Money Matters 6th February 2018

Every week this year, the equity market rally has changed – the acceleration in global growth has started to stimulate higher bond yields and energy prices, thus sowing potential headwinds. In the short run, we saw 3 “canaries” for investors: the US 10 year bond yield, the oil price and wage growth.
Last week, as if like clockwork, equities experienced their heaviest losses in 2 years after all 3 measures broke out of their almost 4 year range. The question now is whether this represents the end of the bull market, or a release of pressure before new highs. Rising bond yields are rightly highlighting that global monetary policy is starting to tighten. However, aside a single US labour market data print on Friday, core inflation pressures remain lacklustre.
S&P 2,762 -3.85%, 10yr Treasury 2.85% +18.12bps, HY Credit Index 316 +21bps, Vix 17.31 +6.23Vol
US stocks recorded their 1st weekly loss of 2018, with the S&P 500 Index suffering its worst weekly fall in 2 years This prompted the VIX volatility index to touch the highest level since November 2016 (17.60) and included heavy losses for healthcare (after Amazon, Warren Buffett and JP Morgan announced plans to establish a joint health care system for their employees) and Energy (following weak results for both Exxon and Chevron).
From a data perspective, the January jobs report was a blowout, with non-farm payrolls registering 200,000 (ahead of consensus), unemployment holding at a 17-year low of 4.1% and, most importantly, average hourly earnings accelerating to 2.9% YOY (the best gain since 2009, with December numbers also revised higher). Other data was also broadly positive; consumer spending increasing 0.4% MOM in December, consumer confidence (both Michigan and Conference Board) at elevated levels and the Case Shiller house price index surging. Interestingly, however, the savings rate fell to a 12-year low and core inflation rose only 1.5%.
The net result of this data deluge, was a rise in bond yields, with the US 10-year moving to 2.83% (from 2.66% at the beginning of the year and 2.40% at the beginning of the year). The market implied probability of a rate hike by the FED on the 21st March is now at 77.5%, which is arguably too low.
Eurostoxx 3,523 -3.17%, German Bund 0.76% +13.80bps, Xover Credit Index 252 -16bps, EURUSD 1.245 -0.21%
Data in Europe, painted a different picture, reminiscent of the “Goldilocks” conditions in the US a year ago. GDP growth for the Eurozone 2017 came in at 2.5% (better than the US or UK), with continued positive momentum signalled by the PMIs (final January number confirmed at 59.6). However, HICP inflation came in way below target, with the core measure at 1%. Recall, unemployment across the Eurozone is still at 8.8% (albeit this masks Germany at 3.6%). As such, there is still spare capacity in the region, which prompted ECB Chief Economist Peter Praet to suggest stimulus needs to remain in place.
Nonetheless, European bond yields rose in sympathy with the US; the German Bund yield touching 0.76% (a 2 year high). As a reminder, on the 4th March, Italy holds a general election, with a hung parliament a strong possibility.
In the UK, the Manufacturing PMI came in lower for the 2nd consecutive month, with both new orders and output declining. The BOE meets on Thursday with no change to policy expected.
The NBH in Hungary left rates on hold at 0.90%, continuing to prefer unconventional policy as its main tool (IRS auctions and mortgage bond purchases). The National Bank of Poland and Central Bank of Russia meet this week, when the latter is expected to cut rates give the strengthening rouble.
HSCEI 1,351 -1.40%, Nikkei 2,268.00 -3.02%, 10yr JGB 0.08% +0bps, USDJPY 109.820 +1.47%
In India, the Modi government announced a budget for the upcoming year that contained a number of important nuances for the market. Whilst the headline deficit figure quelled fears of populism-led fiscal slippage, the imposition of a long-term capital gains tax on equity holdings left a somewhat bitter taste in the mouth.
With the economy still in the early stages of recovery from the dual shocks of GST implementation and demonetisation, in addition to crucial general elections on the horizon for 2019, this was an important budget for India’s political and economic future.
The fiscal deficit target for the upcoming financial year, commencing 1st April 2018, was set at 3.3% of GDP. This is a narrowing versus the deficit expected for the current outgoing year, which is now set to come in at a revised 3.5%.
The revised 3.5% deficit for the year now ending, up from initial forecasts of 3.2%, had been cause for concern for the market. The Indian 10-year yield has risen 100bps since July 2017 to 7.5%, as investors priced in fiscal slippage and the repercussions for both country risk and inflation. Lower than expected GST revenue, plus a slower than expected economic recovery, led to the deficit expansion. The increase in the oil price exacerbated these trends.
In the context of last year’s fiscal slippage, nascent economic recovery, and the upcoming general elections, there was a risk that the government would opt for a larger deficit this year, enabling higher spending to woo voters. Instead, the government’s return to the path of fiscal consolidation is a long term positive for the investment case for India, by way of reducing country risk and inflationary pressure.
Despite these important implications for India’s fiscal position and Modi’s re-election prospects, media coverage of the budget focused on the imposition of long term capital gains tax on equity investments at a rate of 10%. Despite all existing equity gains being grandfathered in to the scheme, avoiding the draconian scenario of retrospective implementation, the tax imposition was enough to weigh on sentiment, as well as confuse retail investors. The Nifty closed the week down 3.9%, with a number of midcap stocks down considerably more, on account of a retail-dominated investor base.
