Money Matters 19th June 2018

Last week saw 3 big central bank meetings, which served to reiterate the varying fortunes of the US, Europe and Japan since the crisis.

  • In the US, the FED raised rates and upgraded forecasts as they predicted – 4 rate hikes for 2018 and a continuation of one of the longest economic cycles in history.
  • In Europe, the ECB called an end to QE, but remained accommodative, not believing that sustained and meaningful growth and inflation are yet achievable.
  • In Japan, the BOJ held firm with their “super-sized” version of unconventional policy, continuing QE and negative rates indefinitely, acknowledging that there is no sign of price growth despite almost no unemployment.

Relative to some expectations, it was the FED that caused pause for thought. After a dovish set of minutes to the previous meeting, the statement and projections were clearly hawkish. It could be argued that the difference lies in the time horizon; whilst 2018 could indeed see 2 further hikes, it could be that the pace of change will slow in 2019.
S&P 2,780 +0.02%, 10yr Treasury 2.91% -2.56bps, HY Credit Index 337 11bps, Vix 13.21 -.20Vol
In the week in which markets received a barrage of important data, political announcements and monetary policy updates, equities were surprisingly quiet; recent volatility subsiding and the S&P 500 finishing almost entirely flat. Meanwhile, having briefly broken 3% yield after the FOMC meeting, Treasuries finished modestly tighter as the USD experienced its best week since April. In truth, the stronger dollar was probably less about the US domestically, and more about a dovish ECB (see more below), risk aversion resulting from Trump’s ongoing trade war and weakness in some specific emerging countries (notably Argentina and Turkey).
In terms of the FOMC meeting, the committee raised interest rates by 25bps to a 1.75-2.00% range as expected – and therefore not of any significance. However, there were also a number of changes to the statement and guidance that caught the market’s attention:

  • Economic activity was upgraded from “neutral” to “solid”
  • Household spending was described as having “picked up” from “moderated”
  • The overall word count was reduced by 100 words, with the statement no longer including the note that “the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.”
  • The “dot plot” projection for interest rates showed a shift in forecast from some members, resulting in an average expectation of 4 rate hikes for 2018 (2 more).

