17 to 23 September: Enough with the trade talks

Although new tariffs levied on Chinese products by the US come into force today (24^th September), it was announced that already imposed tariffs will rise from 10% to 25% in 2019 and China responded its own measures in retaliation, markets reacted positively and gained considerably last week. The counter-intuitive response, e.g. the weakness of the broad dollar index (DXY) or the strong bounce of Chinese stocks, is a clear sign that markets have just had enough and lost interest in trade talks. In our interpretation, the positive reaction by markets could have been induced by a combination of various factors:

• the – potential – unwinding of bearish positions in the EM universe as authorities have started to finally address woes in Turkey and Argentina,
• building expectations that trade tensions and imposed tariffs will not weigh on actual economic activity significantly and/or
• recent stability of the RMB, which implies that China will not up the ante.

We are not fully convinced that markets are out of woods just yet, but to upset global market sentiment any further, the POTUS or China would have to strike an even harsher tone. Such an outcome is not likely, in our opinion, as neither the US nor China could reap economic or political benefits from such a scenario. Of course, Trump may think differently…

Looking ahead

All eyes are on the Federal Reserve’s monetary policy meeting this week, as the FOMC will almost surely deliver a further 25bp hike to continue the tightening cycle. The rate hike itself will be a non-event, since it has been priced in for a long time. More importantly, Chair Powell will present the Fed’s updated macroeconomic projection, the FOMC’s latest ‘dot plot’ and answer questions in the regular press conference. In the second half of the week, markets will need to digest the third read of the 2018 Q2 GDP data and the August PCE inflation measure in the US. Relative to the US, Japan, the Euro Area and the UK will only release second-rate data, as the Bank of Japan publishes the minutes of its last rate setting meeting, several Eurozone member states reveal inflation figures, while the UK posts the final read of the Q2 GDP figure.

The Asian calendar is packed for the week, as the central banks of the Philippines and Indonesia are expected to raise their respective interest rates, while their Taiwanese peer might leave policy unchanged. Even though there is still a week to go until the end of Q3, the Vietnamese statistical office is scheduled to release Q3 GDP data. Latin American countries will release a wide variety of high-frequency indicators for economic activity throughout the week, and at the end of it, the Brazilian central bank will release its Inflation Report, while the Colombian central bank will hold a policy rate decision. In addition, Brazilian political news flow and NAFTA 2.0 talks will attract the attention of market players. African markets will keep a close eye on the Kenyan, Nigerian, Egyptian and Moroccan central banks’ monetary policy decisions in addition to Moroccan, Kenyan and Egyptian Q2 GDP releases.

10 to 16 September: Can a Goldilocks market return?

Risk aversion in global markets faded by the end of the week, due to several coinciding factors:

• Trade tensions eased, as the US and China signalled that they might (or might not) continue negotiations on tariffs and the conduct of international trade.
• The release of lower-than-expected CPI inflation in the US implied that current inflationary developments in the US do not call for aggressive monetary tightening by the Federal Reserve, which in turn depreciated the USD compared to the beginning of the week.
• Sentiment was lifted by interest rate hikes carried out by the Turkish and Russian central banks that helped the recovery of both nation’s currencies.

Looking ahead

All eyes remain on the US and China and whether the administrations of the two countries will continue trade discussions. The economic diary for developed markets is relatively light this week, as neither major policy events nor highly relevant macroeconomic data are scheduled. In the Euro Area, the event of greatest market-moving potential will be a speech delivered by ECB President Mario Draghi, who may provide further colour on the reaction function of the ECB’s decision-making body. The Japanese counterpart of the ECB holds its usual rate setting meeting on Wednesday, where the MPC is unlikely to change the course of monetary policy. In the US, data releases will be scarce, since only the current account balance and PMI figures will be revealed. However, both are unlikely to drive markets.

