Money Matters 18th September 2018

Risk aversion in global markets faded by the end of last week, due to several coinciding factors:

  • Trade tensions eased, as the US and China signalled that they might (or might not) continue negotiations on tariffs and the conduct of international trade.
  • The release of lower-than-expected CPI inflation in the US implied that current inflationary developments in the US do not call for aggressive monetary tightening by the Federal Reserve, which in turn depreciated the USD compared to the beginning of the week.
  • Sentiment was lifted by interest rate hikes carried out by the Turkish and Russian central banks that helped the recovery of both nation’s currencies.

Discussions on trade tariffs will continue to weigh on global market sentiment, which may hinder asset price recovery in the EM universe. From a fundamental point of view, economic growth has not been visibly hurt yet and tariffs are unlikely to cause any substantial disruption that could derail the global growth momentum. A Goldilocks scenario may not return in the strict sense, but once global market sentiment clears, asset prices could benefit from a low inflation and high growth environment.
Looking ahead
All eyes remain on the US and China and whether the administrations of the two countries will continue trade discussions. The economic diary for developed markets is relatively light this week, as neither major policy events nor highly relevant macroeconomic data are scheduled. In the Euro Area, the event of greatest market-moving potential will be a speech delivered by ECB President Mario Draghi, who may provide further colour on the reaction function of the ECB’s decision-making body. The Japanese counterpart of the ECB holds its usual rate setting meeting on Wednesday, where the MPC is unlikely to change the course of monetary policy. In the US, data releases will be scarce, since only the current account balance and PMI figures will be revealed. However, both are unlikely to drive markets.
The Asian economic calendar is almost completely empty, since the Thai central bank’s monetary policy meeting and Malaysian inflation from August bear the potential to have an impact on financial markets. Latin American markets will continue to focus on the political polls and related news flow in Brazil. In addition, the Brazilian central bank is scheduled to hold a rate setting meeting, where no rate moves are expected. Argentina will release Q2 GDP figures, which are likely to reflect the underlying weakness of the Argentine economy. At the end of the week, South Africa releases inflation figures, which will be followed be the monetary policy decision of the South African central bank.
US Equities 18 Sept 2018UNITED STATES
S&P 2,905 +1.16%, 10yr Treasury 2.99% +5.71bps, HY Credit Index 317 -12bps, Vix 12.71 -2.81Vol
US equities visibly benefitted from the recuperation of risk appetite by market players, as almost all major US stock indices gained during the week. The S&P 500 rose almost 1.2%, while the Nasdaq Composite gained more than 1.3%. The broad dollar index (DXY) last about 0.5% of its value due to the lower-than-expected CPI inflation reading that spurred market players to adjust their expectations for the Fed funds rate’s forward-looking trajectory. The improvement in global market sentiment was also reflected in the US Treasury yield movements, as the whole yield curve shifted up, due to abating of flows seeking safe haven assets. By the end of the week, the 10-year yield rose 6bp and hit 3%.
High-frequency data in the US underwhelmed in August, as both inflation and retail sales data were below the Bloomberg consensus. Headline CPI inflation eased to 2.7% YoY, while the core inflation measure slipped to 2.2% YoY. Furthermore, retail sales volume rose only 0.1% MoM.
Weakness in both inflation and retail sales imply that the underlying inflationary pressure is not too strong and does not call for aggressive monetary tightening by the Fed. That thought held the market back from breaching the 3% threshold for the 10-year US Treasury.
Europe 18 Sept 2018EUROPE
Eurostoxx 3,339 +2.23%, German Bund 0.45% +6.30bps, Xover Credit Index 282 -9bps, USDEUR .860 -0.68%
European markets were buoyed by the risk on mood, which was amplified by the relatively dovish comments by ECB President Mario Draghi, who reiterated the need for a sustained and substantial monetary accommodation. Due to the stronger risk appetite, the major indices of the big four economies rose, and this was amplified by the strength of the euro vs. the dollar. The bounce in risk sentiment also re-directed from safe haven assets, i.e. German Bunds, to riskier assets on the periphery of the Euro Area, such as the Italian and Portuguese bond markets. As a result, the Italian spread over the 10Y German Bund of 0.45% shrank to 253bp.
