HOLD ON TO YOUR HATS
Although the main global equity and bond benchmarks were relatively stable last week, this masked a number of large moves in underlying markets. In Brazil and Italy, politics weighed on sentiment, whilst a surprise rate hike in Turkey stemmed recent weakness. Meanwhile, the copper price hit the highest level since 2014 as Chinese imports hit the highest levels since 2000.
This week, several events have the potential to create further volatility:
- After wreaking havoc at the weekend’s G7 summit, Donald Trump will meet North Korean leader Kim Jong-un in Singapore on Tuesday.
- The FED is likely to raise rates in the US for the 7th time this cycle on Wednesday, whilst the ECB may alter their forward guidance on Thursday by bringing QE (which has resulted in the central bank owning 22% of European government debt) to an end.
S&P 2,779 +1.62%, 10yr Treasury 2.96% +4.39bps, HY Credit Index 345 0bps, Vix 12.52 -1.28Vol
US Treasuries were little changed and equities rallied, pushing the Nasdaq to a record high and the S&P 500 to its best level since early March (3.4% from its peak).
At the G7 summit, Donald Trump surprised his peers by refusing to support a previously agreed joint statement tweeting (en route to Singapore), “Based on Justin’s false statements at his news conference, and the fact that Canada is charging massive Tariffs to our U.S. farmers, workers and companies, I have instructed our U.S. Reps not to endorse the Communique as we look at Tariffs on automobiles flooding the U.S. Market!” Indeed the POTUS went on to label Canadian PM Justin Trudeau “dishonest and weak.” French President Emmanuel Macron responded “International co-operation cannot be dictated by fits of anger and throwaway remarks.” As the weekend progressed, Trump apparently grew increasingly enraged – pointing his twitter gun at all countries who enjoy a trade surplus versus the US (his single metric of focus): “Why should I, as President of the United States, allow countries to continue to make Massive Trade Surpluses, as they have for decades, while our Farmers, Workers & Taxpayers have such a big and unfair price to pay? Not fair to the PEOPLE of America! $800 Billion Trade Deficit…”
From a data perspective the ISM non-manufacturing came in well above consensus at 58.6.
Eurostoxx 3,470 +0.74%, German Bund 0.48% +6.30bps, Xover Credit Index 304 -11bps, USDEUR .847 -0.90%
After brief euphoria that the country had agreed a government, Italian bonds and equities came under renewed pressure last week as investors reflected on the new government’s policies. As we have long highlighted, Italy faces an unsustainable economic future without fundamental change to the Euro project.
In the UK, a timely reminder of the retail environment was served by the department store House of Fraser announcing its portfolio of 59 leased stores was “unsustainable” and that a restructuring would see 31 units close. Moreover, Poundworld appointed administrators. This comes after a number of other retailers entered company voluntary arrangements (CVA) in recent months including New Look, Mothercare and Carpetright. More positively, the services PMI improved in May to 54 from 52.8 a month earlier.
Turkish CPI inflation edged up to 12.15% YOY, while PPI accelerated to 20.16% YOY in May, matching market estimates. Consumer inflation dynamics were driven by both core (e.g. services) and non-core items (e.g. unprocessed food). In order to contain inflationary pressure and to strengthen the credibility of monetary policy, the Turkish central bank surprised markets by delivering a 125bp policy rate hike on Thursday, raising the one-week repo rate to 17.75%.
The hawkish move by the Turkish central bank put a stop to the FX-market sell off. The rate hike, however, was insufficient to attract additional capital to strengthen the lira against major currencies. The pass-through of the Turkish lira’s persistent depreciation implies fast inflation in the coming months, which makes further monetary tightening probable to combat inflation.
Fitch Ratings kept Poland’s credit rating at A- with “stable” outlook thanks to the country’s strong macro fundamentals, sound monetary framework and solid banking sector. The agency pointed out that the gross public debt to GDP ratio at 50.6% is slightly above the peer median, while net external debt to GDP ratio at 31% is high compared to peers (median at 12.7%). Fitch emphasized the downside risks to the country’s rating stemming from the political tensions between the Polish government and the European Commission.
The National Bank of Poland kept the policy rate stable at 1.5% in line with market expectations. NBP Governor strengthened the MPC’s previous forward guidance by emphasizing the need for interest rate stability throughout 2018.
