Digest Dec 2015 No10 : Perhaps, in a year that featured fears
Advanced economies continue to make progress
- The tepid expansion among EMs is unlikely to stymie growth within advanced nations, where domestic spending has accelerated noticeably. U.S. domestic demand growth has been hovering at 3% for more than a year, reinforcing the notion that the economic drivers are mainly focused inward for America at this point in the cycle. The sizeable appreciation in the greenback is expected to continue to dampen exports, but the broader economic foundation is strong enough to support a modest degree of rate hikes.
- The beleaguered euro zone did manage to outperform the growth expectations. Surprisingly perhaps, in a year that featured fears of a "Grexit." However, unlike the U.S., the European Central Bank (ECB) is still stepping on the stimulus-accelerator to lift domestic demand through a combination of quantitative easing and negative interest rates. Private sector lending has been responding and unemployment rates are falling through most of Europe. Both of these positive trends should help to underpin continued gains in domestic demand going forward. The euro area should benefit from a slight tick-up in growth to 1.7% in 2016, a testament that the region has come a long way from the dismal 2014 performance that was roughly half this pace. However, the outlook remains heavily dependent on a central bank that is unlikely to lift its foot off the monetary accelerator.
- Past stimulus initiatives in Japan are also starting to bear fruit. After a 0.7% increase this year, Japan is forecast to grow at a faster 1.2% pace in 2016. That may sound slow, but it is fairly good for an economy whose working age population is falling by 1.5% each year. That reality makes Japan's recent solid employment growth more impressive, as it comes from rising labor force participation.
- As a large energy importer, Japan has also enjoyed a big boost to its purchasing power due to lower oil prices. All of these forces should help sustain the domestic economy in the face of softer EM demand, although a planned sales tax hike in 2017 is expected to crimp overall GDP growth in that year.
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US bond funds hit by record withdrawal
- Rattles in US high yield bond market is just making investors jittery, which led to record wave of withdrawals from bond mutual funds and exchange traded funds. According to Lipper data, latest weekly withdrawals from the bond market is largest since 1992, time when the company started tracking flow.
- Several funds, namely Third Avenue, Lucius, Stone Lion credit fund have either barred withdrawal by investors or liquidate their portfolio and returned the money. Average yield on US hybrid bond market ticked up higher than 8%, while for energy debt it has reached close to 14%. Now that weakness might be spreading to investment grade market too.
- Investors have withdrew $5.1 billion last week from investment grade portfolio for the week ending on 16th, accompanies by close to $4 billion withdrawal from high yield debt market.
- Slow economic recovery coupled with weakness in China and commodities are contributing more to the worsening outlook than 25 basis points hike from FED. Highly levered corporate balance sheet remain another concern, in a time of rate hike.
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Spain heads to the polls this weekend for general elections
- This is likely to mark the end of the two-party system that has prevailed for nearly four decades. The outcome of the vote nevertheless remains highly uncertain. At the very least, the status quo is unlikely to persist. Polls point to the ruling Partido Popular in a coalition, most probably with centre-right Ciudadanos, to remain in power. But the very high number of undecided voters (and the difficulty pollsters have had in predicting many election outcomes this year) means anything is possible, including an unstable minority govt or an alternative coalition altogether.
- A PSOE-Podemos or PSOE-Ciudadanos govt are both still conceivable though polls suggest these outcomes are less likely. While a left-leaning majority would represent a clear break from the current status quo, PSOE would likely exert a moderating influence on Podemos, which has itself already rolled back from some of its more controversial proposals.
- The coalition negotiations themselves could at the very least imply a prolonged period of policy uncertainty. This may weigh on business investment in particular--precisely at a time when the Spanish economy is becoming increasingly reliant on domestic demand. The fiscal/structural adjustment process also remains incomplete, and an inconclusive result may weigh on market sentiment (though seems less likely to materially impact EUR).
Saudi liquidity likely poor towards year end
- GCC markets might not have read the memo about the US Fed's dovish hike. The 1 year and 2 year swaps moved higher yesterday towards 1.86 and 2.14% respectively.
- Liquidity is poor towards year end, but the direction seems clear. A solid USD typically indicates low oil prices and indeed this is exactly manifested yesterday.
- "Clearly markets remain anxious about the impact of low oil prices and the strong USD upon the USD-SAR peg... Investors can expect swap rates to continue grinding higher and forward markets to edge higher also", says Commerzbank.
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New Polish government tightens grip on power
- New polish government, which came to power after winning 235 seats (closest opposition ruling PO party with 138 seats) in October election has raided NATO-affiliated facility in a Midnight raid and replaced the head.
- Defence ministry officials and military police raided the facility at 1:30 am in the morning to remove officials those were not supported by current government.
- Deputy defence minister told this is to guarantee normal functioning of all government institutions and defended the move it is defence ministry's sovereign right.
- Next year, NATO will hold one of its bi-annual summit in Warsaw, sometime in July. So the move is pretty significant, to push new government's agenda on the discussion table. However, such mid-night move to a NATO facility is unprecedented in its history and shows the new government, which is also known as EU skeptics are ready to take up bold, even unprecedented actions.
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What does the BoJ's policy decision mean for the Yen
- The Bank of Japan as widely expected kept monetary policy steady and maintained its money printing drive at the current rate on Friday, but reorganised its massive stimulus programme in an effort to advance premier Shinzo Abe's plans to boost the economy. Further, the BoJ maintained the same cautiously optimistic views as in previous meetings that growth is on track to recover, with exports improving and business sentiment at favourable level.
- BoJ added several accommodative measures which can be summarised as follows:
- Extend the duration of the Japanese government bonds (JGBs) buying from 10 to 12 years from 2016
- Set up a new 300-billion-yen fund to buy more ETFs that encourage investment
- Extend eligible collateral for the central bank's provision of credit
- Extend growth lending programs by one year
- Boost the total amount of issue of each J-REIT to be bought
- The Japanese Yen fell over 0.6 pct against the dollar and the Nikkei rose more than 2 pct in an immediate reaction to the policy decision. Markets saw the new steps as a return to the incremental policy style Kuroda had abandoned when launching his stimulus programme in 2013. This set of dovish actions may have caused the currency to drop at the start of the announcement. But as markets digested the news, yen pared losses and extended gains to 1.3 pct on day vs dollar in london trade, hitting the session's high of 121.145
- At the press conference BOJ Governor Haruhiko Kuroda stressed that the BoJ's fine-tuned stimulus package should not being seen as additional easing. Kuroda said the fine-tuning will allow the bank to sustain or even expand stimulus more easily, dismissing the views of some investors that it was taken to avoid bolder steps as its bond buying was drying up market liquidity. He said the new steps do not amount to additional monetary easing as they did not address downside risks to the economy. He also said they were not directly spurred by the Fed's decision on Wednesday to raise interest rates.
- Japanese Finance Minister Taro Aso said on Friday that the Bank of Japan made an appropriate decision earlier in the day to supplement its massive stimulus programme. However the changes announced are small relatively to the existing QQE programme and hence are unlikely to have any noticeable and lasting effects on the JPY.
- Japanese equities finally closed down 1.90 pct at 18,986.80. The yen saw wild swings during the day. At 1040 GMT, USD/JPY was trading at 121.55, day's range being 121.06/123.55, while EUR/JPY was at 131.56.
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