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Weekly 09th June 2017


Highlights of the week

  • Markets: German interest rates stable, US rates slightly up; The UK elections outcome hit the pound. European corpo-rate bonds were driven by a supportive sentiment; equity markets still calm.
  • Eurozone: Q1 growth revised upward.
  • US: a dip in the non-manufacturing PMI; the job market remains robust.



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The week at a glance

Other events


The first round of the French legislative elections will be held this Sunday, 11 June. This is a two-round single-member-district vote. To win election in the first round, candidates must obtain more than 50% of the votes cast and at least 25% of the votes of registered voters. Candidates are eligible for the second round only if they obtain at least 12.5% of the votes of registered voters.

Voter turnout will be decisive. If it is low there will be few three-way and four-way contests in the second round, something that would help out La République En Marche, President Macron’s movement. Polls point toward an absolute majority for the movement. Even if it does win an absolute majority, the government will still face a daunt-ing task, given the diverging stances on political issues and the sheer number of reforms planned in unemploy-ment benefits, the labour code, pensions, etc.


Economic indicators


Q1 growth revised upward. Eurozone GDP rose +0.6% in Q1 (compared to the previously announced +0.5%). This is the biggest quarterly gain in two years. GDP grew 1.9% year-on-year (since Q1 2016). During the quarter, household consumption increased by +0.3%, public consumption by +0.4%, and investment by +1.4%. The con-tribution from foreign trade was nil, due to a rise in imports (+1.3%) very near that in exports (+1.2%)..

Positive economic news continues to build in the eurozone. Our GDP growth forecast for 2017 (+1.6%), which had been raised recently, now seems a little low (the ECB has just raised its own forecast to +1.9%), and we are probably going to increase it again. It is hard to see what could break the momentum of this recovery over the short term. The focus is more on underlying inflation, which is still not increasing (just +0.9% year-on-year in May)..

United States

A dip in the non-manufacturing ISM; the job market remains robust. The non-manufacturing ISM fell slightly to 56.9 (vs. 57.5 in April), which is still high. Its employment component jumped to 57.8. In addition, the number of job openings rose dramatically in April to 6.04m (from 5.78m in March), which is an all-time record.

Despite changing political tides, the economic recovery sails on. Growth will probably rebound temporarily in Q2 after a disappointing Q1. The pace of GDP growth is still trending at roughly 2% per year. It could hold steady in 2018 (probably with the support of modest tax cuts) before sinking slightly, with long-term productivity and popula-tion trends pointing in the direction of 1.5%.


Revised Q1 GDP figures are misleading. The Cabinet Office released the revised Q1 GDP figure, which was not quite as upbeat as the initial estimate. Real GDP rose at an annualised pace of 1.0%, compared to the initial 2.2% estimate. The latest figure is the lowest since Q4/2015. However, end domestic demand is solid if the contribution of inventories is excluded. Inventory drawdown took 0.4 percentage point out of GDP. Consumer spending, which boosted growth by 0.7 percentage point, was driven by strong purchases of durable goods such as autos and home appliances. Business investment was also resilient, pushing up Q1 GDP by 0.4 p.p. 

Nonetheless, the economy appears to have reached a plateau after galloping at above its potential since the beginning of 2016. This may sound odd, given that industrial production and retail sales rose in April by 4.0% m/m and 1.4% m/m, respectively. However, producer inventories have risen in four straight months and the inventory-to-shipment ratio is at a nine-month high. Business confidence consumer services such as retailing and home builders slipped to 46.9 in April and May (50: neutral) from its 47.4 first-quarter average. The landscape will lead to stable GDP growth in Q2 on the back of inventory pile-up and tepid consumer spending.


China’s Producer Price Index (PPI) momentum continued in May 2017. In terms of price data, the May 2017 PPI came slightly weaker at 5.5% (vs. consensus 5.7% and prior 6.4%), and CPI yoy came in line at 1.5% (vs. consensus 1.5% and prior 1.2%). In terms of trade data, China’s May 2017 export growth yoy in CNY terms came in better than expected at 15.5% (vs. consensus 14.3% and prior 13.5%), while import yoy growth in CNY terms surprised on the upside as well at 14.8% (vs. consensus 8.3% and prior 11.9%). In terms of FX reserve data, China’s May 2017 FX reserve came in slightly better than expected at US$3053.6bn (vs. consensus US$3046bn and prior US$3029.5bn), by adding US$24bn in May 2017, the fourth straight month of increase.

Within the May China price, trade and FX data, there are several highlights: 1. PPI remained relatively high at 5.5%, and we believe it will gain momentum again after the current destocking is over. 2. Imports remained strong in May 2017 in iron ore at 5% yoy growth (vs. -2% in April), coal imports at 17% yoy growth (vs. 32% in April), and crude oil at 15% yoy growth (vs. 6% in April). We continue to hold the view Chinese economic stabilization will be sustainable in 2017 and very likely into 2018.

South Africa

For the second consecutive time, GDP shrank by 0.7% quarter-on-quarter in Q1 2017, vs. the +0.8% con-sensus forecast. Technically, that means that South Africa has slipped into a recession. However, year-on-year growth came to 1%, in line with the consensus.

This poor performance of the South African economy is due mainly to weakness in manufacturing. On the ex-penditure side, household consumption was undermined by a very high level of unemployment and wage stagna-tion. Public consumption also declined but to a lesser extent. Investment continued to rise but at a slower pace. This figure backs our scenario of weak, 0.8% growth in 2017.


