BURSTING THE BUBBLE
After a month long flirtation, the US 10 year decisively broke through the 3% yield barrier last week, prompting a sharp appreciation of the USD. Whilst US yields have now more than doubled from their 1.35% nadir in July 2016, this still represents an extremely low level by historical standards. Nonetheless, as discussed in recent weeks, the market is now clearly in a different and more volatile paradigm from that enjoyed during 2017.
The question is whether this is the end of the current expansion or just a later cycle environment. On balance, it’s important to note that the global cycle is not entirely synchronous; there are strong domestic stories for example in India, Egypt and much of Latin America. Moreover, China-US trade discussions appeared to end with a positive tone over the weekend. However, the longer-term issues of the developed world are starting to seep back to the front page, with Italy front and centre. Furthermore, the impacts of higher rates for USD borrowers and a higher oil price more generally, will present something of a drag over coming quarters.
With regards to the oil price, WTI ended with little change on the week but the Brent traded above USD 80 for the first time since November 2014.
S&P 2,713 -0.54%, 10yr Treasury 3.07% +8.64bps, HY Credit Index 341 +10bps, Vix 13.42 +.77Vol
At headline level, US equities fell back last week (the S&P 500 declining -0.54%). However, this masks considerable dispersion. Interest rate sensitive sectors such as real estate and utilities fell heavily, whilst small caps, energy and materials finished conclusively higher. The main motivation for these moves was the fixed income market. The US 10 year peaked at 3.126% yield (a 7 year high), before closing above 3.05%. Moreover, the USD enjoyed healthy gains, rising over 1% on a trade weighted basis and advancing over 3% against a number of emerging market currencies. However, the currency still remains well below its 2017 highs.
From a data perspective, retail sales rose broadly in line with expectations and other indicators were also positive, including Empire State manufacturing, leading indicators and the Philly Fed.
At the political level, there were also a number of developments:
- North Korea threatened to pull out of the upcoming (12th June) summit with the US in Singapore, taking objection at the continuation of joint US-South Korea military exercises.
- Negotiators from the US, Canada and Mexico failed to meet the 17th May deadline imposed by the House of Representatives. As a consequence, it is likely that any deal will be delayed until next year as Mexico’s new government will take office in December.
- On Sunday, the US agreed to put tariffs on China on hold stating, “We’re putting the trade war on hold, right now, we have agreed to put the tariffs on hold while we try to execute the framework.” This came after China promised to “significantly increase purchases” of U.S. goods and President Trump agreed to ease a ban on Chinese telecommunications company ZTE
Eurostoxx 3,575 -1.23%, German Bund 0.55% +2.00bps, Xover Credit Index 278 -7bps, USDEUR .853 +1.47%
German bonds were broadly unchanged but peripheral bond yields rose sharply last week, as a definitive “risk-off” tone swept Europe. Indeed, this was mirrored in equities as the Eurostoxx was unchanged in local currency terms, but Italian, Spanish and Greek stocks fell.
The main catalyst for weakness was Italian politics, with it looking increasingly likely that a ruling coalition will be formed by the anti-immigration, anti-establishment combo of the Northern League, and the 5Star Movement. The 58 page joint policy document revealed on Friday includes measures to accelerate the deportation of illegal immigrants and for imams to be registered with the state. Further, a leaked draft version suggested the partners would request EUR 250bn of debt forgiveness from the ECB, albeit this did not make the final version. Nonetheless, this prompted French Finance Minister Bruno Le Maire to comment, “If the new government took the risk of not respecting its commitments on debt, the deficit and the cleanup of banks, the financial stability of the entire Eurozone will be threatened.” Nominees for prime minister and cabinet posts were agreed on Sunday to be put to the president today.
The Italian 10-year closed at 2.23% on Friday, some 33bps higher on the week and with the Italian-German spread at the highest since January. However, it is still fair to say market unease is marginal given Italian bonds traded over 3% higher than German in 2013 and over 2% higher only last year.
Elsewhere in the Eurozone, industrial production for March rose modestly but consistently with a Q1 slowdown and Greece agreed on the next steps for completing its final bailout review with creditors. This may lead to debt relief in the form of extensions to repayment periods on loans, a so called “extend and pretend”.
HSCEI 12,392 +0.08%, Nikkei 23,002.37 -0.52%, 10yr JGB 0.06% +0bps, USDJPY 111.340 +1.28%
Japan’s longest stretch of growth for 28 years came to an end in Q1, with a GDP contraction of 0.6%. In addition, Q4 2017 growth was revised down from 1.6% to 0.6% and inflation came in below expectations at 0.70%.
China released a mixed data batch for April. Retail sales and fixed asset investment both slowed compared to March, from 10.1% YOY to 9.4% and from 7.5% to 7.0% respectively. Industrial production accelerated, however, from 6.0% to 7.0%.
Despite a strong showing in the popular vote, Modi’s BJP was unable to form a stable government in Karnataka following local elections.
The BJP emerged as the single largest party in the state, and were subsequently invited by state governor Vajubhai Vala, a BJP loyalist, to form a government. On Thursday, BJP politician BS Yeddyurappa was sworn in as Chief Minister, having been given an unprecedented 15 days to prove his majority.
On Friday, however, India’s Supreme Court overruled Governor Vala’s decision, and ordered BJP’s Yeddyurappa to prove his majority during a vote on Saturday. Knowing he lacked the votes, the BJP candidate subsequently resigned, with Congress now expected to form a government.
