Money Matters 28th November 2017

Since the summer, Donald Trump’s tax reform has edged closer to reality. Indeed, next week the bill hits the Senate, where Republicans hope their wafer-thin 2-person majority will be enough to pass a vote of support. Back in November last year, when Trump won election, there was much hope pined on this fiscal re-balance – and in some ways, this is well founded. The US has some of the highest corporate tax rates in the world and aggressive cuts could well engender a revival in investment. However, there is another side to this coin. In order, to be long-run deficit neutral, the plan envisages large income tax hikes. And here lies the rub.  These increases are initially offset by a package of temporary tax breaks. This is to say, the Republican’s plan a very 21st century solution; stimulate now and let someone worry about the cheque in the future.
Of course, in the case of the US, with a market near all-time high valuations and after one of the longest periods of economic expansion in history, it’s easy to be a hater. However, for now, economic growth is “picture perfect” with good momentum and low inflation keeping interest rates low and the relative appeal of equities high.
US crude prices hit a 2-year high last week as a leak in South Dakota led to the shutdown of the TransCanada Keystone pipeline. OPEC meet on Thursday when an extension of production cuts could be announced.
United States 2UNITED STATES
S&P 2,602 +0.91%, 10yr Treasury 2.34% -0.17bps, HY Credit Index 317 -8bps, Vix 9.67 -1.76Vol       
US equities rose last week, with all major indices touching new record highs. Financials, however, lagged as the US yield curve continued to flatten. As a reminder, the spread between long-dated and short-dated US Treasury bonds has narrowed continuously through the year, with the current 2s-10s yield differential sitting at 0.58%. This recent acceleration has been driven entirely by the front end; the 2-year has moved 0.5% in under 2 months to a 9-year high. Relatedly, the probability of a March 18 rate hike has moved from 5% to 55%, with a 13th December hike now fully discounted. This week’s moves were prompted by the release of the minutes to the FED’s October meeting. Whilst “many policymakers” saw a near-term hike as warranted, “several” were concerned about soft inflation.
Economic data released on the week was mixed – leading indicators and Michigan consumer sentiment solid but existing home sales durable goods missing expectations.
Eurostoxx 3,574 +2.03%, German Bund 0.35% -0.10bps, Xover Credit Index 237 -8bps, EURUSD 1.194 -1.19%                        
Last week’s European PMIs were a blockbuster, with the composite index touching the highest level since April 2011 (led by manufacturing but with services also at a 6-month high). Indeed, this was confirmed at the national level, with the French INSEE and German Ifo surveys at multi-year or all-time highs.
In contrast to the “dovish” FED meeting minutes, the ECB release showed evidence of some dissent over the long-term direction of monetary policy. Concerns were voiced over the “open-ended” nature of the current programme, whether the 9-month extension was “overly long” and on financial stability risk, given the availability of cheap money to the banking sector.
In the UK, the Chancellor of the Exchequer presented a budget in which he was forced to relax previous deficit targets owing to weakness in the UK economy. Elsewhere, EU negotiators are expected to complete a review of progress by the end of this week to determine whether there has been sufficient progress to move talks forward. Recent reports suggest that Europe may have won a battle of wills on the “divorce bill”, with PM May ready to offer EUR 40bn. As we have commented before, we believe this is one of the only “bargaining chips” held by team GB.
In Hungary, the NBH announced more unconventional measures. Specifically, long-term interest-rate swaps to take duration risk from banks and a mortgage bond purchase programme to compress mortgage spreads. Elsewhere, in Turkey, continued weakness in bonds, equities and the currency forced the central bank to reduce overnight funding to zero – equivalent to raising rates by 0.25%.
HSCEI 1,177 +2.62%, Nikkei 2,249.00 +1.09%, 10yr JGB 0.04% 0bps, USDJPY 111.230 -0.40%             
Hong Kong stocks recorded their highest close since 2007, after a generally strong earnings season, led by continued mega-cap outperformance.
From the beginning of 2017 to Wednesday 22nd November, the Hang Seng Index rose 36.4% in local currency to hit 30,003.49, its highest level since October 2007.
Index heavyweight Tencent, after posting another consensus beat for Q3, has now risen 125% year to date, and is responsible for around a third of the HSI’s gains this year. After becoming the first Chinese technology company to achieve a USD 500bn market cap, Tencent briefly overtook Facebook in market value.
Elsewhere in the Chinese market, share prices of some of the largest online lending companies dropped sharply on news that local regulators are toughening their stance on the industry. Online microlender Qudian, backed by Alibaba, dropped 16% in reaction to news that approvals for new online lending licenses had been immediately suspended. This comes just weeks after the company raised US$900m in an oversubscribed New York IPO.