Despite no real reaction from the bond market, the update was therefore clearly hawkish.
Turning to the POTUS, the long-awaited summit with North Korea passed in unconventional fashion; as one observer commented “The summit statement is big on hyperbole and short on substance – it reads like it was written by the North Korean negotiating team.” Trump himself was more bullish “I signed an agreement where we get everything, everything.” A more accurate summary would be that Trump has appeared to diffuse a situation he created but achieved nothing new – high vol, no return politics. Later in the week, Donald followed through with his threat of USD 50bn in tariffs on Chinese goods. In response, China’s finance ministry said it would impose 25% tariffs on 545 US products including soybeans, beef, whiskey and off-road vehicles. Further measures may be added to target energy exports such as coal and crude oil.
From a data perspective, headline PPI inflation hit a 7 year high in May, but this was mostly due to the rise in the oil price; the core measure was more subdued. Retail sales positively surprise. This week will see the release of the June PMIs.
Eurostoxx 3,462 +0.22%, German Bund 0.39% -4.60bps, Xover Credit Index 299 -14bps, USDEUR .862 +1.42%
In classic Draghi style, the ECB delivered a “dovish tightening” at their meeting on Thursday. The governing council confirmed that they will reduce asset purchases from EUR 30bn to EUR 15bn at the end of September, before ending quantitative easing in December. However, they also vowed to wait until at least mid-2019 to raise rates (the main rate is currently at -0.40%). As a consequence, core bond yields declined slightly. Elsewhere, Italian bond yields fell sharply after new European Union Affairs Minister Paolo Savona said the euro was “indispensable”. In reality, the market probably decided that, despite the long-term unsustainability, there is no imminent catalyst to unsettle Italy’s fiscal position.
Elsewhere, UK inflation for May came in at 2.4%, below expectations and therefore bolstering the likelihood of the BOW keeping interest rates unchanged at coming meetings.
The central bank of Russia kept the policy rate flat at 7.25% in line with expectations. In its statement, the Monetary Policy Council acknowledged upside risks to inflation and downplayed the idea of monetary easing to spur economic growth.
Unless international market sentiment improves and pressure on EM assets ease, the Russian central bank has very limited room – if any – to carry out monetary loosening in any form.
Private consumption boosted Turkish GDP growth in 2018 Q1, as the annual real growth rate accelerated to 7.4% YOY, surpassing market expectations. The demand side was also bolstered by investments (9.7% YOY), while the supply side was primarily driven by services (10% YOY), industry (8.8% YOY), construction (7% YOY) and agriculture (4.6% YOY).
Tighter monetary conditions and intensifying macroeconomic imbalances suggest that the real GDP growth rate might decelerate in the coming quarters. Declining confidence indicators also strengthen the case for economic deceleration. The government’s official GDP growth target is 5.5% for 2018, while market consensus foresees real GDP to expand by 4.0-4.5% YOY.
The Turkish current account deficit widened to USD 5.4bn in April, and overshot median expectations. The widening was primarily due to soaring imports, as they increased by 16.2% YOY, while exports rose by 7.1% YOY. The widening current account gap put further pressure on the Turkish lira that kept depreciating vs. major currencies in spite of the tighter domestic monetary conditions. Other CEEMEA currencies struggled last week as well, such as the Hungarian forint, as the Fed has turned more hawkish and the ECB has announced its intention to terminate the asset purchase program by the end of December.
The common feature of Turkey and Hungary is that both countries have high gross external debt to GDP ratios and central banks with questionable credibility. As long as markets do not see a guarantee that the two central banks are committed to putting brakes on ex ante inflation, the Turkish and Hungarian currencies are likely to remain under pressure.
HSCEI 11,870 -2.48%, Nikkei 22,680.33 -0.30%, 10yr JGB 0.04% 0bpsUSDJPY 110.490 +1.00%
The Bank of Japan voted 8-1 vote to leave policy unchanged (short-term rates at -0.10%, JPY 80trn of asset purchases a year and a 0% yield target on the 10 year). Governor Haruhiko Kuroda reiterated that it was too early to discuss policy normalisation given lacklustre inflation.
Trade tensions between China and the US reached new heights this week, with a round of mutual $50bn tit-for-tat tariffs showing that neither side is willing to soften its stance.
Within hours of Trump announcing tariffs on 818 imports from China, to be followed by a further 284 products subject to public consultation, Beijing responded in kind with its own $50bn salvo, with American beef, soybeans and off-road vehicles among the casualties.
Rhetoric emanating from Beijing became more hawkish than at any other point during the last year of sabre-rattling, with the Commerce Ministry commenting that “all the economic and trade-related achievements previously reached… will be rendered invalid”. 
While Trump’s policies are not due to be implemented until next month, and with China’s countermeasures still yet to be disclosed in full detail, a window remains for the self-styled US dealmaker extraordinaire to turn peacemaker. “I have a wonderful relationship with President Xi … We’ll all work it out”, the President reassured. 
China’s latest data batch was overall uneventful. Retail sales growth rose sharply, from 8.5% to 9.6% YOY in May, while industrial production growth slightly softened, from 7.0% to 6.8%. Fixed asset investment growth year to date came off, from 7.0% to 6.1%.
India’s current account deficit narrowed last quarter, falling to $13.0bn in the three months to March, down from $13.7bn the previous quarter. Foreign reserves rose by $13.2bn over the period. Inflation ticked up from 4.58% in April to 4.87% in May, data which the central bank would have had early access to when deciding to raise interest rates 25bps just a few days prior to the release. Industrial production growth rose, from 4.5% in March to 4.9% in April.
With foreign reserves oscillating around all-time highs above $400bn, and the full year current account deficit for FY18 coming in at 1.9% of GDP, India remains on a much stronger footing than during the last wave of FED-induced negativity around emerging markets. At the time of the Taper Tantrum in 2013, India’s current account deficit was running above 5%, foreign reserves were 25% lower, and inflation was double digits. 
Pakistan’s economic woes continue unabatedOn Monday, a further 5% devaluation of the PKR did little to reassure markets of the country’s economic outlook. Then, after the Finance Minister’s most recent refusal to engage with the IMF, with any decision now expected to be delayed until a new government can be formed, yields on Pakistan’s $1bn notes due in April 2019 rose to above 8%, an all-time high since their issuance in 2014. While general elections are slated for July 25th, there is strong potential for an electoral upset and subsequent policy uncertainty, with unknown quantity Imran Khan potentially taking control of a coalition government.
latinamericaLATIN AMERICA
MSCI Lat Am 2,428 -1.82%
Brazil’s IPCA inflation came in at 2.86% YOY in May, accelerating slightly from 2.76% in April. This increase is fully attributed to the impact of food and fuel shortages resulting from the truck drivers’ strike. We expect inflation to continue on a slight upward trend for the coming months. The BRL depreciated nearly 3% reflecting the change in inflationary dynamics and a continuation of uncertainty related to its October presidential elections.
Peru’s central bank maintained the benchmark interest rate at 2.75%, on the back of low inflation and better activity data. Employment improved with the unemployment rate falling to 6.6% in May, however it was the GDP data for the month of April that surprised with a 7.8% growth rate compared to a year ago.
The new minister of Finance David Tuesta, is making initial steps towards a labour reform, which will become more palatable as the country’s growth accelerates.
Similarly, in Chile, the central bank kept the repo rate at 2.5% principally due to inflation remaining low and a stable currency despite the FED tightening cycle and weaker EM currencies generally. Chile’s Imacec index, a GDP proxy, rose by 4.2% in April compared to a year ago, that is the fastest growth rate in five years. 
Argentina’s central bank kept the benchmark rate unchanged at 40%. Inflationary pressures are mounting due to the ARS devaluation and regulated tariff increases. CPI inflation for April came in at 26.3% YOY increasing from 25.5% in March. The monetary policy committee prefers to wait and see where the economic variables settle, following the crisis in May, where they raised rates to 40%, and the announcement of the USD 50bn IMF support package. On Thursday the central bank president Federico Sturzenegger resigned, the market had clearly lost confidence in his ability, with the continued depreciation in the Argentine Peso despite higher rates reflecting this reality. He was replaced by Luis Caputo, the former finance minister, which may raise questions regarding the central bank’s independence. Only time will tell.
Markets seem unconvinced by Argentina’s macroeconomic policies as the ARS has devalued another 11% since the announcement of the IMF agreement. This recent correction has already erased all equities gains in USD since Macri took office back in October 2016.


