BODY SWAP
In 2015 and early 2016, the UK was a bright spot for developed world growth. Meanwhile, much of Europe (led by France and Italy) languished in a post-crisis quagmire, hampered by indecision and bureaucracy. This year, the dynamics appear to have reversed:
In the UK, Theresa May’s decision to call a snap general election backfired spectacularly. After a limited and inconsistent campaign, the Conservatives lost their small majority in parliament. In the aftermath, the Prime Minister has not done much better; an agreement with the DUP in Northern Ireland is still outstanding and there is a sense of an overall lack of leadership. Similarly, there is discord at the Bank of England – with a division between the dovish Governor, focused on the weak growth picture, and a more hawkish minority (including the Chief Economist), concerned about recent inflation and low levels of unemployment. After a period “defying gravity”, with resilient consumer spending and exports benefitting from better global growth and a weaker GBP, the UK economy is weakening. On current evidence, we worry about the ability of government to manage Brexit negotiations and think policy uncertainty will create a further drag.
Meanwhile, Europe is enjoying its day in the sun. In France, socialist Francois Hollande (whose politics led to the nickname “Flanby”, a jelly-like caramel custard) was decisively beaten by Emmanuel Macron in the Presidential election, with the latter’s centrist “En Marche” party (formed only 14 months ago) capturing a convincing majority in parliamentary voting. This has resulted in a surge in business sentiment (May composite PMI and INSEE Business climate indicator both at 6-year highs). In addition, the Italian banking system is finally addressing the insolvency and undercapitalisation of many of its participants. Earlier this year Unicredit raised EUR 13bn in capital, this week 2 mid-sized banks from the Veneto region were put into wind down and shortly (there is some doubt about the feasibility of the announced plan) the world’s oldest bank, Monte Paschi, should receive state aid to address its monster book of non-performing loans. Last, the usually dysfunctional ECB mostly appear to be sticking to a single script, keeping policy easy based on low inflation.
In commodity markets, oil prices entered a bear market (a decline of over 20%). WTI prices have no fallen over 25% YTD from their high on the 1st January at USD 58.30 and dipped below USD 43 for the first time in 18 months.
UNITED STATES
S&P 2,438 +0.21%, 10yr Treasury 2.14% -0.91bps, HY Credit Index 336 +4bps, Vix 10.15 -0.36Vol
Despite considerable volatility in energy and technology stocks, the S&P 500 has spent the last 3 weeks tightly oscillating around the 2,440 level. On Monday, the index briefly touched a new all-time high, before retreating to end the week broadly unchanged.
In terms of economic data releases, it was a quiet week. Existing and new home sales for May surprised positively (post weaker April numbers), whilst the manufacturing PMI came in slightly below expectations. Meanwhile, all 34 big US banks passed the first round of the FED’s annual stress tests (which imposes scenarios including a jump in unemployment to 10% and commercial real estate losses of 35%). Indeed, Jerome Powell (the Governor responsible for overseeing the test) commented, “As we consider the progress that has been achieved in improving the resiliency and resolvability of our banking industry, it is important for us to look for ways to reduce unnecessary burden.” This will support government initiatives to reduce regulatory oversight for the industry. Next week, a second-round announcement will approve or reject bank dividend and share buyback programmes.
The week may shed some light on the timing of the FED’s balance sheet reduction programme and their next interest rate hike (markets’ have only one additional 25bps rate hike priced by the end of 2018). Janet Yellen speaks on global economic issues in London on Tuesday, whilst there are also speeches planned by Governors Kashkari, Bullard, Dudley, Harker and Williams. Last week, Dudley gave a hawkish commentary (based on the tight labour market), whilst Evans admitted being “a little nervous” because of low incoming inflation numbers. As a reminder, the current US expansion is already the third longest in history.
