Money Matters 4th September 2018

ECB President Mario Draghi and his fellow members on the European Central Bank’s Governing Council have been doing everything right to commit a policy mistake, similarly to their predecessors under Jean-Claude Trichet. Mr. Trichet pulled the trigger too quickly by lifting the policy rates in 2011 contributing to the W-shaped recession in the Euro Area. Mr. Draghi is on the same trajectory, as macroeconomic developments do not warrant policy normalisation anytime soon.
Inflationary processes in the Eurozone remain quite unsettling, as both annual headline and core inflation measures decelerated compared to the previous month. In July, both headline and core CPI inflation decelerated 0.1ppt to 2% YoY and 1% YoY, respectively. The weakness in both measures was induced by sluggish services price inflation, which moderated to 1.3% YoY. Even though the headline measure has been hovering at the ECB’s inflation target, the core rate that filters out volatile prices driven mostly by external forces (such as energy prices), remains extremely depressed. In addition, annual growth of the M3 monetary aggregate eased to 4% YoY in July vs. 4.5% YoY in May. The speed of M3 growth is more-or-less in line with the pace by which the European Central Bank has been scaling back its monthly asset purchase. The pace in July implies that credit growth is likely to have a neutral impact on GDP growth and is very unlikely to contribute to it anytime soon.
As the saying goes: ‘When it looks like a duck, swims like a duck and quacks like a duck, then it probably is a duck.’ In this case, the Euro Area’s economy perfectly exhibits the symptoms that call for further aid by the monetary authority, especially since no structural reforms are in sight in the member states that crucially need them.
Looking ahead
Developed markets face a rather exciting week, as the economic diary is packed. Most importantly, the US releases the usual monthly jobs report, which almost always moves markets. This time, nominal wage growth is in the limelight, since wage inflation are the last piece of the puzzle in the US that is needed for a steeper rate hike trajectory. Meanwhile in the Euro Area, some of the relevant ECB policymakers will give speeches and might provide some insights on the Governing Council’s intentions. On Friday, final GDP figures will be released, which finally reveals the detailed breakdown of the Euro Area’s growth in Q2.
Asian countries kick off the week by releasing August manufacturing PMI figures on Monday and continue with the publication of inflation data. In the second half of the week, India publishes its current account balance that could have an impact on the rupee’s exchange rate.
Latin America will be dominated by Brazilian political news flow, Argentine crisis management and NAFTA negotiations between Mexico, the US and Canada. As a result, the economic diary will be secondary this week.
African markets will be mostly influenced by developments in South Africa, where the political debate on the reform related to land expropriation is in the limelight. Furthermore, Q2 GDP release on Tuesday will shed light on the recovery of the South African economy.
United States 4 SeptUNITED STATES
S&P 2,902 +0.93%, 10yr Treasury 2.86% +5.06bps, HY Credit Index 330 +4bpsVix 12.86 +.87Vol
Although European, and the majority of emerging and frontier markets, fared badly during the week, US stock markets headed north. The S&P 500 rose 0.93% led primarily by IT and consumer discretionary, while telecom stocks weighed on the overall performance. The broad dollar index (DXY) was virtually unchanged. The US Treasury yield steepened, since the 2-year yield rose 1bp, while the 10-year increased 5bp, lifting the 2s10s spread to 23bp.
President Trump sounded constructive on striking a new trade deal with Mexico and Canada. Negotiations may successfully come to an agreement in the coming week(s). Other countries, however, were not as lucky as Mexico and Canada. At the end of the week, the POTUS rejected the offer by the EU to remove the tariffs on cars imported from the US. In addition, the US President threatened to pull out of the World Trade Organization.
Both headline and core PCE inflation measures edged up 0.1ppt to 2.3% YoY and 2% YoY in July, respectively, matching median market estimates.
The July PCE reading was strong enough to bolster the case for the long-awaited 25bp rate hike in September by the Fed. According to the Fed funds futures, market players are almost completely convinced that the FOMC will lift the Fed funds rate to 2.00-2.25%.
