Money Matters 30th May 2018

Two weeks ago, the US 10-year bond yield broke decisively through 3% and the oil price (Brent) rose above USD 80. Last week saw an abrupt “about turn”, as dovish Fed minutes continued geopolitical wrangling and speculation of easing OPEC supply restrictions, prompted the largest drop in US yields in over a year and a 7% intra-week decline in the oil price (with further declines yesterday).
Regarding oil, last Monday prices hit their highest levels since 2014 on speculation the US would impose new sanctions on Venezuela. However, after the experience earlier this decade of extreme price volatility, it appears OPEC members are keen to foster a less “boom and bust” environment. As such, later in the week both Saudi and Russian ministers talked about the prospect of increasing their production to offset losses elsewhere. Indeed, the US rig count also continued to climb.
In general, markets remain in a more volatile and difficult environment. However, it is possible that last week marks a change in direction; the chief concerns of higher US rates and oil prices mitigated by a change in tone from the FED (see below) and OPEC respectively.
S&P 2,721 +0.31%, 10yr Treasury 2.88% -12.46bps, HY Credit Index 343 +4bps, Vix 14.43 -.20Vol
Consistent with the general theme of reversal, recent outperformers (small caps, energy and materials) underperformed last week as utilities and real estate stocks recovered. The yield curve flattened, and the USD continued to strengthen.
Donald Trump’s trade and foreign policy was again in the limelight:

  • On Tuesday, China announced a reduction in tariffs on some imported vehicles by 10% (from 25% to 15%). However, the following day Trump stated his administration was considering their own 25% tariff on imported cars.
  • On Thursday, he issued a short but rambling letter calling off the planned summit with North Korea on the basis of “the tremendous anger and open hostility displayed in your most recent statement”. However, over the weekend, US officials met with their North Korean counterparts in the demilitarised zone and there remains a strong possibility the summit will be reinstated.

At the macro level, the most significant release was of the minutes to the May FOMC meeting. Despite continuing to signal a June hike to 1.625%, which is now 92.5% priced by the market (“It would likely soon be appropriate for the Committee to take another step in removing policy accommodation”), the overall tone was dovish:

  • Re inflation, the minutes commented “a temporary period of inflation modestly above 2 percent would be consistent with the Committee’s symmetric inflation objective.”
  • Re the prospect of an inverted yield curve, “several” felt avoiding an inverted yield curve would be wise, given the historical association between inverted yield curves and recession risk.
  • Re the overall level of rates, a “few” members stated that we are getting close to the neutral rate (the level at which monetary policy provides neither stimulates nor detracts from growth) and therefore it might be appropriate to revise forward guidance.

