Money Matters 17th July 2018

ONLY WHEN THE TIDE GOES OUT
The last decade with abundant liquidity and low commodity prices would have been the ideal period for governments to roll out structural reforms in order to reduce vulnerabilities and build up buffers. However, in aggregate, not much has been done; many countries barely ‘muddled through’ the post-GFC years. In particular, indebtedness remains unresolved as the global debt-to-GDP ratio stands at 318% at the end of 2018 Q1, only 3 percentage points below its all-time peak from 2016 according to the Institute for International Finance. High global debt in the context of increasing interest rates, tightening USD liquidity, a stronger dollar and bloating risk premia means that sustainability of debt and growth will be an even greater challenge for policymakers. Of course, there are exceptions; countries that carried out reforms and raised barriers to protect themselves from external shocks. These include Egypt, Peru and India. Time will tell, which countries were prudent enough to create reserves to weather the next economic downturn. As Warren Buffett famously put it ‘Only when the tide goes out do you discover who’s been swimming naked.’
Crude oil prices crashed during the week, as WTI and Brent fell about 5% and 7%, respectively from Wednesday to Thursday. The price of oil was dragged down due to dollar strength and the on-going trade disputes between the US and China, and the extent of the move was amplified by the release of news stipulating that Libya restarted oil production at a major field that had been shut down for months. West Texas Intermediate crude for August delivery closed at USD 70.58/bbl, while Brent crude futures price for September delivery was at USD 74.92/bbl on Friday.
UNITED STATES
S&P 2,801 +1.50%, 10yr Treasury 2.84% +0.54bps, HY Credit Index 336 -12bps, Vix 12.18 -1.19Vol
The POTUS announced that 10% tariffs will be levied on another USD 200bn worth of Chinese imports effective end-August. As a result, the total amount of imposed tariffs would amount to roughly half of imported products from the China to the US. Chinese officials indicated that it was their intention to deliver counter measures. It is, however, unclear how the Chinese could equally penalize the US, since total value of imports from the US is a mere USD 120bn.
Both headline and core consumer price inflation accelerated by 0.1ppt to 2.9% and YoY 2.3% YoY in June, respectively. The acceleration of the indices was in line with market expectations.
The Federal Reserve (Fed) released the semi-annual Monetary Policy Report, which contained a rather upbeat assessment of the US economy. According to the document, the US’s domestic economy is resilient enough not to be derailed by trade tensions and the imposition of tariffs.
Even though CPI indices are not integral parts of the Federal Reserve’s reaction function, since the FOMC is tracking the personal consumption expenditure (PCE) index, CPI is usually a good proxy for measuring the domestic price pressure in the US. In other words, underlying inflation trends are convincing enough for the Fed to carry on with the rate hike cycle in 2H18. The Fed’s latest Monetary Policy Report signalled that the tightening cycle will continue this year. According to Fed funds futures, markets see greater than 50% probability for two additional 25bp rate hikes in the second half of the year that could lift the Fed funds rate to 2.00-2.25% by end-2019.
EUROPE
Eurostoxx 3,453 -0.44%, German Bund 0.35% +4.80bps, Xover Credit Index 291 -13bps, USDEUR .855+0.60%
The President of the ECB, Mario Draghi delivered a speech to the European Parliament’s Committee on Economic and Monetary Affairs. In Mr Draghi’s view, the pick-up in inflation dynamics within the Euro Area should be sustainable, even if the ECB withdraws financial accommodation. Despite the optimistic depiction of the European economy, Mr Draghi reiterated the need for ‘patience, persistence and prudence.’
The minutes from the European Central Bank’s (ECB) June monetary policy meeting revealed that members of the Governing Council (GC) voted unanimously for the phase-out of the asset purchase programme by the end of this year. The minutes also highlighted that the GC intends to strengthen the role in policy of interest rates, and ultimately, reintroduce it as the primary tool in the conduct of monetary policy.
Several prominent government officials – including Foreign Secretary Boris Johnson – resigned from Theresa May’s government, since their view differed from Mrs May’s on the “hardness” of Brexit. The Prime Minister revealed her Brexit plan, which entails a free-trade agreement between the EU and the UK for goods, but not for services. According to the white paper presented by Mrs May, the UK’s financial services industry would lose access to the EU market.
The UK’s Statistical Office, the ONS released the first monthly GDP figure in history. GDP rose 0.2% in the three-month period through May, while the economy expanded by 0.3% MoM in May.
The Russian Minister of Finance released the latest fiscal plan for the period between 2019 and 2022. GDP growth is foreseen to slow from 1.9% in 2018 to 1.4% in 2019 and accelerate to 2% in 2020 and 2.3% in 2021. The fluctuation in economic output growth will be driven by tax reforms and an overhaul of expenditure. As a consequence of the MinFin’s efforts, the fiscal position should turn into a (greater) surplus.