Hungary released a wide variety of macro data last week. The detailed breakdown of 2018 Q1 GDP data confirmed that the Hungarian economy expanded by 4.4% YOY and also revealed that internal demand was the primary driver of growth, as final household consumption rose by 5.8% YOY, gross fixed capital formation expanded by 17.1% YOY, while net trade had neutral impact. In April, retail sales expanded by 4.3% YOY, industrial production rebounded and grew by 7.8% YOY, while monthly trade surplus shrank to EUR 539mio. CPI inflation accelerated to a four-year high, to 2.8% YOY in May.
High-frequency data in April were consistent with the idea that internal demand should bolster growth in 2018 Q2 similarly to Q1. The fact that inflation almost reached the central bank’s target will not spur the MPC to turn hawkish anytime soon, since inflation was driven higher primarily by non-core items, such as fuel prices.
Russia’s CPI inflation rate came in at 2.4% YOY in May, undershooting market expectations. Core inflation edged up by 0.1ppt to 2%. The headline figure was unchanged compared with the number observed in April. However, the contribution of individual components visibly changed, as food price inflation virtually stagnated, while gasoline prices soared.
The build-up of inflationary pressure due to gasoline prices might affect the central bank’s behaviour, as the MPC might refrain from interest rate cuts in the future and stick to wait-and-see stance.
HSCEI 12,191 +1.22%, Nikkei 22,804.04 + 2.35%, 10yr JGB 0.05% 0bps, USDJPY 110.010 +0.01%
Japan’s economic data made interesting reading last week as workers’ real earnings grew just 0.8% in April, despite unemployment at 2.5%. Moreover, Q1 GDP was confirmed at -0.6%. Indeed, household spending (which represents about 50% of GDP) declined for a third consecutive month in April.
China’s inflation printed unchanged in May, with CPI at 1.8%. Consumer price pressure remains benign in Asia’s largest economy, with most sub-indices little changed from their April levels.
Sino-US relations thawed slightly this week, with China’s second-largest telecom equipment maker ZTE agreeing to pay a $1bn fine, in exchange for the lifting of crippling sanctions that have cost the company an estimated $3bn in revenue. Having been reprimanded for violating US sanctions on Iran and North Korea, ZTE became a pawn in trade negotiations between the US and China.
The Reserve Bank of India delivered a 25bps interest rate hike, with a unanimous decision from the six member Monetary Policy Committee. The RBI revised up its inflation forecast for FY19 marginally, from 4.65% to 4.80%, while maintaining a neutral stance going forward.
Whilst the domestic Indian economy could likely have continued to operate with a reasonable degree of stability without the need for a rate increase this year, the RBI appears to have played it safe in acknowledgement of global factors. With tightening US interest rates and a higher oil price giving several EM central bankers a new set of headaches, the RBI has been proactive in signalling to the market its commitment to inflation targeting and stability, even while the economy is only part way through its recovery.
Much of the Indian financial system began to price in this rate hike ahead of time, with most commercial banks having already raised lending rates in the last two quarters, while bond yields have been ticking up since the middle of last year.
Inflation in the Philippines rose slightly to a five-year high of 4.6% in May, from 4.5% in April. This was, however, below the market’s expectation of 4.9%. Core inflation printed lower at 3.6%.
Headline inflation has now printed above the top end of the 2%-4% central bank target for three consecutive months. While the BSP showed a preference for overlooking the temporary inflationary impacts of recent tax reforms, the central bank bit the bullet on 10th May by delivering its first interest rate hike for three years, tightening by 25bps. However, with official forecasts projecting a plateau for inflation in the coming months, and with the central bank not ruling out further rate hikes at upcoming meetings,the BSP could likely maintain a handle on inflation through the rest of the year.
Pakistan’s politics took a further farcical turn this week. While a caretaker government has successfully been appointed to hold office until general elections can be concluded, the caretaker Prime Minister, along with the country’s provincial governors, have failed to disclose their personal assets to the Election Commission. Given that the previous Prime Minister was impeached after having undeclared assets exposed as part of the Panama Papers scandal, this latest issue highlights just how little progress has been made since Nawaz Sharif was disqualified from office last year.
