Money Matters 18th December 2018

Markets have been bracing for a recession in the US, and as a result investors have been increasingly selling risk assets. The US Treasury curve has already semi-inverted, as the 2- to 5-year segment flattened, while the 10-year remains barely above the shorter maturities. Both stock and bond markets can be good indicators of future recessions, however, they can also give false signals. Paul Samuelson, a Nobel laurate economist famously quipped that ‘The stock market has called nine of the last five recessions’ implying that stock markets can be overly bearish from time to time and signal incoming recessions at inappropriate times. It is worth acknowledging the downside risks to the current economic cycle posed by the trade war and the tightening cycle of the Fed, and in addition recognise that this is one of the longest-running business cycles in modern economic history. Despite the aforementioned facts, there is a shared view that the US economy is unlikely to slip into a recession over the next 12-18 months, with the base case being a moderate slowdown of GDP growth.
The economic diary for the week ahead is loaded with relevant policy events and macroeconomic data releases. For obvious reasons, the Fed’s monetary policy decision, updated macroeconomic projection, adjusted dot plot and Chair Powell’s press conference are going to be in the limelight. Furthermore, the US authorities release the third print of the Q3 GDP data, and publish the November PCE inflation figure, i.e. the Fed’s preferred inflation gauge. On the other side of the Atlantic, the Bank of England is expected to keep the policy rate stable in the UK.
Within the EM universe, markets will need to digest several central bank decisions. Asian markets will primarily focus on the Indonesia and Taiwanese central banks’ monetary policy decision. In addition, Chinese President Xi gives a speech in which he might signal how the trade discussion between the US and China develops. Latin American investors will focus on the Q3 Argentine GDP release followed by the rate-setting meetings of the Mexican and Colombian monetary authorities. In Africa, the Moroccan central bank will deliver its policy decision.
ISM Manufacturing US ImageUNITED STATES
S&P 2,600 -1.26%, 10yr Treasury 2.88% +4.45bps, HY Credit Index 417 +4bps, Vix 21.63 1.60Vol
Stock markets in the US delivered a rather dismal performance again. The S&P 500 declined 1.3%, while the Nasdaq Composite lost 0.8% of its value during the week. From a sectoral point of view, financial and energy companies received the greatest blow, while utilities held their own. During the week, the US dollar gained, as the broad DXY index rose 1%. Meanwhile, Treasury yields slightly rose, the 2-year tenor increased by 2bp to 2.73%, while the 10-year rose by 4bp to 2.89%, lifting the 2s10s spread to 16bp.
A set of monthly macroeconomic data in the US reaffirmed the case for a rate hike next week:

  • Industrial production growth hit 0.6% MoM SA, while retail sales grew 0.2% MoM SA in November.
  • Headline CPI inflation slipped to 2.2% YoY, due to plummeting oil prices. Meanwhile, core inflation edged up by 0.1ppt to 2.2% YoY.

