Money Matters 22nd November 2017

There was not necessarily a clear catalyst for the more elevated volatility seen last week. However, it would be fair to say that weakness in credit over the past month has spilt into broader nervousness. Strong economic momentum at the global level appears to continue. However, there is also a sense that the best period for markets is behind us; valuations are generally rich, the monetary impulse is likely to turn negative in 2018 and there is a feeling of investor fatigue.
This week, US markets are closed on Thursday for Thanksgiving.
S&P 2,579 -0.13%, 10yr Treasury 2.33% -5.49bps, HY Credit Index 327 -6bps, Vix 11.43 +0.14Vol                    
Last week, the S&P 500 had both its worst trading session in 50 days (a 0.55% decline on Wednesday) and its best in 67 days (a 0.82% gain on Thursday). This pushed the VIX volatility index to its highest intraday level since August at 14.51%. Indeed, the skittishness extended to fixed income and the US Dollar:

  • High Yield bond funds experienced one of their largest weeks of outflows on record (USD 4.43bn). This came after a relatively sharp decline in prices over the last month, which a Bank of America note aptly summarised as “driven primarily by a confluence of several meaningful and yet only loosely related events.” These include the collapse of the Sprint/T-Mobile merger and Teva’s credit downgrade.
  • The US Treasury yield curve (represented by the yield differential between the 2 and 10 year bonds) touched its flattest level in 10 years at 0.65%. This implies investors are sceptical about the longer-term potential for higher interest rates.
  • The trade weighted USD lost ground for the second consecutive week.

