The global economy continues to enjoy a growth recovery, with recent data suggesting there has been renewed strength at the beginning of the Northern hemisphere’s summer. However, from a cyclical perspective, there is a clear difference in the maturity of this expansion across different regions:
- North America continues to look late cycle, with interest rates and inflation on an upward trend. Last week, the Bank of Canada raised rates for the first time in 7 years, Mexican inflation touched a near 10 year high and US data continued its tepid trend.
- Conversely, across Emerging Markets inflation is slowing and growth accelerating. Last week, Indian inflation fell to 1.5% and Brazilian inflation touched 3% (both the lowest levels since the 90s). Meanwhile, Chilean inflation also came in lower than expected, Peru cut rates and Chinese GDP growth came in better than expected. This suggests the world’s largest economy will post its first year-on-year growth improvement since 2010.
S&P 2,459 +1.41%, 10yr Treasury 2.31% -5.37bps, HY Credit Index 325 -20bps, Vix 9.77 -1.68Vol
US bonds and equities both posted gains last week as interest rate hike expectations receded following a weak CPI inflation reading and Janet Yellen’s testimony to Congress. Indeed, the trade-weighted USD fell within a whisper of 1-year lows (7% lower YTD).
In terms of the FED Chair’s speech, although the market read a dovish tone, there was relatively little of note. Perhaps of comfort, Yellen stated:
- “Monetary policy is not on a pre-set course…in this regard, as we noted in the FOMC statement last month, inflation continues to run below our 2 percent objective and has declined recently; the Committee will be monitoring inflation developments closely in the months ahead.”
- “Recent readings on inflation are partly the result of unusual reductions in certain categories of prices”.
- There was no reference to asset prices being “somewhat rich”.
However, there was equally a reiteration that further hikes (and a normalisation of the FED’s balance sheet) are likely:
- “It’s premature to reach the judgment that we’re not on the path to 2 percent inflation over the next couple of years.”
- “The Committee intends to gradually reduce the Federal Reserve’s securities holdings…the Committee currently expects that, provided the economy evolves broadly as anticipated, it will likely begin to implement the program this year.”
- Sticking with the FED, there was intense speculation that the Trump administration would nominate former Goldman Sachs President and current National Economic Director Gary Cohn as the next Chairperson (Yellen’s term ends in February). Cohn would be a somewhat controversial choice as he is not a trained economist, but would bring a heightened understanding of financial markets. Certainly, his appointment would be seen as market positive – CNBC’s Jim Cramer claiming it would “add 5% to the S&P”.
In terms of economic data, CPI inflation disappointed (the core measure missing expectations for the 4th month in a row), consumer sentiment and business optimism continued to decline from elevated levels and retail sales also fell. Only industrial production bucked the trend.
The Bank of Canada increased interest rates to 0.75% from 0.50% on Wednesday. Governor Poloz commented “I know not everybody will think a higher interest rate is good news, but it’s a symptom of an improving economy.” The bank expects economic growth of 2.8% this year, and inflation to remain below its 2.0% target.
Eurostoxx 3,527 +2.25%, German Bund 0.59% +2.40bps, Xover Credit Index 243 -11bps, EURUSD 1.144 -0.59%
European equities enjoyed their best week for 2 months. Industrial Production for the Eurozone surprised positively, coming in at 1.3% MOM and 4% YOY for May. This prompted a further rise in German Bund yields to 0.60%, although all other European sovereign yields declined. The ECB meets this coming Thursday. The market expects no change to policy, with guidance on scaling back accommodation coming in September.
Across the channel, it was another tale of woe for the UK. Despite unemployment falling to its lowest level since 1975 (4.5%, equal to the Bank of England’s assessment of full employment), real core wage growth registered its 3rd consecutive negative month and its worst reading in 3 years at -0.6%. This trend is likely to continue over coming months, with the Bank of England forecasting -0.8% growth for the full year. Furthermore, the Bank of England credit conditions report suggested lending standards had tightened during the second quarter and the RICS house price survey showed a decline in house prices.
Despite a weakening overall picture, the MPC is split on interest rate policy. In particular, some members want to hike based on high inflation and a low unemployment rate. Last week Deputy Governor Ben Broadbent stated, “It is a bit tricky at the moment to make a decision” as there are many “imponderables”.
The Bank of Israel kept interest rates unchanged, highlighting near-term downside risks to inflation.
HSCEI 1,077 +4.69%, Nikkei 2,011.00 + 2.26%, 10yr JGB 0.08% 0bps, USDJPY 112.590 -1.10%
Despite Japan enjoying the best growth period for many years during recent quarters, Prime Minister Shinzo Abe’s popularity fell to an all-time low last week (approval rating at 36%), with his ruling LDP losing more than 50% of its seats in the Tokyo Metropolitan Assembly election. On high turnout, Abe’s party won 23 seats, about half the number before this election. The BOJ meets this week.
China’s credit data for June was mixed. New Loans (RMB 1.54trn) and Total Social Financing (1.78trn) both exceeded consensus expectations. However, the overall credit growth rate decelerated from 15.2% YOY in May to 14.7% YOY in June. The credit impulse (defined as three-month total social financing as a percentage of GDP) dropped below the 10-year average. M2 growth registered at a record low 9.4% YOY, down from 9.6% in May.
China’s trade data came in marginally ahead of consensus for June. Exports accelerated from 8.3% YOY in May to 11.3% YOY in June, imports from 14.5% YOY to 17.2%, while the trade balance rose slightly month on month from US$40.5bn to US$42.8bn.
Import strength was attributed to commodity demand as domestic construction activity remained buoyant, while exports accelerated on the back of firm global demand (with the US and Japan among the highest growth destinations for Chinese exports).