Although the Markit manufacturing PMI weakened to 53.9, it continued to signal a strong expansion of manufacturing output in the US in the coming months.
Markets Earnings ReliefEUROPE
Eurostoxx 3,081 +0.28%, German Bund 0.25% +0.30bps, Xover Credit Index 339 -8bps, USDEUR .884 +0.77%
Due to the euro’s depreciation vs. the greenback, European stock indices delivered underwhelming returns expressed in USD during the week. As a result, the major stock indices of the four largest Eurozone economies went sideways in USD terms. German Bund yields were broadly unchanged, as the 2-year yield was -0.61% and the 10-year 0.25%.
The European Central Bank (ECB) kept the reference rates stable, in line with market expectations. Furthermore, ECB President Draghi officially announced the termination of the asset purchase programme at the end of December. It appears the President shifted the focus away from net asset purchases and to the reinvestment policy, which aims to maintain the size of the ECB’s balance sheet. The ECB’s staff downgraded the GDP forecast for 2019 to 1.7% and kept it at 1.7% for 2020 – just above the Euro Area’s growth potential. Furthermore, the ECB continues to see inflation to undershoot its 2% target on the whole forecast horizon, i.e. by the end of 2021.
UK Prime Minister Theresa May has won the Conservative Party confidence vote by 200-117 votes. This protects her against another motion from her own party for the next 12 months. However, the Parliament can still vote her out of office with a parliamentary wide no confidence vote. PM May will now try to get ‘reassurances’ from the EU that the Northern Ireland backstop will not last indefinitely.
Asia PacificASIA
HSCEI 10,352 -0.06%, Nikkei 21,506.88 -1.92%, 10yr JGB 0.04% 0bps, USDJPY 113.390 +0.62%
The general investor sentiment in Asian markets was somewhat risk-averse, while there were some exceptions to the rule. The lack of clear direction was also reflected in the MSCI Asia Pacific ex. Japan’s movements, which closed the week down by only 0.5% in USD. Thailand, South Korea and Malaysia underperformed, as their respective indices decreased by 2.4%, 1.8% and 1.6% in USD. In contrast, the Philippines, Taiwan, India and Indonesia rose 0.2-0.4% in USD, respectively.
The second read of the Q3 Japanese GDP was revised downward to -2.5% in seasonally adjusted annualised terms or -0.6% QoQ SA. The detailed breakdown revealed that business investment was significantly downgraded compared to the first estimate, which was adversely impacted by natural disasters. Private consumption was downgraded as well, albeit moderately.
At the CPC Political Bureau meeting, Chinese President Xi reiterated the ‘six stability goals,’ namely; employment, financial market, foreign trade, foreign and domestic investment, and market expectations. This was the first time when an optimal combination of policies were discussed which may signal that local-level policymakers could have more flexibility in the future.
China released a wide set of high-frequency economic indicators for November:

  • Fixed asset investment in China further improved in November, as headline fixed asset investment growth strengthened to 5.9% YoY YTD. Continued strong manufacturing investment growth (9.5% YoY YTD) was the primary driver, while the growth of infrastructure investment (3.7% YoY YTD) and real estate investment remained stable (9.7% YoY YTD).
  • Although retail sales growth in nominal terms slowed to 8.1% YoY in November, from 8.6% YoY in October, sales value adjusted for inflation reflected improvement, to 5.8% YoY.
  • In contrast, industrial production decelerated by 0.5ppt to 5.4% YoY.
  • M2 money supply growth in China remained stable at 8% YoY in November, in line with the median market estimate. The annual rate of money supply growth did not accelerate compared to October, due to the high base a year ago. Meanwhile, total loans grew by 13.1%YoY, matching the pace in the previous month.

