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Weekly 16th June 2017


Highlights of the week

  • Markets: a steep increase in short-term German yields; little change in the major currencies. Credit markets generally outperformed other risky assets on both sides of the Atlantic; a slight resurgence in risk aversion.
  • Eurozone: solid improvement in jobs in Q1.
  • US: core inflation is weaker than expected and retail sales are disappointing.



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The week at a glance

Other events


The US Senate passed amendments to codify and tighten sanctions against Russia. Two points seem fundamental to us: (1) any decision by the US President (eg lowering or intensifying sanctions) will have to be approved by the Congress; (2) a huge tightening of the financing conditions for Russian companies in the energy and financial sectors.

In a context where the price of oil remains relatively low, these changes, if voted by the Lower House, will undoubtedly have a negative effect on the price of Russian assets, even as the economy returns to positive growth rates.


Economic indicators


Solid improvement in jobs in Q1. Total employment rose by 0.4% in Q1 2017 (and by 1.5% YoY). Country-by-country, the YoY increase was +1.5% in Germany, +0.7% in France, 1% in Italy, and +2.4% in Spain (based on Eurostat data). The total number of jobs (155m) is now above its pre-crisis (Q1 2008) level. The number of hours worked, however, is still far below that level.

The recovery continues to spill over into the job market. However, as the ECB recently stressed, there are still heavy excess capacities (with the unemployment rate still high in some countries and a high number of part-time workers who would like to be working full-time).

United States

Core inflation is weaker than expected and retail sales are disappointing. The consumer price index slowed in July to +1.9% YoY, driven mainly by basis effects in energy prices. However, core inflation also slowed to +1.7% YoY (it was forecast unchanged at +1.9%). This is its smallest increase in almost two years. Retail sales fell by 0.3% in May (vs. a +0.1% forecast). “Control group” retail sales, which represent consumer spending as calculated in GDP, were flat (vs. a +0.3% forecast), but rose by 0.6% in April, based on revised figures, vs. +0.2% reported previously.

Beyond temporary sector impacts that may have pushed down prices in May, core inflation has been surprisingly low for several months now, very likely driven by wages, which are sluggish despite a very low unemployment rate. This phenomenon (which is also being seen in European countries with low jobless rates, Germany in particular) is clearly due to structural changes in the job market (with jobs being created mainly in services, with a high percentage of short-term jobs) and residual excess capacities (involuntary part-time work, for example).


Turkish GDP growth released at 5% y / y in Q1 2017, higher than in Q4 2016 and expected by consensus (3.5%). 

This figure is relatively high. The main factors supporting growth were public expenditure (+ 9.4%) and exports (+ 10.6%). Household consumption remained sustained (+ 5.1%) but slightly lower than in Q4 2016 (+ 5.7%). To the extent that industrial production in the second quarter has increased sharply and retail sales have deteriorated less, growth in Q2 could be as high. In this context, our growth forecast for 2017 (+ 3.4%) could prove to be too low, especially since monetary policy seems too accommodating.


China’s May 2017 money data came in mixed. As for the May 2017 money data, new yuan loans came in better than expected, at RMB 1.11trn (vs. consensus RMB 1trn and prior RMB 1.1trn); total social financing came in slightly weaker than expected at RMB 1.06trn (vs. consensus RMB 1.19trn and prior RMB 1.394trn); M1 growth was slightly weaker than expected, at 17.0% yoy (vs. consensus 17.6% and prior 18.5%); M2 growth slowed more than expected, at 9.6% (weaker than consensus 10.4% and prior 10.5%). As for May real economic activity data, (1) China’s May fixed asset investment ytd yoy growth came in slightly weaker than expected, at 8.6% (vs. consensus 8.8% and prior 8.9%). (2) China’s May industrial production ytd yoy growth came in slightly better than expected, at 6.7% (vs. consensus at 6.6% and prior at 6.7%); (3) China’s May retail sales ytd yoy growth was in line, at 10.3% (vs. consensus 10.3% and prior at 10.2%).