The European Central Bank remained on hold, not changing the policy rate and leaving forward guidance unchanged. President Draghi emphasised that, in the Governing Council’s view, the Euro Area’s economy is on track and will deliver strong GDP growth figures, while inflation may gradually converge to the ECB’s target. Compared to the previous meeting, the Governing Council tweaked the language related to the termination of the asset purchase programme by including data dependency to actually end monthly net purchases in December.
The Russian central bank caught market players off-guard by lifting the policy rate 25bp to 7.50%. According to the MPC, the deterioration of the inflation outlook called for tighter monetary conditions. After the announcement was made, the RUB gained vs. the USD.
The Turkish central bank delivered a drastic rate hike of 626bp, as the MPC raised the policy rate to 24% in response to mounting inflation and currency weakness. Turkish markets reacted positively to the policy measure, as domestic asset prices gained after the announcement.
Both central banks’ policy moves to tighten financial conditions, contributed to the improvement in global market sentiment. 
A supermajority of Members of the European Parliament (MEP) approved the report prepared by MEP Sargentini, which found that Hungary and its government do not fully adhere to the EU’s common values. There are no practical consequences of the report being approved.
Asia Pacific 18 Sept 2018ASIA
HSCEI 10,446 +0.19%, Nikkei 23,094.67 + 2.60%, 10yr JGB 0.12% +0bps, USDJPY 111.910 +0.91%
Asian markets greatly benefitted from the improvement in global market sentiment. As a result, the MSCI Asia Pacific ex. Japan index gained 0.71% in USD during the week. The Indonesia, Vietnamese and Thai indices clearly outperformed their Asian peers increasing between 2.4-2.6% in USD. The Philippine market underdelivered, as the economy still faces challenges, such as high inflation and a twin deficit, while being threatened by adverse weather conditions. As a result, the Philippine stock index fell 2.81% in USD.
Japanese GDP quarterly growth was revised up to 3% in annualised terms in 2018 Q2, as the business investment expansion was significantly upgraded, to 3.1% QoQ.
Japanese economic expansion will probably continue in the coming quarters. However, GDP growth may slow in 2018 Q3, due to adverse weather conditions and natural disasters.
The Indian current account deficit was 2.4% of GDP in 2018 Q2, 0.1ppt lower than in 2017 Q2 suggesting that non-oil components improved. Therefore, if it was not for the surging oil prices expressed in INR terms, the Indian current account balance would have actually improved compared to the same period over a year ago. Meanwhile, net foreign portfolio outflows from India markedly increased, to USD 8bn in 2018 Q2, which is in strong contrast with developments in 2017 Q2, when USD 12bn flowed into India in net terms.
Chinese high-frequency indicators in August were a mixed bag, but leave room for optimism. Both industrial production (6.1% YoY) and retail sales growth (9% YoY) slightly improved amidst trade tensions compared to July. In contrast, fixed-asset investments (including construction) continued to lose some of the growth momentum (5.3% YoY). Growth of private sector fixed-asset investments, that account for about 60% of total investments, slowed 0.1ppt, to 8.7% YoY. Meanwhile, infrastructure spending decelerated to 4.2% YoY in the period between January and August 2018.
Although retail sales and industrial production growth held their own amidst trade tensions that weighed on economic confidence, investments are yet to be spurred by recent fiscal and monetary policy measures. The fact that investments have not benefitted yet from stimuli is not surprising, as a visible impact is expected in 2018 Q4 at the earliest.
Vietnamese macroeconomic data were once again strong in August. Manufacturing output expanded 13.3%, exports rose 14.5%, while imports increased 11.5% (all in YoY YTD terms). As a result, the trade balance has turned into a surplus of USD 2.75bn since the beginning of the year. FDI disbursements remained solid and the Nielsen Vietnam Consumer Confidence Index remained robust. Inflation remained benign, as the headline CPI inflation measures was 3.52% YoY YTD.
Latin America 18 Sept 2018LATIN AMERICA
MSCI Lat Am 2,436 -0.74%
Some Latin American markets lagged behind their developed peers, as the broad MSCI EM Latin America index declined 0.74% in USD. The Argentine and Brazilian indices weighed on the broad market index, as each fell 5.98% and 4.02% (in USD), respectively. Colombia delivered the strongest performance during the week rising 4.22%, followed by Mexico and Chile gaining 3.61% and 3.18% (all in USD), respectively.