PPI inflation in China accelerated from 4.6% YOY in May to 5.5% in June, as factory gate prices showed further strength. CPI came off 10bps versus last month, printing at 1.5%.
India’s CPI inflation rate slowed further, adding to expectations that the central bank (which currently operates the highest real interest rate of any economy in Asia) will resume its interest rate cutting cycle at the August meeting of the Monetary Policy Committee. June’s inflation rate came in at 1.5% YOY, which is outside the Reserve Bank of India’s target band of 4% +/- 2%.
Earlier this year, the RBI signalled a change from an accommodative to a neutral stance and introduced more hawkish rhetoric causing bond yields to spike, before reverting back to dovishness in just a matter of weeks, and rates now appear to be heading lower once again. Implicitly, the RBI will be betting heavily on a strong summer monsoon in their decision to cut rates. Otherwise higher food prices in the second half of the year could rain on their parade and cause the MPC to rethink their approach.
India’s industrial production index grew only 1.7% YOY in May, down from 2.2% in April. The volatile index was likely impacted by destocking ahead of GST implementation on 1st July.
Both Malaysia (3.00%) and Korea (1.25%) left interest rates on hold in line with expectations. Malaysia’s central bank has been on hold for six months, whilst Korea is now not expected to move rates until the middle of 2018.
MSCI Lat Am 2,714 +6.76%
Brazilian assets rallied last week on the back of the labour reform passing in the senate and the conviction of Lula for corruption charges.
Brazil’s Senate approved the labour reform, by 50 votes to 26. Among the main alterations prompted by the reform are:
- The permission for agreements between employer and employees to prevail over the legislation;
- The creation of new types of work contract, including intermittent work;
- The expansion of the possibility of individual agreements, including a 12-hour shift with 36-hour rest; and the establishment of hour banks to compensate overtime without the need for collective bargaining.
- The bill makes it more difficult and expensive to file a suit with the Labour Justice, removes the obligation of companies to negotiate mass layoffs with unions and ends the mandatory nature of the union tax.
This bill does a lot to normalise the Brazilian labour market, making it more flexible. It removes barriers preventing the private sector from hiring. Longer-term, it should lower the structural rate of unemployment.
Former Brazilian President Lula was sentenced to 9.5 years in prison, convicted of corruption and money laundering.
This is a huge blow to his leftist Workers’ Party and its chances of regaining control over Latin America’s biggest country. This news was welcomed by financial markets as it increases the probability of reform continuing beyond the next election.
Brazil’s inflation now sits well below the 4.5% target, around the lower bound of 3.0%. In the 1st half of 2017, the IPCA has climbed 1.18%, far below the 4.42% reported during 1H16. This was the lowest YTD rate for the first semester since 1994.
Mexico’s core inflation for June reached 6.31% YOY, up from 6.16% YOY in May. Headline inflation was 4.83% YOY in June, up from 4.78% YOY in May.
Mexico is the only large Latin American country with increasing inflation and interest rates. In this case it seems this is the symptom of an economy close to the peak of its economic cycle.
Peru’s central bank cut interest rate by 25bps to 3.75% as the supply-side shock of Coastal El Nino is receding and inflation is falling.
Chile’s inflation dropped below the lower bound of the central bank’s 2%-4% tolerance range to 1.7% YOY (from 2.6% a month prior), the lowest annual inflation since October 2013.
Although the central bank kept the benchmark rate on hold last week at 2.5%, an easing monetary policy would be appropriate to support weak economic activity. A comeback of investment and business confidence is likely, following presidential elections in November 2017. Pinera, the market’s favourite, is leading the polls.
S&P lowered the Chilean foreign sovereign long-term debt rating to “A+” from “AA-“. This is in line with the Negative outlook granted in early 2017. The downgrade was priced-in given that Chile’s CDS have been trading well below the “A” countries for several quarters already.
The downgrade shouldn’t have a significant impact as Chile’s net external debt is small, thanks to the FX reserves accumulated in the “rainy day” fund from copper exports.
MSCI Africa 864 +7.08%
The IMF approved the second tranche of a USD 12bn loan to Egypt. The USD 1.25bn instalment was approved on account of Egypt’s “success in pursuing an ambitious economic reform program”, which in recent weeks has included restriction of the bread subsidy programme to save EGP 8bn, a 100% increase in metro ticket prices by 2018, and up to 42% hike on the price of fuel and gasoline.
Egypt’s banking system has attracted more than USD 57bn cash inflows since the EGP float in November, according to the central bank governor. The commitment to fiscal consolidation and economic reform at the government level is therefore beginning to achieve the intended results.
Egypt’s inflation edged up to 29.8% YoY in June from 29.7% in May, but slowed to 0.8% MOM from 1.7% in May. Clothes and footwear jumped to 29.7% from 19.1% YoY, coinciding with Eid holidays when purchases of clothes normally spike. Food and beverages prices slowed to 40.3% YoY from 41.1% in May, while housing and utility costs remained steady at 7.7% YoY.
The South African Finance Minister announced an ambitious 14-point plan to revive the economy. Of note are the plans to recapitalise SOEs through the sale of non-core assets, reduce government guarantees to SOEs, and engage further on the mining charter.
The South African government has suspended the controversial new mining charter pending court ruling on a case brought against the charter by the Chamber of Mines, an industry body. This in a week when the Public Prosecutor backed down from her recommendation to revisit the South African Reserve Bank mandate, acknowledging that she didn’t have the power to convey a “mandatory review” by Parliament to change the Constitution.
Source: Alquity Global Market Update www.alquity.com