After a 9-month period in which equity markets have stretched their legs into a “perfect calm” of rebounding global growth, last week saw a mid-week stagger as a 1-2 political punch combo threatened to derail momentum. First, allegations surfaced that President Trump fired FBI Director James Comey to cover up his own and/or his campaign officials’ improper behaviour. Second, reports suggested Brazil’s President Temer might have been complicit in illicit payments to former speaker of the lower house of Congress Eduardo Cunha.
Taking a step back, we continue to believe the global economy has strong momentum and, whilst this political unrest should prompt a pause for thought, we do not see it as a knockout blow. Markets have enjoyed a serene regime in which all indicators flashed green. Going forward it is likely to be less straightforward.
US markets might be underappreciating the significance of the investigation into the President, and the severe lack of political capital to make any progress on pre-election promises. Given also the late cycle positioning of the US economy, a cautious approach to US equities may be prudent. With respect to Brazil, the economy is in a much better place than 18 months ago, with falling inflation opening the door to aggressive interest rate cuts from the central bank. Pending structural reforms are important to avoid a “double dip” recession, and as such the inevitable delay and loss of credibility will have an impact, but the picture is not unequivocally bad. This is to say, it might be rash to “buy-the-dip”, but it is also too early to give up on the secular recovery story.
In commodities markets, oil moved higher on the announcement that Saudi Arabia and Russia had agreed to extend output cuts.
S&P 2,382 -0.38%, 10yr Treasury 2.23% -9.11bps, HY Credit Index 332 +2bps, Vix 13.32 +1.64Vol
Although ending the week only modestly lower, US equities experienced a “mid-week tumble” with the biggest one-day loss since September for the S&P 500 and since June for the Nasdaq. This followed allegations that President Trump had requested ex-FBI Director James Comey drop his investigation into ties between Trump campaign officials and the Russian government. It also prompted:
- Volatility to (briefly) escape its slumber, the VIX touching 15.50 intraday.
- The USD to post its biggest weekly fall for over a year (dropping 2.16% on a trade weighted basis).
- 10-year Treasury yields to retreat from 2.34% to 2.25%.
On the data front, after a much weaker Q1 than expected, it appears Q2 is getting off to a better start, with hard data catching up with soft data. Industrial production for April grew at its fastest pace in over 3 years, capacity utilisation hit a 20-month high and the Conference Board’s index of leading economic indicators rose for the 4th straight month.
Former FBI Director Robert Mueller III will now run an investigation into Donald Trump’s firing of James Comey. This not only creates uncertainty, but will also suck up the time and energy of policymakers. As such, it is even less likely any progress can be made on Trump’s reform agenda. More positively, it does appear that US growth is steadying somewhat after a poor start to 2017 – extremely bullish sentiment finally following through to real activity. Nonetheless caution on US assets remains based on valuation, a tight labour market and the expectation of continued tightening from the FED.
Eurostoxx 3,580 +1.07%, German Bund 0.36% -2.30bps, Xover Credit Index 251 -3bps, EURUSD 1.117 -2.46%
European equities outperformed as the ZEW survey in Germany posted the best assessment of current conditions since 2011 and the highest expectations for the next 6 months since 2015 (albeit still below its long-term average). Meanwhile, new French president Emmanuel Macron appointed Republican Edouard Philippe as prime minister.
In Greece, the bill required to conclude the Troika’s second review was passed by parliament, setting up the next disbursement of ESM loans. There are reports debt relief measures are now being discussed, but it is thought unlikely these could be consummated before German elections. The review process has nonetheless taken its toll, with Q1 GDP registering the 2nd consecutive quarter of economic contraction and GDP for full year 2017 unlikely to show any growth for the 3rd consecutive year. The European “bailout” approach therefore continues not to work.
In the UK, Theresa May unveiled the Conservative Party manifesto ahead of the the general election on the 8th June.
Meanwhile, retail sales came in well-ahead of consensus for April (but may well have been affected by the timing of Easter) and unemployment fall to 4.6%, its lowest level since 1975. Despite this headline strength for the labour market, caution remains as wage growth fails to keep pace with overall inflation. Nonetheless, the GBP performed well and has now recouped over 5% of its losses versus the USD.
In Poland, the MPC left rates on hold at 1.50%.
HSCEI 1,036 +0.00%,, Nikkei 1,967.00 +0.27%, 10yr JGB 0.05% +0bps, USDJPY 112.190 -1.80%
Hold the phone – Japan’s economy grew 2.2% annualised in Q1 to mark its 5th consecutive quarter of growth – the longest run of positive readings for 11 years.
China’s economic indicators continued to demonstrate weakness in April, following an unexpectedly strong first three months of the year.
Industrial production growth slowed from 7.6% YOY in March to 6.5% YOY in April, retail sales moderated slightly from 10.9% YOY to 10.7% and fixed asset investment slowed from 9.2% YOY to 8.9%.
This follows a recent period of softness in PMI data, which has shown a deceleration since Q1 though remains above 50 in the expansionary zone.
Thailand’s economic growth rate accelerated in Q1 2017 to 3.3% YOY from 3.0% in the final three months of 2016, beating expectations. Rising rural incomes and a stronger agricultural sector contributed to the quarter on quarter improvement, while goods exports and public investment were also strong.