MSCI Africa 866 -3.66%
South Africa’s government released an improved version of the hotly contested mining charter with the following key proposals:

  • Raising black ownership at permit-holding mining companies to 30% from 26% within 5 years
  • A minimum 50% of the board must be black South Africans, 20% of which must be black women
  • A minimum 70% of the mining-goods procurement budget must be spent on South African manufactured goods, with a 60% percent local-content value
  • A minimum 80% of the money spent on services must be to South African companies
  • New mining right holders shall pay a trickle dividend equal to 1% of EBITDA to employees and communities; and
  • New mining right applicants must have a minimum of 30% black shareholding before securing the permit, and 10% of that ownership must be granted for free to communities and qualifying employees.

The new draft charter notably concedes on the contentious “once empowered, always empowered” principle. This will be greeted with relief by mining companies who have argued that another round of large empowerment deals would dilute existing shareholders and weigh on investments. However, the requirement for 10% of black ownership target for new mining right applicants to be granted for free, will prove contentious. Unlike his predecessor, Mining Minister Gwede Mantashe engaged all stakeholders in drafting the new charter, an indication of the new administration’s approach to businesses and other stakeholders.
Staying in South Africa, business confidence fell in Q2 2018, back to 39 points after surging from 34 to 45 points in Q1, mining production in April declined by 4.3% YOY (expectations -3.6%), however, Fitch affirmed the country’s BB+ rating.
In Kenya, the Treasury Cabinet Secretary made the strongest move yet to repeal interest rate caps. In his budget speech, Henry Rotich proposed repealing the regulation which caps commercial lending rate at 4% above the Central Bank Rate (currently 9.5%) and puts a floor of 70% of the CBR on deposits, on the basis that it has negatively affected financial access and economic growth.
Separately, Mr Rotich proposed a “Robin Hood” tax of 0.05% of any amount of KES 500,000 or more transferred through banks or other financial institutions.
The proposal will be debated in parliament with MPs able to vote on the suggested repeal.  The timeline is at this stage unknown and political considerations are likely to impede the repeal.
Lastly, Nigeria’s inflation slowed to the lowest rate in more than two years in May. Annual inflation slowed to 11.6% in May, from 12.5% in April. Food inflation fell to 13.5% from 14.8%. The central bank has kept benchmark rates tight at 14% for more than a year to curb inflation, support the naira and attract foreign investors into its debt market.
The central bank will come under increasing pressure to cut rates to boost lending and growth which remains fragile, particularly in the non-oil economy. 

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