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Weekly 27th January 2017


Highlights of the week


  • Markets: Interest rates move up; the dollar depreciated slightly. Spreads are relatively stable on the euro and dollar corporate bond markets; Dow Jones breaks 20,000 points for the first time!
  • Eurozone: Slight dip in the business climate in Germany.
  • United States: GDP growth slightly below forecast in Q4.



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The week at a glance

Other events


Triggering Brexit will have to be approved by Parliament. On Tuesday 24 January, the UK Supreme Court ruled that the government must hold a vote in parliament before invoking Article 50 of the Treaty of Lisbon, which governs the exit of a Member State from the EU (recall that the UK Prime Minister said she would invoke Article 50 before the end of March). However, the Supreme Court ruled that no consultation of the Scottish Parliament was required.

This verdict will not prevent the government from triggering the Brexit process. Parliament had already let it be known that it supported the Prime Minister’s timeline. However, increased involvement by Parliament could facili-tate attempts from certain MPs to push for a softer Brexit than the one that the government (officially at least) is seeking.


The Constitutional Court approves the electoral law The Italian Constitutional Court approved most provisions of the new electoral law, one of the reforms put forward by former Prime Minister Matteo Renzi. This law enables any party winning more than 40% of the vote to be allocated 55% of the seats in Parliament. However, one of the provisions (that a second round be organized if no party wins 40% of the vote) was rejected. This law only applies to the Lower House and not to the Senate, reform of which was rejected in last December’s referendum.

The Constitutional Court’s verdict increases the likelihood of early elections, which many parties are calling for. The removal of the provision for a second round makes is less likely that an anti-euro party will gain control of Parliament, but more likely that governments will have to rely on fragile coalitions, or even that there could be inconclusive elections with a hung Parliament.


Economic indicators


Slight dip in the business climate in Germany. The preliminary eurozone PMI stayed at a high level in January, at 54.3 (vs. 54.5 anticipated and 54.4 in December). Activity picked up slightly in manufacturing and dipped a little in services. France’s composite PMI rose, while Germany’s fell. Also in Germany, January’s IFO index was down to 109.8 (vs. 111.3 anticipated and 111.0 in December). Its current business situation component rose slightly, but the expectations component slid. Finally, in France, the INSEE manufacturing business climate indicator remained stable and relatively high.

German business climate indicators may be reacting to the rising uncertainty surrounding US economic policy. Notwithstanding these jitters, we do not think it is enough to alter our scenario of a continued recovery in the eurozone.

United States

GDP growth slightly below forecast in Q4. US GDP advanced 1.9% in Q4 (annualized figure, vs consensus at 2.2% and Q3 growth at 3.5%). Personal consumption increased by 2.5%, government consumption by 1.2% and investment by 2.4%. International trade brought a negative contribution of -1.7pp while inventories brought a positive contribution of 1pp.

US quarterly growth figures are very volatile and often extensively revised. The deceleration from Q3 is not that significant, as Q3 growth included a large positive base effect due to weak H1 2016 figures. Investment is slowly recovering. The strong dollar may have played negatively on the contribution of international trade, but not to the extent that it would be the main culprit for such a large drag, which certainly has more to do with volatility and statistical factors.



China’s Q4 2016 real GDP growth rate provided an upside surprise at 6.8% yoy (vs. consensus and previous-ly 6.7%), with the full-year 2016 real GDP growth rate at 6.7%, which is exactly in the range of the government’s target of between 6.5% to 7%. China’s December 2016 real economic activity data came in virtually in-line. (1) China’s Industrial Production yoy growth came in slightly weaker than expected at 6.0% (vs. consensus 6.1% and previously 6.2%); (2) China’s Retail Sales yoy growth provided an upside surprise at 10.9% (vs. consensus 10.7% and previously 10.8%); (3) China’s Fixed Asset Investment ytd yoy growth came in slightly weaker as well at 8.1% (vs. consensus and previously both at 8.3%).