Seasonally-adjusted annualised quarterly real GDP growth in Q2 was revised up 0.1ppt to 4.2%, as growth of imports was weaker than in the first read, while investments were slightly stronger than reported in the flash estimate.
The revision of Q2 GDP growth was so minor that it does not overwrite the broad macro picture in US. The question in focus remains to what extent the above 4% growth is sustainable.
Eurostoxx 3,392 -1.25%, German Bund 0.34% -1.90bps, Xover Credit Index 300 -11bps, USDEUR .861 +0.29%
European markets had a difficult time during the week, as most of the major European stock indices fell (in USD terms). The major indices of the big-four economies struggled, especially the Spanish and Italian ones, which lost 2.2 and 2.5% of their values in USD terms, respectively. The risk-off mode of markets was reflected in German sovereign yields as well, as the whole German curve shifted downward 1-2bp, depressing the 10-year tenor to 0.33%. Risk premia in the periphery widened, as Italian, Spanish and Portuguese yields rose substantially.
The German general government ran a budget surplus of 2.9% of GDP in 2018 H1 vs. 1.1% of GDP a year ago. The balance improved due to the larger surplus registered on the federal level led by the economic upswing and increasing employment.
Shortly after budget figures were released, the German government announced a series of (planned) budgetary measures that provide stimulus to households through increased pensions, reduced employees’ contribution to the unemployment insurance scheme and guaranteed pensions remain stable at 48% of the average salary until 2025, while raising the cap on pension contributions from 18.6% to 20%. The measures will become effective on 1st January 2019, should Parliament pass the legislation.
EU Chief Negotiator Barnier cited that the European Union stands ready to ‘to offer a partnership with the UK such as has never been with any other third country. Mr. Barnier’s remark fit the speculations released during the weak that the parties might agree on extending the deadline for a Brexit deal.
The turmoil in Turkey continued, as market players are not convinced that Turkish authorities possess the operational independence that is required to deliver the appropriate policy measures to restore confidence. Losses in Turkish asset prices are amplified by the fact that Turkish authorities bring measures that are unconventional and inappropriate at the same time. Such measures last week, was increasing taxes on USD-denominated deposits held at domestic banks to 16%, while waiving the tax on long-term TRY-denominated deposits. The step provided temporary relief for the lira’s exchange rate, but it is rather unlikely that it will put a permanent top to the struggle of the Turkish currency.
Unemployment in Hungary stagnated at 3.6% in the three-month rolling period between May and July 2018. Over a year, the measures dropped 0.6ppt, while labour force participation increased to 62.5%.
Hungarian investments in real terms increased 15.3% YoY in 2018 Q2. The increase in investment activity was uneven across private and public sectors, as investments by private companies grew 10.1% YoY, while projects initiated by public institutions jumped 44.1% YoY. The uneven nature of investment activity is reflected in the industry-breakdown as well, since infrastructure investments continued to outweigh the creation of productive capacities.
HSCEI 10,797 +0.90%Nikkei 22,707.38 +1.28%10yr JGB 0.12% +0bpsUSDJPY 110.900 -0.12%
Asian markets were a mixed bag throughout the week. Taiwan did significantly better than other markets, as the Taiwanese stock index rose 2.3% in USD, while the broad MSCI Asia Pacific index (excluding Japan) rose only 1.11% in USD during the week. Indonesia continued to suffer (-1% in USD), due to being among the most externally vulnerable economies, while Pakistan lost its post-elections bliss (-2.16% in USD).
Indian real GDP surprised to the upside by growing 8.2% YoY in 2018 Q2 (or FY2019 Q1) vs. 7.7% YoY in the previous quarter. Growth was broad-based; all industries contributed to the stronger-than-expected figure. On the demand side, private consumption moderately accelerated, as it expanded 8.6% YoY. Public consumption was very strong by rising 8.6% YoY. Gross fixed capital formation growth bounced to 10% YoY due to the low base. Import volume kept its momentum by increasing 12.5% YoY, while exports strengthened to 12.7% YoY. The production side was spurred by industrial production growing 10.3% YoY led by the rebound in manufacturing output, which rose 13.5% YoY. Services growth decelerated to 7.3% YoY. Agriculture was unusually strong by rising 5.3% YoY.