Thailand’s economic growth rate accelerated in Q3 to 4.3% YOY, up from 3.8% in Q2, beating market expectations. This is Thailand’s fastest YOY growth rate recorded since Q1 2013. Exports continue to be the most important driver of the Thai economy, outweighing the drag from softer domestic consumption, which has seen the effects of benefits transfers given to farmers in the first half of the year begin to fade out.
President Duterte continued his efforts to diplomatically reposition the Philippines closer to China and further from the US.
After some playground trash talk about former President Barack Obama’s mother shortly after taking office, Duterte announced last year in Beijing an explicit “separation” from the United States in terms of both economic and military ties. Since then, the populist president has moved the Philippines closer to China, securing $14bn in trade deals and $9bn in low-interest loans during his first state visit alone. This week, he gave Chinese companies the “privilege” of entering the Philippines’ telecom market to disrupt the current inefficient duopoly, in addition to the 14 joint agreements signed during Chinese Premier Li Keqiang’s visit to Manila earlier this month.
With the US taking a more passive approach in the Asia Pacific region under President Trump, a tailor-made power vacuum is appearing that China will gladly fill. The most contentious issue for the specific Philippines-China relationship will remain to be the disputed South China Sea territories and China’s claims to the ‘nine dash line’ area, which stretches in to waters claimed by the Philippines. For now, Duterte is playing hard to get, encouraging China’s economic flirtations, without wanting to go all the way and publicly withdraw the Philippines’ objections to China’s claims on the South China Sea on the international stage.
MSCI Lat Am 2,818 +1.52%
On December 17, Sebastián Piñera and Alejandro Guillier will compete for Chile’s presidency.
Market-favourite Sebastián Piñera has won the 1st round of Chile’s presidential poll, but failed to avoid a run-off. He obtained 36.6% of the votes, in contrast to 43% in the polls (average for polls published between September and early November). Relative to polls, the biggest outperformer was Beatriz Sánchez the candidate of the Frente Amplio, clinching 20.3% of the votes (vs. 14% in polls) and making her a close 3rd given Guillier’s 22.7% of votes.
However, moving to the composition of congress, the right-leaning parties did better than the corresponding presidential candidates. With 47% of the lower chamber and 44% of the senate from 2018 to 2022 (one of the highest figures since the return to democracy in 1989, with the exception of the 2009 election). A potential Piñera government would therefore probably have an easier time negotiating with moderate opposition members in order to get legislation approved, compared to his first term. Indeed, it would be very difficult for Guillier to pass any hard-left leaning reforms, as he would face strong opposition in Congress.
These results introduce a significant amount of uncertainty to the Presidential race which is likely to result in a much more volatile price action between now and the second round on December 17th.
Voter turnout came in at 46%. Participation in the run-off election is likely to hold the key for the final outcome.
Chile’s GDP grew 2.2% YOY during 3Q17, reaching its strongest annual expansion since 1Q16 amid an improving private consumption and a better trade balance. Inventory rebuilding was a strong contributing factor. In QOQ terms economic activity expanded by 1.5%, its best result since 4Q12.
Chile’s current account recorded a 2.2% of GDP deficit in 3Q17 (USD 1.5Bn), taking the twelve-month-rolling deficit to 1.7% (USD 4.6bn), underlining the strong macro-economic positioning of Chile.
Argentina’s central bank kept its benchmark interest rate on hold, at 28.75%. The central bank said that the current level of tightness of monetary policy is adequate to slow inflation and minimizing impact of coming increases in regulated prices.
Argentina’s September GDP grew +3.8% YOY, below expectations of 4.5% and August print of 4.5%. Argentina’s October trade deficit of came in at USD 955Mn, which should bring the current account deficit of 3.8% of GDP in 2017.
The mix of high inflation and widening current account deficit points towards an overvalued currency.
Mexico’s Central Bank kept the benchmark rate steady at 7%, in spite of a deterioration in the inflation outlook.
The board will monitor the relative monetary policy stance between Mexico and the US, exchange rate pass-through, the output gap, and wage pressures as the most important variables for further policy decisions.
Peru’s GDP growth accelerated in 3Q17 to 2.5% YOY (from 2.4% in 2Q17).
Brazil’s current account showed its smallest deficit in a decade YTD and for the month of October, totalling USD 343Mn, narrower than market consensus (USD -900Mn). This print brings the last 12 months current account deficit to 0.5% of GDP.
Brazil’s government announced that it will push a revised version of its social security reform to be voted in Congress. It further waters down the proposal approved by the Lower House Special Committee in May, focusing mainly on:

