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Weekly 30th June 2017


Highlights of the week

  • Financials Markets: Yields were up sharply in developed economies; the euro rose sharply on Mario Draghi’s re-marks. Euro and dollar credit spreads are near five-year lows; little change this week, but significant sector rotation.
  • Eurozone: economic confidence is at its highest level; headline inflation slowed, but underlying inflation rebounded.
  • United States: Q1 GDP growth revised upwards.




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The week at a glance

Other events



The public prosecutor, Rodrigo Janot, charged the president Michel Temer with corruption on Monday. This move was highly expected and was made after the release of the final investigation report by the Federal Police (PF) indicated the crimes of i) corruption and also ii) obstruction of justice. According to Prosecutor Janot, there is “abundant” proof that the president received bribery money and Temer acted “in violation of his duties to the State and to society”. However, it is important to note that for Temer to go on trial, the Lower House of Con-gress must first approve Janot’s charge by a two-thirds majority and the president has been working in the past few weeks with his allies to ensure that he can stop the process.

While there is a good chance that this process will be blocked in Congress (Temer has the majority), this indicates that the political crisis as well as its political wear on the government will remain for some time yet and, as such, might delay the structural reforms: this scenario has hit agents’ growth forecasts for 2018 as they have been revised down weekly since the outbreak of the crisis. Regarding the USD/BRL, the currency depreciated slightly - after the news (-0.2%) and -1.2%% over the week - as these charges were highly expected. That said, any sur-prise news on the political front will be crucial for the currency’s path.


Economic indicators



Economic confidence is at its highest level. The European Economic Sentiment Indicator reached 111.1 in June (vs. 109.5 expected and after 109.2 in May). This is the highest level for nearly 10 years.

Headline inflation slowed to 1.3% in June (after 1.4% in May) but underlying inflation rebounded to 1.1% year-on-year (vs. 1.0% expected by the consensus and 0.9% in May). Headline inflation slowed mainly because of the slowdown in energy price inflation. However, the price of services has accelerated significantly (+1.6% year-on-year).

The series of pleasant economic surprises continues in the eurozone. All the evidence suggests that growth was strong in Q2, after an already robust Q1 (+0.6% vs. Q4 2016).
Regarding core inflation, temporary factors played a part in June (the timing of German holidays impacted prices in the tourism sector). However, it seems that the recovery is starting to bring a modest upward pressure on core inflation. This trend will probably continue in H2, although at a subdued pace: excess capacities that remain in the labour market continue to limit increases in wages. Unless there is a major change in oil prices, the base effects on energy are no longer likely to significantly impact headline inflation for the July to September figures.

United States

Q1 GDP growth revised upwards. According to the third estimate, real GDP increased at an annual rate of 1.4% in Q1 (vs. 1.2% under the second estimate), higher than the +1.2% consensus forecast. The upward revision from the second estimate is due mainly to a greater contribution of household consumption (+0.75 vs. +0.44 pp) and heavier exports (+0.82 vs +0.69 pp), which were partially offset by lower private investment (+0.60 vs +0.78 pp).

GDP growth ultimately came out slightly higher than suggested by the disappointing Q1 figures. GDP growth is expected to rebound temporarily in the second quarter, still supported by private consumption. While 2018 GDP growth will depend on upcoming tax cuts, long-term productivity and population trends would point to a GDP growth rate in the direction of 1.5% afterwards.


Industrial production is drifting with a lack of direction. Output fell 3.3% m/m in May, virtually in line with market forecasts. Shipments of capital goods climbed 2.1% to the highest level since January 2015 whereas shipments of consumer goods plunged 4.2%, reflecting a sharp 7.4% contraction in durables. Manufacturers’ output is expected to rise 2.8% in June, followed by a 0.1% decline in July.

Production appears to stand out if we smooth out monthly fluctuations (January: -2.1%, February: +3.2%, March: -1.9%, April: +4.0%). However, inventories have accumulated since December last year while shipments have edged down 0.6% since then. We are relatively optimistic about business investment but recent anaemic data leave us cautious about consumption. Capital formation is about to accelerate with the capacity utilisation rate running above 80%. Moreover, receding global political and geopolitical risks are encouraging companies. In contrast, cutbacks in summertime bonus payments and extremely slow growth in regular payments are weighing on households. Retail sales grew 2.0% y/y in May, compared to 2.6% for the consensus and 3.2% in the previous month. We have to be careful that relatively strong y/y prints are in reaction to the events in the same period of last year, i.e., the earthquake that affected the southern part of Japan and the emissions test cheating by Mitsubishi Motors and subsequent plunge in auto sales in April last year. Precarious readings for consumer prices also indicate the vulnerability of personal spending. The consumer barometer of the Tokyo metropolitan area was unchanged from a year earlier in June, slowing from +0.2% in May.


China’s June official manufacturing PMI came in much better than expected at 51.7 (vs. consensus 51.0 and previously 51.2), remaining in expansion territory for 11 consecutive months.

