Money Matters 7th November 2017

It was more of the same for global markets last week, as the busiest week of the quarter (if not the year) in terms of news flow which reiterated strong economic momentum and unusually low inflation.
This week is somewhat quieter, but Donald Trump’s trip to Asia perhaps provides a “wildcard” for markets. There was also further corporate earnings releases (with a focus on retail in the US) and amendments proposed to the US tax reform bill at the beginning of the week.
S&P 2,588 +0.26%, 10yr Treasury 2.32% -7.39bps, HY Credit Index 315 +1bps, Vix 9.58 -0.66Vol
Just like last week, the S&P 500 extended its winning streak with a Friday rally to hit 8 consecutive positive weekly returns (the best stretch in 4 years), whilst the VIX volatility index dropped back to 9.50% (near its all-time low just below 9%). This came alongside a positive tone to the week’s news releases.
In terms of monetary policy:

  • Donald Trump confirmed his nomination of Jerome Powell (an existing member of the FED’s Board of Governors since 2012) as Janet Yellen’s replacement. Assuming Senate confirmation (which is very likely), Powell will take up his new office on the 4th His appointment is seen as positive because it ensures continuity and because he represented the most dovish candidate under consideration.
  • The FOMC left interest rates unchanged but upgraded their assessment of economic activity from “moderate” to “solid”. In so doing, they all but confirmed a 25bps December rate hike, which is now 96.7% priced by the futures market.

In terms of fiscal policy:

  • On Thursday the Republicans revealed the “Tax Cuts and Jobs Act”; the first formal outline for reforming the US tax code. The main focus is to cut corporate taxes (from 35% to 20%) and to consolidate benefits. Indeed, in its current form, the proposal is disproportionately beneficial to the wealthy and is likely to be far too expensive (growing the deficit by an estimated USD 1.51trn).

In terms of economic data:

  • The employment report highlighted the special nature of the current expansion. The unemployment rate dropped to 4.1% (a 16-year low) but only because of a drop in the participation rate to 62.7%. This is to say recent marginal gains in the proportion of American’s working were erased and the structural story of a smaller share of the population entering the workforce, continues. Moreover, despite the headline tightness in the labour market, average hourly earnings disappointed at 0% MOM and 2.4% YOY.
  • Soft data remained bullish, with consumer confidence, Chicago PMI and ISM manufacturing all at elevated levels. After a lag, the US economy has clearly benefitted from the broader global acceleration over the last few months.

In terms of corporate activity:

  • After around 80% of S&P 500 firms have reported 3rd quarter earnings, earnings are on course to grow at 5.9% YOY (a slower pace than in Q2). Last week’s results including Apple, which bested expectations.
  • USD 60bn of M&A transactions were announced (the busiest week of the year).

