1.7% in January 2018 and -4.1% in December 2017.
The positive print comes before a new mining charter, expected by May, which in keeping with what the Ramaphosa administration has done to date, is expected to provide policy and regulatory certainty and restore confidence to the sector. Global concerns aside, the South African mining industry could be set for a positive year. 
South African manufacturing production increased 0.6% YOY in February, below consensus expectations of 2.7%. The overall growth was due to higher production of food and beverages, glass and non-metallic mineral products, motor vehicles, parts and accessories and other transport equipment, while petroleum, chemical products, rubber and plastic products contracted. Seasonally adjusted manufacturing production decreased 2.4% MOM in February, following MOM changes of -1.6% in January 2018 and 1.0% in December 2017.
Manufacturing accounts for c.13% of South Africa GDP. The decline in rate of growth suggests the positive sentiment in the country is still tentative and has not crystalized into more activity. 
Moroccan GDP growth slowed to 2.9% YOY in Q1 2018, down from 3.8% in same period last year, driven by a decline in agricultural output by 0.5% YOY in Q1. The non-agricultural sector grew 3.2% YOY in Q1 up from 2.4%, boosted by mining activities and market services.
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