We have been calling continuous manufacturing PMI stabilisation within expansion territory. The June official manufacturing PMI remained at a very high level, where output rose strongly (54.4 in June vs. 53.4 in May), new orders improved significantly (53.1 in June vs. 52.3 in May), and new export orders also increased (52 in June vs. 50.7 in May). And as we expected, purchasing prices rose significantly too (50.4 in June vs. 48.9 in May). As we expected, PPI weakness is temporary due to excessive inventories, and after destocking, it will move back up again. We continue to believe the current economic stabilisation is sustainable through to the end of 2017 and most likely into 2018 as well.


Monetary Policy



The Brazilian Central Bank (BCB) revised down its annual inflation target for 2019 and 2020, cutting it from 4.5% to 4.25% and to 4%, respectively. This was the first cut in the target since 2005. Among other things, the BCB stated that (i) consensus inflation expectations pointing to inflation of around 4.25% for longer horizons represent an opportunity to set the inflation target for 2019 and 2020 at lower values than the one estab-lished for 2018 and that ii) such a move is an important step towards moving towards lower inflation rates in a gradual and consistent manner in order to minimise risks and be sustainable over time.

The move is the central bank’s attempt to bring interest rates to lower levels: the country has one of the highest real interest rates in the world. The lower inflation environment and especially inflation expectations anchored at lower levels certainly provides room for this and such action was highly expected among economic agents. How-ever, we note that such action in the current context of a deepening of the political crisis can be considered at least as ‘strange’, as i) the government has insisted that they have ‘gains on the economic front’ to survive the corruption scandals and ii) the central bank stated ‘ongoing reforms’ (which are certainly being delayed) as one of the factors that favours such a change.


Financial markets


Fixed -income

Yields were up sharply in developed economies. Ten-year German and US yields rose to 0.46% and 2.29%, respectively. The 2-5-year section steepened and inflation break-even points rose in both Europe and the US. Sovereign spreads mostly shrugged off Mario Draghi’s remarks.

Although yields were up this week, sovereign bonds are still too overpriced in both the US and Europe. The mar-ket is pricing in excessively low inflation expectations and, we feel, is underestimating FOMC members’ determi-nation to undertake further Fed Funds hikes over the coming 18 months.

Foreign exchange

The euro rose sharply on Mario Draghi’s remarks. The EUR/USD came back to 1.14 and the euro’s effective exchange rate monitored by the ECB moved back to levels not seen since late 2014 (prior to the QE announce-ment). The yen was the week’s biggest loser (- 0.7% on the week vs. the dollar), with the USD/JPY moving back to 112. The USD/CNY parity fell once again to a low since the US elections.

The euro’s gains this week are only a first taste of what we expect in the coming quarters. Our EUR/USD target 12 months out is 1.20. The yen’s shift during the week shows how much the BoJ’s 0% yield target is making the yen dependent on long-term rates in the US.


Euro and dollar credit spreads are near five-year lows. German yields rose this week on Mario Draghi’s remarks pointing towards a normalisation in monetary policy in 2018.

Corporate bonds have ridden a highly favourable environment so far this year. Investors are confident in global growth and the market is still hoping that monetary policies will remain accommodative during the coming quarters. However, central banks’ arguments as to why monetary policy has to be so accommodative have evolved. For example, the Fed is increasingly citing risks of financial instability driven by the sharp decline in risk premiums on the equity and corporate bond markets. We continue to keep a close eye on the most heavily leveraged issu-ers, as they are the ones that will be most vulnerable to a toughening in financing conditions or a decline in their revenues.


Moderate change this week, but significant sector rotation. Last week featured a rally in oil prices (+5%), higher bond yields and a stronger euro (+2% vs. $). Oil rallied on the simultaneous announcement of a reduction in US crude output and US gasoline inventories. The surge in yields on both sides of the Atlantic is due mainly to the receding of downward pressures on inflation, as oil prices rise. And in the euro zone Draghi’s more hawkish than usual tone provided an additional boost to yields and the euro.

Against this backdrop, the spectre of tapering had contrasting effects on the equity markets. Among markets, the MSCI EMU, penalized by appreciation of euro, lost 2%, Europe -1.4%, US and UK around -1%, while Japan and Emerging remained stable. Beyond these limited markets fluctuations, sectors were the most impacted this week. Banking stocks, for example, which are sensitive to higher interest rates, surged by almost 3% in Europe, while sectors that like low interest rates, such as real estate and utilities, went down by the same extent. Similarly, many export-driven stocks, such as Essilor and LVMH, took some heat from the rally in the euro, which is now up more than 8% on the year to date. All in all, while long bond yields are evening out their recent pessimism, sectors sensitive to interest rates are likely to continue adjusting accordingly.


Key upcoming events

Economic indicators

US: The unemployment rate is expected to come out stable in June.

Eurozone: Manufacturing PMI should have stabilized in June.








Key events

2017.06.30-key events


Market snapshot

2017.06.30--market snapshot

Letter finalised at 3pm Paris time

ITHURBIDE Philippe , Global Head of Research
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Weekly 30th June 2017
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