IT’S COMPLICATED
Market moves this week suggest this dynamic continued – the S&P 500 hit 39 consecutive days without a move of more than 1% (a new record), whilst equities outside Europe climbed the “wall of worry”, moving higher.
Actually, there were potentially a few cracks in the status quo:
Congenial Trump: after weeks of bashing Japan for currency manipulation, Trump went out of his way to extend a warm welcome to Prime Minister Abe, “The bonds between our two nations and the friendship between our two peoples is very, very deep. This administration is committed to bringing these ties even closer,” then later “When I greeted him today at the car… I shook hands but I grabbed him and hugged him because that’s the way we feel.”
- Mixed Data: although in aggregate still pointing towards continuing economic momentum (China trade data strong), US sentiment and European industrial production disappointed.
- Peripheral Roller Coaster: the Greek 2-year yield touched 10.23% (from below 6% a week prior) before consolidating around 8.5%.
- Central Banks “Internalising”: the RBI India did not cut rates as expected. Not significant in isolation, but following a broader trend of backing away from the monetary Kool-Aid (see also UK, Korea, Malaysia, Indonesia).
UNITED STATES
S&P 2,316 +0.81%, 10yr Treasury 2.42% -5.75bps, HY Credit Index 323 0bps, Vix 11.36 -0.12Vol
Most US indices touched all-time highs, alongside a stronger USD and lower bond yields. Volatility remains extremely low (30 day realised at 6.58%, which equates to an average move of only 0.31% per day). This has pushed the VIX back towards the lowest levels since July 2014 (Friday’s close at the 99.4th percentile over the last 5 years).
From a data perspective, the Michigan consumer sentiment survey declined from recent highs. It would be a little hasty to extrapolate too much from a single print, but it was interesting to note the “expectations component” fell back, erasing the election surge. Elsewhere, President Trump made most of the headlines:
- Obamacare Repeal taking longer than expected; After promising the Affordable Care Act (ACA) would be replaced within a week, Trump now suggested “I would like to say by the end of the year, at least the rudiments, but we should have something within the year and the following year.” The major significance, is that, given Congress wants ACA addressed before turning to tax reform, it could be a while (even into 2018) before Trump delivers anything concrete on tax.
- But Tax reform will be worth waiting for… During a meeting with aviation executives on Thursday, the President promised to outline “something phenomenal in terms of tax” in the next few weeks
- The Immigration story isn’t over; Although the 3-judge panel at the 9th U.S. Circuit Court of Appeals unanimously voted against reinforcing Trump’s travel ban, Don was not for moving: “We will win that battle…we also have a lot of other options, including just filing a brand new order…perhaps Monday or Tuesday”. This may include exempting legal permanent residents from the travel restrictions or a Supreme Court appeal.
EUROPE
Eurostoxx 3,283 -1.46%, German Bund 0.33% -9.20bps, Xover Credit Index 299 -8bps, EURUSD 1.066 +1.36%
We’ve talked at length about the strong rebound in business surveys over the past few months (Eurozone manufacturing PMI for January at a 6-year high). However, hard data for December, in the form of Industrial production (IP) for Germany and France, disappointed last week. IP data is extremely volatile and therefore, given the breadth of positive indicators elsewhere, we stick to our expectation of a recovery for European manufacturing, at least over H1 2017.
After a period out of the spotlight, Greece returned to the front page. The second review of the “bailout” programme was supposed to have been completed last year but yields spiked mid-week as (similar to last time) the IMF is threatening not to participate without greater fiscal consolidation or additional debt relief. However, “substantial progress” was made on Friday, which helped support prices. Greece has no material repayments until July and thus, notwithstanding the noise, there is no imminent flashpoint.
In France, the National Front created headlines when their head of strategy stated 20 per cent of France’s total public debt “falls under international law [and would stay denominated in euros] … but for the rest we will have the right to change the currency”.
In Germany, the nomination of Martin Schultz as leader of the SPD two weeks ago (ahead of the German elections) has seen a dramatic turnaround in the polls. His party now lag Angela Merkel’s CDU/CSU coalition by only a few points. As former Head of the European Parliament, Schultz is considered to offer the potential of greater German support for its union partners (Eurobonds, joint deposit insurance).
ASIA
HSCEI 1,025 +4.55%, Nikkei 1,945.00 +1.69%, 10yr JGB 0.09% 0bps, USDJPY 113.560 +0.54%
The Reserve Bank of India surprised the market this week by leaving interest rates on hold at 6.25%, in addition to changing the official policy stance from ‘accommodative’ to ‘neutral’. This was the third consecutive central bank meeting where a rate cut was expected but not delivered.
