PAPER SHUFFLING
After a 9-month odd bull market, some divergence and loss of momentum has prevailed over recent weeks. Over the next month, a number of policy announcements could shape market direction. In particular:
- FED and ECB monetary policy decisions at which the US will likely raise rates and Europe may signal a more hawkish stance on policy.
- UK general elections and the start of Brexit negotiations.
- Italian electoral reform (setting up an Autumn election) and the conclusion of Greek negotiations with the EU to unlock the latest tranche of funding.
UNITED STATES
S&P 2,416 +1.43%, 10yr Treasury 2.23% +1.19bps, HY Credit Index 327 -3bps, Vix 9.81 -2.23Vol
The minutes to the FED’s May meeting contained two points of interest:
- As broadly expected, the committee continue to look through recent weak data as “primarily reflecting transitory factors”. As such, “most participants anticipated that gradual increases in the federal funds rate would continue” prompting the market probability of a 15th June rate hike to rise to 84% (from 78% a week ago and 67% a month ago).
- The reinvestment policy for interest and principal repayments from the FED’s stock of assets purchased under quantitative easing gained greater prominence in discussions. Specifically, “nearly all policymakers expressed a favourable view” of a plan whereby the bank would announce limits on the dollar amounts of securities that would not be reinvested each month. These caps would then increase every 3 months. “Most participants judged that a change in the committee’s reinvestment policy would likely be appropriate later this year” and that “the approach would also likely be fairly straightforward to communicate.”
Since 2008, the FED’s balance sheet has expanded from under USD 1trn to over USD 4.5trn (an increase of over 30% of US GDP). Allowing some of this portfolio to “run-off” as bonds mature, is the next step in policy “normalisation”. However, the outlook is still very much for a “new normal” in which interest rates have limited scope for increases. This is well demonstrated by US bond yields. Despite an approximate 1% gain in 2-Year Treasury yields over the last 3 years (reflecting realised hikes), the 10-year yield is lower by 0.4%, sitting at only 2.23%. This is to say the market expects a very shallow hiking cycle and therefore little potential for strong growth and inflation.
From a market perspective, the S&P has now returned 7 consecutive daily gains since the Trump/Russia “sell-off of the year”. This is despite weakness in the energy sector, which continues to lag the rest of the market (by over 20% YTD) on lower oil prices. In terms of economic data, the second estimate of Q1 GDP growth was revised up to 1.2%, however personal consumption remained weak and more recent releases disappointed. In particular, new and existing home sales contained broad based declines and the Michigan consumer sentiment survey was revised lower. The employment report is released later this week.
EUROPE
Eurostoxx 3,553 -0.35%, German Bund 0.30% -3.70bps, Xover Credit Index 254 -4bps, EURUSD 1.113 +0.24%
Sentiment surveys across the Eurozone continue to go from strength to strength; the PMIs for May held at 6-year highs whilst the German IFO “Business Climate” recorded an all-time high. As in the US, this strong “soft data” is out-performing “hard” activity data. Nonetheless, the European economy continues to display good momentum.
The next ECB meeting on the 8th June has the potential to shape market direction over the summer months. On the one hand, the governing council have a (German influenced) history of reacting quickly to any pick-up in activity. This is to say, with the French election in the past, there could be a change in rhetoric aimed at preparing the market for a wind-down of quantitative easing and eventual rate hikes. On the other hand, there is no real threat of inflation breaching the 2% target (in fact it is more likely headline inflation moderates over the coming months). Mario Draghi commented “At its June monetary policy meeting the Governing Council will receive an update of the staff projections and a more complete information set on which it will be able to formulate its judgement on the distribution of risks around the most likely outlook for growth and inflation…overall, we remain firmly convinced that an extraordinary amount of monetary policy support, including through our forward guidance, is still necessary for the present level of underutilised resources to be re-absorbed and for inflation to return to and durably stabilize around levels close to 2 percent within a meaningful medium-term horizon.”
In a meeting with senior EU officials, Donald Trump spoke with his usual eloquence stating “The Germans are bad, really bad…look at the millions of cars they sell in the US. It’s terrible. We’ll put a stop to that.” Also because of the expanding auto emissions scandal, this saw the auto sector under-perform broader equities.
