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Weekly 24th March 2017

 

Highlights of the week

  • Markets: US yields fell; the US dollar was relatively stable. Credit index spreads widened this week; a slight loss of power on equities after a long upswing. 
  • Eurozone: the business climate continues to improve.
  • US: orders for durable goods increased in February.

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The week at a glance

Other events

Eurozone

The UK will trigger the Brexit procedure on Wednesday 29 March. The UK government announced that Prime Minister Theresa May would trigger Article 50 of the Lisbon Treaty on Wednesday 29 March. Article 50 governs the procedure for a member-country to leave the European Union. Under Article 50, the UK’s exit would, in principle, become effective two years later. On Wednesday 22 March, Michel Barnier, the EU’s official Brexit negotiator, said some “difficult times” were ahead. He said that several issues would have to be dealt with before talks could begin on a future free trade agreement, particularly on the UK’s “evening the ledger” and the issue of expatriates on both sides.

There is still little visibility on the future framework of relations between the UK and the EU. If the EU indeed makes settling difficult separation issues a prerequisite for beginning talks on a future free trade agreement, it may leave little time to negotiate the latter (even the entire 2 year period looks a bit short for this purpose). And the election calendar in France and Germany doesn’t make things any easier. Remember that for the Europeans, the objective is to achieve a trade-off between maintaining good trade relations with the UK and the wish to keep the UK from benefiting from overly favourable conditions which might encourage Eurosceptic political movements in other countries.

 

Economic indicators

Eurozone

The business climate continues to improve. According to its Flash estimate, the euro zone’s PMI Composite index improves again in March vs. February (to 56.7 vs. 56 in February and 55.8 forecast), thus pointing to very robust expansion. The improvement came in both industry and services. Equivalent indicators for France and Germany also rose. In France, however, the INSEE business climate indicator slipped while remaining at a high level (104 vs. 107 in February). And nominal wages rose in the euro zone by 1.6% year-on-year in Q4 (vs. +1.5% in Q3). The increases were +2.9% in Germany, +1.5% in France, +0.1% in Italy, and +0.2% in Spain.

There was lots of good economic news in the euro zone in Q1. So rising political risks do not seem to be under-mining the recovery. Higher wages in Germany, even higher than in other major countries, should help rectify the major imbalances in international trade between the member-countries.

United States

Orders for durable goods increased in February. They were up +1.7% (vs expected +1,2% and after +2.3% in January). However, orders ex-defense and ex-aviation (used to forecast corporations’ capital spending) retreated -0.1% (vs +0.6% expected). New home sales beat forecasts in February (at 0.59m vs. 0.56m forecast and 0.56m in January, based on annualized figures). But this was not the case of existing home sales (5.48m vs. 5.57m forecast and vs. 5.69m in January).

These figures are highly volatile but, on the whole, economic figures remain positive in the US. The recovery is continuing. Whether it accelerates will depend on the ability of the new President to deliver at least part of his promises.

Japan

 

Low interest rate and efforts of reinvigoration boosted property price. Nationwide land price for all purpose rose by 0.4% y/y last year, for the second consecutive year of increase. The ascent was marginally accelerated from 0.1% in 2015. Commercial land in particular climbed 1.4% as recovery in corporate earnings prompted companies to expand premise while low interest rates stimulated real estate investment. Prominent cities in local areas have recorded much higher annual appreciation than the 3 largest cities – Tokyo, Osaka and Nagoya since 2013. In 2016, the core suburban cities advanced 6.9% whereas the 3 mega cities gained just 3.3%.

As for residential properties, price rose for the first time in 9 years. Low mortgage rate and tax cut on mort-gage fueled housing investment in regional areas. The regional hubs posted a 2.8% gain while the 3 big cities marked a meagre 0.5% increase. Developers became aware of rising acquiring costs in the major cities.

PM Abe’s determination to rejuvenate regional economies and subsequent dispersal of transportation infrastructure ultimately stimulated property price. The government actively extended super express. In the meantime local railways introduced luxury saloon trains and airline low-cost carriers increased routes. Land developers increased construction of restaurants, shops and hotels in provinces, expecting better accessibility will bring more foreign tourists and business persons. In this process, a substantial number of regionally-focused REITs were generated to chase relatively high returns. 