Mexican industrial production increased 1.3% YoY in July, exceeding the median market estimate. The weakness in the July figure was primarily induced by mining, as mining activity was down 7% YoY, due to the contraction in oil output (-7.7% YoY). On the bright side, manufacturing increased 2.4% YoY, construction rose 4.5% YoY and utilities 4.1% YoY.
The Peruvian central bank kept its policy rate unchanged at 2.75%. The communication by the MPC remained broadly unchanged, as members agreed that inflation may converge to the 2% target, while inflation expectations remain anchored. The MPC added that although the economy has strengthened, economic activity has been running below potential. By pointing out that the output gap remained negative and is yet to close, the Council suggested that interest rates are unlikely to change in the coming quarters.
According to the latest political polls in Brazil, Jair Bolsonaro not only continued to lead polls, but gained further support, as he polled around 25%. Mr. Bolsonaro was followed by Mr. Gomes (13%) and Mrs. Silva (11%). Pro-business candidate Mr. Alckmin gained to 10%.
The Argentine central bank kept the policy rate unchanged at 60% in line with broad market consensus. The MPC acknowledged that the higher interest rates will require a long(er) period of time to fully impact inflationary developments. Members continued to pledge not to change the policy rate at least until December. Overall, the MPC was rather hawkish, as it underlined that it remains vigilant and is ready to deliver further measures to curb FX market volatility.
Africa 18 Sept 2018AFRICA
MSCI Africa 766 +0.32%
Even though global market sentiment improved by the end of the week, not all African markets benefitted from it. The broad MSCI EFM Africa index went sideways, as it rose only 0.32% in USD terms. The Ghanaian market increased the most, as the index edged up 4.46% in USD. In contrast, the Nigerian, Egyptian and Kenyan indices underperformed by declining 6.2%, 3.74% and 3.67% (all in USD), respectively.
Egyptian inflation accelerated to 14.2% YoY in August vs. 13.5% YoY in July, due to the subsidy cuts carried out by the government in compliance with the IMF’s programme. Meanwhile, core inflation edged up 0.3ppt to 8.8% YoY in August.
The acceleration of inflation was broadly in line with the median market expectation and will probably fade over the course of the next couple of quarters, as the economy adjusts. Higher inflation itself does not call for a higher policy rate, since forward-looking real interest rates remain strongly positive.
South African retail sales are among the first signs of proof that the economy might slowly recover after two consecutive quarters of contraction in 2018 Q1 and Q2. The volume of retail sales grew 1.3% YoY in July, while the June volume growth was revised up to 1.8% YoY. The recovery itself will probably take a long period of time, as the business confidence index continues to signal weakness in the broader macroeconomic environment.
Moody’s has given the benefit of the doubt to South Africa by stating that there is little chance of the country losing its investment grade credit rating this year. The credit rating agency cited however, that it is imperative for South Africa to bolster the frail economy (e.g. high unemployment rate at 27%) and to address budgetary leakages. Currently, Moody’s is the only agency that recognises the country as investment grade (Baa3), as the agency assigns the lowest investment grade level with stable outlook to South Africa. In contrast, S&P and Fitch recognise the country as a non-investment grade economy.
Moody’s granted some additional time for South Africa to stabilise its public finances and put a stop to the increasing gross public debt to GDP ratio, which rose to 53.1% of GDP by the end of 2017, from just below 28% in 2008. Unless the government delivers a comprehensive and credible package to tackle the fiscal issues, Moody’s will most likely downgrade the country.
The precautionary credit line provided by the IMF to Kenya expired last week. The IMF’s criteria for the renewal of the credit line were clear, with one of the key requirements being the imposition of a 16% VAT on fuel that ensures fiscal stability. However, in direct opposition, the Kenyan government decided to postpone the introduction of this tax. In a twist, the legislative body then failed to pass the law in a timely manner and therefore a previously enacted piece of legislation automatically imposed the levy. The Revenue Authority therefore started (temporarily) charging for the VAT in the middle of September.
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