The Asian economic calendar is almost completely empty, since the Thai central bank’s monetary policy meeting and Malaysian inflation from August bear the potential to have an impact on financial markets. Latin American markets will continue to focus on the political polls and related news flow in Brazil. In addition, the Brazilian central bank is scheduled to hold a rate setting meeting, where no rate moves are expected. Argentina will release Q2 GDP figures, which are likely to reflect the underlying weakness of the Argentine economy. At the end of the week, South Africa releases inflation figures, which will be followed be the monetary policy decision of the South African central bank.

3 to 9 September: Ninety-nine problems, but a rate hike ain’t one

Turmoil in the EM universe will probably continue this week, as none of the countries that triggered the risk-averse global market sentiment and meltdown in the EM universe have dealt with their idiosyncratic issues just yet. In other words, neither the Argentine, nor the Turkish authorities have addressed the issues of their respective economies in an appropriate manner. In addition, unresolved trade discussions between the US and the rest of the world continue to weigh on global market sentiment. As a result, behaviour of market players is likely to remain rather risk-averse, which could mean that EM asset prices will keep sliding before they bounce back. Due to the idiosyncratic nature of the meltdown triggers within the EM universe, markets will remain policy- and event-driven rather than fully focusing on the classic economic diary, since there are plenty of individual stories to follow:

• Argentina will continue to muddle through these hectic times, as the country’s government is yet to deliver a comprehensive package that is acceptable by the IMF in lieu of financial assistance.
• Meanwhile, there are speculations in the market that the Turkish central bank might deliver a rate hike this week. However, even a massive rate hike would not be enough to restore Turkey’s macroeconomic stability, as the confidence in the Turkish political leadership’s willingness to bring appropriate measures is strongly doubted.
• Furthermore, Brazilian market sentiment and asset prices will be continued to be strongly influenced by political news flow and polls, as time passes until the Presidential election in October.
• And of course, the US is yet to renew the NAFTA deal with Mexico and Canada, while trade negotiations with China seem to be stuck and a decision on tariffs on EU goods is yet to be announced.
• Finally, Brexit talks continue between the UK and EU, which could further add to the worries of investors.

Looking ahead

In the context of the aforementioned sources of unpredictability and uncertainty, the European Central Bank holds its usual rate-setting meeting this week, where no rate changes are expected. President Draghi will probably argue for the need to terminate the asset purchase programme in December, as scheduled. However, the President will not have an easy task to retain the credibility of the ECB in light of weakening economic data in the Euro Area. During the week, the Federal Reserve in the US releases the Beige Book that should offer further clarity on the general state of the US economy.

The economic diary in Asia is relatively light this week, as only China will release a broad set of macroeconomic data from August that might re-affirm that the pro-active policies by the Chinese government were sufficient enough to offset the tariffs-induced weakness. In Latin America, the Argentine central bank is scheduled to hold a rate-setting meeting. However, it is very unlikely we hear any relevant announcements by the Argentine MPC this time, since it is very difficult to argue in favour of a higher policy rate (currently 60%). And finally, in Africa, Kenya and Egypt are scheduled to released Q2 GDP figures, while South Africa may publish high-frequency macro indicators from July. Egypt and Nigeria will reveal inflation from August, as well.

28 August to 2 September: Mario Draghi’s trichet moment is imminent

ECB President Mario Draghi and his fellow members on the European Central Bank’s Governing Council have been doing everything right to commit a policy mistake, similarly to their predecessors under Jean-Claude Trichet. Mr. Trichet pulled the trigger too quickly by lifting the policy rates in 2011 contributing to the W-shaped recession in the Euro Area. Mr. Draghi is on the same trajectory, as macroeconomic developments do not warrant policy normalisation anytime soon.

Inflationary processes in the Eurozone remain quite unsettling, as both annual headline and core inflation measures decelerated compared to the previous month. In July, both headline and core CPI inflation decelerated 0.1ppt to 2% YoY and 1% YoY, respectively. The weakness in both measures was induced by sluggish services price inflation, which moderated to 1.3% YoY. Even though the headline measure has been hovering at the ECB’s inflation target, the core rate that filters out volatile prices driven mostly by external forces (such as energy prices), remains extremely depressed. In addition, annual growth of the M3 monetary aggregate eased to 4% YoY in July vs. 4.5% YoY in May. The speed of M3 growth is more-or-less in line with the pace by which the European Central Bank has been scaling back its monthly asset purchase. The pace in July implies that credit growth is likely to have a neutral impact on GDP growth and is very unlikely to contribute to it anytime soon.