The latest monetary aggregates suggest that looser monetary conditions have started to propagate into the real economy, and as a result, the targeted credit extension to private firms and SMEs may continue. The improvement in monetary aggregate growth, however, has not fully materialised in the real economy yet. 
The governor of the Reserve Bank of India (RBI) unexpectedly and abruptly resigned from his position during the week. The outgoing governor, Mr. Patel cited ‘personal reasons’ for his departure. The Indian government and the former RBI governor have not seen eye to eye for some time and this has likely led to his resignation, well before the expiry of Mr. Patel’s mandate in September 2019. Mr. Shaktikanta Das takes over the office, who is a retired career civil servant with significant financial experience.
Headline CPI inflation in India fell to 2.3% YoY in November, to a 17-month low. The deceleration of inflation was broad-based, as both core and non-core inflation contributed to the lower-than-expected inflation figure.
The persistent undershooting of the central bank’s inflation target could open up room for a dovish shift in policy stance as the new Governor takes office. The monetary policy decision in February will not only be dependent on the trajectory of inflation, but also on the fiscal stance and global financial market sentiment. 
The incumbent Indian Prime Minister’s BJP party lost power in all three of the key states in the elections; Madhya Pradesh, Rajasthan and Chhattisgarh. Although the outcome of the elections was in contrast with the market’s expectation that the BJP can retain at least one of the states, it is thought that it should not be a source of concern in the context of the upcoming national election in 2019.
Credit rating agency Fitch downgraded Pakistan from ‘B’ to ‘B-’ with ‘stable’ outlook. Fitch cited that Pakistan has low reserves, high external debt, while the country’s position remains weak. In addition, the public to GDP ratio has been on the rise, which may continue without a credible fiscal reform package in place.
MSCI Lat Am 2,549 -1.60%
Latin American markets had a challenging week, as the majority of stock indices finished the week in the red. The broad MSCI EM Latin America index reflected the bad investor sentiment, as the index declined 1.6% in USD. The Chilean market outperformed by going sideways, while the Colombian benchmark underperformed, losing 4% of its value in USD.
The central bank of Peru kept the policy rate at 2.75%, in line with market expectations. According to the statement released by the Monetary Policy Committee (MPC), underlying inflation gauges are within the range around the 2% target, while economic activity indicators show an improvement in Q4. The MPC pointed out that economic activity continues to be below its potential.
In line with the median market estimate, the Brazilian central bank kept the policy rate stable at 6.5% for the sixth consecutive meeting. The MPC released an updated inflation forecast in which the inflation estimate for 2019 was slashed to 3.9-4% (below the midpoint of the central bank’s inflation target band of 4.25% for next year).
By reducing next year’s inflation forecast, the Brazilian central bank sends the implicit message to the market that the probability of a rate hike over the coming quarters has substantially decreased.
Annual growth of industrial production in Mexico decelerated in October. Industrial output grew 1% YoY, vs. 1.8% YoY in September. Adjusted by calendar effects, the deceleration of industrial activity was even sharper, to -0.1% YoY, from 2.6% YoY in September. The detailed breakdown reveals that mining activities continued to contract, while construction activity decreased.
Argentine CPI inflation rose to 48.5% YoY (3.2% MoM) in November. Since the beginning of the year, consumer prices rose 43.9% YoY. Meanwhile, core inflation hit 46.2% YoY. The persistently elevated core measure indicates that the pass-through of currency weakness continued to impact consumer prices in November.
MSCI Africa 749 +0.89%
African stock markets also performed poorly during the week, with the majority of the stock indices decreasing in USD terms. The underperformance by Kenya and Morocco were the most noticeable, as their respective indices declined 2.2% and 1.6% in USD, respectively. In contrast, Egypt was the brightest spot within the African space, as the country’s broad stock index rose 5% in USD.
CPI inflation in Egypt slowed more than expected in November, as the headline rate slipped by 2ppt to 15.7% YoY, returning to the central bank’s target range of 10-16%. Meanwhile, core inflation – filtering out impact of unprocessed food, energy and regulated prices eased by 0.9ppt to 8% YoY, to a two-year low. Fruit and vegetables prices were the primary drivers of easing inflationary pressure in November.
Easing domestic inflationary pressure is good news for the central bank of Egypt, as the monetary authority has gained additional room for policy manoeuvre to refrain from tightening financial conditions.
Consumer price inflation quickened in South Africa, as headline inflation rose 0.1ppt to 5.2% YoY in November. The core measure accelerated to a greater extent, by 0.2ppt to 4.4% YoY. The acceleration was primarily due to food and transport prices, while services price inflation remained contained.
Meanwhile, South African retail sales volume growth bounced in October, hitting 2.2% YoY (0.6% MoM SA) after contracting in September (-0.7% MoM SA). Manufacturing output growth also beat expectations, with the rate of growth strengthening to 3% YoY in October.
Nigeria’s GDP expanded 1.8% YoY in Q3, strengthening from previous quarter’s 1.5% YoY pace. The bounce was mainly led by non-oil manufacturing activity. Agricultural activity and services strengthened as well, while construction weakened compared to Q2. Overall, the Nigerian economy grew 1.8% YoY in real terms in the first three quarters of this year.
Nigerian real GDP growth is likely to gain further momentum in Q4 and throughout 2019, especially after the elections, when policy-related uncertainties are likely to fade. This in turn could strengthen business confidence and economic activity. According to Nigeria’s Minister of Budget, GDP may grow by 2% this year and 3% next year.
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