From a fundamental perspective, economic data was mostly robust (retail sales, CPI inflation, industrial production and housing starts all meeting or exceeding expectations). Moreover, Congressional Republicans continued to make progress on tax reform, with approvals from the House and a Senate panel. However, the tone on Capitol Hill was not all positive; on Thursday Robert Mueller subpoenaed Trump’s election campaign for documents relating to Russian Interference.
Elsewhere, at the corporate level, General Electric shares fell over 12% after announcing a restructuring that included halving of its dividend.
Europe 2 - NewspapersEUROPE
Eurostoxx 3,547 -0.08%, German Bund 0.36% -4.90bps, Xover Credit Index 246 -3bps, EURUSD 1.177 -1.06%                        
The 2nd release of Q3 GDP growth for the Eurozone, saw a modest upward revision (0.613% QOQ from 0.585% QOQ). Although this is a marginal slowdown from Q2 (0.65% QOQ), it confirms the improved momentum. Nonetheless, equities declined and bond yields tightened with broader sentiment. This week, Europe also starts on the back foot after the FDP in Germany pulled out of coalition talks with Angela Merkel. This leaves the Chancellor facing either new elections, running a minority government, or seeking alternative partners such as the Social Democrats.
In the UK, CPI inflation came in at 3.0% YOY and retail sales were slightly better than expected, but still declined 0.3% YOY. Meanwhile, reports suggest Theresa May will “blink first” and raise her offer of a Brexit divorce settlement to EUR 40bn from EUR 20bn in order to break the current negotiation deadlock.
After the Turkish Lira fell to record lows versus both USD and EUR on Friday, President Erdogan commented “they say central banks are independent, so we shouldn’t interfere. This is the end result because we haven’t interfered.” Indeed, he went on to say it should not be “taboo” for him to comment on monetary policy. Counterintuitively, the President wants lower rates, which would surely exacerbate the problem
Norway’s central bank, which runs the world’s largest sovereign wealth fund holding some 1.5% of global equities, proposed that oil and gas companies be removed from its benchmark index.  This would require divestment of some USD 35bn in oil related stocks in order to reduce the country’s exposure to the space. A final decision is likely at least a year away.
Asia - IndiaASIA
HSCEI 1,155 -1.28%, Nikkei 2,226.00 + 0.05%, 10yr JGB 0.04% 0bps, USDJPY 112.060 -1.20%                  
Japanese stocks fell last week, ending their 9-week consecutive positive run.
The global narrative surrounding India’s economic progress has shifted somewhat during the second half of 2017. From a tone of optimism and recognition for the transformational work carried out by the Modi government, both foreign news outlets and India’s domestic champagne socialist English- speaking media have turned to criticising the government for the short-term disruption these policies have caused. Almost a year on from its implementation, many commentators have been taking shots at Modi’s demonetisation programme, labelling the project a failure based on the percentage of banknotes which were returned to the formal system. Others have focused on the compliance burden and adjustment costs associated with the new Goods and Services Tax.
The talking heads eulogizing these myopic views took an inevitable kick in the teeth this week, as two key new developments reminded investors just why India has been one of the best performing stock markets globally in 2017.
Firstly, Moody’s upgraded India’s sovereign credit rating for the first time since 2004. After raising India’s rating from Baa3 to Baa2, the US-based institution commented that it expects that “continued progress on economic and institutional reforms will over time enhance India’s high growth potential… and will likely contribute to a gradual decline in the general government debt burden over the medium term”.
This is a vote of confidence in the Indian reform story. It strikes at the heart of the arguments being made against Modi’s economic reforms, by those who claim that the undeniable long term structural benefits they bring are not worth the sacrifice of 1-2 quarters of below-trend GDP growth.
From the more specific standpoint of an equity investor, a visible recovery in corporate earnings has been among the most important developments required to maintain a compelling investment case for India, given the market’s strong outperformance year to date. The end of the reporting period for the three months to September provided investors with just that this week, with the Nifty companies collectively witnessing double-digit earnings growth for the first time in six quarters. This came despite the disruption associated with the Goods and Services Tax (GST) implementation on 1st July.
China’s latest data batch showed a slight slowdown across the board in October. Retail sales fell from 10.3% YOY in September to 10.0%, fixed asset investment growth dropped from 7.5% to 7.3%, while industrial production slowed from 6.6% to 6.3%.
The Philippines’ economy grew 6.9% YOY in Q3, bouncing from the 6.5% expansion rate of the previous three months. This was the fastest rate of expansion for four quarters, and was a significant upside surprise to consensus, with the market expecting a more muted rate of growth on the account of being only a year in to President Duterte’s term, with new leaders in the Philippines historically taking time to get their feet under the table and begin enacting growth-friendly policies.
The quality of growth however, is slightly weaker than the headline figure suggests, with private consumption growing only 4.5% YOY and investment growth slowing from 9.4% YOY in Q2 to 7.1% in Q3.
Indonesia’s central bank left rates on hold at 4.25%, in line with expectations. Policymakers cited ‘limited growth in household consumption and banking intermediary’, leaving the window open for further rate cuts in the medium term.
Malaysia’ economy accelerated to a 6.2% YOY growth rate in Q3, up from the 5.8% recorded in Q2. This was an upside surprise, with both domestic and external driven growth accelerating.
The outperformance of the Malaysian economy so far in 2017 has raised the spectre of rate tightening from the central bank early next year.
Latin America - VenezuelaLATIN AMERICA
MSCI Lat Am 2,776 +0.74%
Standard & Poor’s rating agency has downgraded Venezuela’s rating from highly speculative (CC) to default (D) after it missed a USD 200Mn payment of interest on its 2019 and 2024 bonds within the 30-day grace period. Venezuela’s 1 to 10-year bonds are now trading between 20% and 30% of par value. Also last week, ISDA, the International Swaps and Derivatives Association, has ruled that Venezuela and its state oil company PDVSA have defaulted on their debts, which will trigger insurance-like contracts on its bonds (CDS).
The restructuring of the USD 60+ Bn international debt is technically complicated by:

  • The US sanctions imposed on Venezuela as a classic restructuring usually involves the issuance of new bonds, but US investors are prohibited from investing in new issues from Venezuela.
  • Venezuela’s lead negotiator with creditors, Vice-president Aissami has himself been sanctioned by the US as an alleged narcotics trafficker, which means US investment groups (the biggest holders of Venezuelan debt) cannot enter talks with him.
  • Venezuela lacks a credible plan to get out of this crisis and the government refuses all help from international organisations.
  • The exact amount, seniority and collateralization of Venezuela’s external debt are unknown as they include bonds, promissory notes, bi-lateral loans from China and Russia (including a non-reported USD 6Bn loan by Rosneft to PDVSA backed by oil deliveries and 49.9% of Citco) and other external obligations.
  • The opacity is reinforced by the multiple issuers (government, state-owned oil company PDVSA, state-owned utility companies and other).

Most of Colombia’s leading indicators signal that the bottom of its cycle was observed in 1H17.

