THE ODD COUPLE
Over the last 2 weeks, market updates have covered the “Goldilocks” economic environment, with broad-based growth but weak inflation. As such, it’s been speculated that any headwind for markets would be more likely to come from the political sphere than from central bank tightening. Indeed, over the summer, US President Donald Trump and North Korean supreme leader Kim Jong Un have combined to stimulate market sell-offs on a roughly one day per week basis.
Last week, North Korea conducted several exercises in response to US-South Korea military exercises. This culminated on Tuesday in a missile that flew over the Japanese island of Hokkaido (the northernmost of Japan’s main islands). In reply, allied aircraft conducted tests of bunker busting bombs near the North Korean border. Equity markets again sold off briefly, with safe havens rallying (the US 10 year yield touching its lowest level since November 2016 at 2.08% yield), before calm was restored.
Until this point, underlying economic strength has therefore ultimately trumped geo-political squabbling. Over the weekend, however, North Korea appears to have “upped the ante”, claiming to have tested a hydrogen bomb that could be mounted on a ballistic missile. The explosion triggered an earthquake measuring 6.3 on the Richter scale and is estimated to have been 10 times more powerful than anything detonated before. Trump’s first reaction was to tweet “North Korea is a rogue nation which has become a great threat and embarrassment to China, which is trying to help but with little success”. It is expected that the principal retaliation tool will be via further economic sanctions.
Although North Korea might provide the most extreme political tail risk, there are certainly a number of other flashpoints on the market’s radar:
- US domestic politics, with a failure to raise the US debt ceiling by the 29th September triggering a government shutdown and continued fractious leadership limiting progress on fiscal stimulus and reform.
- German Federal elections on the 24th September, which Angela Merkel is expected to win to secure a 4th term in power.
- EU-UK Brexit negotiations, which appear deadlocked and are in our view unlikely to progress in the near term.
S&P 2,477 +1.37%, 10yr Treasury 2.16% -0.02bps, HY Credit Index 323 -11bps, Vix 10.13 -1.15Vol
US stocks rose last week with particularly strong gains for technology (the best performing sector in August, recovering from its early summer wobble) and healthcare (after Gilead Sciences reached a USD 11.9bn agreement to acquire cancer specialist Kite Pharma).
Slow-moving Hurricane Harvey has set new records for rainfall from a single event, with parts of Houston (a city that represents 3% of US GDP) receiving over 50 inches of rain. As a consequence, 23% of US refinery capacity is currently offline, whilst other refineries have struggled to import crude. This has had polarising effects; on the one hand, US gasoline prices have risen around 17 cents pushing futures to 2-year highs. On the other, the oil price has come under renewed pressure because of short-term reduced demand. In terms of overall economic impact, certainly there will be a shift in US GDP growth from Q3 to Q4. Thereafter, it will be a trade-off between the (negative) country-level tax on consumption from higher gasoline prices, down-periods for business in Houston and the inevitable hold-up in Washington from disaster-relief, against (positive) re-investment and rebuilding.
As has been the case for most of this year, economic data was mixed. The consumer confidence index for August strengthened more than expected, the Chicago PMI held firm (against expectations for a retrenchment) and the ADP measure of payrolls improved. However, the employment report was broadly weaker. Payrolls rose less than 156k (versus 180k expected) and were revised down for the 2 prior months (by a total of 41k). The unemployment rate ticked higher (4.4% versus 4.3%) and wage growth was disappointing at 0.1% MOM.
US markets were closed at the beginning of the week for Labour Day.
Eurostoxx 3,427 -0.09%, German Bund 0.36% -0.10bps, Xover Credit Index 236 -9bps, EURUSD 1.189 +0.57%
Inflation in the Eurozone for August rose faster than expected (1.5% versus 1.3%) albeit the “core” measure remained well grounded. This week there is an ECB meeting at which there may be some discussion of QE tapering. The governing council face opposing trends:
- Positive, Growth is enjoying its best period since the financial crisis and, given the scale of the QE programme, it will become increasingly difficult to continue purchases at the current EUR 60bn per month rate (there simply won’t be the bonds available for purchase under current guidelines).
- Negative, Inflation is still well below target, overall unemployment (9.3%) suggests still ample spare capacity and the EUR has experienced a more than 5% appreciation this year on a trade weighted basis.
The Riksbank in Sweden also meet on Thursday.
German Chancellor Angela Merkel and French President Emmanuel Macron separately voiced support for the creation of a Eurozone finance and economics minister to increase fiscal integration across the region. There is little detail to the proposal, but we view a lack of fiscal union as the key issue for the single-currency project. Steps in this direction would therefore be positive, assuming popular support.
Denmark, the country with the highest tax revenue of the developed world (47% of GDP), is proposing to introduce sweeping tax cuts in order to incentivise work, promote pension saving and reduce levies on cars. The total reform could sum to USD 3.7bn.
Israel left rates on hold at 0.1% for the 28th consecutive month, amid continued deflation.
HSCEI 1,118 -0.06%, Nikkei 1,950.00 +0.25%, 10yr JGB- 0.01% 0bps, USDJPY 109.460 +0.85%
18th October was confirmed as the date for China’s 19th Party Congress. This gathering of China’s top leaders will produce the next Five Year Plan for the economy, as well as appoint the country’s top politicians and bureaucrats for the next five years. The overwhelming expectation is for President Xi to continue to consolidate power across essentially every sphere of government, in a manner not seen in China since the 1980s.
Sticking to the script of having a well performing economy in the run up to the National Congress, China’s official manufacturing PMI strengthened from 51.4 in July to 51.7 in August.
