9 to 15 July: Only when the tide goes out…

Topical:

The last decade with abundant liquidity and low commodity prices would have been the ideal period for governments to roll out structural reforms in order to reduce vulnerabilities and build up buffers. However, in aggregate, not much has been done; many countries barely ‘muddled through’ the post-GFC years. In particular, indebtedness remains unresolved as the global debt-to-GDP ratio stands at 318% at the end of 2018 Q1, only 3 percentage points below its all-time peak from 2016 according to the Institute for International Finance. High global debt in the context of increasing interest rates, tightening USD liquidity, a stronger dollar and bloating risk premia means that sustainability of debt and growth will be an even greater challenge for policymakers. Of course, there are exceptions; countries that carried out reforms and raised barriers to protect themselves from external shocks. These include Egypt, Peru and India. Time will tell, which countries were prudent enough to create reserves to weather the next economic downturn. As Warren Buffett famously put it ‘Only when the tide goes out do you discover who’s been swimming naked.’

Crude oil prices crashed during the week, as WTI and Brent fell about 5% and 7%, respectively from Wednesday to Thursday. The price of oil was dragged down due to dollar strength and the on-going trade disputes between the US and China, and the extent of the move was amplified by the release of news stipulating that Libya restarted oil production at a major field that had been shut down for months. West Texas Intermediate crude for August delivery closed at USD 70.58/bbl, while Brent crude futures price for September delivery was at USD 74.92/bbl on Friday.

2 to 8 July: The ‘unreliable boyfriend’ might keep his promise and deliver a hike in August

Bank of England Governor Mark Carney delivered a rather upbeat view on the UK economy last week. In the Governor’s opinion, the economic softness observed in Q1 was mostly due to adverse weather conditions and economic momentum picked up in Q2. He added that recent macroeconomic indicators are in line with the BoE’s forecast presented in the May Inflation Report and that the recuperation should persist thanks to accommodative monetary conditions. Further acceleration in growth, however, calls for tighter monetary conditions. The Governor therefore implied that the long-awaited second 25bp rate hike of the cycle might just be delivered in August thanks to this (perceived) improvement in the macroeconomic environment. The market agrees, with futures contracts pricing a strong probability of such an increase.

In contrast with the upbeat short-term assessment, Carney pointed out a wide variety of risks that could derail the UK’s economy in the long-run. Such risks are related to on-going global trade tensions and Brexit. Indeed, yesterday an example of these risks manifested as David Davis (the UK government’s Brexit secretary) resigned after being side-lined and in disagreement with Theresa May’s “soft” Brexit strategy. However, should the risks subside going forward, the upbeat mood of business leaders, which is reflected in the May PMI figures, together with ongoing weakness in the BP, could translate into additional economic output that could lead to further policy normalisation by the BoE.

25 June to 1 July: Sit back and unwind

As a tumultuous quarter came to a close last week, almost all investors we met were in unwind mode – selling equities and shifting into sectors and regions perceived to be more defensive. As we have messaged many times over the past 6 months, the global cycle is certainly ageing, which should prompt more volatility. However, in our view, without President Trump’s harsh trade and foreign policy rhetoric, underlying conditions would still be resilient enough to support markets. The POTUS has certainly therefore made his mark. Last week this continued as the Trump administration’s efforts to stop all nations from importing Iranian oil contributed to a sharp appreciation in the commodity’s price (a large draw in US inventories also signalling a tightening market).

Elsewhere, global M&A volumes hit an all-time high during the first half of 2018 – amounting to USD 2.5trn compared to the previous high in 2007 of USD 2.3trn. After wild returns for fixed income managers in May, the best quarterly performance for the USD since 2016 and US corporate bonds posting 2 consecutive quarters of negative returns for the first time since the crisis, this has many investors talking about “echoes” from previous bear markets. Whilst we have been cautious on the long-term prospects for developed markets ever since the crisis, we don’t believe this is yet a foregone conclusion. Of course, if the trade war does not de-escalate, the impact of threatened tariffs on all sides would be very material and could plunge the global economy into recession. If instead more balanced agreements can be found over the next few months, markets may have already discounted enough for the time being.

18 to 24 June: Getting Serious

In Washington, President Trump upped the ante on trade last week. Currently, USD 50bn of Chinese imports will become subject to 25% tariffs from the 6th July. However, if the EU and China do not reverse their retaliatory actions, the POTUS has now threatened further levies on China of up to USD 400bn and measures specifically targeting non-US automakers of up to USD 360bn. In total such tariffs would amount to 4.1% of US GDP. Therefore, considering also the responses of the US’s trade partners, it is fair to say the global trade war just got serious. We would expect Trump’s counterparts to make efforts to de-escalate the situation, but with Donald involved there is certainly now a genuine tail risk for the market.
Elsewhere, OPEC agreed to boost production to make up for production shortfalls in Venezuela and Iran. The exact increase in output is not clear, as some members may not be able to meet targets, but should be in the region of 600k-1m barrels per day. Oil prices rose in response.

11 to 17 June: You can go your own way

Last week saw 3 big central bank meetings, which served to reiterate the varying fortunes of the US, Europe and Japan since the crisis.