 

Monetary Policy

Russia

The CBR decreased its key rate by 25 bps to 9.75%.

This decision was not self-evident because the tone of the last press release urged rather caution due to external and internal risks. The CBR justifies its choice by two factors: (i) a more pronounced slowdown in inflation and (ii) lower expectations of inflation. The CBR announces that if inflation and activity conditions are met, it will continue its easing cycle. It is therefore likely to expect a further rate reduction at the next committee to be held on 28 April.

 

Financial markets

Fixed-income

US yields fell, as doubts arose on President Trump’s ability to implement reforms. The 10-year US yield lost 8bp, to 2.42%. The 10-year US/Germany spread moved below 200bp. In Europe, credit risk premiums fell sharply in sovereign bonds. In particular, the 10-year spread between France and Germany moved slightly below 60bp.

The fact that the Fed showed greater caution on 15 March (with no increase in growth forecasts) and that there are growing doubts on Donald Trump’s ability to make progress on reforms are likely to keep US yields from rising. In Europe, however, an easing in political risk could pull German yields slightly upward.

Foreign exchange

The US dollar was relatively stable. Notable strong and weak performances in the week were by: i) the Japanese yen, which gained 1.4% against the USD, reaching the 111 level, a four-month high; and ii) the Australian dollar, which lost 1.1% against the dollar. Both movements were closely related to concerns that the new Republican healthcare bill would not pass in the US House of Representatives and lower US yields. Also remarkable was the strong appreciation of the GBP/USD (+ 0.6%) to 1.247, a one-month high. The pound was supported by better-than-expected retail sales data which increased the rumors that the BoE has room to increase interest rates soon. The Brazilian real was the worst-performing currency (-1.2%), due to rising concerns of fading support for the planned pension reform. The euro was stable around 1.08.

The outcome of the vote on Trump’s Obamacare reform bill scheduled for Thursday and postponed to Friday is going to play a decisive role in the dollar’s short-term performance. A failure on it would signal that the governments’ ability to approve meaningful changes and significant policies – including the highly-expected US fiscal package - might be compromised. This would certainly be very negative for the US dollar at least until tax reform passes, if it does, in Congress (there is talk that it may be passed by August).

Credit

Credit index spreads widened this week. High yield underperformed investment grade on the euro and dollar markets. HY nonetheless remains the best-performing segment on the year to date.

The outperformance of high beta segments is due to investors’ great expectations for growth. The overall level of confidence in the US economy has risen considerably since Donald Trump was elected president of the United States. Investors quickly priced in an acceleration in growth from the new administration’s policies. At the same time, more cautious FOMC members have not included fiscal stimulus assumptions in their economic scenarios. They are forecasting growth of just 2% in 2018, vs. almost 2.5% by the consensus. The acceleration in growth expectations, combined with highly accommodating financing conditions, constitutes an ideal configuration for risky assets. Doubts on the new president’s policies or a toughening in financing conditions would inevitably lead to an adjustment in valuations.

Equity

A slight loss of power on equities after a long upswing. It is interesting to note that this time-out has more to do with the debate over the budget in the US and the questioning of protectionism after the G20 than with the political debate in France. Furthermore, year-to-date performances have been very close between the US (+5%) and the eurozone (+4.2%). The emerging markets have broken away from the pack somewhat (+12%) while catching up from their end-2016 underperformance after the US presidential election.

The equity markets, which accelerated their gains after the US election, are now overbought, which is resulting in some outflows. On the face of it, though, nothing is serious for the moment, because the economy's nominal recovery is reflected in an actual recovery in profits, while discussions between the US presidential administration and Congress will not be concluded before the summer. 

 

 

Key upcoming events

Economic indicators

  • United States : GDP Q4 is expected to be slightly better. 
  • Germany: IFO business climate should be stable.
2017-03-24-weekly-economic-indicators

 

Auctions

 

2017-03-24-weekly-auctions

 

Key events

2017-03-24-weekly-key-events

 

Market snapshot

2017-03-24-weekly-market-snapshot

 

Letter finalised at 3pm Paris time

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