Despite the bullish tone, small caps again underperformed. Moreover, the “mini-taper tantrum” was (for now) consigned to history as yields on the US 10-year fell back to 2.34% (from 2.42% a week ago). This is explained not only by Jerome Powell’s selection but, more importantly, by the “Goldilocks” economic data – strong economic growth, but little-to-no signs of inflation and wage growth (within the November employment report).
Eurostoxx 3,675 +1.15%, German Bund 0.34% -1.90bps, Xover Credit Index 224 -10bps, EURUSD 1.161 -0.00%
European economic data mirrored the US, with strong growth numbers (0.6% QOQ Q3 GDP for the Eurozone) but weaker inflation (0.1% MOM, 1.4% YOY for the HICP measure).
In the UK, the MPC raised rates (as expected) for the first time in 11 years. Specifically, the committee voted by 7 votes to 2 in favour of a 25bps hike to 0.50% (Ramsden and Cunliffe dissented), whilst summarising that “all members agree that any future increases in [the] Bank Rate would be expected to be at a gradual pace and to a limited extent.” Indeed, the bank warned there “remain considerable risks to the outlook, which include the response of households, businesses and financial markets to developments related to the process of EU withdrawal.” As a consequence, GBP fell sharply after the announcement, with the market judging there was little scope for further tightening. However, this was mostly reversed over the week as Deputy Governor Broadbent stated that the UK may need a “couple more” rate rises to get inflation “back on track while at the same time supporting the economy”.
In terms of UK economic data, manufacturing and services PMIs were both somewhat better than expected (reflecting global strength), whilst consumer confidence marginally declined.
Turkish CPI inflation accelerated in October, contributing to further declines in the currency towards all-time lows.
HSCEI 1,152 -0.34%, Nikkei 2,254.00 +2.31%, 10yr JGB 0.02% 0bps, USDJPY 114.270 +0.34%
The Bank of Japan left policy unchanged but upgraded GDP growth expectations and downgraded the inflation outlook. This week President Trump is in town from Sunday to Tuesday.
China’s Manufacturing PMI data for October came out with a mixed set of prints offering few new insights. The official NBS Manufacturing PMI came in at 51.6, coming off from September’s level of 52.4 and slightly below expectations. The unofficial Caixin Manufacturing PMI, however, was flat month on month at 51.0, slightly ahead of consensus.
Taiwan’s economy grew 3.1% YOY in Q3, a sharp acceleration from the 2.1% GDP growth rate recorded in Q2, beating expectations. Exports contributed to the higher growth rate, rising 11.2% YOY in Q3, compared with 5.0% growth last quarter. This was enough to outweigh soft private consumption, which decelerated to 1.9% YOY growth, from 2.0% last quarter.
After a blip in Q2, Taiwan’s economy is now growing at its fastest rate for two years on the back of export strength. This has also translated to domestic improvements, with unemployment running at multi-year lows and consumer confidence on a steady upward trend.
India’s unofficial Manufacturing PMI corrected in October. After September’s bounce to 51.2, the activity indicator dropped to 50.3.
There remains significant noise in the data in India, as the economy continues to adjust to the transformational goods and services tax rolled out by the government in July this year.
Thailand’s inflation rate remained stable in October at 0.9% YOY, the same level recorded in September. Food costs rose, though this was offset by lower transportation costs.
Despite sub-1% inflation, the Bank of Thailand is expected to leave interest rates unchanged through to the end of the year, on account of the already visible recovery in economic activity in addition to broader objectives to encourage households to de-leverage.
Inflation slowed slightly in Indonesia, edging down from 3.7% YOY in September to 3.6% YOY in October.
South Korea’s inflation rate softened slightly in October to 1.8% YOY, from 2.1% the previous month, on account of lower food inflation and base effects washing out of utility prices.
Australian bond yields fell sharply after retail sales missed expectations for the 3rd consecutive month. The RBA meets this week.
In Saudi Arabia, 11 princes, 4 ministers and a number of former ministers were detained by the new anti-corruption committee headed by Crown Prince Mohammed bin Salman. These included international investor Prince Alwaleed. This came only hours after a ballistic missile targeting Riyadh airport was intercepted.
MSCI Lat Am 2,773 -2.77%
Argentina’s president Macri outlined the guidelines of a reform package that will be sent to Congress in the next few months. The ruling “Cambiemos” coalition is taking advantage of its important victory in the last mid-term elections to reach a “national accord” and consensus over a set of basic conditions to create jobs and reduce poverty.
The 3 main topics of his speech were:

  • Fiscal stability and macro-economic rebalancing: he insisted that the country has to equilibrate its public accounts, at all levels (national, provincial and local) and must unwind the “tax escalation” of the past few years. He hinted to a pension reform, as the current system is unsustainable, and reaffirmed the need to fight inflation.
  • Employment: He laid down initiatives to register and train workers in the informal labor market, change the regulation, reduce red tape, reduce the high number of litigations in the labor justice and diminish related costs.
  • Institutions: he mostly touched on reinforcing independence, transparency, accountability and checks and balances.

The next day, his finance Minister Dujovne delivered the content of a tax reform. The main highlights were:

  • Accelerate VAT reimbursement for CAPEX (incentive for companies to invest)
  • Reduce corporate tax rate on undistributed profits (incentive to invest)
  • Lower tax on labor cost (incentive to create jobs)
  • Increase taxes on alcohol, carbonated drinks and tobacco
  • Make the tax on gasoline proportional to CO2 emissions

