The past month has shown debtor nations with excessive net foreign liabilities and dependent on external capital are vulnerable to the Fed tightening policy and reining in US dollar liquidity. At this point in the cycle we continue to favour positioning portfolios in creditor nations and countries with net foreign liabilities less than 50% of GDP: IMF research indicates levels above this threshold are associated with increasing risk of external crises.
We’ve seen a fairly muted market response following the end of a relatively more hawkish FOMC meeting last night where, as largely priced in, the Fed hiked rates by 25bps, to 1.75%-2.00%. Of note, however, was the flattening of the UST curve, which saw the 2s10s spread fall below 40bps to September 2007 levels (at time of writing). Meanwhile, the dollar took a tumble; this could also be due to the reignition of US-China trade tensions which we expect to hear more on as both sides have said they will publish tariff lists as early as tomorrow.
It seems this week there have been a number of reminders for politicians and businesses that they can’t have their cake and eat it too:
First, senior officials at the EU were reportedly rubbishing the Shadow Brexit team’s ‘commitment’ to retaining single market benefits whilst demanding restrictions on the free movement of people. One member of the European Commission dismissed Labour’s plan as ‘cakeism’.
With the Fed widely expected to raise interest rates by a further 25 basis points at the end of its two day meeting on Wednesday, it might be tempting to think of it as a non-event. However, as we have been highlighting for at least the past year, it’s not just interest rates that matter, the size of the Fed’s balance sheet is also an important factor. Whether we get much clarity on this aspect from this meeting remains to be seen but it is something we will be watching closely; here’s why.
Well, as they say, never a dull moment. We have come from fire and fury to little rocket man insults and competing claims over the size of their nuclear buttons on one side of the Pacific Ocean, to the leader of the free world broadsiding North America’s oldest and closest friends at this weekend’s G7 summit on the other. Donald Trump pulled no punches over the weekend at the G7 in Canada, accusing Justin Trudeau, the Canadian Prime Minister of making ‘false statements’ in addition to refusing to sign the joint communique which states that the G7 ‘acknowledge free, fair, and mutually beneficial trade is a key engine for growth and investment, while creating reciprocal benefits, are key engines for growth and job creation’ as well as committing to the modernisation of the World Trade Organisation (WTO).
Recent economic data for Chile has been encouraging. In Q1 the economy grew 4.2% yoy, its fastest rate in the past 4 years, although this is coming off a low base in Q1’17. The domestic sector was robust expanding 3.8% yoy and fixed investment continued to recover growing 3.6% yoy. Exports gained 7.2% yoy adding to growth: the mining sector expanded 19.3% yoy helped by a recovery in the copper price. The OECD also recently raised its 2018 GDP growth forecasts for Chile to 3.6%.
Brannan made (although eventually lost) his fortune promoting and equipping the Gold-Rush-Hype, Bloomberg his billions equipping us for the Financial-Information-Age… and more recently Bitmain has made billions dominating a new market selling ‘mining’ equipment to the modern world: everyone from the teen-tech-savvy-crypto-enthusiasts to someone’s grandmother who saw a ‘bit-thingie’ advert in last month’s Reader’s Digest (possibly) as well as inconceivably large institutions mail-ordering a – or a few hundred-thousand – Bitmain mining-rigs.
This morning, the euro rose to a 10-day high along with sovereign yields across the EU as ECB Chief Economist, Peter Praet gave a rather typical presentation outlining the journey and challenges of “Monetary policy in a low interest rate environment” to the “Congress of Actuaries” in Berlin (I know, how did we forget to put this in the diary?). His formal remarks, as usual, were dry but a good synopsis of the factors and thinking that have guided the Central Bank’s current policy stance: highlighting the “innovative and bolder measures” particularly their “Asset Purchase Programme (APP) [which] has been the pivotal component of [their] strategy for countering and reversing the crisis.”
Bahrain's economy is expected to grow by 3.2% this year, according to the IMF’s Mission to Bahrain findings; a pick-up in oil prices and increased non-hydrocarbon sector output has supported growth. However, the nation's economy remains strained, especially versus its neighbours. The IMF warned of “a rise in fiscal and external vulnerabilities”, adding that the nation’s “deficit is projected to remain sizeable, with a rising interest bill as public debt continues to increase”; public debt stands at roughly 85% of GDP currently.
The G7 is no more… it's now the G6 + 1 as French Finance Minister Bruno Le Maire called it, warning ‘Unfortunately, we are being treated to a G6 + 1, with the United States squaring off against the rest and risking the economic destabilization of the planet’. Of those in the remaining G6, you can take your pick of who is the most outraged with the US Administration over trade tariffs and protectionism (indeed, not just the G6), asking Steven Mnuchin, US Treasury Secretary, to jointly convey their ‘unanimous concern and disappointment’ about the situation to his boss.
