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Weekly 2nd June 2017


Highlights of the week


  • Markets: developed yields slightly lower (again); remarkable performances, especially by emerging markets, driven by idiosyncratic factors. Credit markets remained positively oriented; equity markets move into wait-and-see mode.
  • Eurozone: French and Italian growth figures revised upwards, unemployment down.
  • US: the unemployment rate hits a new low, despite weaker-than-forecast nonfarm payrolls.



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The week at a glance

Other events


The main political parties have agreed to amend the election law. Although they appeared to be far apart on this topic, the Democratic Party (centre-left, the leading coalition party), the Five Star Movement (anti-system, the leading opposition party) and supporters of Silvio Berlusconi (the right) have agreed to set up an electoral system inspired by the German example. Half of the deputies would be chosen on the basis of a majority-vote system and the other half based on a proportional system, but with only those parties who have obtained at least 5% of the votes being represented. This change will have to be approved by Parliament in July. The secretary-general of the Democratic Party and former prime minister, Matteo Renzi said he wanted early elections to be then held in September (rather than in May 2018, after the end of the current legislative period).

Early elections are now likely even though it could be a challenge to organize them in September, as this would be just before the parliamentary debate on the budget. The Eurosceptic forces (primarily the M5S and the Northern League) are strong, but they are unlikely to join forces, given how far apart they are on most issues. Hence, another pro-European coalition is likely to emerge from these elections but still one that will continue facing challenges in enacting the reforms the country needs. Keep in mind, however, that Italy’s economic and financial situation is gradually improving (the European Commission has just agreed to the State bailout of MPS, Italy’s shakiest major bank).


Economic indicators


French and Italian growth figures revised upwards, unemployment down. Growth in French GDP for Q2 was revised upwards from +0.3% to +0.4%, while Italian GDP growth was revised from +0.2% to +0.4%. Over four quarters, the rise in Italian GDP reached +1.2%, the fastest pace since 2010. In addition, the Eurozone jobless rate fell again in April to 9.3% (after 9.4% in March and 10.2% in April 2016). Finally, bank lending to non-financial corporations continued to recover: +2.4% over one year in April after +2.3% in March.

The upward adjustment of GDP growth for Italy, a country identified as the eurozone’s economic "weakest link” as it faces a period of political uncertainty, is truly good news. The recovery continues to spread through the job market at a steady pace. However, absolute unemployment remains high, limiting the potential for higher wages.

United States

The unemployment rate hits a new low, despite weaker-than-forecast nonfarm payrolls. The US economy generated only 138K new jobs in May (vs 185K expected and after an April figure that was revised down to 174K vs 211K previously announced). Nonetheless, the unemployment rate declined to 4.3% (vs 4.4% in April) or its lowest since Feb. 2001. The participation rate declined to 62.7% (vs 62.9%). The annual rise in average hourly earnings remained unchanged at +2.5%, and so did average weekly hours at 34.4.

Labour market figures are volatile on a monthly basis. Nonfarm payrolls are decelerating, but less rapidly than expected at this stage of the cycle (near full employment). The acceleration in wages remains moderate, even though, due to statistical reasons, average hourly earnings figure probably under-estimate the real trend.


Winning bells ring for the corporate sector.  Pretax profits soared 26.6% y/y in Q1/17, the highest spurt since  2010, on the heels of a robust 5.6% increase in sale revenue.  Manufacturers recorded a hefty 70.3% rise in profits, reflecting robust demand for iron and steel, electronic devise, industrial machines and motor vehicles.  Capital expenditure rose 4.5% in the quarter to reach the level before the Global Financial Crisis.  The level is the fourth highest in history.  Companies increased the purchase of equipment for substituting laborers along with for the purpose of capacity expansion.  

We remain bullish on the Japanese corporate sector though just less so.  Beyond the first quarter of this year, there are several economic indicators to be monitors with caution.  Exports are losing momentum in April, mirroring somber automobile sales in China and the U.S.  Industrial production jumped 4.0% m/m in April and recouped losses in the previous month.  Yet the Ministry of Economy, Trade and Industry showed less encouraging forecast in which manufacturers’ production will fall 2.5% in May followed by a limited 1.8% rebound in June.  As for capital formation, improving profitability prompts companies to accelerate spending.  Moreover labor market is extremely tight as jobs-to-applicant ratio surged to 1.48 jobs for one candidate, the highest since 1974.  Companies must aggressively proceed labor saving and automation.  

From macroeconomic aspect, consumer spending remains precarious owing to a limited hike in wage and salaries.  However encouraging is retail and wholesale companies exhibited a 24.6% gain in profits in Q1/17 backed by 7.5% rise in sales.  Retailers have improved profitability through review of lines of business, downsizing of business in rural areas, flexible personnel management, efficient delivery system and unmanned and 24-hour-operating warehouses.


China’s May official manufacturing PMI came slightly better than expected at 51.2 (vs. consensus 51.0 and prior at 51.2), remaining in expansion territory for the 10th consecutive month. However, China’s Caixin manufacturing PMI came in weaker than expected at 49.6 (vs. consensus 50.1 and prior 50.3). 


We have been saying that manufacturing PMI will stabilise within expansion territory, but the weaker-than-expected Caixin manufacturing PMIs raise doubts for the markets on whether Chinese economic stabilization is peaking. We don't think so, and we think the current weakness amounts to temporary corrections, given inventory during the restocking period in the past year. The official May manufacturing PMI remains high, while output slightly weakened (53.4 in May vs. 53.8 in April), new orders were unchanged (52.3 in May), and new export orders improved (50.7 in May vs. 50.6 in April). However, both input and output prices continue to correct, which suggests that the PPI (producer price index) continues to correct before rebounding later. We continue to believe the current economic stabilization is sustainable to the end of 2017 and most likely 2018, as well.