  • Colombia’s retail sales advanced 1.1% YOY in 3Q17, implying an acceleration against 2Q17 (-0.3%) and 1Q17 (-1.4%), suggesting that the negative effect from both the VAT hike and high interest rates in the 2016-1Q17 period, is gradually fading amid higher disposable income and lower rates (ex-auto sales increased by 1.5% y/y in 3Q17 vs 0.2% in 2Q17 and -1.3% in 1Q17).
  • Colombia’s industrial production rose 0.6% YOY in 3Q17, slightly recovering from a very weak 1H17 (+0.4% in 1Q17 and -3.0% in 2Q17).
  • Colombia’s trade deficit in 3Q17 came in at USD 1.7Bn, below the USD 3.0Bn deficit recorded in 3Q16, leading to a narrowing of the 12-month rolling deficit to USD 8.5Bn (from USD 11.5Bn in 2016). The better than expected print was favoured by a firm recovery in traditional exports and a still weak internal demand as the whole economy is rebalancing through the FX mechanism (freely floating currency).

As a result, Colombia’s GDP expanded by 2.0% YOY in 3Q17, which is still below its long-term potential, but the output gap is slowly closing.
The economy accelerated vs 1H17 when it posted the weakest pace of growth since 2009 (1.3%), implying that the worst of the current economic cycle is finally behind us. That said, activity is still sluggish, suggesting that the recovery will continue to be gradual.
Brazil’s IPCA Inflation accelerated to 2.70% YOY in October from 2.54% the month before, still below the central bank’s target.
Fitch affirmed Brazil’s Long-Term Foreign Currency rating at BB with a negative outlook. In the release, the agency cited that “Brazil’s ratings are constrained by the structural weaknesses in its public finances and high government indebtedness and weak growth prospects.” However, “the country’s capacity to absorb shocks is underpinned by its flexible exchange rate, robust international reserves position, a strong net sovereign external creditor position, and deep and developed domestic government debt markets.” The agency concluded by stating that an improved policy environment, reduced external imbalances, and the passage of some microeconomic reforms in recent months are supportive of the credit profile”.
Brazil’s core retail sales expanded 6.4% YOY in September 2017.This suggests that retail sales resumed an upward trend following 2 slower months that probably reflected a reversal of the temporary boost provided by withdrawals from inactive accounts held under employment protection program FGTS. In the coming quarters, retail sales should slowly recover towards their pre-crisis level driven by falling interest rates (lower risk-free rate and contraction of spreads), lower debt levels among households, and gradual improvement in the labour market.
The only question remains the pace of the recovery in consumption as most of these factors will be very gradual and part of the increasing disposable income will first go towards deleveraging.
Peru’s GDP expanded 3.2% YOY in September 2017, a strong sequential acceleration (2.3% in 3Q17 vs. 2.4% in 2Q17). This was the 98th consecutive month of growth.
Africa - MugabeAFRICA
MSCI Africa 911 +4.73%
In Zimbabwe, President Robert Mugabe’s 37 years tenure seems to be ending. Mr Mugabe was fired as the leader of the ruling Zanu PF party on Sunday and was given 24 hours to quit as head of state or face impeachment. This came after a de facto coup saw Mr Mugabe, his wife Grace Mugabe, and other associates detained by the military earlier in the week. In his place, the ex-vice-president Emmerson Mnangagwa, who had been fired by Mr Mugabe two weeks earlier, was appointed as the interim leader of Zanu PF.
In Nigeria, headline inflation moderated for the ninth consecutive month; YOY, CPI declined to 15.91% in October from 15.98% in September, and 2bps to 0.76% on a MOM basis. Food inflation however remained sticky at 20.31% YOY vs. 20.32% in September.
In Egypt, the central Bank kept overnight deposit and lending rates on hold at 18.75% and 19.75%, respectively, the trade deficit fell 26.7% YOY to USD3.31bn in August, driven by a 17% YOY increase in exports and 14% decrease in imports, and S&P upgraded Egypt’s outlook to positive from stable, on the back of rising reserves and strengthening economic growth. In other news, the UK is expected to lift its travel ban on Sharm El Sheikh, which is positive for the country’s tourism industry.
Lastly, an IMF delegation emphasised that Morocco is ready to move towards a flexible exchange rate regime.

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