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Weekly 24th February 2017


Highlights of the week


  • Markets : Sharp drop in German yields and widening in sovereign spreads; the dollar stuck to its adjustment process and was down against all major currencies. IG and HY euro bond spreads seem to be ignoring the political risk from French elections; equity markets continued to perform well.
  • Europe: Europe : Very good business climate indicators.
  • US: Existing home sales up.



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The week at a glance

Other events


The European Commission is cautious in its review of economic imbalances in member-states. In present-ing its member-country review on Tuesday 21 February, the European Commission showed some restraint in identifying the “excessive imbalances” that member-states are asked to rectify. It was especially kind to Germany and the Netherlands (despite the very heavy current account surpluses), but pointed the finger at six countries – France, Bulgaria, Croatia, Italy (which just barely escaped an excessive deficit procedure), Cyprus and Portugal.

The European Commission went easy on Germany, the Netherlands and Italy to avoid stoking tensions in an uncertain political environment. As for France, the Commission took note that it had made some headway in shrinking its public deficit public but that that it would keep a close eye on the promises made by the next govern-ment.


Economic indicators


Very good business climate indicators. The euro zone Flash PMI Composite rose to 56 (vs. 54.3 forecast and 54.4 in in January), driven by both manufacturing and services. The PMI also improved in Germany in manufac-turing and services. In France, it rose in services but fell in manufacturing (while remaining in expansion territory). The IFO indicator of business confidence in Germany also improved, to 111.0 (vs. 109.6 forecast and 109.9 in January). It rose in both its current conditions and future expectations components. In France, INSEE’s manufac-turing confidence indicator came to 107, a 10-year high. Meanwhile, Q4 2016 German GDP growth was confirmed at +0.4%, while UK GDP growth was revised upward (to +0.7% vs. +0.6% previously announced).

The least you can say is that the economy is confident against the backdrop of the high political uncertainty sur-rounding the 2017 election agenda (with elections in the Netherlands, France and Germany and possible elec-tions in Italy). But let’s not get carried away. The February indicators may be overestimating the strength of the economy and 2017 is loaded with lots of potential pitfalls.

United States

Existing home sales up. Sales of existing homes were surprisingly high in January (at 5.69m vs. 5.54m forecast and 5.51m in December). February Flash PMI estimates, however, slipped to 54.3 vs. 55.3 forecast and 55 in February in manufacturing, and to 53.9 vs. 55.8 forecast and 55.6 in January in services).

While not offering as much upside surprise as their Eurozone counterparts, US figures on the whole remain solid so far this year.



The Mexican GDP grew 2.4% yoy in Q4 2016, better than in Q3 (2%) and as expected by consensus (2.2%). In 2016, Mexican GDP has increased by 2.3%, slightly less than in 2015 (2.6%). The tertiary sector remains the main factor supporting growth. On the other hand, the drop in mining and oil and the slowdown in manufacturing production continue to weigh on Mexican growth.

The election of D.Trump has complicated the task of the Mexican authorities and in particular of Banxico. Following the sharp fall of the peso, the Banxico has been constrained to drastically raise its rates in order to anchor inflation expectations even though the economy had already decelerated. The tightening of the monetary policy certainly does not bode well, but this effect may be temporary. In particular, the reaction of the markets was undoubtedly excessive. Besides, the peso has regained all that he had lost after the election of Trump. We there-fore maintain our scenario of a 2% growth in the Mexican economy in 2017.


Monetary Policy


Unsurprisingly, the BCB lowered its key rate by 75 bp to 12.25%. The press release focused on several points. Regarding inflation, the BCB believes that it should continue to decline in particular because the fall in food prices constitutes a supply shock favorable to the economy. However, although the discourse is slightly less negative than previously, the BCB continues to raise uncertainty about the external environment as a limiting factor and stresses the importance of adopting and implementing budgetary reforms necessary for the consolida-tion of the Brazilian economy.

The press release therefore suggests that the BCB should continue its monetary easing cycle without at this stage foreseeing an acceleration. It is therefore likely that the BCB will again reduce its rate in April by 75 bp. The con-sensus is for a Selic at 9.5% by the end of 2017. Without major external shock, with a more than gradual recov-ery, the BCB could well go beyond. We do not exclude that the Selic could fall below 9% by the end of 2017.


Financial markets


Sharp drop in German yields and widening in sovereign spreads. The 10-year German yield dropped to 0.20%, a year-to-date low, while the two-year yield hit a new all-time low (-0.95 %). The 10-year France-Germany spread ended this week almost where it ended last week, while the CDS premium hit a high since August 2013. Italian and Spanish spreads widened significantly. In addition, euro inflation break-even points gave up a little less than 10 basis points on the week.

As we mentioned in the editorial, European bond markets will continue to be driven in March and April by political events, and peripheral and semi-core bonds will remain under pressure, feeding into a decline in German yields, as the Bund serves as a safe haven.

Foreign exchange

The dollar stuck to its adjustment process and was down against all major currencies. The Mexican peso was the highlight of the week, gaining 3.2% against the USD, following a decision of the Banxico to introduce a hedging program, offering up to $20bn in FX hedges in order to support the peso. The measure seems to be well accepted by the markets, as the USD/MXN broke through the 20 per dollar floor for the first time since the US elections. The South Korean won and the Turkish lira also had outstanding performances, gaining 1.35 and 1.09%, respectively. The euro was relatively stable, fluctuating around the 1.05-1.06 level and finished the week at 1.06. The yen also appreciated slightly (0.6%) to 112.

The Banxico’s hedge facility program is another intervention measure adopted by the central bank in the year in order to support the MXN. In January, the central bank intervened in the spot market, which was perceived by markets as a “risky strategy” to defend a currency under pressure, as such action could fast blow the international reserves of the country. The hedge program has the advantage of not having an impact on international reserves (as it is settled in pesos) and may give some support to the currency. That said, we believe this is for the very short run as: i) a worse-than-expected outcome in trade negotiations could result in large shifts in the MXN; and ii) domestic challenges in the country, such as lower growth expectations, low oil production and the current account deficit do not offer any relief to the currency. Moreover, it is important to highlight that the currency’s better per-formance was also supported by the weakness of the USD, which seems to have its performance more tied to political news - concrete news on the fiscal package is highly expected - as recent good data flows and a more hawkish Fed have failed to support the currency.


IG and HY euro bond spreads seem to be ignoring the political risk from French elections. Despite the widening in the France-Germany spread, IG and HY euro spreads have remained stable.

IG and HY euro bond spreads seem to be ignoring the political risk from French elections, even though the French elections will also be a decisive event for the euro credit markets over the coming weeks. Spreads on euro-denominated corporate bonds could widen in the event of heightened sovereign risk and/or a reduction in the ECB’s purchasing pace. Clearly, euro bond markets will continue to be driven by political risk and the direction of ECB policies.


Equity markets continued to perform well. They were still being buoyed by good numbers on economic activity in Europe and Japan (PMIs were very high and exceeded expectations).

Investors chose to be optimistic while awaiting elections in the Netherlands and France, as well as the US budget slated for release in mid-March. This budget will tell the Fed which policy to adopt. Yet for now, the reflationary environment (recovery in growth and inflation) is promising for equities, despite the overvaluation of the US market.



Key upcoming events

Economic indicators

  • US: GDP is expected to accelerate in Q2. 
  • Eurozone: Manufacturing PMI and CPI should remain stable in February.






Key events



Market snapshot



Letter finalised at 3pm Paris time

ITHURBIDE Philippe , Global Head of Research
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Weekly 24th February 2017
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