Greek government bonds gave back some of their recent gains after the Eurogroup meeting did not manage to close the second review. Nonetheless, the overall impression was positive, with a conclusion apparently in sight.
In other political news, the probability of a snap Italian election this year appears to have increased. In an interview with “Il Messaggero”, former PM Renzi said that he favours a German style “proportional representation” electoral system with a cut-off of 5% to enter parliament. Moreover, he commented that Italy could go to the polls at the same time as Germany this autumn. This constitutes a shift from Renzi and comes after Silvio Berlusconi, the leader of the centre-right Forza Italia party, and BeppeGrillo, the head of the Five Star Movement, also backed the German model in recent weeks. Opinion polls are very tight, with no clear winner between Renzi and Grillo.
Although there are tentative signs of life in the Italian economy over the short term, in the context of the Euro, the country remains terminally economically ill. Like in Japan, there is no way to generate proper and sustained real economic growth. Indeed, the country has not been helping itself; there has been no reform and the banking system is still to be properly recapitalised.
In the UK, Q1 GDP was revised down to 0.2% QOQ (with consumption growth at a 2-year low) whilst pre-election polls signalled a tightening in the lead of PM Theresa May’s Conservative party over the opposition Labour party (to as low as 5% from as high as 19%). The Conservative’s poor showing in opinion polls comes after a campaign which has been seen by most as complacent. This pushed both GBP and Gilt yields lower. The UK 10-year currently sits at a 1% yield versus CPI inflation at 2.7%. The general election falls on the 8th June, with formal Brexit negotiations commencing on the 19th.
The NBH in Hungary left interest rates unchanged at 0.9% as it continues its reliance on unconventional measures.
ASIA
HSCEI 1,061 +2.90%,, Nikkei 1,967.00 +0.57%, 10yr JGB 0.04% +0bps, USDJPY 110.850 +0.06%
On Wednesday, former Fed Chairman Ben Bernanke spoke at a BOJ seminar. He suggested current stimulus efforts may be losing their effectiveness and that the BOJ may need to raise the inflation target above 2% whilst coordinating with the Government on a fiscal stimulus plan.
Moody’s downgraded China’s sovereign credit rating from Aa3 (negative outlook) to A1 (stable outlook).The rationale was based on an expectation for increasing leverage across the economy due to slower progress on economic reform.
Equity markets paid little attention to the news, with H shares finishing the week +2.9% in USD and A shares +0.7%. The RMB also strengthened 43bps against the dollar
Pakistan’s stock market rose +3.7% in USD last week, on the back of a two-punch combo of reporting the country’s highest GDP growth rate in 10 years and a pro-growth budget announcement for FY18.
GDP growth was reported at 5.3% YOY, with the official Economic Survey attributing this to accommodative monetary policy, increased development spending, higher private sector credit growth and structural improvements made in the energy sector. The target for next year’s growth rate was set at 6.0%.
After the GDP release, the government then announced a pro-growth budget, with an allocated 37% increase in infrastructure investment and an increase in the total budget outlay from 12% to 16% of GDP, matched off by targets to raise tax revenue by 13%.
One of the world’s best performing stock markets last year, returning 46% in USD in 2016, Pakistan is now days away from joining the MSCI Emerging Markets Index, with significant passive inflows expected in to the market. These liquidity factors, plus the fundamental characteristics of a large, growing population underpenetrated by modern trade, are slightly balanced out by the recent trends seen in the current account deficit and foreign reserves. On a longer-term view, Pakistan requires a large amount of restructuring in order to avoid having to repeatedly turn to the IMF for funding. After the 2018 general election, investors will have a far better indication of just how likely this is to take place.
Bank of Korea left interest rates on hold for the 11th consecutive meeting at 1.25%, with a unanimous decision and in line with expectations. The MPC statement showed a slight increase in optimism, commenting that there is moderate upside risk to the 2.6% growth forecast for this year. The inflation outlook was unchanged at 2.0%.
Thailand also kept interest rates on hold at 1.25%, with the BOT’s Monetary Policy Committee also reaching a unanimous decision. Policymakers described an improving growth outlook and expectations for gradually rising inflation, while attributing the recent downside surprise in inflation to supply-side shocks impacting food prices due to a favourable base effect from last year’s drought.