Overall, GDP growth outlook is solid and looks to be set on a strong upward trajectory in FY2019.
The Chinese central bank (PBOC) re-introduced the counter-cyclical factor in the daily fixing mechanism to stabilise the currency by offsetting the depreciation pressures on it. The last time the adjustment mechanism was in place was in January. According to the PBOC, the counter-cyclical factor is intended to reduce the impact of ‘irrational expectations,’ ‘herding’ and to prevent ‘overshooting’ as much as possible. There is no publicly available transparent description of how the mechanism works.
The Chinese manufacturing PMI rose 0.1 to 51.3 in August, while Bloomberg consensus projected a slight decline. Even though the production component improved, the component for new export orders continued to decrease into contractionary territory. In contrast with new export orders, overall new orders rose, indicating the increasing domestic demand for manufacturing products. PMIs for medium and small companies rose, while they weakened for large ones – albeit all of them were in expansionary territory. The components for prices significantly increased, signalling intensifying inflationary pressure.
Chinese lawmakers passed legislation that amends the personal income tax law. Revisions include raising the minimum threshold for personal income tax, adding special expense deductions, shifting from monthly to comprehensive annual income taxation. The higher threshold will become effective on 1stOctober, while some other parts of the law will be effective on 1st January 2019.
This step fits the previous communication by Chinese authorities that fiscal policy should take on a more (pro-) active role in order to support domestic economic activity.
According to the Philippine Finance Secretary Carlos Dominguez, the Philippines may issue Panda and Samurai bonds in the next 12 to 18 months, as the country does not want to be absent from any major market. The Secretary added that increasing the policy rate is the appropriate step to constrain consumer price inflation. In his view, the impact of tighter monetary conditions will not hamper economic growth. The Finance Secretary emphasised that the government will not pass a fiscal package that endangers budgetary stability, as keeping the annual budget deficit below 3% of GDP is a priority.
The Indonesian Minister of Finance Sri Mulyani reiterated that the government intends to curb imported goods without constraining economic growth.
The South Korean central bank held the policy rate at 1.5%, as expected. The MPC noted that employment dynamics in the domestic Korean economy have been sluggish and expressed concerns regarding the turmoil in the broader universe of emerging markets. Furthermore, the MPC identified downside risks stemming from trade tensions. The Governor stressed that the Council remains in wait-and-see stance and is ready to deliver the appropriate measures, i.e. rate hike, should economic and financial market conditions warrant.
Vietnam released a broad set of macroeconomic indicators from August, which suggested that the economy is in rather good shape. Industrial production slightly slowed to 13.4% YoY YTD in tandem with exports that decelerated to 14.5% YoY YTD. In contrast, expansion of imports strengthened to 11.6% YoY YTD most probably driven by stronger domestic demand, as retail sales volume expanded 11.2% YoY YTD. As a result of exports outpacing imports, foreign trade deficit narrowed to ca. USD 0.1bn. CPI inflation moderated from July’s 4.5% YoY to 4% YoY in August.
The Governor of the Thai central bank said that the monetary authority has been monitoring the capital inflow to Thailand very closely, as the degree of influx has exceeded the flow to other emerging economics within the region. Consequently, the central bank has kept a close eye on the baht’s exchange rate, as it appreciated faster than its regional peers due to the inflows. The Governor hinted that the central bank might consider tightening in the not too far future.
According to the Thai Deputy Prime Minister, the economy may grow 4.5% YoY in 2018. The Deputy added that the economy is in strong enough shape to shake off the impact of higher interest rates, should the central bank tighten.
Manufacturing production grew 4.64% YoY in July. Manufacturing growth was driven by automotive production, electronic parts, petroleum, sugar and rubber products. Since the beginning of the year, manufacturing increased 4% YoY.
Should further macroeconomic data underpin the idea that the Thai economy is in a good shape and the strong performance is sustainable, the central bank will probably consider starting the normalisation of monetary policy as early as 2018 Q4.