MSCI Lat Am 2,473 -3.74%
Argentina arrived at an agreement with the IMF for a USD 50Bn support package (10% of GDP) for the next 3 years. Argentina committed to reduce its primary fiscal deficit to 2.7% of GDP in 2018, 1.3% in 2019 and 0% in 2020, with inflation targets of 17% in 2017 and 13%in 2020. The country also committed to passing a bill prohibiting the monetization of the deficit (central bank buying Treasury bonds). This package will cover all FX needs to repay debt and interest as well as the current account deficit up until 2020, giving breathing room to Argentina and time for the government to adjust its fiscal imbalances.
Colombia’s current account deficit came in at 3.1% of GDP in the 12 months to March and continues to improve. Higher oil price and a weaker currency (vs. 2015) led Colombia to register its lowest Q1 trade deficit since 2014.
This, combined with structural reforms passed in 2016, lower inflation and interest rates and improving consumer and business confidence bode well for a cyclical recovery and closing the output gap.
Pinera’s state of the union address pointed to a stabilisation of the macro-economic and regulatory environment in Chile to boost private sector-led growth for the next 5 years.
The fiscal, health and pension reforms combined with a commitment to fiscal consolidation and to an infrastructure investment plan should ignite a positive growth cycle in Chile.
All lights are green for Chile: consumer and business confidence at their high, very low debt, strong trade and current account, strong FDIs, low inflation, strong institutions, excellent economic policies and a strong private sector.
Brazil’s market fell strongly for a second consecutive week. MSCI Brazil index is now down 17.8% YTD in USD for 2018. Anti-establishment candidates are widening their lead in the polls for October’s presidential election, whilst market friendly centre-right candidates are losing steam. Intervention in SOEs’ governance, the fiscal situation, the strength of institutions and the outlook for structural reforms are all likely to deteriorate under the volatile extreme-right and extreme left candidates.
It seems the market underestimated social risk in the short-run. The recent truckers’ strike prompted a knee-jerk response from government that goes against fiscal consolidation.
MSCI Africa 899 -2.29%
South Africa’s economy contracted 2.2% in Q1 2018, the worst quarterly decline in nine years, much weaker than the -0.5% consensus expectation and compared to a 3.1% expansion in Q4 2017. The slowdown was broad based with six out of ten sectors declining including Agriculture (declined -24% QOQ, contributing -0.7pps), Mining (-0.8pps) and Manufacturing (-0.8pps). Measured against Q1 2017, the economy expanded 0.8%.
Adding to evidence that economic growth remains fragile, private-sector activity measured by the Standard Bank PMI slipped to 50.0 in May from 50.4 in April, while business confidence fell for a fourth consecutive month to 94.0 in May from 96.0 in April.
The contraction and subdued outlook is a setback to the improved sentiment that followed the election of Cyril Rampahosa in February. However, a slow recovery was to be expected given the scale of the country’s decline under former president Jacob Zuma.
Elsewhere in South Africa, April’s manufacturing output was up 1.1% YOY compared to a revised 1.6% contraction in March, and May vehicle Sales were up 2.4% after a 4.1% growth in April.
In Egypt, non-oil private sector activity slipped back below the neutral 50.0 mark in May, after moving to expansion territory in April. The seasonally adjusted Emirates NBD PMI fell to 49.2 in May from 50.1 in April, though a vast improvement on the trends observed prior to the November 2016 reforms.
Moving on to Kenya, private sector activity growth slowed from April’s 16-month high on the back of slower increases in output, new orders and employment. The Markit Stanbic Bank Kenya PMI for manufacturing and services fell to 55.4 in May from 56.4 in April.
Elsewhere, the Kenyan treasury released an Income Tax Bill which include proposals to raise corporate and individual income tax, remove tax holidays for investors in the special economic and export-processing zone, and change from zero-rated VAT to VAT exempt on various goods. The Bill will become law upon approval by Parliament as well as the President.
The country’s high debt (debt to GDP at c.57%) and high budget deficit (8.9% of GDP) gives the treasury limited policy options to fund a growing expenditure. The Bill, if enacted, could hurt investor sentiment and compound the challenges faced by the private sector which has already been crowded out of the debt market by government borrowing.
This week’s global market outlook is powered by Alquity www.alquity.com