As the saying goes: ‘When it looks like a duck, swims like a duck and quacks like a duck, then it is probably a duck.’ In this case, the Euro Area’s economy perfectly exhibits the symptoms that call for further aid by the monetary authority, especially since no structural reforms are in sight in the member states that crucially need them.

Looking ahead

Developed markets face a rather exciting week, as the economic diary is packed. Most importantly, the US releases the usual monthly jobs report, which almost always moves markets. This time, nominal wage growth is in the limelight, since wage inflation are the last piece of the puzzle in the US that is needed for a steeper rate hike trajectory. Meanwhile in the Euro Area, some of the relevant ECB policymakers will give speeches and might provide some insights on the Governing Council’s intentions. On Friday, final GDP figures will be released, which finally reveals the detailed breakdown of the Euro Area’s growth in Q2.

Asian countries kick off the week by releasing August manufacturing PMI figures on Monday and continue with the publication of inflation data. In the second half of the week, India publishes its current account balance that could have an impact on the rupee’s exchange rate.

Latin America will be dominated by Brazilian political news flow, Argentine crisis management and NAFTA negotiations between Mexico, the US and Canada. As a result, the economic diary will be secondary this week.

African markets will be mostly influenced by developments in South Africa, where the political debate on the reform related to land expropriation is in the limelight. Furthermore, Q2 GDP release on Tuesday will shed light on the recovery of the South African economy.

20 to 27 August: Jerome Powell’s cautious remarks spurred stock markets

Although markets still believe that two additional 25bp hikes by the Fed are a done deal in the second half of this year, the speech by Fed Chairman Jerome Powell at the Jackson Hole Symposium highlighted that the current composition of the FOMC might just be slightly more dovish than it was previously thought. The Fed Chairman’s speech at Jackson Hole revealed some of his dovish bias, as he argued that symmetric risks surrounded the trajectory of Fed fund rates, i.e. hiking too fast could choke growth, while tightening too slowly could overheat the economy and contribute to building up imbalances. Going forward, the Fed’s policy will be data dependent, related to the aforementioned two risk factors.

Stock markets in the US benefitted from Mr. Powell’s remarks, as they touched new historical highs. Meanwhile, US Treasury yields slightly eased and the broad USD index (DXY) lost ground in response to the Fed Chair’s comments. According to Fed funds futures, markets have fully priced in a 25bp hike for the September meeting, and see greater than 67% probability of an additional 25bp hike in December. Whether the hiking cycle continues in 2019 remains highly uncertain.

The approach presented by Mr. Powell was at odds with the message delivered by the latest minutes, in our view. While the minutes strongly implied two further hikes this year, Mr. Powell was significantly more cautious. We are of the view that the number and extent of rate hikes are not the ultimate drivers of global financial markets, but the size of the Federal Reserve’s balance sheet, which will speed up as of October as planned. We think it is important to underline that the change in Chair Powell’s tone may be due to the shifts in global market sentiment and the changing macroeconomic landscape rather than the comments made by President Trump.

Looking ahead

The diary in the US contains macro data with market-moving potential this week. The second read of the headline 2018 Q2 GDP figure should not deliver too much of a surprise, as the median market estimate puts Q2 growth at 4% in SAAR terms, matching the first read. The detailed breakdown, however, bears the potential to move markets, as it might pinpoint whether the Q2 pace is sustainable in the medium run. In the second half of the week, the Fed’s preferred inflation gauge, the PCE, will be released.

Within the Euro Area, Spain, Italy and France will publish their detailed GDP figures from Q2 as well. In addition, the August harmonised CPI inflation rate will be revealed. All of the indicators will serve as guides for markets to potentially re-price expectations for the timing of the first rate hike after asset purchases terminate at the end of December.

