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The oil price was under pressure again last week as OPEC’s extension of output cuts (rather than an incremental reduction) and US production hitting the highest level since August 2015 (with a record 20th straight weekly increase in rigs), weighed on sentiment. More generally, the pick-up in inflation, which started in the middle of last year, has abated in recent weeks (the Eurozone experienced deflation on a 1-month basis from April to May). This creates a quandary for central banks – whether to respond to better global growth or keep their foot on the throttle to bring price pressures closer to target.
The ECB is expected to sit somewhere in the middle this week – overall dovish, but with some adjustment to their language. We also have James Comey testifying to Congress regarding Trump’s involvement with Russia and the UK General Election on the same day as the ECB announcement (Thursday). Recent GBP weakness has priced a weakening in support for the Conservatives.
UNITED STATES
S&P 2,439 +0.96%, 10yr Treasury 2.16% -8.74bps, HY Credit Index 321 -6bps, Vix 10.07 -0.06Vol
As with European peers, major US equity indices hit record highs last week, as bonds also rallied. Indeed, the May employment report prompted a large leg lower in the US 10-year yield to a 7-month low at 2.15%. This meant a continuation of the yield curve “flattening” we have recently highlighted – the difference between 2 and 10 year yields is now only 93bps. The equity market/yield curve juxtaposition is interesting; bond markets implying limited scope for ongoing growth and/or inflation but stocks making hay whilst the sun shines. The strong asset price performance also pushed volatility measures lower, with the VIX falling back below 10%.
In terms of the employment report, the numbers were universally disappointing. Non-farm payrolls came in at 138,000 (compared to the consensus forecast at 182,000), with additional downward revisions to March and April (meaning the last 3-months has seen the slowest rate of job gains in 5 years). Unemployment did fall to a 16-year low at 4.3%, but this was largely because the participation rate dropped to 62.7%. Wage growth held firm at 2.5% YOY. Other data was mixed, although there are tentative signs that the gap between “soft” survey data and “hard” activity data is moderating – personal income data for April improved, whilst consumer confidence declined for the 2nd consecutive month. In aggregate, the releases are unlikely to have shifted the FED’s intentions for next week’s monetary policy meeting; the market now prices a 95% probability of a 15th June hike, with a 50% probability of a further move before the end of the year.
Global data provides some explanation for the concurrent equity/bond market rallies. Namely, the strong growth impetus that started in mid-2016 is mostly continuing (boosting stocks), but the pick-up in inflation is proving short-lived (moderating expectations for rate hikes).
In terms of the US, whilst it’s expected that growth in Q2 to be a little better than Q1, it could be argued that momentum is better elsewhere. Moreover, the decline in the labour force participation rate highlights the longer-term structural problems facing the country. The proportion of the US population in or seeking employment has declined over the last 20 years from a high of 67.3% to today’s 62.7% (not seen since the mid-1970s). Last, the tight labour market has the potential to stimulate increased wage growth over the next 12-months, which could bias the FED towards a faster rate of tightening. This was alluded to by the Dallas Fed Governor Kaplan on Friday, stating “there are dramatically more skilled job openings in the US than there are workers.”
EUROPE
Eurostoxx 3,586 +1.19%, German Bund 0.29% -5.70bps, Xover Credit Index 248 -1bps, EURUSD 1.127 -0.88%
European data underscored the resilient growth/lower inflation trend with HICP inflation for the Eurozone in May coming in at -0.1% MOM (core inflation over the last 12 months running at 0.9%) but the manufacturing PMI confirmed at a bullish 57 (a 6-year high). The continued positive sentiment was reflected by investor positioning, with the 10th consecutive week of positive equity fund inflows.
Away from the broad positive tone, Greek and Italian government bonds moved lower – Greek because of the impasse in funding discussions due to resume on the 15th June and Italian on the increased likelihood of electoral reform, which would both push forward the next election and increase the likelihood of an anti-establishment party victory.
It’s only taken 9 years but apparently Italy’s oldest bank, Monte Paschi di Siena, will now be properly recapitalised, after agreement in principle between Rome and its EU partners. The plan still requires the ECB to confirm the bank is solvent and for private investors to complete a purchase of the bank’s non-performing loan portfolio. The capital deficit is unfortunately likely to have risen from the December estimate of EUR 8.8bn. A plan for Banca Popolare di Vicenza and Veneto Banca (two mid-sized Italian banks will similarly insolvent balance sheets) is also required.
Ahead of this week’s general election, UK data was consistent with a modestly softening economic outlook. Lending data for April weakened marginally and the manufacturing PMI came in lower.
Israel left rates on hold at 0.10% for the 26th consecutive month. The central bank commented that it “intends to maintain the accommodative policy as long as necessary in order to entrench the inflation environment within the target range.”
ASIA
HSCEI 1,058 +0.84%, Nikkei 2,017.00 + 3.32%, 10yr JGB 0.05% +0bps, USDJPY 110.470 -0.80%
The Chinese authorities announced a proposed amendment to the RMB daily fixing mechanism to incorporate a “counter-cyclical adjustment factor”. This would be expected to reduce the volatility of FX movements, though at the same time would be a step back in terms of China’s previously articulated objectives to liberate the exchange rate as part of an overarching goal of increasing the role of market forces in the major spheres of the economy.