Turkish President Erdogan finished cementing his power and overhauling his cabinet after winning the elections in June. The finishing touches included the appointment of his son-in-law as the new minister of treasury and finance. Furthermore, President Erdogan claimed the exclusive power to name members on the Monetary Policy Council.
Fitch downgraded Turkey’s credit rating by one notch to ‘BB’ and assigned ‘negative’ outlook to the rating. The credit rating agency cited that downside risks to macroeconomic stability have intensified due to the widening current account deficit and the substantial exposure to foreign currency-denominated debt. In addition, the credibility of economic policy deteriorated to such an extent that is likely to adversely impact economic growth prospects.
Financial markets seemingly agree with Fitch’s view, as the USDTRY exchange rate temporarily hit 4.9 – a new historical low for the Turkish currency. CDS and risk premia on Turkish sovereign debt assets painted a similar picture.
The Monetary Policy Council of the Polish central bank kept the benchmark interest rate at 1.5%, as expected. Adam Glapinski, Governor of the central bank, indicated that the MPC has no apparent reason for hiking the policy rate until 2020.
Hungarian CPI inflation accelerated to 3.1% YoY in June, in line with median market expectations. Core inflation was observed at 2.4% YoY.
Although the central bank’s 3%-inflation target has finally been achieved, the MPC is very unlikely to give up its dovish stance anytime soon.
Czech Prime Minister Andrej Babis was granted parliamentary approval for a minority government. Babis is known for his Eurosceptic views, opposing the introduction of the euro and the Czech Republic’s deeper integration into the EU.
Czech inflation delivered an upside surprise in June, as the headline rate unexpectedly spiked by 0.4ppt to 2.6% YoY.
Strengthening price pressures, wage growth momentum and promising leading indicators suggest that the central bank will seriously consider raising the policy rate at least once in the second half of this year.
ASIA
HSCEI 10,665 +1.16%, Nikkei 22,597.35 +1.90%, 10yr JGB 0.04% +0bps, USDJPY 112.450 +1.78%
In its quarterly assessment, the Bank of Japan (BoJ) foresaw broad-based economic expansion, as both domestic and external developments are rather favourable. BoJ Governor Kuroda claimed that the Japanese economy should grow moderately, and the ultra-easy monetary policy will be sustained as long as inflation is below target.
Growth of Indian exports was robust for the second consecutive month, as they rose 17.6% YoY in June. In spite of soaring exports, the foreign trade balance widened to USD 16.6bn, as imports outpaced exports, increasing 21% YoY. The growth rate of imports was pushed up by strong domestic demand and also by higher oil prices.
Inflation remained contained and exhibited an only moderate increase despite the low base in June 2017. Headline CPI inflation rate rose slightly, to 5% YoY, while core inflation rose to 6.45% YoY.
Chinese CPI inflation remained quite soft in June, as the annual headline figure of 1.9% YoY, was in line with market expectations. The annual figure accelerated by 0.1ppt compared with May and remained below the CB’s 3% inflation target. Core inflation was unchanged at 1.9% YoY. Details show that food prices (-0.8% MoM) kept inflation dynamics slow (especially fruits and vegetables), while vehicle fuel (1.8% MoM) and tourism prices (1.4% MoM) pushed up inflation.
Producer price inflation spiked 0.6ppt to 4.7% YoY in June vs. May. The jump was partly due to the low base in last June, partly led by oil and gas extraction (4.5% MoM), petroleum and coking (2.3% MoM) and ferrous metal products (1.1% MoM).
Chinese foreign trade data in June was a mixed bag, as exports grew 11.3% YoY (faster than expected), while imports rose 14.1% YoY (substantially slower than expected). The Jan-Jun external trade surplus decreased to USD 135.4bn. Trade surplus with the US hit a record high of USD 28.97bn in June.
International reserves held at the People’s Bank of China (PBOC) rose slightly from May to June, as the yuan depreciated throughout the month. According to the report by the PBOC, foreign exchange reserves amounted to USD 3.1tn, moderately surpassing the median market expectation.
Even though Chinese authorities have not yet revealed how they intend to retaliate against the imposition of USD 200bn tariffs by the US, speculation has surfaced that China might opt for ‘qualitative’ measures instead of ‘quantitative’ ones. Such measures may include delaying M&A approvals and licenses for US firms and ramping up inspections of US products.
The sovereign wealth fund (SWF) of China is seeking permission to invest in domestic stocks and bonds, according to rumours reported by Bloomberg. The assets under management by the SWF amount to about USD 941bn.
The central bank of South Korea kept the policy rate at 1.5%, as expected. The decision was not unanimous, since one member favoured a rate hike over policy continuity. The GDP forecast for 2018 was revised downward by 0.1ppt to 2.9%. The Governor added that “trade war impact on the Korean economy may not be minimal.”