The 1.5% of GDP cost of this tax reform over 5 years should be absorbed by GDP growth.
Argentina’s efforts to implement structural reforms were rewarded by S&P who raised Argentina’s sovereign debt rating to B+ from B. The rating agency’s communiqué stated that “higher investment and stronger policy predictability will generate moderate albeit sustainable growth in the next 3 years”.
Colombia’s central bank unexpectedly cut its benchmark rate by 25bps to 5.0%.
Even though, inflation is still close to the upper limit of the central bank’s target range, it surprised the board to the downside during the last 3 months, leading it to cut full-year inflation projections for both 2017 (4%) and 2018 (below 3%). The central bank anticipates that indexation effects and the impact on prices from the increase in VAT earlier this year will fade, allowing both total inflation and core inflation measures to converge to the target. According to the press statement, the monetary policy committee is also more confident with the activity recovery (revised the growth forecast for 2018 to 2.7% from 2.4%), but it would not be enough to close the output gap.
Brazil’s fundamentals are getting sounder as the fiscal and current accounts are rebalancing and its financial system is deleveraging after a 15-year credit binge.
Brazil’s total loan growth in the system fell 2% YOY in October after falling 2.1% in September. From 51% at its peak, the credit to GDP ratio fell to 47%. Non-performing loans slightly declined but remain elevated at 5.4%, while spreads declined to 50.7% in consumer lending and 15.4% in commercial lending.
Brazil’s public sector posted a primary deficit of BRL 21.3Bn for September. On a trailing 12-month basis, the primary deficit narrowed to 2.35% of GDP, and the nominal deficit shrank further to 8.75%.
Brazil’s trade surplus reached USD 5.2Bn in October, bringing the YTD figure is the highest in the historical series started in 1992. While imports (+9.9%) are recovering due to the stronger BRL and gradual improvement in economic activity, exports (+19.9%) are benefitting from higher commodity prices (+28.2%, reflecting not only higher prices, but also an increase in volumes), a large agricultural harvest and strong demand from China (+33.4%, China purchased 23.7% of Brazilian exports in 10M17, up from 21.3% in 10M16).
Chile’s industrial production expanded 1.0% YOY in September (+5.2% in August), leading to growth of 3.2% in 3Q17 (up from -1.7% in 2Q17).
Mexico’s GDP growth weakened to 1.6% YOY in 3Q17, dragged by two large earthquakes, which disrupted economic activity in September.
Peru’s headline inflation decreased to 2.04% YOY in October (from 2.94% in September), while core inflation fell to 2.35% YOY (from 2.45%) during the same period, on the back of falling food prices.

Venezuela is getting closer to default after Maduro called for a restructuring of all government and PDVSA’s debt. The restructuring of USD 60Bn in outstanding bonds would be the last straw after the country already defaulted on its citizens through hyperinflation, on PDVSA’s suppliers and after its 2 biggest creditors (China and Russia) already accepted a restructuring. The structuring of such a restructuring seems extremely difficult to execute given the sanctions imposed by the US on Venezuela but the situation remains confusing after Maduro’s announcement last week.
MSCI Africa 871 +1.11%
Kenya’s incumbent president, Uhurru Kenyatta, won the repeat presidential election, winning 98.3% of the vote, which was boycotted by the main opposition party. Turnout was low, 38.8% compared with 79.5% in August, while violence prevented voting in 25 of Kenya’s 290 counties. The opposition party led by Raila Odinga had until Monday 6 November to file a Supreme Court case seeking to overturn the election, otherwise Kenyatta will be inaugurated on November 14.
The political instability has seen private sector activity fall to a record low. Kenyan PMI for manufacturing and services slumped to 34.4 from 40.9 in September, its lowest since the series began in January 2014.
In South Africa, private sector activity rose to 49.6 in October from 48.5 in September, though still below the 50 mark that separates expansion from contraction, while new vehicle sales up 4.6% YOY in October and the Absa PMI, an index which gauges manufacturing activity, rose to its best level in five months, 47.8 in October from 44.9 in September, driven by an increase in new sales orders.
In Egypt, mildly positive data prints were seen with PMI edging up to 48.4 in October vs. 47.4 in September with contractions in output, new orders and employment all easing and business confidence hitting a 26-month high, while the central bank paid off a USD450mn final installment loan to Turkey and Libya, and reported a stable MOM net international reserves figure for October at USD36.7bn. Egypt however dropped 6 places to 128 out of 190 countries in the Ease of Doing Business index 2018, though it’s noteworthy that the time and cost of starting a business halved to 14.5 days and 7.4% of income per capita, respectively, and the data for the report is typically gathered in Q1 and would not reflect the impact of the reforms implemented since.
Lastly, Nigeria’s manufacturing PMI stood at 55 index points in October 2017, indicating an expansion in the manufacturing sector for the seventh consecutive month, while the country gained 24 places in the Ease of Doing Business report, improving to 145th position.

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