The two positives from May money data are that new yuan loans are still healthy and that M1 is still 7.4% higher than M2. The market should not worry too much about the M2 slowdown. Among April real economic activity data, there are several highlights: 1/ May property FAI yoy grew at +7.3% (vs. +9.6% in April), which remains high, as we expected. Also, FAI in highway remains strong in May at 19.6% yoy (vs. +24.4% in April) 2. The improvements in industrial production in May are coal production, which recovered to +12.1% yoy (vs. 9.9% yoy in April). We continue to believe China stabilization is sustainable to the end of 2017.


India’s May wholesale prices yoy (WPI) were much lower than expected, at 2.17% (vs. consensus 2.9% and prior 3.85%). India’s May CPI yoy came in weaker than expected as well, at 2.18% (vs. consensus at 2.40%, and prior 2.99%).

The weakness in CPI and WPI was driven by lower-than-expected food prices. The May inflation reading brings it below the lower end of RBI inflation target. RBI is flagging a rate cut after its September meeting. We continue to expect RBI to hold at the current level for longer than expected, given that the US hiking cycle continues (preventing from cutting), but also because of persistent weaker-than-expected inflation (preventing from hiking).  


Monetary policy


The Bank of Canada (BoC) has clearly changed its tone to more hawkish. A speech on Monday by the Deputy Governor, Mrs Wilkins, showed that the central bank has shifted its view on economic resilience. In contrast to an interpretation two months ago, it now perceives that strong growth momentum is on track. Even though she also highlighted that inflation is still low, she stated that in the face of such strong growth the “Governing Council will be assessing whether all of the considerable monetary policy stimulus presently in place is still required”.

The BoC is stating outright that it will not cut rates anymore and that it will now think about the timing of the next tightening. Economic growth surprised positively recently and the BoC’s measure of the output gap (the key variable for the inflation outlook in the BoC’s framework) has greatly diminished. This is what makes the BoC more confident in the inflation outlook despite very weak core CPI figures (by the way, they hiked in 2010 while core CPI was weak). On the top of that, the past appreciation of trade-weighted CAD will have a less downward impact on CPI. We also note that Mrs Wilkins’ hawkish tone was confirmed by Governor Poloz and it does therefore seem that the BoC is preparing markets for an increase in interest rates soon.


The Central Bank of Russia (CBR) reduced its key interest rate by 25 bp to 9%, slightly lower than expected by the consensus, which was expecting a 50 bp decrease.

The CBR's decision to pursue its cycle of monetary easing is not surprising since inflation came in at 4.1% in May, which is very close to the target set by the CBR at 4% and that expectations are also anchored to the downside. On the other hand, the CBR preferred to exercise caution with a decrease of only 25 bp. In its press release, it points to upward inflation risks resulting from a number of factors including downward pressure on the ruble (low oil prices and the risk of tougher sanctions on the part of the United States) and economic recovery which could push wages higher. The CBR states that further rate cuts are envisaged in the second half of the year. Obviously, further monetary easing and its magnitude will be data dependent and undoubtedly on the basis of oil and ruble prices. We are therefore expecting, all other things being equal, a decrease of only 25 bp at the next committee in July.


The Central Bank of Turkey (CBRT) maintained its policy rates unchanged as expected by consensus.

In its press release, the CBRT says it remains vigilant and does not rule out tightening its monetary policy if needed. With double-digit inflation and 5% growth in Q1 2017, it seems to us that the time was right for a rate hike, especially as growth continues to be driven by domestic credit. The CBRT considers that its monetary policy is already restrictive. On the other hand, with downward pressures on the exchange rate declining sharply and oil prices falling, the CBRT believes that the rising risks to inflation have declined. Without external shock, CBRT is likely to maintain its rates at the next meeting of the committee. From our point of view, domestic price pressures are such that it is difficult to envisage a rate reduction before 2018.