The overall conclusion is that the FED sees the end of its current hiking cycle on the horizon. It is likely Trump’s fiscal stimulus will provide sufficient comfort for further hikes this year, but next year could well mark a pause unless global growth finds another wind.
Eurostoxx 3,454 -2.66%, German Bund 0.31% -17.30bps, Xover Credit Index 317 -20bps, USDEUR .863 +1.04%
European equities, particularly in the periphery, underperformed as yield spreads widened between Italian, Spanish and Portuguese bonds and the German benchmarks. This was driven primarily by Italian politics and the increasing likelihood of an anti-establishment, Eurosceptic government after the selection of Law Professor Giuseppe Conte as candidate for PM.
However, over the weekend, plans for a coalition government crumbled after President Mattarella blocked the selection of Paolo Savona as finance minister stating “The uncertainty over our position in the euro alarmed Italian and foreign investors who invested in shares and companies… the rise in the spread increases the debt and reduces the opportunity to spend on social measures. It burns companies’ resources and savings and foreshadows risks for families and Italian citizens.” And on Monday, former IMF official Carlo Cottarelli was named PM to run a technocratic government. This prompted further pressure on bonds, for example the 2-year rising 50bps in yield (biggest move in 6 years). In short, the country remains in a constitutional crisis with calls to impeach the President and the new PM unlikely to survive a vote of confidence, which would trigger fresh elections with no clear route to a sustainable government.
Meanwhile, in Spain the main opposition party, the Spanish Socialist Workers’ Party, filed a no-confidence motion against Prime Minister Mariano Rajoy after his party was found to have benefited from an illegal kickbacks-for-contracts scheme. The PM will face the vote on Friday and Spanish stocks were down over 3% during the last 2 days.
From a data perspective, the Eurozone composite PMI fell to its lowest level in over a year (54.1), albeit remaining in positive territory. The French INSEE survey was also weaker, but the German IFO beat expectations.
Elsewhere, automakers suffered sharp share price declines following Donald Trump’s tariff threat.
In the UK, retail sales for April recorded a positive surprise. However, it is hard to draw too many inferences given cold weather negatively impacted the March number.
The Turkish lira lost another 5% over the week, despite an emergency 300bps hike in the “liquidity window” as investors failed to be persuaded that President Erdogan’s influence was waning. However, yesterday the bank moved to simplify its system of interest rates including more than doubling the one-week repo to 16.5%. As such, the currency recovered much of the previous week’s fall.
HSCEI 11,968 -2.44%, Nikkei 22,358.43 -1.03%, 10yr JGB 0.04% 0bps, USDJPY 108.880 -1.24%
China made further concessions as part of ongoing trade deliberations with the US, announcing a cut to import duty on foreign cars from 25% to 15%. This follows Trump’s softening of his stance against Chinese tech giant ZTE, which has already lost an estimated US$3bn in revenue on account of US sanctions.
Whilst the high-level rhetoric from the US around the reduction required in the bilateral trade deficit remains fiery, there appears to be a trend towards de-escalation and compromise at the level of specific policy implementation. 
President Xi also met with German Chancellor Angela Merkel in Beijing this week, with the spectre of Europe moving more clearly in to the crosshairs of Trump’s war on trade likely among the topics of discussion.
Thailand’s economy accelerated in Q1 2018, with GDP expanding at 4.8% YOY, the fastest growth rate recorded for five years. Activity strengthened, having posted a 4.0% expansion in Q4 2017, on account of stronger private sector consumption and export growth. This coincides with the recent increase in the inflation rate to 1.0% YOY in April, the highest reading for over a year but still below the 2.5% target.
Taiwan’s economic growth rate was revised to 3.04% YOY for Q1 2018, from an initially reported 3.02%. Whilst the magnitude of the data revision was immaterial, the government did follow the announcement with an increase in its official growth forecast for 2018, on account of a strong global economy and buoyant demand for technology exports.
Bank of Korea left interest rates on hold at 1.50%, in line with expectations. The tone of the official statement was largely unchanged. The Monetary Policy Board highlighted oil and capital outflows from certain emerging markets as potential risk factors, while leaving its domestic growth outlook unchanged.
Inflation in Malaysia inched up to 1.4% YOY in April, 10bps higher than the March figure.
latinamericaLATIN AMERICA
MSCI Lat Am 2,565 -1.68%
Centre-right and market-favourite Ivan Duque led the 1st round of Colombia’s presidential election with 39.7% of the votes. On the 17th June, he will face left-wing Gustavo Petro who gathered 24.8% of the votes.
Duque is now largely expected to become the next Colombian president, implementing structural reforms, reinforcing institutions and implementing sensible pro-growth economic policies. 
Chile’s Q1 2018 GDP growth rate at 4.2% was the highest since Q3 2013. It was above expectations and accelerated from a 3.3% rate in Q4 2017.
Chile’s economic recovery is being supported by strong external demand, higher copper prices, low interest rates and low inflation, in an environment of high business and consumer confidence.