EUROPE
Eurostoxx 3,568 +0.07%, German Bund 0.25% -2.10bps, Xover Credit Index 231 -5bps, EURUSD 1.121 +0.03%
The June PMIs for the Eurozone contained a modest increase in the Manufacturing measure (+0.3 to 57.3) and a large decline in Services (-1.6 to 54.7), resulting in an overall decline in the Composite number by 1.1 points to 55.7. To put this into context, the Composite PMI rose around 4 points between September and March and had been broadly flat for the last 3 months. June is therefore the first important decline for 9 months. Nonetheless, the week of the 21st June saw the 13th straight week of inflows into European equities. According to a Bank of America Merrill Lynch note, there has been USD 20.4bn of investment into European stock funds year-to-date versus USD 15.9bn into the US.
On Friday, the ECB confirmed that 2 mid-sized Italian banks, Veneto Banca and BancaPopolare di Vicenza, were “failing or likely to fail”. As a consequence, both will be put into wind down. However, in a move that has effectively broken the deadlock, this will occur under Italian law rather than new European BRRD banking rules. This means, taxpayers will pay up to EUR 17bn (and a minimum of EUR 5bn) to protect senior creditors. This comes after the EUR 3.5bn already injected into these banks and before the Monte Paschirecapitalisation is finalised. BancaIntesa will take on the “good assets” and some employees of the Veneto Banks. BancaCarige (a Genovese bank) is rumoured to be next in the firing line.
In the UK, Bank of England Governor Mark Carney commented on Tuesday that “now is not yet the time” to tighten monetary policy given low wage growth and weakening consumer spending and business investment. However, the following day, the bank’s chief economist Andy Haldane contradicted his boss, suggesting it would be prudent to raise rates in H2 to counter recent headline.
The Norges bank in Norway left rates on hold, but removed its easing bias; Governor Øystein Olsen stating “the balance of risks suggests that the key policy rate will remain at today’s level in the period ahead.” Norway briefly entered a technical recession earlier this year, with lower oil prices weighing on the economy.
In Hungary, base rates were also left on hold at their all-time low (for a 13th consecutive month), but there was some incremental easing in the form of a reduction in the cap on 3-month deposits. This unconventional measure aims to push liquidity into the broader economy.
ASIA
HSCEI 1,053 +0.45%, Nikkei 2,015.00 +0.52%, 10yr JGB 0.06% +0bps, USDJPY 111.470 +0.36%
After four years of consultation, MSCI has announced plans to add Chinese A shares to its benchmark indices. The implementation will occur in two stages, in May and August 2018.
222 Chinese A share companies, with a combined market cap of $696bn, will be added to MSCI Indices. All of these companies are accessible to foreign investors via either the Hong Kong Stock Connect or QFII programmes. An inclusion factor of 5% was applied, meaning that A shares join the index at 5% of the level justified by their market cap, with a 0.73% weighting in the MSCI Emerging Index.
The liquidity impact is likely to be immaterial for the A share index, with the market frequently trading over USD 50bn per day, and the expected flows based on the MSCI EM weighting being less than USD 20bn.
Whilst the decision itself was not a huge surprise (many saw this as a case of ‘if rather than when’) the number of stocks included was larger than expected.
Before the weighting or number of stocks can be increased further, MSCI has laid out a number of factors where improvement is needed (the same factors that caused many investors to resist the idea of A shares joining the index initially) namely; evidence of stability of the Stock Connect programme, increase or removal of daily trading quotas, a reduction in the prevalence of trading suspensions and a relaxation of the rules around index products.
As part of ongoing attempts to maintain a ‘Goldilocks’ liquidity level, consistent with accommodating growth while curtailing the accumulation of excessive systemic risk, The People’s Bank of China has injected a much larger amount of liquidity in to the system via reverse repos during the month to date than it did in April or May.
So far in June the PBOC has injected RMB 430bn, versus just 20bn in May and 210bn in April. This is in response to rising bond yields and sub-optimal liquidity in the onshore fixed income market. In response, 10 year yields on Chinese government debt dropped below 3.5% for the first time in 2 months.