Inflation in India remained firm in April, with CPI rising to 4.6%, from 4.4% in March.
The Reserve Bank of India remains data dependent with a neutral stance. As we head in to the monsoon season, it is unlikely that the central bank would adjust policy before learning the outcome of the weather pattern that is most crucial to India’s agricultural output and food price inflation.
Indonesia raised interest rates by 25bps to 4.50%, the first increase in the policy rate for four years.
With domestic growth and inflation running at normal levels, this was a move chiefly aimed at managing the economy’s external balances. As an emerging market operating twin deficits and as a net consumer of foreign capital, Indonesia’s currency has already come under pressure during 2018 in this strong-dollar environment. With the Rupiah down 4% year to date against the dollar and the central bank already having used foreign reserves to support the currency, there could be potential for a second rate hike in the coming quarters.
Vietnam received a sovereign upgrade from Fitch ratings to BB with a stable outlook, on account of rising foreign exchange reserves, strong GDP growth and economic reforms. Local stocks and bonds both rose on the announcement.
Malaysia’s GDP growth came in softer than expected for Q1 2018 at 5.4% YOY, down from 5.9% in Q4 2017. Domestic demand and investment both slowed in the run up to this month’s general election.
Thailand left rates on hold at 1.50%.
MSCI Lat Am 2,701 -5.92%
Brazil’s equity market tumbled last week following the central bank’s announcement that it will pause its easing cycle, and keep the benchmark rate unchanged at 6.5%. The monetary policy committee assessed that the latest economic activity data showed some deceleration, but still points to a consistent, albeit gradual, recovery. The market was expecting a 25bps cut and clearer guidance. The market was already weak due to increasing risk aversion globally and a rumour that the government will downgrade its 2018 GDP growth expectation. The USD/BRL also reached its lowest level in 26 months on Thursday at 3.7.
On a more positive note, Brazil’s retail sales grew 7.8% YOY in March and 1% QOQ in 1Q18.
Andean economies are on a recovery path:
Colombia’s Q1 GDP growth came in at +2.2% YOY, accelerating from 1.8% in Q4 2017. This was driven by:
- Retail sales growing 5.3% YOY (accelerating from -2.2% in Q4 2017 and consensus of 2.8%)
- Manufacturing production coming in at +0.3% YOY, above consensus, despite the drag of the construction sector, which contracted the most since Q1 2010.
- Consumer confidence breaking into positive territory for the first time since 2015. This index rose to 1.5 April vs -3.2 in March, helped by lower inflation, lower interest rates and higher oil prices. The expectation component was particularly strong.
However, this remains way below Colombia’s long-term growth potential.
Higher oil prices, an expansionary monetary policy, the fading of uncertainty around presidential elections and stronger global growth will be the drivers of the recovery. Longer term reforms implemented in 2016 maintain Colombia on a sustainable growth path.
Peru’s GDP grew 3.9% YOY in March, its highest level in 14 months and beating all analysts’ expectations. Both mining and non-primary sectors performed well, despite the various delays in public infrastructure spending, such as reconstruction following the March 2017 floods. This brings Q1 2018 GDP growth to 3.2%, still below its long-term potential.
Mexico’s industrial production contracted 3.7% YOY in March and 0.8% in Q1 2018. Uncertainty regarding NAFTA 2.0 and the likely victory of AMLO as president is having its impact on the real economy.
Argentina’s CPI inflation rose to 25.5% in April.
This is likely to increase further in the coming months as imported inflation will rise significantly following the ARS depreciation and the large current account deficit.
On a more positive note, the fiscal deficit was reduced to 5.6% of GDP in April and the government committed to bring the primary fiscal deficit down to 2.7% of GDP in 2018.
The combination of monetary and fiscal policies tightening and high inflation should negatively impact GDP in the coming quarters despite the recent positive momentum.
MSCI Africa 918 -5.96%
The Central Bank of Egypt left interest rates on hold; overnight deposit and lending rates remained at 16.75% and 17.75% respectively. The MPC said it still sees Egypt hitting its inflation target of c.13% in Q4 2018 and single digits thereafter, but signaled downside risk from expected cuts to energy subsidies this summer and surging global oil prices.
Staying in Egypt, unemployment continued its steady decline, falling to 10.6% in the first quarter of the year, down from 12% a year earlier.
South Africa’s unemployment rate was unchanged at 26.7% of the labour force in the first quarter of 2018 compared with the last quarter of 2017.
This comes at a time when confidence is at an all-time high but as yet has not translated into the strengthening of key economic indicators. The recovery is likely to be long and arduous but the new administration appears committed to returning the country to sustainable growth and realising its potential.
Nigeria’s annual inflation fell to the lowest rate since May 2016. Annual inflation fell to 12.5% from 13.3% in March. Food inflation fell to 14.8% in April from 16.1% in March. MOM, inflation increased by 0.8%, same as the previous month.
The central bank has kept rates tight at 14% for more than a year, however the Central Bank Governor has indicated that rates will come down when inflation comes closer to the upper end of its target range of 6% to 9%. The MPC is scheduled to review rates this week.
Tunisia’s central bank held interest rates at 5.75%.
This week’s global market outlook is powered by Alquity www.alquity.com