Money Matters 5th December 2017

After a mad dash on Friday, the US Senate passed their version of the “Tax Cuts and Jobs Act” by 51 votes to 49. Senator Bob Corker was the only Republican to vote against the bill. Although considered the other two potential dissenters, Flake and McCain also gave their support. A conference committee will now be tasked with eliminating the differences between this Senate bill and that proposed by the House.
The consensus view of Trump’s flagship reform is that it will help stimulate near-term growth and is likely to prompt an upgrade to FED forecasts, therefore raising the potential for rate hikes next year. The market is currently pricing around a 0.4% increase in rates for 2018. However, outlined last week, the overall value of the measures is widely debated. Trump has tweeted a letter signed by 137 “economists” strongly endorsing the initiative, but the quality of those lending their support is comical; some have been shown not to exist, others are not economists and almost none are well known. In contrast, a survey by the University of Chicago amongst the IGM Economic Experts Panel, some of the most respected academic economists in the world, showed 100% consensus that the bill will raise US debt-to-GDP substantially and 98% consensus that GDP will not be substantially higher than under the status quo. As Oliver Hart of Harvard commented “many of the changes look like handouts to the rich”.
In any case, a final agreement by the end of the year is possible and could set the stage for an interesting 2018. Whist strong growth momentum will not dissipate in a hurry, the economic backdrop for markets has probably now peaked.
As expected, OPEC and the group of non-OPEC countries led by Russia agreed to extend production cuts for 9 months through to the end of 2018, subject to a 6-month review. Oil prices were largely unchanged.
S&P 2,642 +1.53%, 10yr Treasury 2.40% +1.97bps, HY Credit Index 319 +3bps, Vix 11.43 +1.76Vol
Whilst the narrow Dow Jones Industrial Average booked its best weekly gain for the year, the Nasdaq finished lower last week. This was after heavy falls on Wednesday, which were perhaps more related to sentiment and positioning than any fundamental news; the punter’s weapon of choice “bitcoin” experiencing eye-watering volatility en route to a new all-time high.
All markets took a dive on Friday morning, after former National Security Advisor Michael Flynn pled guilty to lying about FBI conversations with Russia’s ambassador. Indeed, ABC News suggested Flynn could claim Donald Trump “directed him to make contact with the Russians”.
Economic data continued its recent bounce; new home sales touching the highest level since 2007, the Case-Shiller index confirming house price appreciation, consumer confidence further improving and the second estimate for Q3 GDP revised higher, to the highest level in 3 years at 3.3%.
Eurostoxx 3,528 -1.68%, German Bund 0.34% -5.50bps, Xover Credit Index 228 -6bps, EURUSD 1.186 +0.33%   
European stocks were more subdued than their US peers and inflation data came in weaker than expected; the HICP measure at 1.5% YOY.
In Germany, Social Democrat leader Martin Schulz denied a meeting on Thursday with Angela Markel had led to agreement over a “grand coalition”. Instead, the SPD was due to make a proposal on Monday. Schulz faces a dilemma – on the one hand seeking to avoid a minority government, on the other wishing to avoid a continuation of his junior role in government, which led to the SPD’s worst ever polling in the recent election.
In the UK, consumer confidence, business sentiment and house prices all declined. However, the manufacturing PMI hit its highest level in over 4 years, buoyed by broader global growth. Elsewhere, the Bank of England raised its special capital buffer to 1% (from 0.5%) for banks in order to protect lenders against “material” risks beyond Brexit. Mark Carney also discussed easing regulation on the financial sector after the UK leaves the EU. This could include removing caps on bonuses and making regulation more “proportionate”.  Last, Theresa May and Jean-Claude Juncker are expected to release a joint text agreeing the UK’s divorce settlement ahead of the 14-15th December EU summit. Effectively, the UK has bowed to EU demands in order to unlock the process. The biggest risk to an agreement is now the consent of the DUP in Northern Ireland, relating to its post-Brexit border with Southern Ireland.
The Bank of Israel left rates on hold at 0.1% and retained its “low for long” guidance (forecasting rates to stay at their all-time low until Q3 2018).
HSCEI 1,154 -3.91%, Nikkei 2,270.00 +0.79%, 10yr JGB 0.04% 0bps, USDJPY 112.960 +0.57%  
China’s unofficial Manufacturing PMI contracted slightly, falling from 51.0 in October to 50.8 in November, but remaining in expansion territory. Production growth was strong, while new orders were weaker. Margins of producers expanded, with output prices rising alongside falling input costs. The headline deterioration was in contrast to the official NBS PMI covering the same period, which showed a moderate improvement from 51.6 to 51.8. 
