THE US’ ECONOMIC OUTLOOK IS NOT AS BAD AS MARKETS DEEM
Although the holiday season usually implies boredom, this was definitely not the case last week, when asset prices exhibited excessive moves – especially in the developed market universe. Market players in the US have been focusing so much on the negative side of data releases and political noise that not only was stock market performance impaired, but rate hike expectations turned upside-down and transformed into rate cut expectations for the middle of 2020. As opposed to the implied stagnation of earnings for 2019 by some of the major indices (such as the S&P 500), it appears that the currently available soft and hard economic indicators do not imply a recession in the US throughout 2019 – only a slowdown. A slowdown should not come as a surprise to anyone, as it has been long known that the tailwinds by President Trump’s tax cuts would abate, while the monetary stimulus by the Fed would be continuously withdrawn. Furthermore, even the combined effect of trade talks between the US and China and the government shutdown in the US is unlikely to be enough to trigger a recession in the world’s largest economy.
Although the monthly US jobs report is behind us, the calendar is stuffed with relevant data releases. Namely: the market will likely closely gauge the ISM non-manufacturing index from December and will also eagerly scrutinise the minutes from the Fed’s last monetary policy meeting. Furthermore, Fed Chair Powell gives a speech on Thursday, while the December CPI inflation measure will be revealed on Friday. The economic diary is lighter in Europe, where the Eurozone retail sales figure and the UK monthly industrial production and GDP statistics are scheduled.
Within the emerging universe, Asian markets will mainly focus on Chinese CPI and PPI inflation from December. In addition, a delegation from the US visits Chinese policymakers to continue trade talks. Meanwhile, within the Latin America space, CPI inflation data will be published in Chile, Mexico, Argentina and Brazil, while the Peruvian central bank decides on the policy rate. African markets will monitor the latest PMI and manufacturing data from South Africa and inflation from Egypt.
S&P 2,532 +1.86%, 10yr Treasury 2.65% -5.05bps, HY Credit Index 429 -18bps, Vix 21.38 -6.96Vol
Stock markets in the US gained by the end of the week, however, the ride was rather choppy, as market players grew increasingly anxious. The major indices, such as the S&P 500, the Nasdaq Composite and the Russell 2000 rose by 1.9%, 2.3% and 3.2%, respectively. However, the overall economic assessment implied by the US fixed income space may be pessimistic. According to the Fed funds futures, the market on aggregate does not foresee any rate hike in the foreseeable future; on the contrary, futures price a rate cut by the Fed around the middle of 2020. By the end of the trading week, the 2-year US Treasury yield eased 2bp to 2.49%, while the 10-year tenor slipped 5bp to 2.67%, bringing to 2s10s spread to 17bp. Currently, the 10-year yield is roughly back at the levels seen a year ago, while the Fed funds rate is 100bp higher, at 2.25-2.50%.
Markets reacted adversely to a worse-than-expected ISM manufacturing gauge during the week, as the index dropped to 54.1 in December vs. 59.3 in November. Despite the large drop, the ISM manufacturing index continues to indicate strong growth. The detailed breakdown reveals that the employment component remained at a very strong level of 56.2. In contrast, the component for new orders plummeted by 11pt to 51.1, staying in the range of expansion. Meanwhile, the jobs report from December reflected the consistent tightness of the US labour market, as the closely-watched non-farm payrolls figure jumped to 312,000 – exceeding both expectations and long-term historical average. In addition, annual earnings growth accelerated to 3.2% YoY.
Eurostoxx 3,045 +1.54%, German Bund 0.21% -3.40bps, Xover Credit Index 351 -6bps, USDEUR .875 +0.31%
The general market sentiment was good enough in Europe to lift the majority of the stock indices compared the closing prices a week ago. France delivered the weakest performance out of the Eurozone’s four largest economies, as it gained 0.9% vs. Germany’s 1.6%, Italy’s 2.5% or Spain’s 2.6% (all in USD). Despite the concerns related to Brexit, the UK’s stock market gained 1.8% in USD. Although the stock indices in the Eurozone were indicative of a good mood, asset price movements in the fixed income space continue to imply that investors remain concerned about the Euro Area’s economic prospects: the German yield curve flattened, as the 10-year yield eased 3bp to 0.21%. Meanwhile, risk premia bloated, as the Italian 10-year yield rose 16bp to 2.9%, bringing the spread over the 10-year German Bund to 269bp.
Headline consumer price inflation in the Euro Area slowed 0.4ppt to 1.6% YoY undershooting the median market estimate, while core inflation remained 1% YoY in December. The deceleration of the headline indicator was mostly due to the sharp decline in energy prices. Meanwhile, the core gauge remained subdued and continued to indicate the absence of domestic inflationary pressures.
As inflation remains well-below the European Central Bank’s (ECB) 2% target and risks are tilted to the downside in terms of economic activity, it appears unlikely that the ECB has room to raise the policy rate this year. Currently, the implied probability of an ECB rate hike by financial markets is less than 50%.
HSCEI 10,124 +0.32%, Nikkei 20,038.97 -0.50%, 10yr JGB – 0.01% 0bps, USDJPY 108.200 -1.78%
Despite jitters throughout the trading week, Asian markets managed to recover to some extent, as many of them finished the week on a positive note. The Philippine (+4.3% in USD), Indonesian (+3.5% in USD) and Bangladeshi (+3.2% in USD) markets exhibited the largest gains. In contrast, Taiwan was the weakest link in the chain by losing 4.3% of its value during the week.