The Reserve Bank of India released the minutes of its June 7th policy meeting. The MPC voted to leave rates unchanged with a majority of 5-1, the first dissenting vote since the monetary policy committee structure was created last year. The dissenter, Dr. Dholakia called for “at least” a 50bps rate cut and commented that he expects inflation to come in at least 40bps lower than the RBI’s estimate during the first half of FY18 (6 months to September 2017). All other MPC members stuck to the “wait and watch” script. With sub 3% inflation, we expect the RBI to cut rates in one of the next two meetings, with August the most likely.
BangkoSentralPilipinas kept interest rates on hold at 3.0%, in line with expectations. The BSP left its inflation forecast for the year unchanged at 3.4% YOY (having reduced this from 3.5% at the last meeting), within the target range of 3.0% +/- 1% and commented that “inflation expectations also continue to be firmly anchored to the target over the policy horizon”, however, that in the short term inflation risks remain “tilted towards the upside”.
The RBNZ in New Zealand left rates on hold, with the Governor commenting “Monetary policy will remain accommodative for a considerable period.”.
LATIN AMERICA
MSCI Lat Am 2,493 -1.61%
Argentina issued a 100-year bond at a 7.9% yield. The USD 2.75Bn issue was oversubscribed as investors rushed to lend to a country that has defaulted 6 times in the last 100 years…
MSCI decided to maintain Argentina as a Frontier Market against investors’ expectations. The Merval index fell 5.9% in USD on Thursday, giving back part of its 28% gains since the beginning of the year as part of this rally was driven by speculation of MSCI EM inclusion.
Argentina is officially out of recession after its GDP increased in 1Q17 after 3 consecutive quarters of declines. GDP grew by 0.3% YOY, up from a 1.9% decline in 4Q16. Private consumption (+0.9% YOY) and investment (+3% YOY) were the main drivers.
Peru’s finance minister resigned after losing the vote of confidence in Congress. He appeared, in a leaked audio recording, to ask the comptroller to approve an airport contract in exchange for a bigger budget.
Since his election, PPK and his team struggle to cut red tape, pass structural reforms and execute big infrastructure projects.
Mexico hiked interest rates by 25bps to 7%, but the central bank signalled that the monetary tightening cycle is likely over. The 325bps tightening cycle should be enough to keep inflation under control.
The significant short-term rate increase was not followed by the long-end of the curve where the 10y treasuries are still yielding 6.8%. This flattening of the yield curve is negative for the banking sector and is usually a good leading indicator of an economic slowdown.
In Brazil, the Senate Committee on Social Affairs surprisingly voted 10 to 9 against the government’s labour reform. Since the committee only makes a recommendation, the bill remains alive and will be submitted to the Senate floor anyway.
Political scandals may have weakened the government’s ability to reach majority in Congress and the Senate.
AFRICA
MSCI Africa 841 +1.06%
South Africa failed to narrow its current account deficit, which came in at 2.1% of GDP in 1Q17 from 1.7% in 4Q16. Although the current account widened, it was still a significant improvement from the 5.0% deficit recorded in 1Q16 and was still narrower than the 3.3% deficit recorded for the year 2016. Data illustrates the South African economy is rebalancing but is still weak and a deterioration in external factors could reduce the chances for recovery but may also derail the ZAR’s recent resilience.
SA inflation ticked up to 5.4% YOY in May from 5.3% in April, on the back of higher meat prices despite a hefty fall year to date in maize prices.
Remittances from expatriate Egyptians rose 11.1% YOY between the currency float in November and end of April. Remittances from November to end of April reached USD9.3bn.
Egypt’s GDP growth accelerated to 4.3% in 1Q17.
2017 will be a transition year, where the whole economy has to absorb the shock of the devaluation and the reforms.
Nigeria’s inflation came in at 16.25% YOY in May.
Source: Alquity Global Market Update www.alquity.com