LATIN AMERICA
MSCI Lat Am 2,565 +2.74%
Mexico’s GDP grew 2.8% annualised in 1Q17. The Mexican economy has performed better than expected in the months following Trump’s election. The spike in inflation, the uncertainty surrounding bilateral relations with the US, the tightening of macroeconomic policies (fiscal cuts and rate hikes), and the consistent fall of oil output haven’t had a broad-based impact on GDP figures yet.
Mexican parties PAN and the PRD announced they would run together in the Mexican Presidential election of June 2018. This should erode the chances of Andres Manuel Lopez-Obrador running on a populist platform of more state intervention in the economy.
S&P placed Brazil rating on watch negative due to “increased risk that a disruptive or slow resolution of recent political turmoil could delay corrective policy measures while country’s economic and fiscal challenges continue to mount”.
Brazil’s current account surplus totalled USD 1.2Bn in April. Over 12 months, the current account deficit shrank to USD 19.9Bn or 1.1% of GDP. The biggest positive contribution came again from the trade balance, with a USD 6.7Bn surplus, way up from USD 4.6Bn in April 2016.
As expected, Colombia’s central bank cut the benchmark rate by 25 bps to 6.25% as inflation keeps converging to the target range.
AFRICA
MSCI Africa 878 +3.55%
Egypt’s central bank hiked its overnight deposit rate by 200bps to 16.75% in an attempt to curb inflation and anchor the currency, in line with IMF recommendations. Inflation should be close to its peak in 2Q17 at 31.5% YOY in April. According to the Central Bank, a record level of foreign investment of nearly USD 1Bn entered the country within days of the rate increase.
This long-awaited rate hike is good news for the Egyptian economy, as it should attract portfolio flows, support the currency and taming inflationary pressures.
Egypt successfully issued a USD 3BnEurobond. This is about twice as much as targeted and at a lower cost than when the same bonds were first sold in January: 5-year paper at 5.45%, 10-year bonds at 6.65% and 30-year bonds at 7.95%. The issue was largely over-subscribed as the order book closed at USD 11Bn.
This is a vote of confidence in the structural reforms process in Egypt by international fixed income investors.
Kenya’s current account deficit widened to 7.7% GDP in February2017 from 5.9% a year earlier. The current account will remain under pressure given higher maize imports and lower tea exports, plus a debt obligation due in June. The decisions of the government to start subsidizing maize flour and increase minimum wage by 18% ahead of presidential elections in August are also weakening the fiscal account.
Nigeria’s real GDP contracted 0.5% in 1Q17, marking the 5thcontractionary quarter in succession.
The worry is that the march out of recession is almost entirely dependent on improvements in oil output and price, rather than policy or reform-led economic growth, and as a result, its sustainability is being questioned.
Nigeria’s stock market rebounded strongly in the past few weeks following the launch of a special FX window for investors and exporters last April.
Despite encouraging signals, the CBN still has a lot to do in stabilizing the market on a sustainable basis. There are reports suggesting that large importers are still not getting their FX orders filled, despite the CBN’s claims of surplus liquidity. Higher FX reserves in recent months have been built on stronger oil prices and relative peace in the Niger Delta. In addition, some civil servants are not getting paid and the banking system is under stress as utilities (at least USD 3Bn), oil-related and other companies (like Etisalat Nigeria for USD 1.2Bn) are unable meet their obligations.
Nigeria now has several exchange rates. You can receive USD 1 in exchange for:
- 197 NGN if you are a pilgrim
- 285 NGN for petroleum products
- 301 NGN at Western Union
- 305 NGN used for the 2017 budget
- 317 NGN on the interbank market
- 366 NGN for personal travel allowance, foreign medical trip or at a bureau de change
- 380 NGN at the parallel market
- 382 NGN using the investors and exporters FX (bid-ask spreads may range from 380 to 420)
Ghana cut rates by 100bps to 22.5% as core inflation ex energy and utility prices continues to trend downwards.
South Africa’s inflation in April slowed to 5.3% YOY from 6.1% y/y in March, thank to food inflation falling to 6.7% YOY from 8.7% in March and fuel to 5.6% from 15.0%.
Source: Alquity Global Market Update www.alquity.com
