GOLDILOCKS KEEPS THE BEARS AT BAY
This week, the Czech central bank became the first to raise rates in the EU since Jean-Claude Trichet’s much lambasted hike in the midst of the sovereign debt crisis of 2011. Of course, the US is already 18-months into a rate increase cycle. However, the pace has been lethargic, as low inflation has persisted despite an economy appearing to be at full capacity. As previously highlighted, something appears to have structurally changed with labour markets; the UK, Japan and the US, are all near estimates of full employment, but are producing only modest wage growth.
For Europe, the ECB’s job is, as always, complicated. There is a great divide, with German unemployment at the lowest since reunification (3.8%), but Eurozone wide unemployment still high at 9.3%. This reflects double-digit jobless rates in southern Europe (for example 21.7% in Greece and 17.1% in Spain) and for youth (18.9%). Meanwhile, across emerging markets, declining inflation is allowing central banks to cut rates (India last week and much of Latin America over recent months). In aggregate, monetary policy remains extremely accommodative from a global perspective.
S&P 2,477 +0.19%, 10yr Treasury 2.27% -2.69bps, HY Credit Index 322 -1bps, Vix 10.19 -0.26Vol
Last week saw a raft of US data with the August employment report the highlight. The headline payrolls number came in ahead of expectations (209k vs 180k expected), whilst the unemployment rate ticked down to 4.3% (from 4.4%) and wage growth maintained its 2.5% YOY rate of increase. Other data was modestly weaker than expected with ISM manufacturing and non-manufacturing, Chicago PMI, construction spending and vehicle sales all missing consensus forecasts.
Wage growth has failed to accelerate as much as its historical relationship with the unemployment rate suggests it should. Nonetheless, the jobs report was good enough to keep the FED on track to announce a tapering of their QE programme in September. The Jackson Hole Economic Symposium on the 24-26th August may shed more light.
Q2 Corporate results season is now 75% complete and earnings are running +10.1% YOY (vs +6.4% expected), albeit this growth rate declines around 2 percentage points stripping out the energy sector. Last week, the Dow Jones Industrial Average hit another all-time high, continuing its strong recent out-performance over other major indices, which were flat or declined. Actually, the S&P 500 has now gone 12 successive days moving less than 0.3% in absolute terms, a new record which continues this year’s trend of hyper-low volatility.
In political news, Donald Trump is backing a bill that would reduce immigration by 41% in its first year by shifting approvals towards education, skills and language over family ties. He also reluctantly signed legislation-imposing sanctions on Russia (knowing that he would be overruled by Congress if he failed to do so). However, a planned speech on Friday to target China’s intellectual and trade practices was postponed. Elsewhere, Special Counsel Robert Mueller investigation into Russia’s interference in the 2016 elections ratcheted up a notch after he impaneled a grand jury in Washington.
Eurostoxx 3,514 +1.26%, German Bund 0.48% -7.40bps, Xover Credit Index 231 -4bps, EURUSD 1.180 -0.20%
European equities out-performed last week. Indeed, European corporate earnings have out-paced those in the US for Q2, with a YOY earnings growth rate of 11% (excluding energy). July inflation data was largely in line, the core measure at 1.2% YOY – still well below the ECB’s 2% target.
Despite ushering in a surge in business confidence and renewed vigour in French economic data, new President Emmanuel Macron’s popularity ratings have tumbled since his inauguration. The Ifop polling agency summarised his decline in support by “Apart from Jacques Chirac in July 1995, a newly elected president has never seen his popularity rate falling as quickly during the summer after the election… some people are starting to get the feeling that he is an exceptional charmer and a communicator but whose Hollywood-like style of communicating is actually an instrument to bring in austerity policies.”
In the UK, the July PMIs came out better than expected with “new export orders” registering their second highest reading on record. This is a consequence of the weak GBP, which came under further pressure last week after the Bank of England voted 6-2 to leave rates unchanged and Mark Carney delivered a dovish press conference. In particular, he commented that uncertainty from Brexit could impair investment and therefore short and longer-term growth. Relatedly, the bank revised down its estimate for GDP growth for this year to 1.7%.
The Czech Republic became the first country in the EU to raise rates in this cycle, after shifting its main policy rate from 0.05% to 0.25%. Further action is likely to be related to whether the ECB chooses to taper its asset purchases later this year.
HSCEI 1,106 +2.17%, Nikkei 2,005.00 -0.01%, 10yr JGB 0.07% 0bps, USDJPY 110.750 +0.00%
China’s official Manufacturing and Non-Manufacturing PMIs moderated in July, though remained above 50. The official NBS Manufacturing figure fell from 51.7 to 51.4, while the Non-Manufacturing gauge moved down from 54.9 to 54.5. Both readings were slightly below expectations. The key output sub-indices weakened, while the price indicators suggested some inflationary pressures creeping in to the data. The unofficial Caixin data, conversely, showed a slight incremental strengthening month on month, with the Manufacturing PMI at 51.1 in July vs. 50.4 in June.
After CPI inflation dropped to 1.5% YOY in June, the Reserve Bank of India cut interest rates by 25bps to 6.00% at the August meeting.
The MPC’s decision was split, with dissenters covering a range of positions; from advocating to leave rates on hold to one voter suggesting a larger 50bps cut was necessary. The outcome was well expected by the market, with inflation now steady at sub-2% levels and GDP growth coming in below expectations at 6.1% YOY last quarter. These factors had also culminated in significant pressure from the Finance Ministry on the RBI to cut rates to give a lift to the economy. At the back of the minds of the MPC members who voted for a rate cut may also have been the recent strength of the rupee, with the INR having appreciated 6% against the dollar year to date, and the implications this has for net exports and global competitiveness.