Today’s May non-farm payroll release showed 223,000 jobs added which was above expectations of 190,000 jobs created although the previous month’s figure was revised down by 5,000 to 159,000. The unemployment rate edged lower to 3.8% versus the prior month’s reading of 3.9% and the participation rate eased 62.7% from 62.8%. Average hourly earnings were slightly above expectations at 2.7% yoy compared to the previous month’s figure at 2.6% yoy.
How time flies, it’s the European Central Bank’s 20th anniversary tomorrow and it appears the latest financial scare within its jurisdiction, in President Mario Draghi’s homeland Italy, has calmed for the moment. In fact, the rally in 10-year Italian government bonds which started yesterday is extending today, up a further 2.5 points, at the time of writing. Since 15th May the benchmark has moved between 1.94% and 3.13%, and currently trades at 2.65%, quite a week for the bond dealers involved.
Holders of Italian 2-year debt brought new meaning to the idea of “paying the price for volatility” given that (until a fortnight ago) they actually prepaid – in negative yields – for the privilege of exposure to Italian market risks. In May alone, Italian short term yields went from -0.15% to close yesterday at 2.70%; 185bps of this 285bps move occurred yesterday. This was unprecedented and equates to 18 standard deviations beyond the average daily move over the past decade (which itself was quite high during the Eurozone Crisis of 2011/12).
We recently wrote a daily on the renminbi-denominated oil futures platform, Dalian Commodity Exchange (DCE), which since its launch has proven to be quite popular with a number of international players signing up almost immediately. Although there is still some way to go in order for RMB-denominated commodity contracts to be more widely accepted internationally, sources have reported that global RMB-contracts in iron ore have spiked this month since the launch of the DCE platform, accounting for roughly 12% of total global trade currently.
In February 2014 Stratton Street highlighted a list of countries likely to suffer a ‘dip’ in fortunes, these are countries where weak fundamentals have been ‘brushed’ aside or ignored, but are nonetheless vulnerable. A backdrop of deleveraging, with the Fed normalising rates and tapering bond purchases, ‘paints’ a very negative view for countries with large net foreign liabilities, otherwise collectively known as "PAINTBRUSH". These “PAINTBRUSH” countries, in no particular order of level of concern, are Poland, Australia, Indonesia, New Zealand, Turkey, Brazil, Romania, Ukraine, South Africa and Hungary.
USTs rallied last night with the shorter dated 5-year most noticeably leading the move; which resulted in a slight steepening of the yield curve. This happened even though there was a $36bn issuance of a new 5-year benchmark bond auction which went ‘ok’ compared to recent deals. The move at the shorter end came after the May 2nd FOMC minutes were released with little change in guidance for the second half of the year in regard to further hikes, but a further hike, in June, was left on the table. The rally in rates was across the curve with the 5-year dropping 7.4bps and the 10-year fell 6.6bps into the US close.
“Survey shows highest support for the EU in 35 years” – the triumphant, if not misleading, words of a EU Parliament publication today – exactly one year before the European elections in 2019 (you know, the one we Brits won’t be involved in). A survey by Eurobarometer that covered almost 28k people from all 28 EU countries showed that “two thirds of Europeans believe their country has benefited from being a member of the EU” and “consider EU membership a good thing”. Great! I suppose no one needs to be concerned that yields on 2-year Italian debt has doubled in the past month because, on the whole, Italians must still be enamoured with the Union if Europe-wide support for the EU is at its highest since measurements began in 1983…
So far this year some of the top performing currencies against the dollar are the offshore and onshore Chinese renminbi, and the Japanese yen. At the time of writing, the offshore renminbi is up ~2.5% and the yen has gained 1.45% against the greenback. On the other side of the spectrum the Argentine peso, Turkish lira and Brazilian real are amongst the worst performers year-to-date; having fallen roughly 23.5%, 16.5% and 10%, respectively.
Over the last week the International Monetary Fund (IMF) has been pushing the EU to agree a debt relief programme for Greece so to ensure that the fund has enough time to start giving the country money. The IMF director for European affairs, Poul Thomsen, warned ‘Time is running out’, however, he did go on to say ‘but if there is an agreement in the Eurogroup meeting in May, then there will be enough time for us to activate the program and for it to coincide with the remainder of the ESM (European Stability Mechanism) program’ Not that EU seem to be taking much notice of the call for urgency, believing the decision on any Greek debt relief is up to two months away according to Valdis Dombrovskis, who has the impressive title of European Commission Vice-President for the Euro and Social Dialogue.
I envision at least three serious long-term consequences of current policy blunders for the US economy. First, at some point, public deficits will crowd out the nascent recovery in private investment – perhaps not this year but by 2019 the burden of financing public debt will begin to interfere with private financing, especially if the private sector is expected to finance public infrastructure projects. Over a longer horizon, the burden of debt will shift to the younger generation whose earnings prospects already are below those of their parents