Money Matters 30th October 2018

That, of course, ‘depends.’ The reaction function of the Fed’s monetary policy depends primarily on two factors: the state of the labour market and the intensity of domestic price pressures. Neither have been impacted, nor have the US’ financial vulnerabilities been exacerbated by the turmoil in financial markets. We may receive further evidence this week that inflation is on track to meet the Fed’s 2% target and/or that the labour market remains at the state of full employment; both are arguments in favour of tighter monetary conditions going forward. Therefore, although recent stock market instability drove the S&P 500 into negative territory year-to-date, the decline of the index might just fall short of forcing the Federal Reserve into rethinking its tightening policy.
Markets will have no time to take a deep breath this week, as the economic diary is fully packed with key macroeconomic data that has the potential to influence asset prices. Most importantly, PCE inflation, manufacturing confidence indicators and labour market figures will be published in the US, including the very closely scrutinised wage growth number. In the Eurozone, Q3 GDP will be published which may challenge the ECB’s view that growth in the Euro Area remains solid and broad-based. Meanwhile, the Bank of England decides on the policy rate this week, when Governor Carney might provide further guidance on the timing of the next hike.
In emerging Asia, all eyes will be on Chinese PMI data from October. Should the indicator show stability, markets will find comfort in the idea that trade tensions have had no significant impact on the underlying strength of Chinese economic activity. In Latin America, Mr. Bolsonaro’s efforts to form a government will be watched closely, while the Argentine crisis management may support markets. Macro data should gain greater importance as the election in Brazil is behind us. As a result, Mexican GDP data from Q3 will be particularly important this week. Meanwhile in Africa, speculation about South Africa’s credit rating will probably continue.
pexels-photo-747113UNITED STATES
S&P 2,659 -3.94%, 10yr Treasury 3.06% -11.66bps, HY Credit Index 386 +19bpsVix 24.36 +4.27Vol
Claiming that volatility in the US stock markets remained elevated during the week is an understatement, as US stocks were massively sold off across the board. The S&P 500 led the pack by falling 4% and is 0.6% below its value seen at the beginning of this year. Energy firms and financials underperformed in this choppy environment, as they dropped 7.1% and 5.2%, respectively. Consumer staples weathered the turmoil relatively well, as the index for staples decreased by only 1.4%. As tighter USD liquidity conditions and mounting political tensions roil markets, investors seek safety in US Treasuries. Consequently, the whole Treasury curve eased by more than 10bp, bringing the 2-year yield to 2.81% and the 10-year to 3.08%.
Real GDP growth in the US hit 3.5% on seasonally adjusted annualised terms in Q3, exceeding the median market estimate. Consumption growth was 4%, while business equipment investment was broadly flat in the quarter. The negative contribution by net exports was largely offset by increased inventory building. Details also revealed that price pressure in Q3 remained subdued, since quarterly core PCE inflation was 1.6% in annualised terms.
In the first three quarters of this year, real GDP growth exceeded both expectation and the economy’s inherent potential, which has two important implications:

  1. The December rate hike by the Fed appears to be a done deal, as the economy is in solid shape to withstand tighter financial conditions,
  2. GDP growth might slow below its potential without further policy stimulus in 2019, which may constrain the Fed in its efforts to normalise interest rates.

Markets are now factoring in fewer than two 25bp hikes for next year, compared with the three increases that the FOMC members have projected.
Europe 30 Oct 2018EUROPE
Eurostoxx 3,148 -3.42%, German Bund 0.36% -10.80bps, Xover Credit Index 302 -8bps, USDEUR .877 +1.08%
European stock markets fared rather badly, as major stock indices lost 3-4% of their value in USD terms during the week. Investors sought haven in sovereign debt assets, which led to the decrease in yields on the majority of the Euro Area bonds. As a result, the 10-year German Bund yield fell 11bp to 0.35bp, below the level where it was seen at the beginning of this year. Italian bonds benefitted the least from the flows to sovereign bonds, due to the debates between the Italian government and the EU on Italy’s budget proposal for 2019. The 10-year Italian spread remains alarmingly wide, at 309bp.
The European Central Bank left the policy rates stable, in line with expectations. Consequently, the main refinancing rate is 0%, while the deposit rate is -0.4%. The President of the ECB, Mario Draghi played down recent weaker economic growth data, concurring with the Governing Council’s judgment that ‘the risks surrounding the Euro Area growth outlook can still be assessed as broadly balanced.’ The ECB is still confident that core inflation will rise towards the end of the year, because of ‘high levels of capacity utilisation and tightening labour markets.’
