A CHANGE IN THE WIND…
Over the past 6 months, equity markets have benefited from the tailwinds of a strong rebound in the global economy and continued monetary stimulus. This week’s events confirm that the second order consequences of a better macro picture are building. In particular, the monetary impulse may be turning negative:
- The FED is extremely likely to raise rates on Wednesday.
- We think the ECB will start adjusting its forward guidance in June (post-French elections).
- Most economists expect the BOJ (meeting on Thursday) will cut bond purchase targets or raise its 10-year yield by the end of the year (and there are reports it has already started buying an annualised 18% fewer bonds than targeted).
- China also has a tightening bias.
This leaves Brazil as the only major central bank still in a credible rate cutting cycle.
The Bank of England also meets this week. Of course, the outlook is not set in stone. After US crude inventories rose by 8.2 million barrels (9th consecutive weekly gain), oil saw its biggest one-day drop in 13 months and touched a 3-month low. The recent surge in headline inflation could therefore reverse. There is also political risk. This week sees Dutch elections, which are expected to pass without major event. In India, Prime Minister Narendra Modi claimed a landslide state election victory in Uttar Pradesh, steamrollering the opposition and generating a wave of support that already makes a victory in the 2019 general election look a very likely outcome. Indian markets are expected to perform strongly on Tuesday (closed for a holiday on Monday).
S&P 2,373 -0.44%, 10yr Treasury 2.56% +9.65bps, HY Credit Index 334 +24bps, Vix 12.18 +0.70Vol
The S&P 500 recorded its first weekly decline since mid-January, whilst small caps (represented by the Russell 2000) underperformed for the 4th consecutive week alongside a sharp decline in energy stocks. The energy sector has lagged the broader market by almost 15% YTD. Government bonds also fell, with the 10-year touching its highest yield since December at 2.62% (within 2bps of the highest level since 2014). Last, the high yield index suffered its worst week since November. Supporting expectations for FED rate hikes was a blowout employment report. Non-farm payrolls came in at 235,000, well ahead of consensus and with positive revisions for the past 2 months. Unemployment consequently declined to 4.7% (actually despite a rise in the participation rate to a 3-year high, reflecting the “underemployment rate”, which includes discouraged workers and part-time employees unable to find full-time jobs, dropping to 9.2% from 9.4%). Average hourly wages grew at a 2.8% annualised pace.
Eurostoxx 3,410 +1.40%, German Bund 0.46% +12.90bps, Xover Credit Index 285 -9bps, EURUSD 1.068 -0.47%
At Thursday’s ECB meeting the governing council upgraded its assessment of the economic outlook (2017 and 2018 GDP growth projection increased by 0.1%), self-assuredly attributing some of the rebound to its own actions. In the accompanying press conference Mario Draghi took his first steps towards a shift in policy; the sentence “if warranted to achieve its objective, the Governing Council will act by using all instruments available within its mandate” was missing from the opening statement. He explained this had “been removed, basically to signal that there is no longer that sense of urgency in taking further actions … that was prompted by the risks of deflation.” Moreover, he commented that the ECB sees a good chance that the “cyclical recovery may be gaining momentum.” Indeed, there had been a discussion about removing the downside bias on interest rates from forward guidance.
Nonetheless, Mario also commented that “Underlying inflation pressures continue to remain subdued, the Governing Council will continue to look through changes in HICP inflation if judged to be transient and to have no implication for the medium-term outlook for price stability.” As such “A very substantial degree of monetary accommodation is still needed for underlying inflation pressures to build up and support headline inflation in the medium term.”
After the meeting, government bonds sold off across the Eurozone, with the German 10-year Bund yield closing around 0.49%, close to 1-year highs.
In the UK, the March budget did not deliver any major changes, with the government maintaining its fiscal targets. Economic data was somewhat soft – Halifax house price index suggesting the slowest growth in over 3 years, Countrywide house rental data the first annual drop since November 2010 and industrial, manufacturing and construction output all below expectations. With respect to Brexit, the House of Lords voted to make 2 amendments to the Withdrawal Bill (protection for EU nationals already living in the UK and a requirement to submit any future agreement before debate at the European parliament). It is likely the House of Commons will reject both amendments and that the Bill will pass in its original form this week. This implies triggering Article 50 by Friday.
