Anxiety ahead of the US elections has drip-fed global equities lower over the past 2 weeks. Certainly, it is clear that a Trump victory is seen as market negative – and on this the Mexican Peso and recent polls had suggested the probability of a Republican victory was improving. However, news on Sunday that the FBI will take no action against Democrat candidate Clinton, after a lengthy email probe, has restored market optimism.
Elsewhere, it looks like Saudi Arabia top ticked the oil price. After hitting a 15-month high on the day of their landmark bond deal, the price of crude has been obliterated, falling 10% last week. This was due not only to perceived difficulties in implementing an OPEC production cut, but also a record build in US oil stocks. As a reminder, Saudi Arabia plan to list up to 5% of the state oil company “Aramco” in 2018 – look out for the oil price surge prior!
S&P 2,085 -1.94%, 10yr Treasury 1.81% -7.06bps, HY Credit Index 434 +19bps, Vix 22.51 +6.32Vol
Ahead of Tuesday’s US elections, the S&P 500 has declined for 9 consecutive days – the longest losing streak since November 1980. Actually, it’s not as bad as it seems with the total decline amounting to only 3%. Nonetheless, nervousness is palpable; the VIX implied volatility index surged 9 points over those 9 days and investors shifted money to cash at the fastest rate in over 3 years (measured by weekly inflows to money market funds)
In the background, November’s FED meeting saw no change to policy (as expected), but the accompanying statement strengthened the stance on inflation. Specifically, the committee inserted the phrases:
- “Inflation has increased somewhat since earlier this year”
- “Market-based measures of inflation compensation have moved up”
Incoming data also supported this rhetoric. In particular, whilst headline payrolls were marginally below expectations, they remained above the 150k level seen as acceptable to the FOMC. Moreover, the balance of the employment report was positive; wage growth rose to its highest level since 2009, there were upward revisions to past numbers and the participation rate fell to 62.8%, with unemployment dropping to 4.9% by implication. This last point is potentially important. Recall, that the percentage of the population in the US workforce has fallen from around 66% pre-crisis. Anticipation of a reversion to this level has been used as an argument for continued labour market slack despite an unemployment rate near historical lows. However, participation is now unchanged in 3 years and thus, arguably, the change should be viewed as structural. As summarised by Vice Chairman Stanley Fischer on Friday, the majority of the committee would therefore probably agree: “This recovery has been and continues to be powerful in terms of one of our two main targets–employment–and it is my view that the labour market is close to full employment.”
Eurostoxx 2,991 -2.52%, German Bund 0.16% -3.20bps, Xover Credit Index 331 -10bps, EURUSD 1.106 -1.37%
European equities declined alongside global peers. Italian stocks underperformed, led by Monte Paschi – the bank that has spent at least the last 7 years insolvent. This followed former industry minister Corrado Passera dropping a recapitalisation proposal, leaving only a JPMorgan led deal on the table. In short, no commercially motivated investor will commit funding to the company and ECB rules are limiting the possibility of state aid.
On a more positive note, Greek bonds posted their biggest weekly advance since June on optimism that the ECB will finally allow some form of debt forgiveness and therefore the IMF will remain part of the “bailout” program.
In the UK, the High Court ruled that Prime Minister Theresa May must first gain Parliamentary approval before triggering Brexit via Article 50. Whilst the UK government has appealed the ruling (judgement likely in January), the market was buoyed by an increased probability of a so called “soft Brexit”. Later in the week, the Bank of England added to the shift in tone by shifting upwards their growth and inflation targets. Moreover, the previous easing bias was removed and Governor Carney instead stated that “monetary policy could respond, in either direction, to changes in the economic outlook as they unfolded.” As a consequence, sterling enjoyed its best week since 2009.
The Turkish lira fell to a record low against the dollar on Friday after authorities arrested the leaders of the main pro-Kurdish opposition party. The country remains on a precipitous path – jailing more journalists than any other country, having nationalised some 500 companies since the failed coup and purging officials across government institutions. Indeed, this week’s World Justice Project’s rule of law index placed Turkey 99th out of 113 countries.
HSCEI 9,608 -0.28%, Nikkei 1,717.00 -1.07%, 10yr JGB -0.05% 0bps, USDJPY 104.510 –1.50%
The Bank of Japan left policy unchanged this week but, again, pushed back the time horizon for reaching its 2% inflation target (by a year into 2018). There appears to be a change in approach by Japanese policymakers – moving from unpredictable, poor execution of massive policy bets to, well, doing nothing. We expect this new regime to be as wholly unsuccessful as the last. The JPY rallied and subsequently Japanese stocks fell. The RBA in Australia also left policy unchanged (at 1.5%), whilst the RBNZ in New Zealand may cut rates this week.
India took another step towards implementation of one of the country’s key economic reforms – the Goods and Services Tax. The government are continuing to work to an implementation deadline of April 1st 2017, with this week’s developments another important step towards hitting that objective (though far from a guarantee).