The statement by the Governing Council and Mr. Draghi’s remarks could be interpreted such that the ECB may want to wait until December when it will have more economic data and its projections are updated.
The EU rejected Italy’s 2019 budget proposal, as the EU Commission called on Italy to submit a revised 2019 budget within three weeks, as the current draft has ‘a particularly serious non-compliance with the recommendations’ issued by the Council to Italy. Italian PM Conte said in an interview to Bloomberg that there was no alternative to the budget and that the deficit target would stay at 2.4% of GDP.
Asia 30 Oct 2018ASIA
HSCEI 10,003 -1.58%, Nikkei 21,149.80 -5.56%, 10yr JGB 0.11% 0bps, USDJPY 111.930 -0.44%
The MSCI Asia Pacific ex. Japan index fell 3.7% in USD during the week and has entered bear market territory, as the index has lost 20% of its value in USD since the beginning of the year. The South Korean, Vietnamese and Taiwanese stock indices underperformed during the week, as they fell 6.6%, 6.1% and 4.6% in USD, respectively. In contrast, Pakistan, Chinese ‘A’ shares and Sri Lanka outperformed by rising 5.4%, 1.7% and 0.5% (all in USD), respectively.
Total profit of Chinese industrial enterprises grew 14.7% YoY YTD in September, down by 1.5ppt from 16.2% YoY YTD in August. The single-month growth decelerated to 4.1% YoY in September. State-owned enterprises’ (SOE) profit growth slowed from to 23.3% YoY YTD, while profit of privately-owned enterprises (POE) grew 9.3% YoY. Since the beginning of the year, SOEs deleveraged while POEs re-leveraged, as the asset-liability ratio of SOEs declined to 59% as opposed to POEs, whose ratio increased to 56.1%.
The Chinese government has rolled out a series of measures to boost infrastructure investments and household consumption in an attempt to offset the trade war’s impact on Chinese economic activity. High-frequency macroeconomic indicators are likely to show the first signs of the stimulus measures’ spurring effect as early as Q4.
The central bank of Indonesia left the policy rate unchanged at 5.75% in its regular monetary policy meeting, in-line with market consensus. The communication released by the MPC implied that policymakers do not foresee further widening of the current account deficit due to the government’s measures introduced in September to curb imports.
Thai foreign trade figures fell short of expectations, as exports fell 5.2% YoY in September as opposed to Bloomberg consensus that projected a 5.3% YoY increase. Imports missed estimates as well, as they increased 9.9% YoY vs. the median Bloomberg estimate of 14.3% YoY. As a result, foreign trade surplus amounted to USD 0.45bn. The regional breakdown revealed that exports to China dropped 14.1% YoY, while the sectoral breakdown reflected a decrease of 7.4% YoY in cars and parts, computers and accessories.
Despite the downside surprise, the foreign trade surplus remains considerable, while real rates remain positive. Both should serve as a cushion for the currency in a challenging market environment. As the trade surplus shrinks and real rates decline, the central bank will need to reconsider its neutral stance soon.
Weak investment activity continued to drag South Korean GDP growth, as economic activity rose 0.6% QoQ in seasonally adjusted terms in Q3, while in annual terms growth slowed to 2.0%. Personal consumer spending and net exports contributed positively to GDP growth, while gross fixed capital formation and inventory stocks decrease strongly weighed on the pace of the South Korean economy’s expansion.
In a surprising political manoeuvre, Sri Lankan President Sirisena swore in former President Mahinda Rajapaksa as the new Prime Minister of the government. From a constitutional point of view, the President can appoint any Member of the Parliament as the Prime Minister. However, the interpretation of provisions relating to the removal of a sitting Prime Minister prior to appointing a new PM is debatable. The President may not have the legal power for such a removal. The fate of the previous Cabinet of Ministers remains unclear, as the President cannot remove any of the ministers without the ‘advice’ of the Prime Minister. The legality of the move will probably be challenged in the coming days.
Latin America 30 Oct 2018LATIN AMERICA
MSCI Lat Am 2,688 -0.55%
During the week, Latin American markets faced challenges posed by the risk-averse global investor sentiment, international political tensions and broad-based USD strength. Consequently, the MSCI EM Latin America index decreased 0.6% in USD during the week. Mexico was among the worst performers, as the country’s stock index fell 4.5% in USD, followed by Colombia (3.6% in USD). Despite the headwinds, Brazilian and Argentine stock markets gained during the week in USD terms, by 2% and 1.4%, respectively.