Monetary policy


The ECB reiterated its downward bias on key rates, citing in particular the receding in deflationary risks. In its introductory press release, the ECB is now saying that that key rates will remain at current levels for an extended period of time. The ECB raised its growth forecasts and lowered its inflation forecasts. In particular, the ECB lowered its core inflation forecasts slightly for 2018 and 2019.

The ECB faced a tough challenge in its communication – reiterating its downward bias on rates while maintaining a highly accommodative bias. This challenge was made easier by its lowering of core inflation forecasts. Discus-sions on rolling QE over into 2018 are expected to begin in September or October.


Financial markets

Fixed -income

German interest rates stable, US rates slightly up. German and US 10-year yields closed out the week at 0.27% and 2.22%, respectively. Breakeven inflation is down again: in the US, the 10-year breakeven inflation rate fell below 1.80%, which had not happened since the American elections. In the eurozone, sovereign spreads contracted slightly this week after the ECB's Governing Council meeting. The 10-year spread between France and Germany fell below 40 bps for the first time since November 2016.

Most likely there is an excess of pessimism priced into the short end of the US yield curve. The two-to-five-year segment has not been this flat since last summer. Short-term, then, we may see another slight steepening in this segment. In Europe, breakeven inflation seems to have corrected too far downward.

Foreign exchange

The UK elections outcome hit the pound in the week. The GBP lost 0.3% against the EUR, hitting a three-month low after results of UK general election pointed to a “hung” parliament, in which no single party has the majority (see editorial). Politics were also the main driver of the Mexican peso, the week’s top-performing curren-cy. The outcome of regional elections according to which President Enrique Pena Nieto’s political party (PRI) held onto the governorship in the state of Mexico, the country’s most populous state, gave support to the currency, as these elections are perceived as a pre-indicator of the 2018 presidential elections. The USDMXN gained 2.5%. The EURUSD almost 1% and the USDJPY was quite stable around the 111 level.

The ECB’s reiterating of its ultra-accommodating tone in monetary policy, together with the downward revision in core inflation expectations for the euro zone (see above) weighed (slightly) on the currency’s performance. That said, macro fundamentals for the currency remain positive, but we can possibly see an accommodation on the short run. In particular, depending on the Fed’s MP statement next week, the USD might gain some strength. As for the pound, we expect increasing volatility in the coming weeks, at least until we have more clarification on the political course.
Regarding the Mexican peso, it is important to note that politics may become an important driver for the curren-cy in the medium run – although the president’s party (PRI) is projected to win the regional elections in Mexico’s most important state, the victory against the leftist party (Morena) is expected to be quite narrow. This together with corruption scandals, weakening economic growth, and soaring violence may point to a tight presidential election next year and, thus, a possible change in the course of the current reforms.


European corporate bonds were driven by a supportive sentiment over the week: spreads moved marginally tighter in both cash bonds and synthetic indices for most of the week, waiting for clues from the ECB meeting. Single-name stories played quite a role, as well, especially in the financial sector, following the news coming from Spain: initial market reaction of subordinated spreads was to the upside, but the following trading session saw spreads coming down to starting or lower levels. On the other side of the Atlantic, spreads were stable within the IG area, while HY risk premia were just marginally higher over the week: a positive sentiment remains in place in the US credit markets, on the back of supportive technicals and the cautious attitude of the Fed in terms of rate normalization cycle.

The very last numbers published by the ECB on CSPP volumes confirmed that the central bank “tapered” corpo-rate bonds purchases less than other asset classes. ECB corporate bonds portfolio, in fact, increased by a total value of EUR 15.2 bln in April and May, therefore by more than EUR 7 bln per month. This is a lower number than the average EUR 8 bln of previous months when total QE purchases were in the EUR 80 bln area, but any-way quite a good number in the new “regime” of EUR 60 bln monthly purchases. This is to say that the ECB looks committed to support its latest purchase programme, launched just one year ago and this approach comforts a scenario in which the tapering may affect more asset classes in which ECB “weight” is already at remarkable levels. At the moment, in fact the ECB own just around 12% of eligible corporate debt, while for example the comparable weight in the covered bonds or supranational bonds is more than double. In a nutshell, technicals, together with improved fundamentals, should continue to support the asset class, despite tighter valuations.


Equity markets still calm. Since the start of the month, equity market performance has remained very stable. For the major markets, returns ranged from +1.5% for the Topix to -0.3% for the FTSE100. For now, swings in oil prices are not influencing the big picture. The key US market continues to grow despite being overvalued. The first reaction of the UK market to the election is moderate and logical: a gentle rise of the FTSE100 (more internation-al) and some profit taking on the FTSE250 (more domestic).

The markets have no catalysts. Corporate profits rebounded in the first quarter and could continue to benefit from a favourable base of comparison until the third quarter of this year. However, we will have to wait until the next earnings season (July) to get a clearer idea. In addition, rates are low enough to keep the US market overvalued, but not yet low enough to raise concerns about the deflationary risk returning. Ultimately, after a stellar start to the year, the risk-reward trade-off is worsening, although there is no major cause for concern at this stage.


Key upcoming events

Economic indicators


US : Industrial production should have decelerated in May.

Eurozone: Inflation is expected to decrease in May relative to the May 2016 level.

2017-06-09-weekly-economic indicators






Key events

2017-06-09-weekly-key events


Market snapshot

Letter finalised at 3pm Paris time

ITHURBIDE Philippe , Global Head of Research
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Weekly 09th June 2017
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