Malaysian industrial production in May matched market expectations, growing by 3% YoY (0.2% MoM SA). The annual industrial growth figure decelerated compared with the previous month, when it was 5.3% YoY (1.5% MoM). Manufacturing boosted industrial performance, as it expanded 4.1% YoY (0.8% MoM SA) thanks to the brisk increase in core manufacturing components, such as non-metallic mineral, basic metal and fabricated metal products (5% YoY), transport equipment (5% YoY), electrical and electronics (4.8% YoY). In contrast with manufacturing, mining (0% MoM) and electricity output (-0.5% MoM) growth exhibited underwhelming dynamics.
The Malaysian central bank kept the policy rate on hold at 3.25%, as the market broadly expected. The CB governor emphasized that in the MPC’s view the balance of risks to the global growth shifted to the downside, while domestic demand should remain strong going forward.
The Philippines is planning to enter the Sukuk (i.e. Islamic) bonds market. According to Treasurer de Leon, the Philippines have a strong intention to tap this market to finance their 2019 budget deficit.
Taiwanese export dynamics were slower-than-expected, 9.4% YoY in June. Import growth remained fast, rose 15.4% YoY. The total external trade balance was USD 4.9bn in June, USD 25.5bn YTD (11.5% higher YoY).
LATIN AMERICA
MSCI Lat Am 2,577 +2.15%
Mexican CPI inflation in June exceeded consensus estimate by accelerating to 4.65% YoY. The faster pace was mostly driven by energy prices and currency weakness. Core inflation continued to decelerate and hit 3.6% YoY.
President-elect AMLO announced a GDP growth target of 4% for 2019.
Chilean GDP expanded 4.9% YoY in May. The non-mining component of the indicator signalled the underlying strength of the Chilean economy as it rose 4.7% YoY. The external trade surplus was USD 483mn in June.
The central bank kept the policy rate at 2.75%, in line with market expectations. The MPC noted the strengthening economic activity, but still sees the output gap as negative. As a consequence, policymakers see the current accommodative stance of monetary policy as appropriate.
The momentum of Peruvian manufacturing production was sustained in May, as it rose 10.5% YoY.
The first set of high-frequency indicators were released since the trucker’s strike in Brazil. The fact that the strike ended had a positive impact on economic performance; auto production rebounded and rose 21.1% YoY in June, a performance last matched in April 2018, before the strike started. Growth of retail sales was seen at 2.7% YoY in May vs. the quasi-stagnation in April.
Even though the central bank of Argentina kept the policy rate flat at 40%, the MPC announced various changes to the monetary policy framework. Policymakers emphasised that they will closely monitor monetary aggregates in the conduct of monetary policy in order to break the inflationary feedback loop and bring inflation down from double-digits. Furthermore, the MPC intends to improve the structure of its balance sheet by reducing the sterilisation (Lebac) stock without expanding the money supply. The MPC also expressed that it aims to reduce the frequency of monetary policy meetings to biweekly. Finally, the central bank will publish more detailed and transparent documents, e.g. the votes of the individual MPC members.
High-frequency indicators suggested the economic momentum is rather strong in Colombia, as retail sales rose 5.9% YoY, while manufacturing production increased 2.9% YoY in May. Meanwhile, inflation remained within the central bank’s target range in May, as the annual rate of headline inflation was 3.2%.
AFRICA
MSCI Africa 872 +0.23%
Egyptian headline CPI inflation rose to 14.4% YoY in June (vs. 11.4% YoY in May) after it peaked at 33% YoY in July 2017. Cuts to energy subsidies lifted fuel, electricity and cooking gas costs for households. Core inflation, a measure that filters out services and products with volatile prices including energy, decelerated to 10.9% YoY.
Although inflation remains in the central bank’s tolerance range of 10-16%, the monetary authority is unlikely to start slashing the policy rate again unless the impact of the subsidy cut fades.
South African manufacturing rose 2.3% YoY in May vs. 1% YoY in April, as the output of motor vehicles and durable consumer goods increased.
The acceleration of South African manufacturing growth is definitely good news, as the data from April and May indicate that the QoQ recession in 2018 Q1 was temporary and the economy is resilient enough to avoid a fully-blown economic slump in Q2.
The head of the Moroccan planning agency cited that the budget deficit is forecast to reach 3.9% of GDP this year and may decrease to 3.6% of GDP in 2019. The planning commission foresees inflation at 1.7% in 2018 and at 1.3% in 2019. The agency added that due to the weakness in agricultural production Moroccan GDP may expand only by 3.1% this year and by 2.9% in 2019.
Nigeria’s central bank pumped USD 210mn worth of liquidity into the domestic interbank market. The central bank’s aim was to ease the USD-shortage induced strains on the Nigerian economy.
The president of Nigeria, Muhammadu Buhari, stated that the country intends to sign up to a USD 3tn African free-trade agreement. Thus far, Nigeria refused to join the FTA, but things might just change soon. South Africa entered the African FTA in early July.
Should Nigeria join the African FTA, tariffs may be reduced over time that could spur trade across African countries, improve economic growth prospects and help alleviate poverty on the continent.
This week’s global market outlook is powered by Alquity www.alquity.com