The Goods and Services Tax (GST) Council, formed of state and union Finance Ministers, agreed four ‘slabs’ of tax rates for goods and services traded across India – 5%, 12%, 18% and 28%. The 5% rate will apply to items of mass consumption, the two intermediate rates to the majority of other products, and the 28% rate applying to consumer durables (currently taxed at 31%), along with luxury and sin goods.
Finance Minister Arun Jaitley also confirmed that INR 500bn will be made available by the central government to compensate those states which lose revenue during the first year of implementation.
The next steps for the government are to obtain approval of these tax rates from parliament during the upcoming winter session (beginning 16th November) and to finalise the categorisation of goods and services in to each tier.
China’s official October Manufacturing PMI came in at a 27-month high of 51.7, well ahead of expectation. Caixin’s unofficial PMI data also supported the view of a strengthening Chinese economy, as did a number of other data points for October, including power consumption, which rose 13.1% YoY. The range of PMI price indices also touched multiyear highs.
MSCI Lat Am 2,463 -5.22%
The Colombian central bank kept rates unchanged at 7.75% but delivered a dovish message hinting at the beginning of an easing cycle by 4Q16/1Q17. BanRep cut its GDP forecast from 2.3% to 2% for 2016 and mentioned that “temporary factors affecting inflation last year are fading faster than initially projected”. That said, monetary policy will be influenced by the approval of the tax reform.
In Brazil and Argentina, repatriation programs have been a big success. The amnesty to taxpayers who declare undisclosed offshore assets in exchange for a fine, has already generated BRL 51Bn in revenue to the Brazilian budget and the repatriation of USD 5Bn worth of assets held by 100,000 Argentinians. This additional revenue should decrease Brazil’s fiscal deficit to 2.5% from 2.7% this year and the capital will hopefully be invested in productive assets and projects in Argentina.
The credibility of Peru’s institutions took a hit when congress appointed 3 directors to the central bank tied to Fuerza Popular (opposition party, leading in congress). Although, this is not a good signal for the independence of Peruvian institutions, one should keep in mind that the President of the central bank Julio Velarde is highly regarded.
There is now concrete evidence that economic adjustment in Argentina is underway. After changes in personnel, we have access to credible macro-level statistics, allowing for analysis and comments on the direction of the economy. In particular, inflation remains high due to the floating of the Peso and the removal of subsidies and regulated prices. However, the recession, high real interest rates and fiscal consolidation efforts are seeing price pressures gradually subside. In turn, lower inflation is creating room for the central bank to cut interest rates (currently at 26.75% from 38% in March), setting the scene for the economy to recover in 2017 (from -2% in 2016 to 3.5% forecast next year).
MSCI Africa 762 –2.30%
Egypt made a number of important steps last week. First, the country signed a USD 2.7Bn swap deal with China. China has been Egypt’s top trading partner since 2013, with total trade registering USD 10Bn in 2015 (USD 9.1Bn of which are goods flowing from China to Egypt) and increasing by almost 30% over the last 3 years. This facility will be used to fund imports from China and temporarily reduce the need for hard currency.
Second, the long-awaited devaluation of the EGP finally took place. The central bank announced that the Egyptian currency will float freely and by Friday the EGP traded at 15.56 per USD, a 43% devaluation from the 8.8 peg. The devaluation came alongside a 300bps interest rate hike, setting the benchmark rate at 14%. Last, less than 24h after the float, the government issued a decision raising prices of fuel, diesel, butane gas, and natural gas by up to 47%.
Egypt now fulfils all the conditions set by the IMF to release the USD 2.5Bn first tranche of its USD 12Bn loan. Specifically, that it has a freely floating currency, energy subsidies have been removed and USD 6Bn of financial resources have been committed by its allies (China and the Gulf countries).
The ZAR rallied last week after charges against Finance minister Gordhan were dropped. In addition, an investigation into links between Zuma, his ministers and SOE executives with the powerful Gupta family was formally launched.
The South African trade balance recorded a surplus of ZAR 6.7Bn in September from a deficit of ZAR 8.9Bn in August. It benefited from a struggling economy with a weak consumer (fewer imports) and improving commodity prices. The economy is adjusting through the usual mechanisms: twin deficit, recession, cheaper currency, improving trade balance (exports become more competitive, imports become more expensive) before initiating a new growth cycle (conditionally on structural reforms to be implemented, fiscal discipline to remain tight and avoiding a downgrade by rating agencies).
The BRVM will be admitted to the MSCI frontier index. The stock exchange of West African countries (Benin, Burkina Faso, Guinea Bissau, Ivory Coast, Mali, Niger, Senegal and Togo) will be represented in the index by Sonatel, Onatel and Societe Generale Cote d’Ivoire. This should put this region under the spotlight and bring it under the radar of international investors.