Despite the latest cut, India still has some of the highest real rates in emerging markets of ~400bps. This represents a significant transformation over the last decade, during which time inflation touched double-digit levels. Whilst proponents of central bank orthodoxy may hold India up as an example of the type of macroeconomic stability that can be facilitated by a well-executed inflation targeting framework, others would argue that India now finds itself with excessively high interest rates at a time when allowing the economy to run hotter at a higher growth rate would seem appropriate. The more pertinent question, however, is whether more aggressive rate cuts are appropriate over the next year or so, given the current trajectory.
Weaker activity data for India in July adds to this view. Services PMI tumbled from 53.1 in June to 45.9 in July, while Manufacturing PMI dropped from 50.9 to 47.9. Whilst the implementation of the Goods and Services Tax unquestionably accounts for the majority of the deterioration, and will prove to be transient, these data points still add to the case for lower rates to boost growth.
Inflation in Korea picked up slightly in July (2.2% vs 1.9% in June). Elsewhere in Asia, price pressure remained absent in Thailand (CPI at 0.48% YOY) while headline inflation in Indonesia softened from 4.4% YOY in June to 3.9% YOY in July.
MSCI Lat Am 2,778 +1.18%
Brazil’s president Temer saw the Lower House reject a request filed by the Public Prosecutor’s Office (PGR) to indict him on corruption charges. While the opposition needed 342 votes to indict Temer, only 227 deputies voted against the president.
This vote will allow the government to set aside the PGR, move on and focus on the social security reform again. The most likely scenario is that this reform will have to be watered-down and only a light version of it will be able to gather the 308 votes necessary in Congress.
Brazil’s unemployment rate shows signs of stabilisation. It came in at 13% in June, the 3rd consecutive month of decline. However, looking at the details, the quality of employment contrasts with the good headline as this gain was mainly due to an increase in employment in the informal sector and of self-employed workers.
These are the first signs that the deterioration in the labour market has come to an end. However, the recovery will be very slow.
Brazil’s consolidated primary deficit accumulated over 12 months to June widened to 2.6% of GDP from 2.5% in May. Achieving the primary deficit target of BRL 142Bn this year remains challenging. The nominal deficit remained high (at 9.5% of GDP over 12 months), the net public debt climbed to 48.7% from 48.1% of GDP, as the gross public debt rose to 73.1% from 72.5% of GDP and the government’s net external assets (mainly FX reserves) rose to 15.7% from 15.3% of GDP.
The nominal deficit to GDP ratio should improve as inflation and interest rates are falling. These data points reinforce the extreme importance of reforms to reverse the structural trend of fiscal deterioration. The debt trajectory remains sustainable for the foreseeable future as long as the fiscal ceiling constitutional rule voted in 2016 is strictly followed. This fiscal ceiling prevents public sector’s expenditure rising in real terms. However, this rule is not sustainable without a reform of the Social Security.
Peru’s 1H17 exports rose by 27.8% YOY to USD 20.1Bn, due to more shipments of minerals, fishmeal and natural gas.
MSCI Africa 866 -2.96%
The Nigerian Manufacturing PMI data indicates an expansion in the economy for the fourth consecutive month; July PMI stands at 54.1 from 52.9 in June 2017 with production level, new orders, supplier delivery time, employment level and raw materials inventory growing at a faster rate. Similarly, non-manufacturing PMI grew for the third consecutive month to 54.4 in July (from 54.2 in June), driven by new orders, employment level and inventory growing at a faster rate but business activity grew at a slower rate vs. June 2017.
On exchange rate convergence, the Nigeria Central Bank (CBN) asked lenders this week to publish quotes reflecting trades in the Importer & Exporter (I&E) Window. The implication is that the CBN understands that the I&E window more accurately reflects where the naira should trade, which is positive. Markets are however still left with the official rate at 305 Naira for government transactions, and there are still many other rates including NIFEX and NAFEX, though data providers are now presenting the NAFEX.
While the central bank’s intervention in providing liquidity through the sale of FX to importers and SMEs is achieving some results, Nigerian country risk remains high; CBN accounts for over 30% of the supply in the FX I&E Window, exchange rate is still not totally market-determined rate, there are significant fiscal constraints with 100% of intake spent on recurring expenses and all capex in the 2017 budget to be funded with borrowing, and over-reliance on oil and keys states (for example Lagos accounts for 55% of VAT revenue while the other 45% is generated from the remaining 35 states).
In Egypt, international reserves surged to USD 36Bn at the end of July 2017, an increase of USD 4.7Bn from June, owing to the disbursement of the second tranche of the IMF loan worth (USD 1.25Bn) and stronger foreign inflows (Egypt received about USD 8.7Bn in FDI in the fiscal year ended June 30 and is expected to top its USD 10Bn target this year). With import coverage rising to 7.1x months (compared to a low of 3.1x in June 2013), the government is better positioned to service its outstanding USD liabilities.
In South Africa, the Absa PMI declined by 3.8 points to 42.9 in July. All five of the major PMI sub-indices weakened with the business activity index under most pressure, declining by 6.1 points to 39.3.
This further contraction in the manufacturing sector highlights the soft demand conditions and low consumer and business confidence in South Africa. Further, there are additional headwinds for the broader economy with reports of Anglogold, Pick n Pay, JSE and Sibanye planning to cut jobs, and policy uncertainty. The recent 25bps reduction in repo rate is expected to boost demand, though against the current set of uncertainties, any impact will be marginal.
Source: Alquity Global Market Update www.alquity.com