Pakistani CPI inflation was 5.8% YoY (0.2% MoM) in August. Core inflation hovered well above the headline measure, as the core rate hit 7.6% YoY. The gap between the headline and the core rates are due to the  fact that core inflation does not take into account food and energy price swings.
MSCI Lat Am 2,464 -1.10%
Latin American markets had a rough week. The broad MSCI Latin America index fell 1.1% in USD. All the major stock indices struggled. The Argentine stock market realised the greatest loss by falling 4.61% in USD. In contrast, the Brazilian market clearly outperformed by virtually going sideways in USD due to the favourable political news flow that former President Lula will be banned from the list of Presidential candidates.
The Mexican trade deficit widened in July, due to the higher value of imports spurred by energy. The deficit amounted to USD 2.9bn in July, while on a 12-month rolling basis, it rose by USD 1.4bn to USD 13.8bn.
The central bank of Mexico released its quarterly report on inflation for 2018 Q2. The Mexican MPC reaffirmed its cautious stance and its commitment to keep monitoring the pass-through of exchange rate movements into consumer prices, the risk premia offered by Mexican assets relative to US ones and the cyclical position of the economy vis-à-vis the output gap. The CB increased the forecast for annual CPI inflation 0.4ppt to 4.2% for 2018 Q4 and 0.2ppt to 3.3% for 2018 Q4. Meanwhile, GDP forecast was adjusted downwards to 2.0-2.6% for 2018 Q4 and 1.8-2.8% for 2019 Q4.
Chilean industrial production decreased 1.6% YoY in July, vs. 4.9% YoY expansion seen in June. The output drop was broad-based, largely driven by non-metallic mining that was adversely impacted by weather conditions.
Peruvian GDP expanded 5.4% YoY in 2018 Q2 due to the very strong performance of household consumption (4.5% YoY) and investments (8.6% YoY). Investments were bolstered by both private and public activity. The build-up of inventories more than offset the drag effect of negative net exports in Q2.
Peru’s current account deficit widened to 1.4% of GDP on a four-quarter rolling basis in 2018 Q2, vs. 1.2% in Q1. The widening of the deficit was not substantial and was primarily due to higher profit remittances by foreign mining firms and wider services deficit.
Real GDP in Brazil expanded at a meagre 1% YoY (0.2% QoQ) in 2018 Q2, while growth was revised down 0.3ppt to 0.1% QoQ in Q1. Economic activity was adversely impacted by the truckers’ strike in Q2. Weakness was broad-based, as many of the sectors contracted in a quarterly comparison, such as industrial output on the supply side or exports and investments on the demand side.
Although the cyclical recovery in Brazil continued in 2018 Q2, due to shaken economic confidence, the momentum of the recovery has become even more fragile. The outlook for the Brazilian economy should brighten by the end of Q3, after the elections.
According to the latest reports related to the Brazilian political scene, former President Lula was barred from running for President in the upcoming elections. Mr. Haddad will take over the candidacy from Mr. Lula. Although Mr. Lula was the most popular Presidential candidate, the popularity of his successor is clearly substantially lower.
The Brazilian current account deficit amounted to USD 4.4bn in July, while on a 12-month rolling basis, the deficit widened to USD 15bn or 0.8% of GDP. The rise in the deficit was caused primarily by the mounting deficit on the profits and dividend line.
Brazilian business confidence fell in the industrial sector to 99.7 in August. Details revealed that the outlook on current economic conditions deteriorated, while expectations for the future somewhat improved. Meanwhile, the uncertainty index moderately declined, but remains very high at 115.3, 12.8 points higher than in February.
According to the Argentine Treasury Minister Dujovne, the country asked the IMF for a USD 3bn disbursement in September. Furthermore, the Minister cited that the Argentine economy might contract by around 1% this year. Not long after the Minister’s remarks, Prime Minister Macri publicly announced that his government requested the early release of the USD 50bn package from the IMF. In response, Managing Director Lagarde stressed that the IMF stands ready to assist Argentina with financial support and engineering appropriate policies to improve the country’s growth outlook.