  • the minimum retirement age (65 years for men and 62 years for women)
  • the transition rule
  • the unification of the retirement rules of workers in the private and in the public sector

According to the Finance Ministry, the revised pension reform would save approximately BRL 480Bn over the next 10 years, or 60% of the BRL800bn that the original proposal aimed to save but still saving 1.5% of GDP by 2025.
Colombia’s central bank delivered a new 25 bps rate cut, bringing the benchmark rate to 4.75%. The board felt confident in pursuing monetary stimulus (the output tap is estimated at around 1.5- 2%) as inflation is falling fast, despite concerns over the economy’s external vulnerabilities.
MSCI Africa 921 +1.08%
S&P downgraded South African local currency debt to junk (BB+ from BBB-), citing further deterioration in the country’s economic outlook and public finances, while Moody’s, the only major rating agency with the country’s foreign and local currency debt in investment grade, placed them on review for a downgrade.
The rand weakened 2% against the dollar after S&P’s announcement, but the decision by Moody’s to hold fire, should prevent a larger sell-off. Downgrade of the local currency debt to sub-investment grade by both S&P and Moody’s could have seen South African government bonds falling out of key indices which require investment grade, such as the Citi World Government Bond Index, a major index tracked by about USD3 trillion of funds. This would have triggered a sell-off of rand bonds from index-tracking and rating-constrained funds, and raise the country’s borrowing costs. The next fork in the road for South Africa is the ANC elective conference next month where a more fiscally responsible slate could be elected. 
Elsewhere in South Africa, CPI slowed to 4.8% YOY in October from 5.1% in September, while the central bank held its benchmark policy rate at 6.75%, citing increased risks to inflation posed by currency weakness, possible credit downgrades and political jostling.
Moving on to Nigeria, its GDP expanded 1.40% YOY in Q3 2017, from 0.72% in Q2, making it the second consecutive quarter of growth after a 1.6% contraction in 2016. The key drivers of the growth were:

  1. Recovery in oil production – oil production increased to 2.03mbpd compared to Q2 revised figure of 1.87mbpd. This plus stronger oil prices (Brent strengthened 3% in the quarter and 13% YOY) led to a 25.89% YOY real GDP growth in the oil sector, and saw oil sector contribution to GDP increase from 8.09% in Q2 to 10.04% in Q3.
  2. Resilient agricultural sector – agricultural sector grew for the 8th consecutive quarter, by 3.06% YOY, though 1.47% lower than the corresponding period in 2016.

The above brings YTD GDP growth to 0.43% but masks the state of the real economy, represented by the non-oil sector, which contracted 0.76% YOY compared to a 0.42% growth in Q2.
The recovery remains fragile and wedded to the oil market outlook. The weakness of the non-oil sector suggests that improvement in forex liquidity isn’t providing sufficient tailwinds for key sectors. Consumption remains subdued and increases the pressure on the central bank to boost growth through a more accommodative monetary policy.  Nonetheless, the resilience of the agricultural sector which is being pushed through a range of policies, including import substitution, will be encouraging to the government, while further improvement in oil market outlook (oil prices have strengthened 10+ percent from the end of Q3 to date) bodes well for Q4 GDP growth.
Staying in Nigeria, the central held its policy rate at 14%, driven in part by the still high food inflation (20+ percent), while the bond market’s appetite for Nigerian government debt remained strong. A dual tranche USD3bn Eurobond issued at 6.5% and 7.25% respectively for 10yr and 30yr debt instruments, was oversubscribed by USD11bn.
In Kenya, the Supreme Court upheld the October 26th election results confirming President Uhuru Kenyatta’s re-election. The opposition NASA party maintained that the re-election was illegitimate, however, the President is expected to be sworn in on Tuesday 28th November 2017. Elsewhere, in Kenya, the central bank held its policy rate at 10% in line with expectations.
Lastly, Robert Mugabe finally succumbed to pressure from the military and his own party, and resigned as president of Zimbabwe on Tuesday. This brings an end to Robert Mugabe’s 37 years authoritarian rule. Emmerson Mnangagwa, who Mugabe sacked as his deputy earlier this month, was sworn in as the new president.
Under Mugabe, Zimbabwe went from the breadbasket of Africa to economic ruin. Mr Mnangagwa could usher in a new era but being an old ally of Mugabe, there are concerns that he will attempt to maintain the autocratic hold on power. The world will have to wait and see, though initial signs from his inauguration where he committed to holding democratic election next year and called for re-engagement with all the countries of the world, appear positive.

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