Mexico’s GDP grew 1.3% YOY in 1Q18, as a consequence of tight macroeconomic policies and the uncertainties associated to NAFTA renegotiation and the presidential elections.
This performance remains un-inspiring and marks a significant slowdown from the previous years. 
Mexico’s retail sales rebounded slightly in Q1 2018, expanding 1.2% YOY. This comes after a sharp slowdown in 2017 (to 1.3% YOY growth, from 8.7% in 2016) due to the erosion of real wages as inflation doubled to 6.8%, from 3.4% in 2017.
Although lower inflation and robust employment data should support consumption, consumer confidence weakened YTD and remittances converted into MXN are less supportive, due to a MXN appreciation. Low consumption growth is likely to continue for this year, but the outcome of its presidential election and the NAFTA renegotiation will impact consumption either way through confidence, fiscal or monetary policy. 
Brazil’s oil giant Petrobras saw its share price tumble on Thursday (-14%) as the government forced a 10% cut in diesel prices for the next 30 days. Truck drivers had been on strike for 4 days. The government reached an agreement with the truck drivers’ union after agreeing to change Petrobras’ pricing policy from daily pricing to changing prices only every 30 days, cutting a tax on diesel to zero and maintaining payroll tax breaks for the highway transport sector.
In trying to prop up its popularity, the government is putting at risk the fiscal consolidation path. Estimates of the cost of such measures vary between BRL 10Bn and 20Bn on an annualized basis. At the same time, the continental size of Brazil makes it very vulnerable to disruption in transportation and the poor state of infrastructure makes it very reliant on trucks. This truckers’ strike was starting to disrupt several sectors of the economy and pushed the government’s back against the wall. 
Colombia’s industrial confidence rose to 2.0% in April (0 is neutral), its highest level since December 2016 and above the -8.5% recorded one year earlier, impacted by the implementation of the tax reform. Retail confidence remains in optimistic territory at 28.7% (vs. 17.8% in April 2017), reaching its highest value since August 2016.
Peru’s Congress approved the legislative powers requested by the executive branch to speed up the reconstruction works, following floods in Northern Peru last year. Legislative powers related to the economy’s competitiveness, the State’s modernization and the fight against corruption have not been approved yet.
MSCI Africa 931 +1.03%
Nigeria’s economic growth softened in the first quarter of 2018, weighed down by the non-oil sector. The economy grew 1.9% YOY in Q1 2018, slower than the upwardly revised 2.1% growth in the previous quarter. The oil sector which accounts for c.10% of GDP, grew 14.8% YOY with output rising to 2mbpd, the most since Q1 2016, while the non-oil sector was subdued, advancing 0.7% after a 1.5% increase in the prior period.
A more positive outlook for oil and an expected increase in public spending in advance of the February 2019 general election would support the economy in the short term. However, given a projected 2.6% population growth rate, the country would need 5+ percent economic growth for real economic transformation. 
The Nigeria central bank held its main lending rate at 14%, as widely expected, citing increased inflationary pressure in the second half of the year.
Moving to South Africa, the ANC government overcame one of the major obstacles to the country’s fiscal position as it seeks to trim a large budget deficit. The government agreed a three-year wage deal with state workers with modest salary increases only slightly above inflation; up to 7% in the first year and projected inflation plus 1% in the second and third years. The increases are well below the 12% demanded by unions, a victory for the Ramaphosa administration, who are trying to restore confidence in South Africa’s public finances.
Elsewhere in South Africa, the central bank left repo rate unchanged at 6.5% given the outlook for CPI which the bank sees as titled to the upside on the back of rising oil prices and possible higher electricity tariffs. On inflation, headline CPI rose 4.5% YOY in April from 3.8% percent in March, following a 1% increase in VAT which came into effect on April 1. On a MOM basis, inflation quickened to 0.8% in April from 0.4% in March. Core inflation, increased to 4.5% YOY from 4.1% in March, while on a MOM basis it slowed to 0.6% from 0.7%.
In Kenya, the central bank held its main lending rate at 9.5% as expected. The MPC noted that there was some room for easing with inflationary expectations within the target range of 2.5% – 7.5% and economic output below the potential level.  However, the impact of the downward revision of the CBR (-50bps) at the previous meeting was yet to be fully transmitted to the economy.
Lastly, Ghana’s central bank cut its policy rate 100bps to 17%. This comes after inflation fell to single digit for the first time since 2012, 9.6% in April 2018, within the central bank’s target range of 8 +/- 2%. Ghana is the final year of a USD 918mn credit facility program with the IMF to narrow its deficit and reduce debt. Inflation has since fallen from 19.2% in March 2016 while the interest rate has been slashed 900bps from 26% and public debt to GDP declined from 73.4% to 60% in the same period.
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