Among the December 2016 real economic activity data, there are two highlights: 1. The improvements seen in industrial production in December are Crude Steel (+3.2% yoy), and power generation (+6.9% yoy). 2. December Property FAI yoy grew stronger than the market expected at +11.1% (vs. +5.7% in November), which corroborates our call that property investment will be much better than the market expected given restocking is in great demand especially in Tier 1 cities. The stabilisation in the Chinese economy in 2016 is a big surprise to the market, evident especially from the real GDP data. However, given both bottom up and top down factors, the Chinese economy certainly showed strong resilience in 2016, as we have called from October 2015. We continue to believe Chinese economic stabilisation is sustainable through to end-2017 given a political transition year where economic, political and social stability are of the utmost importance.



Monthly indicators for December came on mix. Industrial production grew by 3.2% yoy above consensus (1.7%) and November data (2.7%). Real wages increased by 2.4% higher than consensus (1.5%) and November (2.1%). Labor market continues to improve with unemployment rate at 5.2% versus 5.4% the previous month. Retail sales surprised to the downside (-5.9%) as consensus expected a lower decline (-3.7%) and compared to November’s release (-4.1%).

Supply side factors seemed to rise whereas demand side ones are still lagging. However, growth outlook remains positive for 2017 and upside risks are surging.


Real GDP growth was higher in November (3.7% yoy) than in October (1.3%) and expected by the consen-sus (2.5%). On a seasonally adjusted terms the recovery appeared less dynamic: 2.4% yoy in November up to 2.1% in October. Services sectors and private consumption has been the main driver of growth. Retails sales grew a robust 11.2% yoy in November versus 10.1% in October. The unemployment rate released at 3.37% in December. Annual headline inflation printed at 4.78% yoy mid-January up from 3.24% during 2H December driven mostly by higher energy prices.

The carry-over for year 2016 is now 2%. However, for the coming months, growth outlook remains a source of concern as the policy-mix is tightening, household purchasing power is deteriorating with inflation rise, and senti-ment indicators are eroding following the outcome of the US election and the uncertainties around the NAFTA. We still expect that a firm labor market, solid growth in workers’ remittances and the positive effects of the deprecia-tion on competitiveness will partly offset the negative factors.


Monetary Policy


The Bank of Japan (BoJ) unexpectedly skipped a regularly scheduled outright purchase of short-term JGBs on 25 January. The surprise action annoyed investors and yields on 2-year and 10-year JGBs advanced by 3.5bp from the previous day. The central bank, however, increased the purchase of middle-term JGBs on 27 January. These operations can be interpreted favourably that the BOJ is showing greater flexibility in conducting outright purchases to smooth the shape of the yield curve.

The BOJ explains the purchase of 1- to 5-year bonds was skipped due to supply-demand balance and the out-come of recent market operations. This may be true, since the BOJ scaled up the purchase of 5- to 10-year bonds later on. Nevertheless, market participants remain sceptical, and the 2-year yield was pinned at -0.20%, compared to -0.24% on 24 January, and the 10-year at 0.08% vs. 0.045% on the 24 January. Irresistible apprehension has been amplified by the BoJ’s upgrade of its regional economic assessment released the previous week. The up-ward revision is likely to lead to stronger views on GDP and CPI in its semi-annual outlook, due out on 31 Janu-ary. At moment, CPI ex-fresh food registered the smallest y/y contraction in December, although the barometer had been declining on a y/y basis for 10 months. The monetary authority is highly unlikely to abruptly taper its purchasing program as long as the core CPI stays below zero. Yet there is no surprise that uptrend in consumer prices, coupled with tighter labour market and sanguine equity price will lead to a slight amendment in monetary policy. Core CPI is expected to emerge in positive territory in February at the earliest.


The South African Reserve Bank (SARB) held its policy rate unchanged at 7%.

The decision was in line with expectations as the inflation outlook in South Africa has deteriorated due to elevated and persistent food and energy prices. The communique has adopted an hawkish tone but we don’t expect the SARB to hike rate in the coming months as the economic growth remains very low.


The Central Bank of the Republic of Turkey (CBRT) raised its overnight lending rate by 75 bp to 9.25% and its late liquidity rate by 100 bp to 11% but maintained its repo rate unchanged at 8% while consensus was expecting a minimum increase of 50 bp.