On a backward-looking view of India’s inflation, the conclusions are straightforward. Inflation has trended down over the last 8 months from 6.1% to 3.4% in January 2017, while interest rates have come down 175bps since January 2015. It would be easy to extrapolate this to a continued disinflationary medium term outlook and associated lower rates. However, there are several uncertainty factors that we believe complicate the analysis of India’s current inflation path:
- The impact of a less favourable base effect of commodity prices
- The lagged effects of demonetisation yet to fully work through the economy
- The subsequent impacts of remonetisation, which we believe are being irrationally ignored by the market (what happens when bank notes become freely available again and ATM withdrawal limits are removed for the first time in three months, will demand or supply reflate faster)
- The imposition of the Goods and Services Tax in July, a transformational reform with one of its overriding objectives being to bring more Indian business and households in to the tax system than ever before, will surely have an impact (if transitory) on the general price level in the economy, as these costs are passed on to consumer prices
- The likely interest rate trajectory of the Federal reserve.
- A firmer global inflation environment
Whilst the long term path of inflation in India has clearly been downward, since the central bank began a credible inflation targeting policy under former governor Raghuram Rajan in 2013, the short to medium term outlook (3 to 6 months in our view) is thus much more clouded.
Indian equities witnessed no material reaction to the lack of a rate cut. However, ten-year bond yields rose 32bps (the biggest move for three years), whilst the rupee also strengthened against the dollar by 33bps, as the market priced in expectations for less accommodative policy.
Given that consumer price inflation has already fallen below the central bank’s medium term target of 4%, we see no reason why the central bank could not return to an easing policy stance once the above uncertainties dissipate.
An issue that had the potential to disrupt the most important bilateral relationship in global trade was diffused this week, when President Donald Trump agreed to abide by the ‘One China’ policy.
During the first interaction between Donald Trump and President Xi Jinping, Trump indicated that the US would, as it has done since 1979, continue to recognise Beijing as the Chinese government, rather than Taipei, in a conversation described as “cordial” by the Whitehouse.
We believe it would be unwise to consider this a signal that Donald Trump intends to be unequivocally friendly towards China in economic as well as diplomatic relations.
The President still has the option of trying to label China a currency manipulator, in the hope that this would make it easier to impose trade sanctions on the world’s second largest economy, in order to reduce America’s current account deficit and bring back manufacturing jobs lost to China over the last two decades.
The well documented critique of this argument is that China has in fact been intervening intensively over the last two years to strengthen, rather than weaken, its currency (this week we learned that reserves fell below $3trn in January to touch a five year low). The time to label China a currency manipulator would have been during the 2000’s, when the government was building foreign reserves and devaluing the Renminbi, on its way to amassing a peak of $4trn of reserves in 2014.
The seasonal effects of an early Chinese New Year played a role in China posting strong trade numbers for January. Exports rose 7.9% YoY (vs -6.2% YoY in December) while imports increased 16.7% YoY (vs 3.1% YoY in December). Even allowing for the short term noise in the data, January’s trade data still paint an improving picture, with imports driven higher by domestic consumption and demand for commodities, while exports rose on the back of higher demand from developed economies.
The Philippines left interest rates unchanged at 3.0% in line with expectations, the eighteenth consecutive month of keeping rates on hold. The central bank did however raise its inflation forecast for the third consecutive meeting, to 3.5% for 2017 from 3.3%, citing higher food and oil prices. Policymakers remain optimistic on the domestic economy, given “buoyant household consumption and price investment”. The market continues to expect the central bank to tighten during 2017.
Moody’s revised its sovereign rating outlook for Indonesia from ‘stable’ to ‘positive’, while maintaining its Baa3 rating, in response to fiscal discipline and the outlook for a lower current account deficit.
Bangladesh strengthened its institutional framework this week with the appointment of an independent election commission.
The election commission is constitutionally empowered to oversee free and fair elections. Previously in Bangladesh, a non-partisan caretaker government would be formed to oversee elections. However in 2014 the opposition BNP boycotted the general election, alleging that they were not being conducted freely and fairly, leaving the Awami League to take a walkover victory. In the following year the BNP held violent strikes and blockades in attempt to disrupt the country and unsettle the government. The BNP have since become disorganised and lost support, with Bangladesh looking as though it were heading towards becoming a one-party state.
