Half a year gone… how time flies when you are having fun… It was all fun and games last week as markets attempted to deconstruct new-found central bank hawkishness. Speaking in London last week, Fed Chair, Janet Yellen remained true to herself divulging very little in the way of monetary policy updates saying ‘raise interest rates very gradually’; although other Fed chat was more hawkish. One thing of interest that equity markets did react to was Yellen’s statement regarding the ‘somewhat rich’ asset valuations. Vice Chair, Fischer also voiced his concerns over the ‘rise in valuation pressures’ adding that although leverage across the system does not appear to have increased, the situation should be monitored.
No new information was provided regarding the unwinding of the balance sheet, however the market is still looking for a September announcement. We suspect the Fed (although the wording has been dulled down) to still remain data dependant, especially with the recent mixed economic data, and the central bank also appears wary of the Trump-administration and its ability to maintain economic and political stability. To this point, the IMF appeared to mock the US administration's growth estimates calling them ‘extremely optimistic’, adding that ‘Even with an ideal constellation of pro-growth policies’ it is unlikely that it will result in a 1% boost to GDP. GDP forecasts were therefore revised lower to: 2.1% for 2017 and 2018 from 2.3% and 2.5% respectively. In the same report, the IMF appeared to warn the Trump administration against devolving cross-border trade practice, stating the move could result in ‘downside risk to trade, sentiment and growth’. However, on the back of the more hawkish Fed rhetoric, and broader positive market sentiment towards global growth, although still subdued - alongside lackluster inflation - the yield on the 10-year UST bounced 16bps higher to 2.31%. The dollar (DXY Index) however remained on the back foot falling 1.69% over the week; despite the stronger Chicago PMI reading and an improvement in the university of Michigan sentiment on Friday.
US economic data has remained mixed, with the likes of the preliminary durable goods orders and mortgage application readings missing estimates. The Chicago Fed National Activity Index also surprised to the downside, falling -0.26 (versus expectations for +0.2). The final read for Q1’17 growth however improved to 1.4% driven by stronger personal consumption, while the Fed’s favoured PCE Core Index fell to a disappointing 1.4% yoy. A data heavy week ahead will start with PMI and ISM readings for June, market consensus is for an improvement in ISM manufacturing to 55.2. On Tuesday, markets will be relatively quiet with the US out celebrating the 4th July holiday. On Wednesday the final factory and durable goods orders will grab some attention before the release of the June FOMC minutes; nothing profound is expected to be divulged. ADP employment change will be watched closely on Thursday ahead of the much anticipated employment releases due on Friday, where markets expect that 177k jobs were created in June, unemployment was unchanged at 4.3%, with a marginal gain in average hourly earnings. Also on Friday the Fed will release its Monetary Policy Report, ahead of Fed Chair Yellen’s testimony next week (12th July), this will no doubt be of some interest; with markets also looking for any further clues from the likes of the Fed’s Bullard, Powell and Fischer who speak this week.
Moving back to central banks, the ECB had to backtrack a little last week after Draghi sounded particularly optimistic, signalling that the central bank could look to taper its (EUR 2.3tn) bond-buying program; the EUR rocketed after these comments to a year high against the dollar and bund yields tracked higher. Off the back of the unexpected knee-jerk market reactions, the ECB appeared to calm the excitement saying that the central bank’s policy stance is currently unchanged though slightly more hawkish than the previous minutes, also highlighting the lack of inflationary pressures and the slack in the labour market remains a concern. The BoE also appeared more hawkish, with Chief Mark Carney suggesting that some removal of monetary stimulus could become necessary, as higher economic growth could eventually lead to a rate hike; sterling surged against the dollar on the back of this, closing the week above 1.30. The final reading for UK Q1’17 GDP came in line with expectations at 0.2% qoq, thus 2% yoy.
In Europe, this week’s data comprises of the euro area's final manufacturing PMI print, which was released this morning, marginally higher at 57.4, and the unemployment rate in May remained unchanged at 9.3%. The EC’s PPI release on Tuesday will be of some interest, expected to have fallen in May. The euro area's Markit PMI and retail sales readings follow on Wednesday, with German trade data and industrial production in France and the UK releases on Thursday.
Meanwhile, the Chinese renminbi had a positive week, with the offshore currency gaining 0.82% against the dollar. Industrial profits were up in May and PMI data was released stronger than expected and well in expansionary territory. The Caixin manufacturing PMI print released this morning beat market expectations, hurdling into expansionary territory once again. The China Beige Book International (CBBI) last week showed that although the property sector has cooled slightly, the rest of the economy has continued to improve; with the likes of manufacturing and retail strengthening, alongside an expansion in hiring and increased revenues across Chinese firms. This is all positive news ahead of the 19th Party Congress in mid-October.
In the meantime news reports suggest that Chinese and Russian companies are set to sign a multitude of business deals during President Xi Jinping’s two-day visit to Russia this week; said to be worth ~USD10bn. Also on the table will be the discussion on ‘deepening the relations of comprehensive strategic partnership and cooperations and strengthening political trust between the two countries’, according to Lu Kang, China's foreign ministry spokesman. The country’s commerce ministry has said that as much as USD 80bn worth of Sino-Russian trade deals will be in operation by the end of this year.
So expect a busy week ahead for China, especially as ‘Bond Connect’ is set to launch today (which also marks Hong Kong’s 20th anniversary of the handover), Bloomberg expects it will be ‘the world’s biggest-ever financial product offering. This is a new platform designed to allow foreign investors access to the USD 9.4tn China-Hong Kong Bond Market without a quota or other technical hurdles. This development coupled with improved accessibility will no doubt see the EM bond indices either include China (e.g. JP Morgan), or increase their holdings in the bond markets. On the data front, Caixin released a series of stronger PMI readings for June this morning and on Friday we will have an idea of the country’s FX reserves which are expected to remain above USD 3tn.
Elsewhere, as the Qatar-Gulf situation continues to unfold, it was a pretty quiet week with the region celebrating Eid. Price movement was marginally changed at the long-end of the curve, where we are holders, while the short-end suffered further selling pressure, as it has since the onset of the ‘crisis’. We heard this morning that Qatar has been given a 48 hour extension to comply to the Saudi-led demands; Qatar have maintained that it is willing to enter into a dialogue, but is not willing to put its sovereignty at risk; which is how it has interpreted the list of 13 demands. Foreign ministers from Saudi Arabia, Bahrain, Egypt and the UAE are set to congregate in Cairo on Wednesday to discuss the situation further. We will continue to monitor the developments and currently remain comfortable with our holdings in the region.