Financial markets

Fixed -income

A steep increase in short-term German yields. The two-year German yield ended the week at -0.65%. This is very low and in negative territory but is still a high for more than 6 months. The week’s two big events on the bond markets happened just a few hours apart – the release of lower-than-expected inflation figures and the FOMC meeting. Nominal yields fell sharply after the first event before rising with the second: real rates rose sharply while inflation break-even points fell sharply. In Europe, Italian spreads narrowed slightly.

Inflation expectations dropped sharply with the fading of the positive oil-related base effects. This factor is unlikely to contribute any more to inflation break-even points over the next few months. Inflation break-even points are too low in Europe, but we are sticking to our positive bias on these assets. Meanwhile, we still expect European yields to rise in the second half of the year. 

Foreign exchange

Little change in the major currencies during the week. The dollar suffered a bout of weakness after the release of inflation figures before recovering after the FOMC meeting. The EUR/USD rate ended the week at 1.12. The Canadian dollar was the best-performing currency on the week, with a hawkish shift in the Bank of Canada’s guidance (see above).

Although the EUR/USD is likely to end the year higher, the rally is likely to stall with the ECB’s taking on more of a wait-and-see attitude in the coming weeks and the Fed’s show of confidence regarding the inflation outlook.


Credit markets generally outperformed other risky assets during the week on both sides of the Atlantic. Synthetic indices tightened to new lows in Europe, with CDS spreads of both high beta segments (crossover and subordinated financials) down by around five basis points. On the cash bond side, EUR HY tightened as well by around five basis points, at the time of this writing, with total returns now above 4% on the year to date. The dovish messages sent by the ECB after the last meeting clearly supported the asset class, which continues to find demand for remaining yield available in the short and medium segments of the curve. Corporate bonds were supported by the recovery in periphery bonds, with Italian spreads down by around 30 bp in just few days on the back of receding risks of snap elections. US HY spreads were generally tighter as well, but to a lesser extent than European bonds. At the same time, they felt little of the pressure on tech stocks.

The ECB’s dovish stance and lower political risk, together with positive macro trends, mean a persistent, favourable combination of fundamentals and technicals for EUR corporate bonds. The other side of the coin remains represented by valuations, which are getting tighter, as spreads further tightened. In the US, macro data are less supportive and leverage is generally higher, but the Fed remains on track for a normalization of rates, which should be gradual. Lastly, central banks will also address balance sheet management, starting to taper liquidity in the system, but the process should be gradual here as well. For these reasons we are keeping our preference for higher beta in Eurozone and IG in US credit markets.


A slight resurgence in risk aversion: Among the market highlights this week was the further receding of inflation in the US and a further decline in oil prices. These dovish signals once again raised questions on the strength of the US economy and softened the impact of Wednesday’s announcement of a new Fed rate hike. The 10-year US bond yield is near to its low on the year and barely above its levels since the election of Donald Trump. On the equity markets, this slight decline in risk appetite capped gains in the indices, with greater declines in two segments – petroleum stocks, which are sensitive to oil prices, and financials, which are exposed to deflationary risks. Conversely, sectors such as real estate and utilities rallied on the falling yields. 

The basic issue for the equity markets is now whether long US yields will continue to pull back, as that would mean the end of hopes in the reflation trade, or whether they are simply at the bottom of a trading range, which would keep the equity rally going. For the time being, the second interpretation continues to prevail. Beyond the coming quarterly results, inflation trends and headway on tax reform will be a special focus of attention.


Key upcoming events

Economic indicators


US : The manufacturing PMI should slightly increase in June. 

Eurozone: Consumer confidence should come out relatively stable in June.







Key events



Market snapshot


Letter finalised at 3pm Paris time

ITHURBIDE Philippe , Global Head of Research
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Weekly 16th June 2017
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