In the second half of the week, the central bank surprised markets by lifting the policy rate 1500 basis points or 15 percentage points to 60% in order to restore the market’s confidence in Argentine financial assets and to curb volatility in the FX market. The MPC pledged not to reduce the policy rate before December.
Although the Argentine authorities are committed to resolve the on-going crisis in a (relatively) market-friendly way with the appropriate economic orthodoxy, the timing and the coherence of announcements made by prominent government officials and the conduct of monetary policy induced further unwanted and unwarranted stress in the market. This idea was clearly reflected in the post-rate hike exchange rate behaviour, as the ARS did not stop depreciating vs. the USD in spite of the aggressive tightening measures.
MSCI Africa 812 -4.29%
African markets struggled during the week. The broad MSCI Africa index fell 4.3% in USD, led by the South African market, which plummeted 3% in USD. Egypt was the only bright spot in Africa, as the Egyptian stock index rose 4.3% in USD.
Tourism revenue in Egypt soared 77% in 2018 H1 to ca. USD 4.8bn, according to an unnamed Egyptian government official cited by Reuters. By the end of this year, tourism revenues will likely reach USD 9bn vs. USD 7.6bn last year.
Remittance inflows from abroad rose 21.1% YoY to USD 26.5bn in FY2017-18 (i.e from July 2017 to June 2018) vs. USD 21.9bn in the previous fiscal year.
Increasing revenues from tourism and the inflow of remittances are crucial for Egypt, since both are among the most important sources for foreign currency.
Private sector credit growth in South Africa slowed to 5.1% YoY in April. Meanwhile, the broad M3 monetary aggregate increased 6.4% YoY.
According to the S&P rating agency, the credit rating of South African long-term foreign currency debt is unlikely to be downgraded deeper into the non-investment grade territory, since the country’s external metrics and monetary flexibility are strong enough. Currently, S&P holds South Africa’s rating at ‘BB,’ two notches below investment grade.
The South African Parliament withdrew a land expropriation bill passed in 2016, but never signed into law that allowed the state to make compulsory land purchases at prices determined by a government adjudicator.
This is an important step by President Ramaphosa to strengthen his own, and also his party’s, credibility as they seek a market and business friendly solution. Such steps help business confidence to recuperate relatively quickly, which over time can translate into more intensive investment activity.
The Kenyan Parliament unanimously voted to postpone the imposition of the 16% VAT on petroleum products, despite being a requirement set by the IMF for the maintenance of its credit line. The government estimated to raise an additional KES 86bn (about USD 0.85bn or 1.2% of GDP) by imposing the VAT. Technically, the VAT exemption ended on Friday, but since the passed legislation has not been approved by the President yet, the tax authority has started charging the VAT on petroleum products.
The Parliament decided to scrap the deposit floor on retail deposits placed at Kenyan commercial banks, while the interest rate cap remains in force. Furthermore, MPs rejected the proposal to levy the ‘Robin Hood’ tax, 0.05% on each bank transfer larger than KES 500,000 (about USD 500).
The Tunisian government foresees GDP to grow 3.5% in 2018 that is 0.6ppt higher than previously expected. The upward revision was based on the fact that tourism has started to recover, while the agricultural sector exhibited decent growth. The Tunisian Minister of Reforms cited that budget deficit may be 3.9% of GDP in 2018 instead of the originally planned 4.9%.
Nigerian economic growth disappointed in 2018 Q2, as GDP grew only 1.5% YoY. Activity in the oil sector contracted 4% YoY. Growth of the non-oil sector reached a decent pace, as it expanded 2.1% YoY. Transportation (21.8% YoY), construction (7.7% YoY) and electricity sectors (7.6% YoY) contributed to GDP growth to a great extent, while agricultural output slowed to 1.3% YoY.
Although headline growth was disappointing, details paint a promising picture of the Nigerian economy’s medium-term prospects. Since the non-oil economy has finally started to recover at a decent pace, the Nigerian economy might just hop on a stronger and more sustainable growth trajectory.
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