Money Matters Oct 25th, 2016

    United States:
    S&P 2,141 +0.38%, 10yr Treasury 1.72% -6.30bps, HY Credit Index 398 -6bps, Vix 13.18 -2.78Vol
    Recent, modestly higher, volatility fell away last week as US equities traded in a narrow range, finishing slightly higher. Bonds again correlated positively, also ending better. From a data perspective, most releases were softer than expected (including Empire state manufacturing, industrial production and housing starts). However, Fed speakers reiterated a desire to raise rates in December:
    ¥ New York Fed President Dudley stated “If the economy stays on its current trajectory I think…we’ll see an interest rate hike later this year.”
    ¥ San Francisco Fed President Williams commented the U.S. economy is “essentially at” full employment and, with inflation “pretty darn close” to 2% “it makes sense to get back to a pace of gradual rate increases, preferably sooner rather than later.”
    This central bank tone saw the probability of a December hike remain at 70%, whilst the USD continued its rally – the trade weighted basket hitting an 8 month high.
    Eurostoxx 3,102 +0.61%, German Bund -0.01% -5.20bps, Xover Credit Index 316 -13bps, EURUSD 1.088 +0.80%
    At last week’s ECB meeting, Mario Draghi refrained from his usual bombastic display, revealing very little new information so as to avoid pre-empting updated macroeconomic forecasts and staff work on QE implementation due in December. The 8th December meeting will therefore be a key event, guiding the market on the scale and duration of QE beyond March 2017.
    Spain may form a government this week. Over the weekend, the federal committee of the PSOE has voted in favour of forming a centre-right government with the PP and thus Mariano Rajoy is set to serve a second term. This brings to an end a 10 month period of political stalemate, albeit the new government will still fall 6 votes short of a majority.
    In the UK, inflation data came in above expectations (highest reading in 2 years) and is likely to trend higher as the effects of sterling weakness and the energy price rebound feed-through. Meanwhile, the broader economy continues to show resilience with labour market and retail sales data relatively buoyant. In this context, it is likely the Bank of England will not now cut rates in November (a 20bps cut to 0.05% had been priced in). Nonetheless, any eventual weakness from Brexit uncertainty will prompt action whatever the short-run inflation outlook (in difference to the ECB).
    Prime Minister Renzi was dealt a blow this week ahead of the 4th December constitutional reform referendum when ex-PM Monti came out in favour of a “no” vote. Polls suggest it is now more likely than not that the country rejects the PM’s amendments. The Spanish-Italian 10yr bond spread is now at the widest levels in over 4 years.
    Portugal avoided a loss of access to ECB bond buying as rating agency DBRS chose not to downgrade the country’s credit rating – leaving their assessment at BBB low with a “stable” outlook. The other major ratings agencies have all held junk ratings since 2011. Elsewhere S&P upgraded their outlook on France from negative to stable.
    shutterstock_447117313Asia Pacific:
    HSCEI 9,862 +0.89%, Nikkei 1,723.00 +2.02%, 10yr JGB -0.05% +0bps, USDJPY 103.860 -0.30%
    In Japan, the 10 year government bond failed to trade on Wednesday for the first time in over a year. There has been a general decline in trading (around 50% on new issues) since the BOJ enacted “yield curve control” and therefore took price volatility out of the market.
    Saudi Arabia set a new record for an emerging market debt issue, raising USD 17.5bn on reported demand of USD 70bn. This was despite a large repricing, limited disclosure and a challenging fundamental outlook (the fiscal deficit touched 16% in 2015 after the oil price slump).
    China’s economy grew 6.7% YoY in Q3, the same rate of expansion seen in Q2. Domestic consumption and fixed asset investment were strong, while trade remains a headwind for the world’s second largest economy.
    September’s data showed the domestic economy remains relatively strong across a broad range of indicators, with retail sales (+10.7% YoY), fixed asset investment (+8.2% YoY YTD) and auto sales (+26% YoY) all outperforming. Exports though were down -10% YoY for the month, which weighed on industrial production, which decelerated slightly from 6.2% in August to 6.1% in September.
    Indonesia’s interest rate easing cycle continued, with another 25bps cut from the central bank. Interest rates have now been cut by 150bps this year to 4.25%. The central bank gave doveish guidance as to the future rate path, citing a domestic economy that was “likely not as strong as expected” in Q3 and a “slow and uneven” global growth environment.
    shutterstock_188781878Latin American:
    MSCI Lat Am 2,600 +4.15%
    Latin American equities keep attracting fund flows. Last week, the asset class received USD 400mn of inflows, bringing the year-to-date inflows to USD 5.2bn. However, despite these flows and a 49.7% performance (MSCI Lat Am, total return), the asset class remain under-allocated by international investors, who only own 14% of their GEM portfolios vs. an historical average of 19.6%.
    Peruvian GDP growth came in at 5.5% YOY in August, bringing the annualised growth rate to 4.3%. This set of numbers bore some encouraging signs with private investment picking up and the ratio of orders to inventories also expanding. Retails sales posted a 2.3% growth and the Lima Chamber of Commerce (CCL) forecasts they could grow 12% in 2016 and 14% in 2017.
    PPK has been elected on the promise of spurring investment, especially in infrastructure (USD 70Bn plan announced) to take over from mining as the next engine of growth. Thus, all signs of private and PPP investments are positive. We should be able to see them in the numbers in 2017 onwards.
    The Ibovespa touched a three-year high as President Michel Temer expressed confidence the country is getting back on track and predicted an economic rebound will take hold in the final three months of the year.
    The Brazilian central bank cut rates 25bps to 14.0%. Falling inflation and progress on reforms (pension, social security, fiscal ceiling) allowed the central bank to start easing. The pace of this easing cycle will be data and reform-dependent.
    The long-awaited Colombian fiscal reform has been presented to parliament. As expected it contains a cut in the VAT rate from 16% to 19% and a cut of the corporate tax rate to 32% (from 43% and a total tax burden of c60-70% of taxable profit for some large companies). The government expects to improve tax collection by 2.7% of GDP by 2022 (helped by the formalisation of the economy), to achieve a fiscal deficit of 1% by 2022, making up for oil revenue decline.
MSCI Africa 783 +2.74%
    Nigeria reported a September headline inflation of 17.9%, up from 17.6% in August. As expected, imported prices drove this CPI growth, as the black market FX starts to be passed-through to customers.
    Nigeria’s inter-bank market was in turmoil last week as a currency forward auction left lenders with Naira cash shortages. The overnight interbank lending rate soared to an eye-watering record high of 153.5% on Tuesday (from 14% the previous week) as lenders were made to pre-fund their auction bids. Whilst, by the end of the week, the interbank rate fell back below 11% (as the central bank sold less hard currency than expected and therefore banks now had surplus liquidity), this shows the appalling quality of Nigerian institutions and the mismanagement of the currency. The Nigerian financial system is at risk of collapse.
    For the fourth consecutive time this year, Bank of Uganda (BOU) reduced the benchmark interest rate, which now sits at 13%, as it looks to stimulate demand in the economy.
    Egypt’s unofficial FX rate reached 15 USDEGP (official rate is at 8.8). Companies 3Q results are disappointing, as they cannot increase prices without affecting volumes, the interest rates burden is rising and thus margins are squeezed. On the demand side, households’ income has not moved and “rainy days savings” are running low. Reforms are needed to unlock IMF loan and relieve the real economy.

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