These moves followed a series of other measures but are still non-conventional. As markets expected a clear and consequent hike of the repo, we don’t expect that these measures will help to stop the collapse of the Turkish lira. Beyond the pure financial aspects, the CBRT is also playing its credibility. Even though the CBRT has mentioned in its statement that it will “use all options available to pursue price stability”, markets become more and more skeptical on the independency of the CBRT especially as President Erdogan has often mentioned his hostility to increase interest rates that are deteriorating growth outlook.


Financial markets


Interest rates move up. In particular, the German 10-year rate is approaching 0.50% for the first time for one year, while its French equivalent has definitely moved past 1% (ending the week at 1.02%). The 10-year US rate ended the week at 2.49% (note that half of the interest rate increase comes from the real yield, with the other half due to the breakeven inflation rate). In Europe, French and Italian spreads widened a little, unlike the Spanish risk premium, which remained relative stable.

The declarations of Sabine Lautenshläger, member of the ECB Board, on a possible exit of the QE programme can partially explain the rise of the German yields. We expect a slight rise of long-term yields in the coming weeks, in Europe and in the US. In Europe, inflation-linked bonds should overperform nominal bonds.

Foreign exchange

The US dollar depreciated slightly. The effective exchange rate on the dollar fell by 0.6% over the week. The EUR/USD exchange rate closed out the week at 1.07. The Turkish lira is still doing poorly, posting the worst performance of the week. In contrast, the Mexican peso turned in the week’s best performance.

The evolution of major currencies continues to be dictated by the long-term rates differential. A fresh move of long-term yields rise would be negative for the yen as the BoJ targets the 10y. yield at 0%.


Spreads are relatively stable on the euro and dollar corporate bond markets. This resilience is especially remarkable in an environment in which long bond yields are rising. Note also the heavy volumes of new issuance on the euro corporate bond market.

Following Donald Trump’s victory, investors raised their US inflation and growth expectations. The reaction on dollar corporate bond markets was highly positive. Bonds prices continue to rise, but it is important to ask how long this trend will continue. It is hard to anticipate the impact of the Trump administration’s measures on the US economy. The stimulus will come late in the cycle and in an environment in which global growth is especially weak. An excessive appreciation in the dollar or a further rise in interest rates would undermine US growth, given that US companies are quite heavily indebted. Curiously, potential changes in taxation could be an incentive for companies to deleverage late in the cycle!

In Europe, better growth prospects also contributed to the narrowing and stability in spreads. At current spreads, there is little potential for further narrowing, especially in the case of CSPP-eligible bonds.


The Dow Jones breaks 20,000 points for the first time! US equities have broken records on multiple occasions over recent months. However, the 20,000-point barrier broken by the Dow Jones is the most symbolic and a testament to the Trump effect which, three months after he was elected, continues to drive the markets. As such, Thursday evening, the MSCI World AC had risen +1.1% since the beginning of the week, including +1.2% in the United States and the eurozone and as much as +1.7% in the emerging markets. More broadly, year-to-date, the global index has gained +2.4%, including +1.6% in the eurozone, +2.8% in the United States and as much as +4.4% in the emerging markets, which were hit hard at the end of last year. Finally, since the election on 8 November, we have seen simultaneous take-offs of the equity markets (+7.6% for the MSCI World AC), the dollar and interest rates.

After the equity market rally in late 2016, 2017 started off on a positive note. However, an increasing number of parties are highlighting the uncertainties of the current environment – how much of Trump’s campaign rhetoric will he actually implement as President, how far will rates rise, will inflation really pick up again, and what about elections in Europe, etc. – and how expensive the markets are. The very sharp rebound in earnings expected in 2017 should calm these fears though. Consequently, given the lack of alternatives, the equity markets are expected to experience further upside phases before consolidating. As such, we do not think the time to take profits is upon us just yet. However, the expected increase in earnings on the one hand, and the dollar and long rates on the other, will be key variables in assessing the opportunity to become more defensive at any given time.



Key upcoming events

Economic indicators

Eurozone : GDP Q4 is expected to improve slightly. US : unemployment rate should stay stable in January.







Key events




Market snapshot





Letter finalised at 3pm Paris time

ITHURBIDE Philippe , Global Head of Research
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Weekly 27th January 2017
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