• In the US, the FED raised rates and upgraded forecasts as they predicted 4 rate hikes for 2018 and a continuation of one of the longest economic cycles in history.
• In Europe, the ECB called an end to QE, but remained accommodative, not believing that sustained and meaningful growth and inflation are yet achievable.
• In Japan, the BOJ held firm with their “super-sized” version of unconventional policy, continuing QE and negative rates indefinitely, acknowledging that there is no sign of price growth despite almost no unemployment.

Relative to our expectations, it was the FED that caused us to pause for thought. After a dovish set of minutes to the previous meeting, the statement and projections were clearly hawkish. We think the difference lies in the time horizon; whilst 2018 could indeed see 2 further hikes, we think the pace of change will slow in 2019.

4 to 10 June: Hold on to your hats

Although the main global equity and bond benchmarks were relatively stable last week, this masked a number of large moves in underlying markets. In Brazil and Italy, politics weighed on sentiment, whilst a surprise rate hike in Turkey stemmed recent weakness. Meanwhile, the copper price hit the highest level since 2014 as Chinese imports hit the highest levels since 2000.

This week, several events have the potential to create further volatility:

• After wreaking havoc at the weekend’s G7 summit, Donald Trump will meet North Korean leader Kim Jong-un in Singapore on Tuesday.
• The FED is likely to raise rates in the US for the 7^th time this cycle on Wednesday, whilst the ECB may alter their forward guidance on Thursday by bringing QE (which has resulted in the central bank owning 22% of European government debt) to an end.

28 May to 3 June: Rolling with the punches

In a holiday shortened week for the US and UK, a veritable smorgasbord of news flow buffeted markets. Our general sense is that two of the most prominent recent headwinds for the market (US rates and the oil price) may now start to cool. With respect to the former, hikes will continue this year, but we believe FED rhetoric may turn more dovish as the FOMC digest the effects of their tightening and the ageing cycle. Indeed, slowing but still above trend growth in Europe is likely to see the ECB pause for thought as well. Similarly, OPEC members seem satisfied with an oil price between USD 70-80 dollars per barrel. This does not mean it is plain sailing; it is now reasonable to conclude that Donald Trump has become a genuine drag on the global economy, indirectly via the uncertainty created by his unorthodox style and directly via his trade policy. Moreover, European politics remains fragile with the surprise change of prime minister in Spain this week, Brexit in the UK and Italy’s unsustainable place in the Eurozone.

21 to 27 May: Hitting Rewind

Two weeks ago, the US 10-year bond yield broke decisively through 3% and the oil price (Brent) rose above USD 80. Last week, saw an abrupt “about turn” as dovish Fed minutes, continued geopolitical wrangling and speculation of easing OPEC supply restrictions, prompted the largest drop in US yields in over a year and a 7% intra-week decline in the oil price (with further declines yesterday).

Regarding oil, last Monday prices hit their highest levels since 2014 on speculation the US would impose new sanctions on Venezuela. However, after the experience earlier this decade of extreme price volatility, it appears OPEC members are keen to foster a less “boom and bust” environment. As such, later in the week both Saudi and Russian ministers talked about the prospect of increasing their production to offset losses elsewhere. Indeed, the US rig count also continued to climb.

In general, markets remain in a more volatile and difficult environment. However, it is possible last week marks a change in direction; the chief concerns of higher US rates and oil prices mitigated by a change in tone from the FED (see below) and OPEC respectively.

14 to 20 May: Bursting the Bubble

After a month long flirtation, the US 10 year decisively broke through the 3% yield barrier last week, prompting a sharp appreciation of the USD. Whilst US yields have now more than doubled from their 1.35% nadir in July 2016, this still represents an extremely low level by historical standards. Nonetheless, as we have discussed in recent weeks, the market is now clearly in a different and more volatile paradigm from that enjoyed during 2017.

The question is whether this is the end of the current expansion or just a later cycle environment. On balance, we remain in the latter camp and reiterate that the global cycle is not entirely synchronous; there are strong domestic stories for example in India, Egypt and much of Latin America. Moreover, China-US trade discussions appeared to end with a positive tone over the weekend. However, the longer-term issues of the developed world are starting to seep back to the front page, with Italy front and centre. Further, the impacts of higher rates for USD borrowers and a higher oil price more generally, will present something of a drag over coming quarters.

As regards the oil price, WTI ended little changed on the week but the Brent contracted traded above USD 80 for the first time since November 2014.

7 to 14 May: One size does not fit all

As the global economy normalises after 18 months of perfect calm, a number of flash points are emerging:

• Argentina has requested help from the IMF after a precipitous fall in its currency and facing an unsustainable fiscal position. This comes only 6 months after the country successfully sold 100 year bonds, which now trade below 90 cents in the dollar.
• The Turkish Lira has depreciated almost 15% YTD ahead of snap elections in which President Erdogan is attempting to consolidate power and where the President has stymied the ability of the central bank to raise rates.
• Italy faces an uncertain outlook, with the prospect of a populist coalition government that will only serve to amplify an already untenable fiscal position.

However, the fact that not every market is in perfect health, does not change our perception on the aggregate picture or our specific “top picks”. In Asia, China and India are outpacing expectations, in Africa the medium-term potential for Egypt and South Africa is improving and in Latin America much of the region is still enjoying favourable cyclical tailwinds.