Chinese equities gave back some gains this week, with H shares falling -1.4%. Despite this, the HSCEI remains one of the world’s top performing markets year to date, up 15.5%.
In addition to negative global cues, sequentially weaker Chinese PMI data for January dampened sentiment. The NBS Manufacturing PMI fell from 51.6 in December to 51.3 in January, a steeper fall than expected, driven largely by trade-related sub-index contraction. The Caixin Manufacturing PMI figure for January was unchanged month on month at 51.5.
Taiwan’s economic growth rate surprised significantly on the upside in Q4 2017 at 3.3% YOY, a three-year high. The improvement was broad based, with domestic consumption and net trade both outperforming.
Indonesia’s economic growth rate accelerated to a four-year high in Q4 2017. Growth came in at 5.2% YOY, surprising on the upside, up from 5.1% in Q3. Strong export growth and investment activity was enough to offset weak consumption, which is yet to respond to the 300bps of rate cuts delivered over the last three years.
The State Bank of Pakistan raised interest rates 25bps to 6.0%, surprising the market, which had been pricing in a pause.
MSCI Lat Am 3,139 -3.16%
Brazil’s 2017 current account deficit stood at USD 9.8Bn or 0.5% of GDP, 59% lower than in 2016 and the smallest value since 2007. The USD 64bn trade surplus in 2017 (vs. USD 45Bn in 2016) was the main positive contribution. In addition, Brazil’s 2017 consolidated public sector posted a primary deficit of BRL 111Bn (-1.7% of GDP), outperforming its target of BRL 163Bn by a wide margin thank to BRL 5Bn better revenue (higher GDP and corporate profits) and BRL 30Bn lower expenditures. Last, industrial production advanced 4.3% YOY in December, above the median of market estimates (2.0%). For 2017, industrial production expanded 2.5%, marking the best annual result since 2010, when it soared 10.2% (the credit-led boom, later proved to be unsustainable).
Mexico‘s 2017 trade deficit narrowed to USD 10.9Bn (0.2% of GDP) and GDP growth for 4Q17 came in at 1.8% YOY, beating expectations and better than the 1.5% recorded in 3Q17. However, industrial sectors are still contracting (-0.7%). The Mexican government achieved all the targets set in the fiscal consolidation plan for 2017, including the first primary surplus in 9 years and a decrease in the public debt to GDP ratio to 46.6% (which had increased by 30 p.p. between 2007 and 2016).
Colombia’s central bank cut the reference rate by 25bps to 4.50%. The communiqué made it clear that this will be the last cut of the easing cycle as it views that it has accommodated enough and the central bank is waiting for clear signals on the inflation front.
Chile’s retail sales advanced by 2.5% YOY during 2017 and have remain resilient all throughout the economic cycle. Chile’s fiscal deficit reached 2.8% of GDP in 2017.
Peru’s GDP grew 2.5% in 2017, mostly driven by the 19% YOY increase in public investment due to important reconstruction projects following floods. Peru’s core inflation dropped to 2.0% YOY in January, its lowest level in 5 years. Headline annual inflation decelerated to 1.3% YOY from 1.4% a month prior and remained below the midpoint of the BCRP’s target range (2%). The negative output gap and the stronger PEN are pushing inflation down.
MSCI Africa 1,012 -7.24%
Egypt’s foreign reserves rose to another historic high of USD 38.2bn in January from USD 37.0bn in December, driven by USD 1.5bn foreign currency inflows into the banking system.
Egypt’s Reserves plummeted to as low as USD 13.5bn in March 2013 after years of economic and political turmoil triggered by the 2011 uprising against former President Hosni Mubarak. However, since the country took the tough decision to implement a raft of economic reforms to secure a USD 12bn loan from the IMF, confidence has returned, the reserves now cover an equivalent of 8 months import. This bodes well for the broader economy, particularly the domestic segment, which is still challenged by high inflation.
In South Africa, PMI rose to a 9-month high in January. The Absa PMI rose to 49.9 in January from 44.9 in December driven by recovery in business activity and sales orders. In contrast, consumer confidence remained in the doldrums; the FNB consumer confidence index improved marginally from -9 in 2Q17 to -8 in 4Q17, but made it the third consecutive year of negative consumer confidence reading, the longest streak since 1982.
In Kenya, the leader of the opposition, Raila Odinga, inaugurated himself as the people’s president and moved to form a parallel government. This comes after a short period of normalcy (3 months) after a protracted and disputed presidential election. The resistance of Odinga and his party risks making an already polarised country ungovernable.
Elsewhere in Kenya, inflation edged up to 4.8% in January from 4.5% in December, driven by increases in the cost of corn and crude, while new car sales fell 20.8% in 2017 due to slower economic growth which was exacerbated by a combination of political turmoil and a cap on commercial interest rates.
Lastly, Nigeria’s manufacturing PMI remained in the expansionary territory in January at 57.3 points. This marks the 10-consecutive month of expansion. Non-manufacturing PMI was also positive at 58.5 points and the 9th consecutive month of expansion.

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