Asian markets will mostly focus on Chinese manufacturing PMI and Indian Q2 GDP data this week. Further deceleration of the Chinese manufacturing PMI could re-ignite risk-averse global market sentiment.

Latin American market players will probably focus on the political news flow in Brazil, especially on the latest political polls. Should the market-friendly Ackmin’s polls improve, Brazilian markets could breathe a sign of relief as asset prices might gain. In the second half of the week, the Mexican central bank publishes the latest Inflation Report, the Brazilian Statistical Office releases Q2 GDP, the Colombian central bank board meets, and finally, the Peruvian CPI inflation rate from August is revealed.

The African economic diary is rather light this week. Both Nigeria and South Africa are scheduled to publish monetary aggregates, while Kenya will reveal August CPI inflation.

13 to 19 August: Turkey is idiosyncratic, not systemic

Headlines were dominated by the market turmoil in Turkey that triggered a mini meltdown in the EM universe. With a few exceptions, all emerging and frontier markets were hit during the week. Consequently, the MSCI Emerging Markets index closed 3.71% lower in USD terms. Recent market movements have been excessive and fundamentally not justified, in our opinion, as most of the emerging and frontier markets do not exhibit such vulnerabilities and idiosyncratic risks as Turkey. The few economies that bear some resemblance to Turkey, such as Argentina, stand ready to deliver appropriate policy responses to curb capital outflow and reduce asset price volatility. Furthermore, there are no significant channels of contagion through the real economy, neither direct or indirect, as the trade linkages between Turkey and other EM countries are rather weak. Although financial linkages between Turkey and the rest of the EM universe are negligible, elevated asset price volatility and excessive capital outflows can sometimes have unintended consequences, such as a sudden changes in the course of monetary policy or an otherwise unexpected downgrade.

Due to the sentiment-driven nature of the recent market mini meltdown, EM indices are likely to bounce back once the risk-averse mood fades. The timing of the rebound depends only on when the US administration deals its finishing blow, as market players wants to see what price a disobedient country pays when it openly rebels against the wishes of the POTUS. We are of the view that the global growth story has not been hurt because of the Turkish demise, and once the horizon clears, EM and FM markets will benefit from a restoration of global risk appetite.

Looking ahead

Since the economic calendar is rather light on macroeconomic data releases this week, markets will focus on developments in Turkey, the trade talks between the US and China, the content and tone of the Federal Reserve’s minutes and speeches delivered by central bankers in the Fed’s annual symposium in Jackson Hole starting on Friday.

The Fed’s minutes from the last rate setting meeting should reaffirm that the FOMC will deliver two more 25bp rate hikes this year, as the Committee’s reaction function overweights underlying economic developments within the domestic US economy relative to external noise, such as Turkey. Chair Powell may reflect on this idea in his speech in Jackson Hole. Markets will have to find comfort in the idea that Turkey is an insulated idiosyncratic story that has little chance to be contagious.

In Asia, Taiwanese unemployment and industrial production and Malaysian CPI inflation releases will be published. In Latin America, Chile, Peru and Mexico will release 2018 Q2 GDP data. In addition, the Argentinian trade balance and economic activity index and Mexico’s CPI inflation and current account balance can influence local market sentiment. In Africa, South Africa will reveal CPI inflation.

6 to 12 August: The POTUS fried Turkey: trying times for illiberal countries

Turkey is experiencing a fully blown currency crisis and financial meltdown. The Turkish economy has been running a substantial twin deficit, faces accelerating inflation and has amassed a significant amount of foreign currency-denominated debt both in the public and private sectors. Structural deficiencies have not been addressed by policymakers and, indeed, were exacerbated by the President forbidding the central bank to respond appropriately by aggressively raising interest rates. Consequently, financial market players have now “thrown in the towel” on Turkish assets, which have already been struggling for a long time.