The Indian economy continues to show signs of recovery, with GDP growth for the three months to September accelerating to 6.2% YOY. The latest PMI data were consistent with this trend, with November’s Manufacturing PMI reaching a 13-year high.
India’s current economic trajectory could be described as one of certain but gradual improvement. Whilst GDP growth is yet to spring back to its apogee of 8% from the previous cycle, a steady upward trajectory in the coming quarters could be expected.
India’s economy grew at a rate slightly below market expectations of 6.3% during Q2 FY18, accelerating from the 5.2% YOY growth rate recorded in Q1. Exports, infrastructure spending and consumption are all contributing to improved momentum, as the disruptions caused by demonetisation and GST implementation begin to fade.
Showing a continuation of this trend beyond the Q2 GDP observation period, India’s Manufacturing PMI increased from 50.3 in October to 52.6 in November. This adds weight to the pervading consensus expectation that India will record a >7% quarterly GPD growth rate before FY18 is out (March 2018).
The multi-faceted investment case for India continues to gain further new dimensions. As well as the ever-present structural drivers of urbanisation and demographics, the country’s cyclical positioning continues to improve, whilst the government continues to deliver on economic reforms. On the cyclical front, there is now an established trend of recovering GDP growth, in addition to double digit corporate earnings growth for the first time in over a year. In terms of reforms, Modi’s latest accomplishment has been a long-awaited recapitalisation programme for the chronically under-funded public sector banking system. Moody’s sovereign upgrade last month offered further recognition that the investment case for India is now coalescing across the three spheres of structural drivers, cyclical positioning and reform momentum. 
In what could prove to be another milestone for the Modi government (or, less likely, an embarrassing bloody nose) it is now just a week from the Gujarat state elections. 
In a symbol of what the party has come to represent, the opposition Congress party in India is expected to name Rahul Gandhi as its new president in the next few days. In taking over from his mother, Rahul Gandhi will symbolise the nepotism that has come to define the hereditary anachronism that ruled India for much of its post-independence history. Having fostered a culture that stifled innovation and held back its most promising talent, the Congress party has been sleepwalking for a generation into the abyss. Whilst Modi’s meteoric rise and his ability to build such a strong platform of support is in large part a story of his party’s own success, the incompetence of Congress has been a truly important factor.
Bank of Korea initiated a rate hiking cycle, increasing interest rates from 1.25% to 1.50%, the first rate tightening since June 2011. The move was firmly in line with expectations, with policymakers guiding for further hikes in future as expected. Given the cautious tone, however, the next rate increase is not expected to come until next year.
MSCI Lat Am 2,730 -3.13%
Brazil’s economy keeps deleveraging. Total credit contracted 1.4% YOY in October, bringing credit/GDP ratio to 46.9%.
Both consumer and industrial confidence advanced strongly in November (+3.7pp and +2.8pp MOM respectively).
In the coming quarters, decreasing inflation and unemployment, increases in real wages, lower interest rates and better credit conditions will pave the way for a consumption recovery. Also, corporate deleveraging is slowing down and growing internal demand will prop up investments. As such both investment and consumption engines should support a strong economic acceleration in 2018. 
Brazil’s public sector posted a BRL 4.8Bn primary surplus in October, surprising the market to the upside. Indeed, excluding exceptional items, tax collection increased 9.4% YOY in real terms during the month, its highest growth since 2011.
The primary deficit reached 2.88% of GDP in the year to October (up from 2.35% in September, reflecting a large amount of extraordinary revenues from the repatriation program in October 2016), while the nominal deficit totaled 9.25% of GDP (up from 8.75%). Public sector net debt retreated to 50.7% of GDP from 50.9% during September (helped by the depreciation of the BRL which increases the value of FX reserves).
If approved, pension reform will be essential for public debt dynamics by reversing the current upward trend in pension expenses and representing a key step to complying with the constitutional spending cap, which could generate the necessary conditions for a structural decline in interest rates and a firmer rebound in economic activity.
Mexico’s GDP shrank by 0.29% QOQ in 3Q17. Even allowing for the negative impact from natural disasters in September on 3Q17’s activity, there are still clear signs of growth gradually decelerating:

  • Retail sales weakened (-0.3% MOM in September, implying 0% YOY growth in 3Q17)
  • Inflation increased (negative for real wages),
  • Remittances converted into MXN decelerated and
  • Consumer credit slowed down.

2018 will be full of uncertainties (Trump’s tweets, NAFTA renegotiation, elections…), which is already weakening investments (negative industrial production growth) and consumption (decelerating same-store-sales). This combined with high inflation and interest rates (flat yield curve) may not bode well for Mexico’s financial markets. 
Mexico’s 3Q17 current account deficit came in at USD 5.5Bn, bringing the annual number to 1.4% of GDP. Also, the Finance minister estimated 2017’s primary fiscal surplus (excluding interest payment) will reach 1.5% of GDP. This would consolidate fiscal consolidation and bring the Debt/GDP ratio to 48.7% in 2017 and 48.2% in 2018 (assuming a fiscal deficit of 2% of GDP).
This set of numbers highlights the soundness and long-term sustainability of Mexico’s macroeconomic positioning. 
Mexico’s finance minister Jose Meade resigned and immediately announced his intention to become the PRI’s candidate for President. Mr. Meade was in his 2nd turn as finance minister and has served in 4 different cabinets. He will represent the pro-business and pro-market candidate, however, he lacks national name recognition. In the latest polls, populist candidate Andres Manuel Lopez Obrador (Morena) scored 31%, Ricardo Anaya, the most likely candidate of the PAN/PRD alliance, posted 19%, and José Antonio Meade lagged behind with 17%, although his candidacy for the ruling party (PRI) only became really serious a few days before the poll was conducted. Finally, it is worth noting that Margarita Zavala, who split from the PAN in October, came in 4th scoring 8%.
Mexico’s President Peña Nieto appointed Alejandro Diaz de Leon as new Governor of the central bank, replacing Carstens. Diaz de Leon has been Deputy Governor since January 2016 and has held different roles at the bank since 1991. This is not a surprise and the monetary policy framework should remain unchanged.
Peru’s current account deficit narrowed to 0.9% of annual GDP in the 12 months to September (from 1.2% of GDP in June 2017). The CAD has shrunk to almost 1/6th of its size over the past 7 quarters (it stood at 4.8% of GDP in 2015).
Peru’s nominal fiscal deficit widened to 2.9% of GDP in the year ended in 3Q17 (from 2.8% of GDP in June). This brought the gross and net debt of the public sector to 24.1% of GDP and 8.2% of GDP respectively. This set of numbers highlights the strength of Peru’s external positioning and leaves room for fiscal stimulus as part of the reconstruction work post-El Nino.
Chile’s industrial production expanded 5.0% YOY in October from 1.1% in September. One should not over-interpret this as the 10.5% YOY gain in mining production (3.6% in September), contributed 4.6pp to the headline industrial production gain in October. However, the industrial cycle rebound is a leading indicator (in line with business and consumer confidence) of a broader economic recovery after 4 years of decline.
Moody’s raised Argentina’s rating to B2 from B3 with a stable outlook, which leaves it 5 levels below investment grade, on par with Angola, Nigeria and Cambodia. Last month, S&P also raised Argentina’s long-term foreign currency rating to B+ (from B).
The rating agency noted that the government has announced tax, pension and labour reforms following its electoral win in October’s legislative midterms. Some of those reforms passed the Senate last week and will go to the lower house to be voted before the end of the year. The reforms address long existing distortions in the economy and aim to bolster the economic recovery by promoting increased private investment, lowering the cost of hiring and reducing the corporate tax rate. A change in how pension payments are calculated, will likely help reduce expenditures and the fiscal deficit. Finally, the government is also continuing to reduce energy subsidies.
MSCI Africa 921 +0.06%
Uhuru Kenyatta was sworn in as the president of Kenya for a second 5-year term on Tuesday. This followed months of political turmoil, disputed elections and several court cases. In his inauguration speech, President Kenyatta promised a “more united, stable and prosperous” nation but his rival remained resolute, promising to take the oath of office as the legitimate people’s president on December 12.
The political division will make governing and addressing Kenya’s challenges including a twin deficit, difficult. 
Moving on to data prints:

  • Kenya’s foreign exchange reserves declined to an 11-week low at USD7,545m, equivalent to 4.7 months import cover, from 5.07 months in September.
  • Inflation fell to a 4-year low of 4.71% in November (vs. 5.72% in October), driven by a 1.33% MOM decline in the food and non-alcoholics’ index as favourable weather led to a decline in the cost of several food items.

In South Africa, Q4 business confidence remained in negative territory, driven by weaknesses in retail, building contractors and manufacturing. This was underlined by growth in private-sector credit demand falling to 5.43% in October from 5.50% in September, and slower M3 expansion, 5.01% from 7.13% in September. In contrast, the PMI rose to 48.6 in in November (vs. 47.8 in October), its highest level in six months, but still below the neutral 50-point mark.
Corruption scandals and political turmoil continues to weigh on business confidence and investments. The country needs concrete pro-business and fiscally responsible policies within the 90 days window afforded by Moody’s ratings reprieve, to arrest a slide back into recession. Interestingly, the rand strengthened 3% this week to a 1 month high on the back of reports that the business-friendly candidate, Cyril Ramaphosa, is ahead in provincial votes for the upcoming ANC leadership election.
In Egypt, the central bank lifted its monthly cap on foreign currency deposits and withdrawals for importers of non-essential goods. A cap of USD50k/month for deposits and USD30k/month on withdrawals was imposed in 2015 to control the flow of foreign currency at a time of severe shortage.
The removal suggests the central bank is comfortable with FX supply/demand dynamics, and bodes well for the EGP which devalued from 8.88EGP/USD to 17.68EGP/USD after it was free floated in November 2016. 
Last, capital inflows into Nigeria more than doubled in Q3 to USD4.15bn, the first such quarterly rise since 2015, just before the economy tipped into recession. The key driver was a USD1.9bn QOQ increase in equity inflows. Elsewhere, OPEC extended its oil production cut until the end of 2018 and secured an agreement from Nigeria to cap its output, though at a level exceeding the country’s current production.

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