India’s economic growth rate fell to a three-year low of 5.7% YOY in the three months to June, significantly missing consensus of around 6.5%, and a slowdown from the previous quarter’s growth rate of 6.1%.
A number of factors contributed to the weakness in India’s economy, including GST-related destocking, rupee appreciation, softer agricultural output and adjustments to subsidy payouts.
Manufacturing growth was a significant under-performer, growing just 1.2% YOY, with GST likely the key driver. The chief statistician behind India’s GDP numbers pointed this out, commenting that there had been a large-scale drawdown in inventories in the run up to the July 1st GST implementation date. Net exports also detracted 2.6ppt from growth, versus 0.3ppt the previous quarter.
India’s growth rate, which has been falling since early 2016, has now dropped below that of China. Demonetisation and GST have played pivotal roles in this phenomenon, however the lack of private sector investment activity cannot be ignored.
In line with the view that short-term disruptions have been the most serious detractor from growth, India’s Manufacturing PMI moved back in to the expansion zone for August, rising to 51.2 from 47.9 in July. The rebound was largely expected, with July’s data blighted by the rollout of the Goods and Services Tax.
Inflation in Thailand crept up 10bps to 0.3% YoY in August, below expectations. Food deflation continues to weigh on the overall price level, while higher fuel prices had the opposite effect.
Korea’s central bank kept rates on hold at 1.25%, in line with expectations.
MSCI Lat Am 2,912 +0.65%
Brazil’s unemployment rate fell to 12.8% in the three-month period ending in July (from 13.0% in June). Similar to June, the improvement in July was mainly due to increases in low quality employment in the informal sector and from self-employed workers. Job creation in the formal market remains subdued.
A recovery in the job market is one of the 4 factors needed to start a new consumption growth cycle.
Real wage growth remains under pressure but there shouldn’t be further degradation. Credit availability is improving and should be supported by the fall in interest rates. However, the consumer confidence index fell to 80.9 in August from 82.0 in July, posting its third consecutive decline. Overall, all leading indicators of the consumption cycle are around a bottom and some of them are starting to make a timid recovery.
Brazil’s business confidence in the industrial sector improved again in August, climbing to 92.2 in August from 90.8 in July. This is the 3rd consecutive rise for the industrial sector. After a blip in May due to political uncertainty, the indicator is resuming its recovery fuelled by FX stability, low inflation and lower interest rates.
Brazil’s central government posted a primary fiscal deficit of BRL 20.2Bn in July, slightly up from BRL 19.8Bn in June, reaching BRL 76.2Bn in 7M17, up from BRL 55.7Bn in 7M16. Budget cuts continue to be insufficient to offset the rise in mandatory spending and the decline in revenues. The social security deficit surged to BRL 96.70Bn in 7M17 from BRL 75.4Bn in 7M16, highlighting the importance of passing the pension reform in Congress.
Colombia’s central bank cut the policy rate by 25bps, to 5.25%, in line with expectations.
The governor indicated that this could be one of the final rate cuts of the year (after a 250bps easing cycle) around the neutral real interest rate.
Argentina’s Industrial activity rose by 5.9% YOY in July, marking the 3rd consecutive increase after several months posting contraction. In 7M17, manufacturing grew 0.8% YOY against the same period one year ago.
In 7M17, Mexico registered a budget surplus of MXN 119.3Bn versus a MXN 378.7Bn deficit in the same period of last year. Even excluding the payment from the central bank due to reserves appreciation (linked to MXN appreciation YTD) and a rise in oil prices (revenue benefitted from a 20% increase in oil-related income) the fiscal consolidation is happening as expenses contracted by 1.9% in the period.
Mexico’s Ministry of Finance forecasts a budget surplus of 1.4% of GDP in 2014, implying a Debt/GDP ratio of 48% from 50% observed last year.
MSCI Africa 915 +0.45%
The Kenyan Supreme Court annulled the results of last month’s presidential election and ordered a new election to be held within 60 days. The ruling saw the Kenyan Shilling fall 0.4% against the dollar, the NSE-20 (Kenya’s main stock index) drop 3.5% to close at 3887.28 points on Friday and the stock exchange halt trading briefly after shares had fallen by the maximum daily limit of 10%.
Staying in Kenya, YOY CPI rose 57bps to 8.04% in July, driven by a 1.04% increase in the food and non-alcoholic drinks index.
Nigeria’s inflation moderated 5ps to 16.05% YOY in July, marking the sixth consecutive month of decline from the 18.72% peak in January. Core inflation eased 30bps to 12.2% YOY. MOM, headline inflation increased 1.21%, 0.37% lower than the rate recorded in June, while core inflation increased 1% vs. 1.32% in June. Bucking the trend however is food inflation, which rose to 20.28% YOY in July (the biggest YOY increase in 8 years), owing to increases in the prices of staples such as bread and cereals, meat, fish, oils and fats, coffee, tea and cocoa, potatoes yam and other tubers and vegetables.
Food inflation continues to erode household purchasing power and is likely to increase further given the recent floods across the Southern region. However, further declines in MOM and core inflation should see headline inflation ease to 15% by year end.
South Africa’s manufactured goods PPI increased 3.6% YOY (vs. 4.0% in June) and 0.5 % MOM, and personal consumption expenditures beat expectations at 6.81% (c.6.1%) compared to 6.2% YOY in June. However, trade surplus declined to ZAR8.99 billion from ZAR10.56 billion in June; exports fell 8.7% MOM to ZAR93.1 billion while imports fell 8% to ZAR84.1 billion.
Source: Alquity Global Market Update www.alquity.com