Money Matters 6th June 2018

In a holiday shortened week for the US and UK, a veritable smorgasbord of news flow buffeted markets. From a general sense, two of the most prominent recent headwinds for the market (US rates and the oil price) may now start to cool. With respect to the former, hikes will likely continue this year, but FED rhetoric may turn more dovish as the FOMC digest the effects of their tightening and the ageing cycle. Indeed, slowing but still above trend growth, Europe is likely to see the ECB pause for thought as well. Similarly, OPEC members seem satisfied with an oil price between USD 70-80 dollars per barrel. This does not mean it is plain sailing; it is now reasonable to conclude that Donald Trump has become a genuine drag on the global economy, indirectly via the uncertainty created by his unorthodox style and directly via his trade policy. Moreover, European politics remains fragile with the surprise change of prime minister in Spain this week, Brexit in the UK, and Italy’s unsustainable place in the Eurozone.
S&P 2,735 +0.49%, 10yr Treasury 2.92% -2.91bpsHY Credit Index 345 +3bps, Vix 13.46 +.24Vol
US equities experienced 4 days of volatility last week, with 3 moves over 1%. Fixed income markets were equally as volatile with the US 10-year trading as low as 2.78% yield after the biggest 1-day decrease in yield since the UK’s Brexit vote 2 years ago on Tuesday. This followed the initial failure to agree a government in Italy.
From a data perspective, the May employment report provided soothing reading with headline payrolls registering 223k (versus 207k monthly average so far in 2018), the unemployment rate hitting an 18-year low at 3.8% and average hourly earnings remaining in their recent range at 2.7%.
Elsewhere, Donald Trump allowed exemptions from steel and aluminium tariffs to expire on Thursday, meaning 25% and 10% levies respectively will now be imposed on imports of the metals from the EU, Canada and Mexico. This immediately prompted an EU response amounting to EUR 2.8bn of tariffs on carefully selected and politically sensitive items such as blue jeans and bourbon. In a similar spirit, Trump reinstated USD 50bn in import tariffs on China and restricted Chinese investment in US technology firms in order to reduce the potential for violation of intellectual property rights. A 3rd round of negotiations with China took place over the weekend, but little progress was made. The FT reported an exclusive focus on reducing the trade deficit and that “the focus was not what the US business community would like to see.”
Eurostoxx 3,482 -1.72%, German Bund 0.40% -2.00bps, Xover Credit Index 290 -2bps, USDEUR .854
In Europe, the focus was squarely on politics. First, Italy’s populist Five Star Movement and far-right Northern League party finally formed a coalition government, naming Giuseppe Conte, as prime minister. This came after changes to proposed cabinet members, President Sergio Mattarella having blocked the initial line-up over the weekend. Italian bonds nonetheless ended lower as investors question the sustainability of this administration and Italy’s broader debt and growth trajectory.
Meanwhile in Spain, nine opposition parties lead by the Socialists were successful in dethroning long time PM Mariano Rajoy after a no confidence vote on Friday. Pedro Sanchez will replace Rajoy and the market greeted the news with little fanfare given the new government’s commitment to maintain the conservative party’s 2018 budget.
Given the greater volatility in peripheral bond spreads, Angela Merkel’s interview with the Frankfurter Allgemeine Sonntagszeitung is unlikely to have calmed nerves. Unlike French President Macron, who is championing an ever-closer union in Europe, Merkel appeared to comment that sovereign bond restructuring should come before any centrally funded bailout.
More generally, it is interesting to note that the Citi Eurozone Economic Surprise Index, which measures incoming economic data against expectations, is currently nearing a 7-year low after a marked slowdown in momentum since the start of the year. This may impact the ECB’s plan withdrawal from QE and, in any case, masks a growth picture that remains (for now) above trend.
In spite of the Turkish central bank’s tightening efforts two weeks ago, the USDTRY exchange rate remained volatile last week. The lira remains essentially rudderless and cannot strengthen against major currencies in a sustainable manner.
The Turkish economic confidence index slid from 98.3 to 93.5 in May. In tandem with Turkey, Russian manufacturing PMI dropped in May to 49.8, projecting potential contraction in manufacturing output. Polish and Hungarian manufacturing PMIs remained in the range of expansion in May, at 53.3 and 55.4, respectively.
Polish Q1 2018 GDP growth was revised up to 5.2% YOY. Both private consumption and investments registered strong growth, 4.8% YOY and 8.1% YOY respectively. Polish inflationary dynamics slightly intensified, as headline CPI accelerated to 1.7% YOY in May.  However, the rate of inflation significantly underwhelmed expectations.
With such strong GDP growth and subdued inflation pressure, the Monetary Policy Council is unlikely give up its slightly dovish stance anytime soon.
Moody’s decided not to change Hungary’s credit rating and outlook. The country remains in the lowest investment grade category at all three major credit rating agencies. While Moody’s maintains a ‘stable’ outlook for Hungary, Fitch and S&P assigned ‘positive’ outlooks to the rating. Moody’s refrained from releasing an update at its last written assessment.
It was no surprise that Moody’s left Hungary’s rating and outlook unchanged this time, since the characteristics of the economy has not improved since the last time.
HSCEI 12,243 -0.23%, Nikkei 22,475.94 -1.30%, 10yr JGB 0.05% +0bps, USDJPY 109.570 +0.05%
China’s official PMI data showed moderate improvement in May, with Manufacturing and Non-Manufacturing indices inching up from 51.4 to 51.9 and 54.8 to 54.9 respectively. The unofficial Caixin Manufacturing PMI printed flat at 51.1.