The final straw for financial markets was when US President Trump announced the imposition of higher tariffs on steel and aluminium imports from Turkey in response to a political issue between the two countries (a US pastor was imprisoned in Turkey, as President Erdogan believed the pastor was connected to the outlawed Kurdistan Workers Party).  Existing structural deficiencies were amplified by the POTUS’ step, and the Turkish lira depreciated substantially hitting new historical lows. At the end of the week, the POTUS raised tariffs even further claiming that the Turkish lira was weak against the strong US dollar and adding that “US relations with Turkey are not good at this time.”

Even though the situation would usually result in substantial tightening on the monetary front, no steps have been taken by the central bank, as it has been captured by President Erdogan, which means that the monetary authority has effectively lost its operational independence and is a casual observer to the collapse of Turkish asset prices. During the week, the Turkish lira plummeted 25.9%, while since the beginning of this year, the currency has lost almost 70% of its value vis-à-vis the US dollar. The 10-year government bond yield exceeded 20.6%. Recent events in Turkey underpin the need for orderly state finances, prudent economic policies and a stable external financing position, especially in emerging economies.

Looking ahead

The US diary for this week contains little of major market significance, as monthly retail sales and industrial production data are unlikely to greatly impact global market sentiment. GDP and inflation data in the Eurozone will provide guidance as to whether the European Central Bank’s plan to terminate the asset purchases this December is appropriate. Meanwhile in the UK, CPI and earnings figures will be in the focus.

Asian markets will mostly pay attention to macroeconomic data this week, as China publishes retail sales and industrial production figures. Furthermore, Indian CPI, Malaysian GDP and Taiwanese GDP statistics will also be released. The Indonesia central bank’s rate setting meeting will be the only scheduled policy event this week. However, it is likely to be a “non-event”, as the policy rate is expected to be stable at 5.25%.

The diary in Latin America is relatively empty. Colombia will release GDP figures, while Argentina published July CPI inflation numbers.

In Africa, Kenya publishes PPI inflation from the second quarter, Nigeria releases July CPI inflation, while South Africa announces mining production performance in June. In the second half of this week, the Egyptian central bank holds a monetary policy meeting.

30 July to 5 August: More smoke than fire

According to speculation reported by Bloomberg, US Treasury Secretary Mnuchin and Chinese Vice Premier  had private discussions in an attempt to restart stalled trade talks between the two super powers that have been roiling financial markets for too long. Meanwhile US Trade Representative Lighthizer officially stated that the US administration has been considering increasing its tariffs from 10% to 25% on USD 200bn worth of Chinese imports.

A key aspect of the story, in our view, is that President Trump and the Republican party are preparing for the midterm elections held in November. Although the populist rhetoric may appeal to voters, the room for threats and economic blackmail is rather limited, since a fully blown trade war would not only weigh on Chinese growth but could dampen US business cycle as well. We remain of the view that the Trump administration is not willing to endanger global economic growth, as it would hurt the US economy, and ultimately would erode standards of living for ‘Average Joe,’ who is the backbone of the incumbent administration’s voting base. Consequently, the POTUS and his team will not escalate the trade war to such an extent that kneecaps the world economy.

US stock markets have ignored most of the recent trade war-related noise, as the S&P500 has increased five weeks in a row, which is the longest streak this year. Since the beginning of the year, the index has risen 5.83%. The recent stock market momentum was driven by strong Q2 earnings, as the overwhelming majority of companies in the S&P500 that have already reported have exceeded expectations. As a result of the strong earnings season and the upbeat stock market sentiment in the US, Apple has become the first company with a market capitalisation over USD 1tn.

Looking ahead

This week is not going to be as exciting as last week, as central banks take a pause, but markets will still have a lot to digest, as the negotiations between the US and China continue and an announcement that can swing markets either direction can arrive at virtually any time.

A limited number of macro data are going to be published in developed markets this week. Germany releases July industrial production figures, and Japan publishes 2018 Q2 GDP data. On Friday, CPI inflation from the US should serve as further evidence that the Fed has more than enough room for manoeuvre to deliver the 25bp hike in September.

Chinese macroeconomic data will dominate this week’s news flow in the emerging market spectrum, as the country publishes foreign exchange reserves, inflation and foreign trade data. Apart from China, Brazil, Mexico, and Colombia release inflation data this week.