The formation of an independent election commission is expected to reverse this process, however, and bring opposition parties back in to mainstream politics and reduce the frustration and isolation-induced obstructionism we saw boil over back in 2015.
LATIN AMERICA
MSCI Lat Am 2,600 +1.34%
The Mexican central bank hiked 50bps, taking the reference rate up to 6.25%. This moves was largely anticipated as it is the only way to anchor the currency and fight inflation, which reached a 5-year high in January at 4.72% YOY.
Colombian annual inflation fell from 5.75% to 5.47% in January, making it six months of reduction from a 16-year high in Jul-16 (8.96%).
Peruvian annual inflation declined to 3.1% YOY (Dec-16: 3.2%) its fourth consecutive contraction, but remains above the target range of the Central bank (2.0% +/- 1pp) for the fifth straight month.
Annual inflation in Chile came in at 2.8% last month, slightly up from 2.7% in December, but still below the central bank’s 3.0% target. This slight surprise to the upside on a month-over month basis and good economic data will likely delay the next rate cut.
Brazil January IPCA came in at 6.3%. Inflation plunged to a 4-year low which fuels bets the central bank will keep its aggressive pace of monetary easing for longer. Almost all economists are forecasting interest rates below 10% at the end of 2017.
Mexico is the only large country in Latin America that is in an aggressive hiking cycle and where inflation expectations are increasing. Falling inflation and interest rates supported by structural political and economic reforms across South America provide a very positive macroeconomic backdrop for Latin American equities.
AFRICA
MSCI Africa 803 +1.24%
Egypt’s net foreign reserves rose to USD 26.4Bn at the end of January from USD 24.3Bn at the end of December. The EGP appreciated circa 6% last week. All the good news coming from Egypt since November IMF loan, VAT reform, decreasing energy subsidies, SOE listing…) is boosting the confidence of international investors. This package of comprehensive reforms is attracting hard currency into Egypt:
- Remittances up 11.8% QOQ in 4Q16 to USD4.6bn (c72% of which were sent after the EGP float). Recovery in remittances comes after consistent declines in the past six quarters, with a sharp 22% YoY weakening in 3Q16.
- The 4Bn Egyptian Eurobond issued two weeks ago was 3x oversubscribed.
- Foreign investment in Egyptian treasuries doubled to USD 500Mn in January from December, helping reduce yields by c1% last week, according to Deputy Finance Minister, Ahmed Kouchouk.
- The Egyptian index is up 10.8% YTD, mainly driven by foreigners.
The Egyptian equity market and exchange rate have been so beaten up in 2016 that it is attractive and a strong rally (from a low base) wouldn’t be a surprise. The way to a stable and sounder macroeconomic situation (trade, fiscal, current account balance) will be long and arduous. We still think that the monetary policy is weak: inflation is running at 24% and real interest rates are still negative.
Nigeria issued a USD 1Bn 15-year Eurobond. International fixed-income investors are starving for yield and priced this B+ rated bond at 7.875%. Although Nigeria Debt/GDP ratio is only 13%, the country struggles to service its debt amid declining oil production and the worst recession in 25 years. Debt service is expected to reach 36% of 2017 forecasted government revenue. Nigeria’s dual exchange rate is crippling the economy. Nigeria’s USD 28Bn is enough to pay down some debt but not enough to service the needs in hard currency of the real economy (current account and investment flows are deeply negative).
Morocco’s official jobless rate fell to 9.4%, thanks to service and construction industries. The government has been developing manufacturing in areas such as automotive, aerospace and electronic components, in an effort to reduce reliance on agriculture, reduce the current account deficit and create more jobs in its crowded major cities. Agriculture, which accounts for some 15% of Morocco’s gross domestic product and employs more than half its workforce, lost around 32,000 jobs last year. Along with the rest of North Africa, the country suffered its worst drought in 30 years, and its cereal harvest declined by more than 70%.
As productivity in the agricultural sector increases, jobs will move from the agricultural sector to the industrial sector. Over the long, term this will increase disposable income. Urbanisation, increasing productivity and disposable income are long-trend tailwind for Morocco.
Zuma’s state of the nation address focused on economic transformation, further state intervention via government procurement and more regulation of concentrated sectors. As expected, there was no cabinet reshuffle. The opposition parties of the DFF and DA showed their discontent, some of them walked out of the parliament, others were booted out.
This SONA was a negative PR event for the ANC and Zuma outlining how much of an electoral and public liability his leadership has become. The risk is that markets become too complacent and price too much of a positive political change in December 2017 for the ANC presidency election.
Information sourced from Alquity
