Money Matters Nov 28th, 2016

General Consensus:
Over the past 3 weeks, global markets have decoupled, with price action suggesting strong consensus positioning across the developed world. In particular, investors have quickly priced in that Trump will bring meaningful fiscal stimulus, accelerated growth and higher interest rates (see equities at all-time highs, USD at multi-year highs and bonds at one-year lows). Conversely, Europe is expected to be trapped in a monetary policy “groundhog day” (US-Germany 2yr yield spread touched record 1.81% this week), whilst there remains little confidence on underlying growth and reform (Italy-Germany bond spread widest in 2.5 years, Italian equities 23% lower YTD in EUR terms). As it relates to emerging markets, fund flows have aggressively reversed, but currency and equity markets have mostly held up well.
It may be that markets have got this right; the US will continue to out-perform as Trump delivers, Europe will lag on ineffective policy and emerging markets will “muddle-through”, with domestic growth, cyclical positioning and reform facing off against a stronger dollar head-wind. However, given the degree of political uncertainty (reality vs. perception for Trump and elections across Europe), we think there is a great deal of risk to the market’s central outcome for 2017.
Next week brings a brief respite ahead of the Italian constitutional reform referendum (4th December) and ECB (8th December) and FED (12th December) meetings.
United States:
S&P 2,213 +1.44%, 10yr Treasury 2.33% +0.24bps, HY Credit Index 392 -23bps, Vix 12.34 -.51Vol
For the first time in 17 years, the US achieved a stock “superfecta” last week – the S&P 500, Dow Jones Industrial Average, Nasdaq and Russell all setting record highs. Meanwhile the post-Trump victory dynamics held, with bonds lower.

In terms of data, most releases were positive – Durable goods, Michigan consumer sentiment and existing home sales all beating expectations (albeit new home sales came in lower). Last, the minutes from the November FED meeting did little to upset expectations of a December hike. Most committee members felt it “could well become appropriate” to raise rates “relatively soon”.