China official NBS manufacturing PMI remained unchanged in May at 51.2, slightly ahead of consensus and equal to April’s print. The official non-manufacturing PMI increased to 54.5 in May from 54.0 last month, on the back of higher services output.
Pakistan’s stock market finished the week down 7.7%, after local institutional selling outweighed the foreign inflows associated with the country’s upgrade from frontier to emerging market status effective from 1st June.
Given that the market had already run up 46% in USD terms in 2016, the impact of the MSCI upgrade appears to have been fully priced in ahead of time. The effects were no doubt exacerbated by the ongoing investigation into the personal finances of Prime Minister Sharif’s family and the recent trends in the current account and foreign exchange reserves, both of which pointing towards a less certain external balance.
India’s GDP growth for Q1 2017 came in at 6.1% YoY, which was below expectations and a deceleration from the 7% growth rate seen in the previous quarter.
Much of the deceleration can be attributed to the aftereffects of demonetisation washing through the numbers. This can be seen at the sector breakdown, with the agricultural sector weakening the most and being the hardest impacted by demonetisation, owing to the rural economy’s cash centrism.
Nominal GDP growth actually accelerated to a three year high in Q1 to 12.5% YoY, but this was counteracted by an unexpected increase in the GDP deflator to 6%, from a level around 3% for the last three quarters.
In the Philippines, the lower house of parliament passed an important piece of tax reform, which once implemented will raise the take home pay of 98% of tax payers. Tax on sugary drinks, autos and high-income earners will balance out the budget impact.
This represents an important win for President Duterte, who admitted himself that economic policy is not his strong point. Further phases of tax reform are expected over the coming year, the passage of which will continue to test the President’s ability to execute policies beyond crime and security.
LATIN AMERICA
MSCI Lat Am 2,546 -1.59%
Brazil’s economy grew 1% QOQ in 1Q17, the first quarterly gain after 8 consecutive quarters of contraction. This officially marks the end of the recession in Brazil. This good performance however hides a less encouraging picture as 70% of this growth came from agriculture, which rose 13.4%.
Brazil’s unemployment rate stabilised at 13.6% in April (vs. 13.7% in March but 11.2% a year ago).
Brazil’s central bank cut the SELIC interest rate by 100bps to 10.25%. Despite the ongoing political crisis and resulting uncertainty about the reforms, the BCB opted for this sizable cut as inflation remains subdued and the economy continues to recover very slowly.
Brazil’s fiscal and current account balances are improving quickly:
- The central government posted a primary deficit of BRL 5.6Bn in 4M17, down from BRL 8.2Bn in 4M16. In the 12 months to April, the primary deficit declined to 2.29% from 2.34% of GDP in the previous month. However, the nominal deficit totalled 9.18% of GDP in the last 12 months and the social security reform is the main key to stabilising the debt trajectory. The net public debt remained stable at 47.7% of GDP.
- The trade balance posted a surplus of USD 7.7Bn in May and USD 29.0Bn in 5M17 (vs USD 19.7Bn in 5M16), as exports surged 18.5% (mainly due to higher commodity prices) and imports rose only 8.4% (recovering due to the stronger FX and gradual improvement in economic activity)
Mexico’s 12-month rolling primary deficit narrowed to MXN 22Bn (0.1% of GDP) in April. The public sector nominal deficit widened to MXN 538.4Bn (2.6% of GDP). Net debt and gross debt fell to 45% of GDP and 48.1% of GDP, respectively.
In a rare harmony, seeing the two largest Latin America economies on the path of fiscal consolidation is good news for the whole asset class.
AFRICA
MSCI Africa 872 -1.79%
Since the November devaluation, Egypt received USD 25Bn inflows, of which about USD 7 billion comprise foreign investments in Egyptian treasuries and equities.
Egypt’s equity market has received USD 734mn net foreign institutional inflows since the float or 2% of its market capitalization.
These flows have accelerated since the 200bps rate hike as the carry trade became more attractive. This bodes well for the currency and for equity market returns.
Egypt’s trade deficit fell 48% YOY to USD 8.5Bnn in 4M2017, on the back of non-oil exports growing 14% YOY to USD 7.4Bn and a 30% YOY drop in imports to USD 15.9Bn in 4M2017.
SA unemployment hit a 14-year high at 27.7% (a level last seen in 2003), as a result of low economic growth, an inflexible labour market and sluggish business confidence. More structurally, a lack of reforms prevents SA form creating a more inclusive growth. Almost 50% of the youth (20-24 year-olds) are unemployed.
South Africa’s trade balance recorded a surplus of ZAR 5.1Bn in April. Exports contracted 0.1% YOY and imports contracted 5.8% YOY. Cumulatively YTD (January – April) the trade balance has recorded a ZAR 9.89Bn surplus compared to R26.39bn deficit recorded over the same period in 2016.
The adjustment mechanism through the FX is working. Following a sub-par growth period and an adverse external environment (low commodity prices and a severe drought), the ZAR depreciated and the trade balance is bouncing (helped by higher commodity prices). Next, the industrial cycle should kick in and lastly the consumer should benefit from the cyclical recovery.
Fitch maintained South Africa’s BB+ rating with a stable outlook, citing the usual concerns around contingent liabilities, SOE governance & business confidence.
Source: Alquity Global Market Update www.alquity.com