 

23 to 29 July: All that glitters is not gold

The US economy expanded by 4.1% in seasonally adjusted annualised terms in 2018 Q2. All core components exhibited expansion, as real consumer spending rose 4%, government spending increased 2.1%, non-residential investments were up 7.3%, exports edged up 9.3%, while imports were flat. Net trade contributed 1.1ppt to headline growth. In contrast, residential investment was the only component that contracted in Q2, by 1.1%. Moreover, seasonally adjusted annualised growth in 2018 Q1 was revised up 0.2ppt to 2.2%.

The headline GDP growth rate and its components reflect the inherent strength of the US economy. However, the pace is unsustainable, in our view. The positive impact of government spending will fade in 2019, as fiscal stimulus runs out. Furthermore, exports are unlikely to continue to rise at this pace. We believe that exports dynamics were exceptionally strong in Q2, because many of the exporters unloaded their inventories before tariffs took effect. GDP growth should be solid in the coming quarters, but without any tailwinds like additional fiscal stimulus or a weaker dollar, growth is unlikely to significantly exceed 3% in the coming quarters.

Indeed, after the release of the US GDP data, global FX market movements reflected widespread doubts about the sustainability of such strong growth going forward. Emerging market currencies in general rallied against the USD, as market players took the view that economic activity will be solid, but not strong enough to trigger a more aggressive response from the Fed. Futures markets strengthened only modestly, now implying a 66% chance that the Fed funds rate will be between 2.00-2.25% at the end of this year and only a 5% chance of 3 more hikes

This week, there are a number of important central bank meetings. On Tuesday, the BOJ will deliver an update, with speculation rife that there will be a change in policy following the biggest jump in yields in 2 years last week (forcing the central bank to intervene). This will be followed by the Fed on Wednesday (no change expected) and the BOE on Thursday (a 2^nd rate hike of the cycle expected for the UK).

16 to 22 July: Take the IMF’s view with a pinch of salt

Last week, the International Monetary Fund (IMF) updated its global macroeconomic assessment and kept the headline aggregate growth forecasts for 2018 and 2019 unchanged at 3.9%. Even though the headline global growth rates have not changed, growth projections for several economies have been revised due to the shifts in the balance of risks induced by trade tensions. Prospects for the Euro Area (2.2% and 1.9%), Japan (1% and 0.9%) and the United Kingdom (1.4% and 1.5%) were downgraded, while forecasts for the US (2.9% and 2.7%) and China (6.6% and 6.4%) have not changed. Overall, the outlook presented by the IMF is rather gloomy, as large weights are assigned to future events with a negative impact on EM growth, such as further and sustained increases in commodity prices and tighter financial conditions induced by the Fed.

We acknowledge that there are looming risks that could weigh on the global economic momentum, but we do not think that the Fed is heading towards a policy mistake that could trigger an unwanted downturn nor that commodity prices will soar. Furthermore, within the EM universe, some countries with insulated domestic economies can rely on their inherent structural growth potential that shields them from the impact of the trade wars, such as China and India, while others possess stable macroeconomic foundations to weather turbulent times, e.g. Peru, Chile and Morocco.

Both the Brent crude oil price for September delivery and WTI for August delivery fell more than 4% last Monday, to USD 72/bbl and USD 68/bbl, respectively. The collapse in crude oil prices were driven by speculations that Saudi Arabia intends to bring additional supplies to the market. Rumours citing that the US could increase the supply in the oil market by releasing its Strategic Petroleum Reserves amplified the extent of the price drop. Furthermore, US Treasury Secretary Mnuchin’s statement weighed on oil prices as well. According to Mr Mnuchin, some crude importers may receive waivers to continue purchasing oil from Iran. Throughout the week both Brent and WTI prices went sideways, as they could not recover even after Saudi Arabia announced later that oil exports may decrease in August. Brent for September delivery closed the week at USD 73/bbl, while WTI for August delivery at USD 70/bbl.