The People’s Bank of China (PBOC), i.e. China’s central bank, slashed the reserve requirement ratio by 100bp. In addition, the PBOC announced various measures to boost lending to small- and medium-sized enterprises in a targeted manner. The central bank’s easing measures were in response to the weak PMI figure of 49.4 in December. The below-50 value indicates that Chinese manufacturing output may contract in the coming months. Details revealed that both domestic and external demand weakened as well as the component for employment. In contrast, non-manufacturing PMI strengthened to 53.8, suggesting that policy efforts to boost infrastructure spending have been feeding into the real economy.
China’s current account surplus further increased in 3Q18, to USD 23.3bn from USD 5.3bn in 2Q18. The year-to-date balance, however, remains in deficit, at USD 5.5bn, due to the wide gap seen in 1Q18. Details of the balance of payments statistics suggest that the capital outflow from China was USD 26.2bn in net terms in 3Q18.
Headline CPI inflation in the Philippines slowed to 5.1% YoY in December vs. 6% in November, due to lower transport (i.e. oil) and food prices. Core inflation eased to 4.7% YoY after a rise to 5.1% YoY in November. Overall, headline inflation rose to 5.2% in 2018 vs. 2.9% in 2017, while core inflation increased to 4.2% from 2.4%. Both are higher than the upper band of the central bank’s 2-4% policy target.
CPI inflation in Thailand hit 0.4% YoY, while core inflation rose to 0.7% YoY in December. Energy prices slowed the headline measure. The consistently subdued core inflation gauge implies that domestic demand remains stable. Annual inflation was 1.1% in 2018, just above the lower bound of 1-4% target.
MSCI Lat Am 2,738 +6.57%
Investor sentiment was positive in Latin American markets, as the broad majority of stock indices headed north during the week. The Brazil index outperformed its peers by rising 8.6% in USD followed by the Argentina market, gaining 7.5% in USD. Peru delivered a weak performance compared to its Latin American peers, as the country’s index increased only 1.6% in USD.
Brazil’s new President, Jair Bolsonaro took office on the 1st January. The President started his inauguration speech with an appeal to Congress for help to fight corruption, crime, and economic irresponsibility. Mr Bolsonaro cited that economic policy will be based on the ideas of free enterprise and the respect for contracts. Furthermore, he vowed to renew Brazil’s democracy and to clamp down on corruption. Later, the President stated in a TV interview that the pension reform proposal could initially set a minimum retirement age of 62 for men and 57 for women by 2022, lower than the 65 and 62, respectively, proposed by former President Temer. Mr Bolsonaro’s comments did not give enough details on how much the eventual savings will be. The actual plan may be presented in early February.
The tone of the central bank of Mexico’s December minutes remained quite hawkish, as MPC members saw upside risks to inflation that mainly stem from exchange rate volatility. The Council also pointed out that the government will need to deliver policies to kick-start investment growth. In addition, members highlighted that although the government’s budget plan is welcome, implementation of it remains key.
Industrial production in Chile was weak in November, as industrial output growth slowed to 0.4% YoY vs. 2% YoY in October. Mining activity bounced, due to the normalisation of the base period, while manufacturing contracted by 4.7% YoY. Adjusting for the unfavourable calendar effect (one fewer working day), industrial production grew 0.8% YoY, while manufacturing decreased 2.6% YoY.
MSCI Africa 770 +2.35%
African markets delivered a mixed performance during the week. While the South African (+2.2% in USD) and Egyptian stock markets (+1.7% in USD) gained, the Ghanaian, Moroccan, Kenyan and Nigerian indices decreased, in the range between 0.5 and 1.3% in USD.
The central bank of Egypt kept the overnight deposit and lending rates at 16.75% and 17.75%, respectively. The MPC cited that global monetary policy tightening, trade wars and volatility in the oil market call for the sustenance of the current monetary policy stance in spite of the dropping inflation rate to 15.7% YoY observed in November. Furthermore, in order to safeguard macroeconomic stability, the central bank may adjust its inflation target to 9% (+/-3%) on average for 4Q20, down from 13% (+/-3%) in 4Q18. Headline inflation dropped to 15.7% in November from 17.7% the previous month, falling back into the government’s targeted range of 13% (±3%).
Egypt may receive the fifth tranche of the IMF facility in January, as the country is preparing to draw the next USD 2bn tranche. The tranche will be tapped later than it was originally scheduled, i.e. by the end of December. According to speculation, the delay was due to the fact that the Egyptian government pushed back on the timeline for a requirement that it further liberalize fuel prices which is a key condition of the IMF reform programme.
Kenya’s GDP grew 6% YoY in real terms in 3Q18. In comparison, real GDP growth was 4.7% YoY in the corresponding period of the previous year. Economic activity became more robust in 3Q18 due to the strong performance of the agricultural sector and higher construction output.
According to the Moroccan Planning Agency, real economic growth in Morocco dipped to 2.7% YoY in 4Q18 vs. 3% YoY in 3Q18. The slowdown was mainly due to the weakening growth of non-agricultural output, to 2.6% YoY. Despite maintaining a growth rate above 3% YoY, agricultural expansion slowed as well in 4Q18, to 3.4% YoY.
This week’s global market outlook is powered by Alquity www.alquity.com