After almost 9 years, Iceland’s government announced that capital controls will be removed on Tuesday. Meanwhile, Poland left the benchmark interest rate on hold at 1.50%.
HSCEI 1,025 -0.75%, Nikkei 1,963.00 +0.33%, 10yr JGB 0.09% +0bps, USDJPY 114.650 +0.65%
India’s Prime Minister, Narendra Modi, claimed a landslide victory on Saturday in the Uttar Pradesh (UP) state elections, winning 325 out of the 403 seats. Home to over 200 million of India’s poorest people, this vote has a number of significant ramifications for India’s political and economic future. The results from three other, far smaller, state elections were also released over the weekend, with Modi performing better than expected in Uttarakhand, winning a majority, while finishing slightly behind Congress in Goa and Manipur. This election was interpreted as a referendum on Modi’s economic reforms enacted so far; most significantly, demonetisation. The fact that one of India’s poorest states, with its cash centric local economy being among the worst disrupted in the country, should vote in favour of this policy can be extrapolated to mean that India as a whole is showing a willingness to tolerate the short-term hardships associated with economic reforms, in exchange for the long term improvements in prosperity and efficiency these reforms promise. This is the most powerful outcome of these elections and suggests that Modi’s support levels have only increased since he swept to power in the 2014 general election, suggesting that winning a second term in 2019 is an increasingly likely outcome. Secondly, the victory in UP guarantees Modi a greater number of seats in the Rajya Sabha, India’s upper house of parliament. Building a two-thirds majority here (which the government currently lacks) will allow the government to pass key reforms which are currently being stonewalled by the opposition in the upper house. The third implication is drawn from the counter-factual – what if Modi had lost this election? A defeat in Uttar Pradesh, along with the government’s disappointing loss in Bihar in 2015 would have created a pattern through which other parties can defeat the government in state level elections. In Bihar, the smaller parties, though not politically aligned in any major way, formed a coalition so as to stand a chance against the BJP, and succeeded. Had this strategy worked in the far larger arena of UP, this would have provided a blueprint for the rest of India’s states as to how to fight against the BJP.
In China, the governor of the central bank held a press conference outlining policy objectives for 2017, with very little new content not already made public. In terms of monetary policy, there was no change to the rhetoric calling for stability and de-risking of the financial system. On the RMB, Governor Zhou claimed that there is no basis for the currency to depreciate further in 2017 and that he expects foreign exchange reserves to stabilise around these levels, with market sentiment now having adjusted in the central bank’s view. Deputy Governor Yi, however, followed up by saying that it is beneficial to use exchange reserves to support the currency as needed. China’s CPI inflation rate came in at 0.8% YoY in February, with lower pork and vegetable prices pushing down consumer price inflation to its lowest level since January 2015. PPI however jumped to 7.8% YoY. The National Bureau of Statistics commented that around ~6% of this can be attributed to the increases in prices of coal, oil and non-ferrous metals seen over the last twelve months. Imports grew 44.7% YoY in February, with seasonality around Chinse New Year inflating the underlying trend of stronger domestic demand.
South Korea’s constitutional court upheld the National Assembly’s decision to impeach the President. The court’s decision was unanimous, with all eight judges voting in favour of the decision, above the six votes required. Prime Minister Hwang Kyo-ahn will now continue his role as acting president until a permanent replacement can be elected, which could likely take place on 7th May according to local media outlets. Given that elections are constitutionally required to be held within 60 days of the court’s decision, and that all elections must be called with 50 days of advance notice, there is only a short window of possible dates. While Korea’s political future continues to progress along a fairly clear path (even if a sub-optimal one), the future of the country’s economy and business establishment is far murkier. GDP and exports remain weak, while senior officials at the country’s largest companies continue to face ongoing criminal accusations.
The RBA in Australia left interest rates on hold for the 6th meeting in succession at 1.50%.