Jair Bolsonaro (PSL) won the second round of the Presidential election, in line with political polls. Mr. Bolsonaro claimed about 56% of the vote in the race against Mr. Haddad (PT). Mr. Bolsonaro stated that his government will be ‘a defender of the constitution, of democracy and of freedom.’ His team of economic advisers is led by University of Chicago-trained Paulo Guedes, who plans to slash import barriers, embark on new free-trade talks, and realign foreign policy more closely with that of the US.
Brazilian asset prices could benefit in the short-term from the win of Mr. Bolsonaro, as his agenda was more market- and business-friendly than that of his opponent. However, a key question remains whether Mr. Bolsonaro can form such a majority in Congress that helps him pass the crucially needed reforms that address the Brazilian domestic economy’s inherent deficiencies.
Mexican index of economic activity (IGAE), which is a monthly proxy for GDP, rose by 1.7% YoY in August, after growing 2.8% YoY in July. Details revealed that industrial production virtually stagnated in annual comparison, while growth of services slowed to 2.4% YoY. Meanwhile, agricultural output grew by a meagre 1.0% YoY.
Foreign trade deficit in Mexico stood at USD 195mn, well below the Bloomberg consensus. The smaller-than-expected deficit mostly reflected the strength of the manufacturing sector, with the significant contribution of motor-vehicle shipments, as well as the higher value of oil exports given high oil prices.
In the first two weeks of October, Mexican consumer prices posted a 0.4% increase. In annual terms, inflation stood at 4.9%, a decrease compared to the 5.2% YoY reading for the previous bi-weekly period. Core prices rose 3.7%YoY, matching expectations.
The central bank of Mexico published its 2018 Financial Stability Report, which highlighted the strength and resilience of the Mexican financial system. The report finds that financial stability risks stem mainly from abroad, as increases in US interest rates, an escalation of international trade tensions, and a lower Mexican growth outlook remain the most relevant risks in the central bank’s view. Stress tests under extreme scenarios show that the banking system remains robust.
Argentine foreign trade balance posted a USD 314mn surplus in September, exceeding market expectations. This is the first trade surplus in almost two years. As a result, the 12-month trade deficit fell by about USD 1bn to USD 9.7bn. The sharp depreciation of the exchange rate and the contraction of internal demand led to a visible improvement of the trade figures, in spite of poor exports of agricultural products.
The central bank of Colombia kept its policy rate unchanged at 4.25%, in line with expectations. The decision was taken unanimously, as most of the MPC’s arguments remained broadly unchanged. MPC members claimed that inflation may continue to hover close to the target, despite elevated inflation expectations. According to the central bank, the Colombian economy has been performing below its potential.
MSCI Africa 696 -4.08%
Majority of African stock markets declined in USD terms. Egypt received the greatest blow, as the country’s stock index fell 4.2% in USD. The South African market underperformed as well by falling 4% in USD. The Nigerian market was among the bright spots in Africa, as the Nigerian stock index slightly gained, about 0.5% in USD.
The South African government’s latest budget raised the deficit estimate. The consolidated budget deficit is estimated at 4% of GDP in FY2018-19, compared with the 2018 budget projection of 3.6%. The government projects a wider fiscal deficit than before due to a combination of higher-than-expected VAT refunds, slower economic growth and higher-than-expected public sector wage settlements. The economic outlook is also weaker than projected; GDP growth projection was revised down from 1.5% to 0.7% in 2018 following a recession in the first half of the year, although it is expected to recover gradually to 2.3% by 2021 as confidence grows and investment gathers pace.
The worse-than-expected fiscal outlook increases the risk of a credit rating downgrade by Moody’s or a change to a negative outlook in the short-term. However, the likelihood that Moody’s will downgrade South Africa to non-investment grade this year seems unlikely.
South Africa’s headline consumer inflation was flat at 4.9% YoY in September. Core inflation was also unchanged at 4.2%. On a monthly basis, headline inflation rose to 0.5% in September after a 0.1% contraction in August.
Morocco’s annual consumer price inflation moderated to 1.1% YoY in September from 1.7% in August due to a slowdown in food prices. Annual food inflation declined to 0.6% in September from 1.1% in August, while non-food inflation increased to 2.1% from 1.9%.
Kenya’s risk of defaulting on debt repayments has increased to ‘moderate’ from ‘low’ according to the IMF. The Washington-based lender cited the higher level of debt together with rising reliance on non-concessional borrowing which has seen Kenya’s interest payments on public debt increase to nearly one fifth of revenue, placing the country in the top quartile among its peers.
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