A better week across credit markets saw the yield on the 10-year US Treasury fall a couple basis points to 2.397%. Hard/soft Brexit chatter continued to dominate headlines which saw sterling fall a further 0.85% whilst the FTSE 100 Index climbed to new all-time highs by the end of the week. Donald Trump and his relentless Tweeting also grabbed some attention, and markets appeared taken aback after his press conference on Wednesday; where there was very little clarity on future policy.
Meanwhile, Steven Mnuchin, Mr Trump's choice for US Treasury secretary is looking to achieve US GDP between 3% and 4% over the coming period, a big change from the around 2% per annum we have seen since 2009, of course we await details of how this will be achieved. We do have Mr Trump’s election promises of infrastructure spending, tax cuts and incentives for American companies to bring offshore funds back home. However, we also expect trade friction and of course immigration issues, which may result in tighter policies on entering the US, and of course a number of undocumented residents being ejected. The difficulty is, in order to achieve this level of growth there needs to be a huge rise in productivity and indeed a big jump in the US workforce, without these elements GDP cannot accelerate. On the surface the immigration policy appears to be in the opposite direction of what the economy requires.
Indeed US demographics are not very good. As mentioned the economy has grown about 2% a year since 2009 while the population has only grown by 0.76% per year, down from 0.93% in the decade to 2008 and the situation is on a downward sloping trend. So productivity challenges since the end of the global financial crisis have been hit by the headwind of demographics moving in the opposite direction. The US will also see fewer domestic consumers buying goods, which equates to less price pressure, leading to a decline in investment in aging plants and equipment - ultimately witnessing falling productivity; the opposite of Mr Mnuchin’s forecast.
Another big story last week, was the Central Bank of the Republic of Turkey’s supposed ‘intervention’ in stemming the lira’s collapse. Despite the lira plummeting over 5.3% so far this year to new lows against the dollar (in addition to the 17.2% collapse last year), the ‘behind-the-curve’ central bank has yet to intervene on a meaningful scale, most probably out of fear. The CBT last week highlighted its concerns over the lira’s slide, and added ~USD 1.5bn of FX liquidity, and cut reserve requirement ratios across the board by 50bps. The central bank’s willingness to act against the fx mismatch saw the currency briefly fall from record highs, but we are not sure this ‘small token’ will be enough to stem further deprecation. A more substantial policy response is required via a rate hike or through further intervention, although reserves are quickly depleting.
Turkey's long-term rating was downgraded to junk in 2016 by both Moody’s and S&P last year, while Fitch maintained its investment grade BBB- rating, with a negative outlook. Having been classed an EM gem since before the financial crisis, investors appear to be falling out of bed with Turkey; a country which we have never been keen to invest in, mostly due to it’s low 2 star net foreign asset ranking, but also because we had previously seen very little relative value in the country. We would rather invest in similarly rated Russian holdings, where we view the fundamentals as being much stronger. State-owned Pemex 6.625% 2035, is also a compelling holding, offering just under 6 credit notches of protection against unforeseen events, while Turkey quasi-sovereign issues, on average, trade only 3-4 notches cheap, with a high likelihood of further downgrades.