MSCI Lat Am 2,541 -2.54%
Brazil’s industrial production marked the first YoY expansion after 34 consecutive months of decline. It expanded 1.4% in January. Signs of an industrial recovery also appeared in electricity consumption where the industrial segment (+4.4% YoY) was responsible for the bulk of the YoY growth (+2.8%). Brazil Q4 GDP contracted 0.9% QoQ leading 2016 GDP to decline by 3.6% YoY. In real terms, GDP is back to its 2010 level. Increases in net exports, a significant decline in inventories, falling inflation, rising confidence, lower interest rates, stronger agricultural production, higher commodity prices and the pension reform to be approved later this year, all bode well for an economic recovery in 2017. However, high unemployment, high consumer and corporate leverage and political uncertainty will conspire against the smooth and broad improvement currently priced in the currency.
Argentine GDP contracted 2.3% in 2016. It was a painful transition year, where the economy had to adjust from 15 years of mismanagement. 2017 will be a make-or-break year where Argentines will pressure Macri’s government if the structural reforms do not translate into a strong economic rebound. Moody’s raised its outlook for Argentina to positive from stable, maintaining its overall rating at B3 (6 notches below investment-grade territory). Comments were very encouraging: “Over the past fourteen months, a number of policies have been introduced which have laid the ground for future improvements to Argentina’s economic and fiscal strength, and for a reduction in its exposure to shocks. The positive outlook reflects the rising likelihood that those policies, and the improvements in Argentina’s institutional strength which they illustrate, will be sustained and bring about lasting improvements in Argentina’s credit profile.”
Inflation in Chile declined to 2.7% in February, 200 bps below the February 2016 reading. Thus, the CPI stood below the Central bank’s target for a fifth month in a row. Importantly, core inflation decreased to 2.2% YoY, its lowest level since December 2013. This leaves ample room for a rate cut, which is needed to support the slow-growth Chilean economy. Monetary policy can be supportive cyclically, but structurally Chile cannot increase its long-term potential growth rate without deeper reforms of its labour market, pension system and education.
Peru’s Minister of Economy and Finance, Alfredo Thorne, announced a fiscal stimulus to boost the economy and achieve employment and public investment growth (to 15%, currently at 5%). The 5 measures announced are:
- A PEN 5.5Bn (0.8% of GDP) fiscal impulse that will create 100,000 direct and indirect jobs through direct public investment.
- Incentivising formal employment through the subsidy contribution to social security for young people entering the formal labour market for the first time (50,000 employments targeted).
- Social housing building (targets at 150,000 newly financed houses through social housing programs working along microfinance institutions).
- A credit program for SMEs (amounts to PEN 1.1 Bn aimed at fixed assets acquisitions).
- The acceleration of Public Works (62 infrastructure projects worth up to PEN1.5bn are selected)
MSCI Africa 802 -0.82%
The Tanzanian central bank cut its discount rate to 12%, from 16%. This is the first interest rate move since 2013. It is aimed at stimulating lending as private sector credit grew at 2.5% in 2016 vs 26.8% year earlier. It is unclear if the IMF expected such a sharp 400bps cut when they warned in January that tight fiscal and monetary policies threatened its forecast for growth of around 7% in fiscal year 2016/17, which ends in June.
Inflation in Egypt reached 30.2% YoY in February from 28.1% a month earlier. Food and beverage prices accelerated to 40.5% YoY. The devaluation of last November still heavily impacts Egyptian consumer and businesses. The central bank needs to hike rates to anchor the currency and fight hyper-inflation.
South Africa’s 4Q16 GDP came in at -0.3% QoQ, negatively impacted by the mining and manufacturing sectors. However, business confidence and other leading indicators indicate that 2017 is starting on a better footing.
Nigeria’s government announced a new growth plan targeting 7% GDP growth, sub 10% inflation and oil output from 1.6Mn bpd to 2.5 by 2020. It also confirmed a privatisation plan to raise capital and more sovereign debt issuance. Despite Nigeria’s relatively-low debt (13% of GDP), rising interest costs and the government’s chronic inability to raise taxes could trigger a liquidity crisis. There was no mention of currency market liberalisation, which would be the first step out of this distressed situation. These announcements were a wishful thinking exercise by a government that has totally lost credibility in the eyes of international organisations, investors and its own citizens.
Source: Alquity Global Market Update www.alquity.com