India once again snatched the crown of ‘world’s fastest growing major economy’ after reporting last quarter’s GDP figures, which showed an expansion rate of 7.7% YOY during the three months to June, up from 7.2% the previous quarter. Strong performance in manufacturing and services drove the improvement, with growth now running at a seven-quarter high.
Bank Indonesia raised the seven-day repo rate by 25bps to 4.75%, during an irregular monetary policy meeting convened last week. This follows the decision to hike rates by an initial 25bps on 17th May. Commentary from the newly appointed governor was more hawkish than the market expected, including comments that the central bank “will continue to calibrate local and domestic market developments to utilise room for further rate hikes in a measured way.”
Notably, this is the first time for over a decade that the Indonesian central bank has raised interest rates despite domestic inflation being within the target range. Clearly, Bank Indonesia is acting to stay ahead of the curve; congruent with a global context of rising US rates and a strong dollar, higher oil prices, and pockets of stress within the EM asset class, notably Argentina and Turkey. Should the second half of 2018 feature any of these trends continuing in a meaningful way, multiple rate hikes are to be expected in Indonesia. 
Pakistan raised rates 50bps to 6.50%, with the policy rate now up 75bps year to date, after nearly two years of unchanged policy.
Still plagued by a quintessential twin-deficits problem, policymaking in Pakistan is at least beginning to follow a more pragmatic path in certain respects. Showing a willingness to tighten rates heading in to an election, and at a time of low domestic inflation, plus a 10% managed depreciation of the currency, shows that some degree of institutional autonomy and credibility is being restored.
latinamericaLATIN AMERICA
MSCI Lat Am 2,569 -3.29%
Brazil’s Q1 2018 GDP came in at +1.2% YOY, higher than consensus expectations. Both household spending and fixed capital investments continued to post substantial growth (2.8% and 3.5%, respectively). The data point confirms the scenario of a gradual recovery.
2Q and 2018 GDP growth will be negatively impacted by the truckers’ strike, which may lead to further analysts to downgrade their GDP growth expectation for 2018. The uncertainty around October Presidential elections will likely  also weigh on growth in Q2 and Q3 2018. 
Brazil truck drivers’ strike finally ended last week, 10 days after it started. Truckers were protesting against rising oil prices following a depreciation of the BRL (vs. USD) and rising international oil prices. To end this strike, Brazil’s government had to announce a reduction of diesel prices by 0.46BRL/L, and the resetting of prices every 30 days instead of daily. The total fiscal cost of these measures is estimated at BRL 13.5Bn BRL for 2018, through subsidies to Petrobras and tax cuts. To compensate these BRL 13.5Bn increase in fiscal expenses, the government also announced an increase in payroll tax, cuts in social programs, lower tax breaks for exporting, chemical and soft drink sectors as well as cut in discretionary expenses.
This type of measure is not easy to roll-back  once implemented. The annualized fiscal costs should be 0.4% of GDP with a very substantial risk to public finances if the BRL depreciate further and oil price keeps increasing.  
Brazil’s primary fiscal deficit came in at 1.8% of GDP in the year to April 2018. The nominal fiscal deficit (including interest expenses) remains elevated. Gross general government debt reached 75.9% of GDP and net public sector debt stood at 51.9% of GDP in April.
Although Brazil is benefiting from a temporary fiscal revenue tailwind (oil royalties, economic rebound…), the slower than expected recovery may increase the pressure on fiscal consolidation in 2H18. Longer-term, Brazil’s debt trajectory is not sustainable without structural reforms like the pension reform. 
US President Trump imposed tariffs on steel and Aluminium imports from Mexico. Mexico retaliated by imposing duties on US imports (from flat steel to cheese).
Although this set of tariffs remains anecdotal, it sends a negative signal regarding the US/Mexico relationship.
Peru’s GDP growth showed clear signs of recovery in Q1 2018 coming in at +3.2% YOY, driven by the acceleration of investment (private investment +5,3% YOY vs 3.2% in 4Q2018) and stronger private consumption (+3.2% from 2.6%).  
Colombia became the 3rd Latin American country to enter the OECD, after Chile and Mexico, becoming the 37th member of the organization. This is a major vote of confidence regarding the strength and independence of Colombian institutions. This inclusion rewards the major reforms recently implemented to align its legislation, policies and practices to OECD standards, including on labour issues, the reform of its justice system, corporate governance of state-owned enterprises, anti-bribery and trade.
This decision should allow Colombia to continue strengthening its institutions and public policies. 
MSCI Africa 920 -0.89%
Kenya’s inflation rose to 3.9% YOY in May from 3.7% in the previous month, remaining close to the middle of the government’s target range of 2.5-7.5%. MOM, inflation fell to 1.0% from 1.4% in April.
In South Africa:

  • Seasonally adjusted Absa PMI fell back into negative terrain after two successive months of expansion. The index fell to 49.8 in May from 50.9 in April, with business activity falling to 47.2 from 49.1.
  • Growth in private-sector credit demand slowed to 5.1% in April from a revised 6.0% in March.
  • The parliament passed a national minimum wage bill by an overwhelming majority. The measure will see millions of workers earn 3,500 rand (USD 277) a month. The policy was championed by President Cyril Ramaphosa as an important step to tackle labour instability and wage inequality.

Elsewhere, the government of Egypt raised water prices by up to 46.5%. The government had last raised water prices by as much as 50% in August 2017. The price hike comes ahead of anticipated cuts to fuel and electricity subsidies, to help revive the economy where subsidies have accounted for about a quarter of state spending.
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