A broadly positive week across asset markets witnessed volatility collapse; the VIX Index traded near all-time lows through most of last week, and on Thursday the Merrill Lynch Move Index dived to its lowest level since it was first published in 1988. The Move Index measures the volatility on one-month UST options based on the 2,5,10 and 30-year benchmarks; the Index has fallen ~34% so far this year. With the upcoming central bank summer lull approaching, asset markets once again clung onto any indications of monetary policy tweaks last week; muted inflation pressures remained the overriding theme.
The ECB surprised the market with a relatively dovish statement, leaving both rates and QE unchanged; with Draghi stating that recent data prints have confirmed a strengthening economy. Following the mini taper-tantrum post-Sintra, Draghi appeared to blame the market for its over-interpretation over his comments on ‘reflation’, he stated that although risks are broadly balanced, inflationary pressures remain weak. The all important QE taper was not addressed, however, Draghi said tightening too early could jeopardise recovery; stating the central bank must be persistent, patient and prudent. The Jackson Hole gathering in late-August may bring some more colour, in the meantime markets are looking for a September taper announcement - at the earliest - in preparation for a Q1’18 move. The more cautious tone did not slow the euro’s continued assault against the dollar; rallying to a two year high. So all-in-all pretty much a non-event in terms of new information, in-line with the earlier BoJ meeting, where the central bank maintained its policy stance off the back of painfully low inflation; and once again pushed expectations for a pickup in inflation to 2%, into FY’19. Should be interesting to see what the BoE says next week, after the ‘disappointing’ June CPI reading; 2.6% versus expectations for +2.9%; it seems the ‘Brexit-effect’ is making hard work of predicting inflation going forward.
This week’s data flow was kicked off with Japan’s preliminary manufacturing PMI reading for July, down from June’s level, but remaining in expansionary territory, at 52.2. Later we will also get the initial PMI releases for the eurozone. There is not much in the way of key data until Q2’17 final UK GDP on Wednesday, on Friday job sector prints and CPI will be watched closely in Japan, and eurozone confidence reports will be of interest, especially after the recent bullish sentiment in the region.
This morning we heard that the IMF has cut its forecasts to UK growth this year to 1.7% resulting from recent ‘tepid growth’, adding that ‘The ultimate impact of Brexit on the United Kingdom remains unclear.’ The Fund’s economic counsellor, Maurice Obstfeld went on to say that although global growth recovery is firmer, as a result of stronger expansion from the likes of China, the US’ growth downgrade is significant. Growth forecasts for the world’s largest economy were markedly cut to 2.1% for 2017 and 2018, from 2.3% and 2.5% respectively, ‘because near-term US fiscal policy looks less likely to be expansionary’.
Staying with the US, the Russia-Trump developments coupled with the Trump-administration’s inability to get the latest iteration of the healthcare bill passed did little to help the dollar back on its feet. Doubts over whether the president will be able to move forth with his fiscal reform agenda have somewhat increased. As such the DXY Index continued its relentless slide to year lows, falling 8.2% ytd by Friday's close, and US Treasuries enjoyed a bounce with the 10-year benchmark yield falling 10bps to 2.24%. A pretty heavy data week ahead kicks-off later today with the Markit PMIs, along with existing home sales. On Tuesday the main bit of data will be the Conf. Board consumer confidence reading, which the market expects will have slipped slightly in May. Thursday will see some property sector data, and the July FOMC meeting, where no rate hike is expected, however, markets will be listening closely to any taper chat. Chicago Fed National Activity Index will grab some attention on Thursday afternoon, especially after the weak reading in May. Then on Friday the second quarter GDP figure will be of interest, expected at an annualised 2.6% qoq, and of course the Fed’s favoured Core PCE reading will garner some attention. Political events will be watched closely this week, starting with Trump Jr. and Kushner’s testimony in front of the Senate intelligence committee, over Russia’s alleged involvement in last year’s US election.
Also last week, the US-China Comprehensive Economic Dialogue (CED) appeared ‘unfriendly’ with no joint statement released, and the closing news conference was called off. Separate statements were released later, with both countries stating a willingness to work constructively and cooperatively. As the world’s two largest economies strive to re-mold their trade-relationship in an attempt to prevent a trade war, the one bit of good news was that after a decade of toing and froing, the US will now be able to ship rice to China; the largest producer, consumer and importer of the commodity. Further trade developments will no doubt be watched closely by the market in the coming week.
Back to China, economic data releases remained robust, taking a number of market makers by surprise. China’s economy expanded by 6.9% yoy H1’17, against market expectations for 6.8% growth, industrial production and retail sales numbers also surprised to the upside. Stronger domestic demand coupled with the stable manufacturing sector, off the back of a marginal pick-up in global growth conditions, have helped maintain stability amid the government’s push to deleverage, in support of the real economy. The renminbi remained stable against the CFETS basket, and strengthened against the dollar over the week helped by strong macro data, increasing fx reserves, and recent comments from the president reiterating the need to keep the exchange rate basically stable at a reasonable equilibrium level. We continue to view the renminbi as being undervalued and expect longer term appreciation against the broadly weaker dollar, especially as market confidence in the renminbi appears to be strengthening, with devaluation expectations shrinking. Markets will also be looking to further updates on the government's public sector deleverage push, where last week President Jinping stated that local governments and state-owned enterprises will come under scrutiny to reduce borrowing.
As for our portfolios, the risk-on sentiment helped boost positions across the board. A rally in crude coupled with improved sentiment - off a positive rating report by S&P - saw holdings in the sovereign and quasi-sovereign space receive a boost. The Middle Eastern region also benefitted from the the stabilisation of oil prices; the Qatar curve had a bias of strength at the long-end, thus flattening. Our sovereign and quasi-sovereign holdings are trading at year-to-date averages, and continue to offer attractive risk adjusted returns, with ~4 notches of credit cushion. This week, we expect markets will be keeping a close eye on the developments within the region, after the announcement last week that Qatar had made changes to its anti-terror rules.