Indonesia received a sovereign upgrade from S&P to investment grade status, from BB+ (positive outlook) to BBB- (stable). The upgrade itself comes as little surprise, with Fitch upgrading Indonesia to investment grade in 2011 and Moody’s doing so in 2012. The timing of S&P’s move was driven by the agency’s scheduled annual review of Indonesia.
S&P noted improvements made on fiscal management as reasons for the upgrade, with the rating agency forecasting that Indonesia will be able to maintain a fiscal deficit below 2.5% of GDP and be able to maintain a government debt to GDP ratio below 30%.
Indonesian equities finished the session up 2.6% in local currency on the day of the announcement.
Bank Indonesia left rates on hold at this month’s meeting at 4.75%, with little change to the central bank’s outlook.
Malaysia’s GDP growth rate in Q1 came out ahead of expectations at 5.6% YoY, the fastest growth rate for two years. This was driven by a broad based acceleration across domestic demand data, while net exports had a negative contribution. The current account surplus also shrank from 3.8% of GDP last quarter to 1.6% due to a lower goods trade surplus.
MSCI Lat Am 2,518 -7.35%
Brazil was plunged back into a political crisis reminiscent of last year’s impeachment saga following reports of a secret recording of President Temer approving a bribe to the jailed former speaker of the lower house of Congress Eduardo Cunha. The tape was submitted to the Supreme Court as part of a plea bargain deal with the Batista brothers, founders of JBS, the world’s largest meatpacker.
The new crisis triggered a sell-off in Brazilian equity and FX markets, the likes of which has not been seen since the 2008 crisis.
In a speech on Thursday, President Temer stated that he will not resign. After careful listening of the publicly released tape, most observers agree that it is less troubling than initially painted and “somewhat inconclusive”. However, Temer’s image has been severely tainted and his ability to maintain the government’s coalition is in question. Thus, the reform agenda should at least be severely delayed.
Brazil’s economy is in much better shape than in 2015 and the political turmoil need not necessarily stop the economic recovery. However, over the longer-term, structural reforms (labour market, fiscal, micro-economic, pension) are necessary conditions to achieve sound macroeconomic balances.
Mexico’s industrial production expanded by 3.4% YOY in March but adjusting for working days, growth was 0%. A long-term trend cannot be inferred from one data point but industrial data is definitely softening after a great run over the past few years.
The Central Bank of Mexico hiked the reference by 25bps to 6.75%. The Central bank is tightening ahead of the FED and trying to fight increasing headline inflation – which was 5.8% in April (from 5.4% in March).
Peru’s GDP in March was surprisingly resilient, growing 0.71% thanks to a boost from the fishing sector, bringing 1Q17 Peru GDP growth to 2.08%.
Chile’s central bank cuts its reference rate by 25bps to 2.50% to support an economy that is likely to remain sluggish until the December elections.
Colombia’s 1Q17 GDP growth came in at 1.1% YOY, in line with consensus. The modest pace of activity was the result of sluggish private consumption (as expected amidst the VAT hike) and a new contraction in investment.
The trade balance has adjusted following the COP devaluation. The declining path of inflation and interest rates support a consumption recovery, and a likely fiscal stimulus in an election year (March 2018) should also support better GDP growth in the coming quarters making 2017 the bottom of Colombia’s economic cycle.
MSCI Africa 858 +1.07%
The IMF reached a staff level agreement for a USD 1.25Bn second loan instalment to Egypt stating that the reform process was “off to a good start”. According to the statement, the EGP float last November, as well as the introduction of VAT and reform of energy subsidies, all had significant effects. Foreign exchange shortages are resolved, and interbank market activity is recovering. “Egypt has regained investors’ confidence,” the statement said, citing strong appetite for Egypt’s Eurobond sale in January, while private sector remittances and portfolio investments had increased considerably.
Egypt’s trade deficit in February 2017 declined 56% YOY to USD 2.1Bn, versus USD4.7bn recorded in the same month last year. This economic adjustment though the FX channel is positive. Exports increased 22.1% YOY in February to reach USD 2Bn, up from USD 1.6Bn. Imports decreased 35.8% YOY to reach USD4.1Bn.
Egypt’s primary deficit was down 47% YOY in the 9 months to March 2017. The overall budget deficit reached EGP273.2Bn (8% of GDP) compared to 9.4% of GDP in 9M FY15/16 (fiscal year from July to June).
Parliament’s approval of new industrial licencing and investment laws will help unlock Egypt’s growth potential, attract investors, lift productivity growth, exports and industrial production, as well as create higher skilled and well-paid jobs.
Kenya’s FX reserves increased to USD 8.3Bn (5.5 months import-cover) due to a recent loan of USD 1.5Bn. However, higher maize imports and lower tea exports are depleting those reserves.
The currency will also remain under pressure because of the massive and growing twin deficits (current and fiscal deficit are both at around 8-9% of GDP). Populist measures before the August elections, such as the interest rate cap and the increase in the minimum wage by 18%, are slowing down GDP growth and worsening the macroeconomic imbalances of the country. The inability of Kenya to raise a Eurobond at an acceptable rate for the past 2 years may be a hint to the vulnerable position of Kenya’s FX reserves.
Source: Alquity Global Market Update www.alquity.com