This Friday brings the December employment report which, theoretically, is the last major data hurdle ahead of the “priced-in” December rate hike. The futures curve then prices a further two moves over the course of 2017.
shutterstock_525056506Europe:
Eurostoxx 3,048 +0.98%, German Bund 0.22% -3.20bps, Xover Credit Index 343 -8bps, EURUSD 1.066 -0.04%
European data continued its recent positive tone with the composite PMI posting an impressive 54.1 and decent business confidence surveys from both France and Germany.
The next trading week is quiet, ahead of Sunday’s Italian constitutional reform vote and the ECB meeting, at which the market expect the governing council to extend quantitative easing beyond the current March 2017. Indeed, the Schatz (German 2yr bond) touched an all-time low yield at -0.75% as excess liquidity conditions across the Eurozone forces those without access to the ECB’s deposit facility into short-dated government bonds.
In France, François Fillon was confirmed as the Republican party candidate for next year’s Presidential election, after a sweeping victory over Alain Juppé. He will be expected to win the 2 rounds of voting (April 23rd and May 7th), most likely facing off against far-right candidate Marine Le Pen in the final round.
In the UK, the Chancellor presented the Autumn Statement. The short summary, is that the UK government now expects to borrow GBP 125bn (6.25% GDP) more than at the March Budget, with 80% of that increase coming from a change in forecasts, and the remaining 20% from new policy measures.
The Central Bank of Turkey surprised markets by raising interest rates for the first time since 2014. This was in response to an 18% weakening of the TRY this year and in defiance to President Erdogan, who has been vocal in asking policymakers to lower rates. The move did not arrest this weakness, with new all-time lows vs. USD post the announcement. We remain concerned about the country. The President is increasingly autocratic and involved in an active dispute with the EU over financial aid (funds have been diverted from agreed projects) and migrant flows (Turkey are threatening to allow more refugees to leave over its borders).
Elsewhere, Hungary left policy unchanged.
Asia:
HSCEI 9,904 +4.74%, Nikkei 1,835.00 + 0.12%, 10yr JGB 0.02% +0bps, USDJPY 111.920 +2.08%
The Japanese Yen continued to weaken last week, breaking through 113 and marking a 14% rally since August.
India continues to adjust to life after demonetisation, following the government’s decision to withdraw the INR 500 and INR 1,000 banknotes from circulation from 9th November (this was done in order to cut off the oxygen supply to India’s shadow economy, the magnitude of which is nicely summarised by the statistic that out of a population of over a billion people there are only 52 million taxpayers).
Whilst the process for depositing and exchanging the old banknotes has inevitably led to short term disruptions, the government has been reasonably quick to tackle specific teething issues where possible and to adapt the specifics of the exchange process. For example, in time for the winter sowing season, farmers have been allowed to purchase seeds using the old bank notes, while the daily ATM withdrawal limit has been increased for small businesses.
A number of commentators have questioned what this policy means for the popularity of Modi’s government. A survey last week (admittedly, commissioned by the BJP and with respondents concentrated in urban areas) asked 500,000 people about their views on the demonetisation programme. Over 93% of those surveyed viewed the development as a positive for India over the long term, whilst the majority believe that the short term disruption is outweighed by the long term benefits. It must be noted however that the survey was conducted through the Narendra Modi official mobile app.
The Reserve Bank of India introduced a temporary 100% cash reserve ratio on incremental deposits received since 16th September, with all other deposits (over 95% of the total deposit base) continuing to come under the pre-existing 4% ratio.
The Rupee also continues to face weakness against the dollar. This is driven by the broader EM selloff, the diametrically opposed changes to interest rate forecasts in India and the US, plus short term outflows driven by concerns around the Impact of demonetisation.
The People’s Bank of China continues to pivot towards a tighter stance on liquidity. The central bank has reduced interbank-market liquidity in order to support the RMB during a time of dollar appreciation and to dampen the on-going capital outflow trends.
The central bank has seized the opportunity of a strongly performing economy (e.g. PMI touching a 27 month high) in order to begin tightening policy. On its current trajectory, the economy is very likely to hit the official 2016 GDP growth target of 6.5%-7.0% for the year with room to spare, leaving plenty of space for policymakers to incrementally remove stimulus in the short term without risking growth.
Thailand’s third quarter GDP growth rate came in at 3.2% YoY, slightly above consensus (3.0%). Private consumption strength caused the upside surprise, growing at 3.5%. Public sector investment and a wider current account surplus provided further support.
shutterstock_525118249Latin America:
MSCI Lat Am 2,296 +1.29%
Colombian 3Q16 GDP growth fell to 1.2% YOY, below consensus, whilst retail sales contracted 1.3% YOY, for the 5th month of declines in a row. The deterioration of the country’s economic performance and the uncertainty around the much needed tax reform also left consumer confidence in negative territory (-3.2%) for the 10th consecutive month.
The Argentinian Central bank cut the benchmark interest rate by 50bps again last week. Although the Central bank governor re-affirmed the objective of maintaining a 4% real rate and transitioning to a new monetary policy framework of formal inflation targeting in January, this cut is needed to support economic activity. GDP contracted 3.8% YOY in 3Q16, underscoring the deeper and longer than expected recession.
Brazil’s finance minister revised his GDP growth forecast downward to 1% from 1.6% for 2017.
The Real lost close to 2% on Friday, following the accusation by former culture minister Calero that President Temer pressured him into authorising a construction project benefiting another cabinet member. There is very little information on the case, but it comes at a delicate time for the government, which is pushing for final approval of a key spending caps bill in the Senate.
Peru introduced a new investment framework. “Invierte” will minimise paperwork as much as possible, while maintaining environmental impact studies, to reduce approval time for PPPs to as little as 6 months from 24-30. It is expected to boost project execution from 70% to 90%+.
Mexican GDP in 3Q16 came in at 2% YOY and stands at 2.3% for the 9 months to September.
shutterstock_523674157Africa:
MSCI Africa 733 +0.60%
South African kept rates unchanged at 7%, while risks for economic growth are tilted to the downside. The jobless rate hit 27.1% in 3Q16, its highest level in 13 years. Headline inflation also accelerated to 6.4% YOY in October, driven by higher food (+12%) and oil prices.
The Central Bank of Nigeria kept rates on hold at 14%. The CBN is stuck between inflation running at 18.3% (a rate hike would help put pressure on inflation) and a recessionary economy (a rate cut would support economic activity). However, given the low penetration of banking in Nigeria, monetary transmission is limited and attempts to spur economic activity via cutting rates have not borne much fruit and any rate cut would further exacerbate FX shortages.
A rate hike is a necessary but not sufficient condition for Nigeria’s recovery. A combination of IMF intervention, floating of the currency, removal of subsidies and capital controls appear the only rational policy in this situation.
Moody’s downgraded Uganda’s credit rating to B2 from B1 and changed the outlook from negative to stable. The rating agency cited the erosion of the country’s fiscal strength since 2013, the increasing debt burden (from 24% to 33% of GDP since 2012) that is projected to reach about 45% of GDP by 2020, as the main reasons for the downgrade.
Ghana’s central bank cut its benchmark interest rate for the first time in more than five years (by 50bps to 25.5%). Monetary policy tightness and continuous exchange rate stability supported the declining trend in inflation to 15.8% in October 2016 from 19.2% in September and its lowest level since July 2014. With the support of the IMF, Ghana is not completely healed yet but looks on the right track.
Information obtained from Alquity Global Market update

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