GDP rose by +1% quarter-on-quarter in Q1 2017, as forecast by the consensus but shrank by 0.4% year-on-year. On the supply side, industrial output rebounded by 0.9% quarter-on-quarter, and agricultural output by 13.4% quarter-on-quarter, while services were stable. On a year-on-year basis, industry and services continued to decline, by, respectively, 1.1% and 1.7%. Only agriculture expanded robustly (by 15.2%). As for spending, only exports improved (+1.9% year-on-year), and inventories played a decisive role in the GDP figure, with a 2.7% contribution. Investment dropped by 3.7% year-on-year, and private consumption, by 1.9%.


Monetary policy


The Brazilian Central Bank (BCB) cut its rates by 100bp to 10.25% maintaining the pace of April. Committee members were unanimous in this decision.

The decision to cut rates by 100bp is in line with market forecasts. For, with 4.08% inflation in April, the disinflation process is clearly under way. Even so, the press release, while not surprising to us overall, did surprise us in how explicit it was on the possibility of a lesser cut in July, due to uncertainty in tax reform. Hence, if the political context does not worsen further and the real holds up, the BCB is likely to stick to its tightening cycle. We forecast three further rate cuts: a 75bp cut in July and two other, 50bp ones by the end of 2017.


Financial markets

Fixed -income

Developed yields slightly lower (again). German and US 10 y. lost respectively 5 and 7 bps to close out the week at 0.28 and 2.18%. The drop has been exacerbated by a worse than expected job report in the US (see above). The short-end of the US yield curve flattened. Italian sovereign spreads widened slightly over the week by the higher probability of snap elections being called in Italy.

The flattening of the US yield curve in the US, with the perspective of the end of the cycle in the US. We stick to the view that German yields will be higher at the end of this year.

Foreign exchange

Remarkable performances, especially by emerging markets, driven by idiosyncratic factors. The highlights of the week were the yuan (+ 0.5%, see above) and the Brazilian real (+0.3%), helped by positive Q1 GDP figures – the fastest expansion in almost four years (see above).  Lower oil prices hit oil-related currencies, the Norwegian krone and the Mexican peso, for example, lost, respectively, 1 and 0.9% against the dollar. We also note a certain stability of the USD/JPY during the week oscillating around 111 and the EURUSD reached 1.13 on Friday, a nine-months high.

Despite Mario Draghi’s comments on Monday indicating the continuity of an easing monetary policy for some time yet, the currency’s prospects remains positive, clearly helped by growth in the region and also by the outlook for the dollar that has been clearly shifted downward:  while disappointing inflation figures raise questions about the continuity and timing of the Fed tightening, rising political uncertainty is not supportive of the dollar in the short term. This also tends to favour high-yielding emerging currencies, but in the case of the Brazilian real (BRL), it is certainly the upcoming developments of political front that are going to be decisive for the currency.


Credit markets remained positively oriented this week. The euro primary market is showing a resurgence in activity after a relatively quiet March due to the French presidential elections and the period of publication of results.

The Euro IG index widened by 5bp in the last 15 days after reaching a low at 105bps. This widening could explained by the high level of activity on the primary market. The CSPP continues to provide significant technical support to the euro credit market. The purchase of national central banks under the CSPP remains on an average of € 7bn per month. It is interesting to note that the cumulative amount of ECB purchases corresponds to the increase in the size of the market for securities eligible for the program. Credit markets should continue to perform even if the spread-tightening potential is now more limited. We continue to favor the segments that offer spread on the euro market (HY, BBB, close, sub) and we remain cautious on the lower rated issuers of HY US.


Equity markets move into wait-and-see mode. After gaining +15.4% over one year (excluding dividends) and +7.9% since the year began, the MSCI World AC Index levelled off this week, awaiting the results of the upcoming Fed and ECB meetings. This lull is especially understandable given that Wall Street recently reached new heights. Meanwhile, doubts about the U.S. president’s leadership were ultimately pushed to the background by an outstanding earnings season. Overall, the markets remained calm, with the exception of Milan, which fell last Monday (-2.1%) due to the possibility of early elections. These could be held as soon as this September instead of May 2018. More particularly, this renewed uncertainty weighed down Italian banks, down 2% to 5%.

The Q1 2017 earnings season was exceptional, and the next two quarters will continue to benefit from bases for comparison that do not pose much of a challenge, especially in the eurozone. After reaching such heights, though, it will be increasingly difficult to deliver upside surprises. To move forward, Wall Street will have move past the contradictory messages from the Fed and the fixed-income market. The central bank is preparing to continue raising key interest rates while 10-year government bonds remain in the low end of the range. We expect that the acceleration in US growth in Q2, the continued decline in unemployment, and the gradual increase in wages should allow Wall Street to hold steady. However, with US equities so expensive, this should mainly benefit the other regions - first and foremost, the eurozone.


Key upcoming events

Economic indicators


United StatesThe non-manufacturing ISM should remain stable in May.

Eurozone: GDP in Q1 2016 is expected to be at the same level as GDP in Q1 2016.







Key events



Market snapshot

Letter finalised at 3pm Paris time

ITHURBIDE Philippe , Global Head of Research
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Weekly 2nd June 2017
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