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The Global Economy in March 2018

Global markets in March were seen recovering somewhat from the volatility experienced in February. But the fears of a US-China trade war continued to affect markets through the month. President Trump went beyond his earlier tariffs on steel and aluminium, calling for tariffs on certain Chinese exports to the US. These tariffs have been met by retaliatory tariffs by China on US exports. However, analysts see these moves as merely attempts at creating leverage for trade negotiations.

At its March meeting, the Federal Reserve announced its first-rate hike for the year as expected. It also forecast at least 2 more hikes in the year, 3 hikes for 2019 and 2 more for 2020. This highlighted its growing confidence that tax cuts and government spending will lead to higher US growth and inflation, spurring further tightening.

Short-term lending rates measured by the 3-month LIBOR moved up to reach 2.3% in the month, having started the year at 1.7%. This increase in global borrowing costs is partly due to the US Fed’s rate hikes, but is also partly due to the impact of US tax reforms causing repatriation of US dollars held in foreign banks by US firms. These foreign banks have raised deposit rates in order to attract funds to replace the dollars being repatriated, pushing up lending rates as well.

Net portfolio inflows of about $7.6 billion were recorded in the 21 emerging market economies monitored by the Institute of International Finance (IIF) for the month. While this marked a reversal of the outflows in February, the overall inflows were much less than what was seen on a monthly basis in the previous year. This could be a reflection of caution seeping into investors’ decision making in terms of both EM debt and equities, while continuing to find them an attractive asset class.

Brent crude prices returned to the $70 price level by end-March helped up by easing concerns of a US-China trade war and promises by Saudi Arabia to continue to work together with Russia and others on balancing the oil market. In addition, unexpected reductions in US stockpiles and another bout of Saudi-Iran tensions helped prices move up during the month.

The Global Economy in February

Global market performance in February contrasted sharply with the performance in January due to the volatility in markets following the selloff in US equities which spread across to other markets globally. Markets have recovered to an extent from the selloff over the course of the month, but the recovery was thereafter affected by concerns about a trade war and whether the US Federal Reserve will hike rates more than three times this year.

President Trump deciding to move ahead with relatively higher tariffs on imports of steel and aluminum, has raised the possibility of a global trade war if China, the EU and others decide to retaliate with tariffs of their own against US exports. Such a scenario carries the risk of denting the current optimism on global growth in 2018.

Meanwhile, Jerome Powell who took over as the new Fed Chairman during the month delivered his testimony to Congress on the Fed’s policies. He highlighted the requirement to balance between the need to prevent the US economy from overheating and the need to move towards the 2% inflation target. In line with this, markets widely expect the Fed to hike policy rates at its March meeting.

Europe saw the confirmation of a new grand coalition government in Germany and the prospects of a hung parliament in Italy, as anti-establishment parties surged leaving no party with a governing majority. Uncertainty in Italy could weigh in on European markets in the weeks ahead as coalitions talks proceed, although no major risk is seen yet.

Net Portfolio outflows of about $4.5 billion were recorded in the 21 emerging market economies monitored by the Institute of International Finance (IIF). The net outflows were concentrated in equities with net inflows to bonds offsetting it to an extent. While EM equities did fare better than developed market equities during the selloff, analysts have pointed out that the MSCI EM Index has gone through four different trends in the last nine weeks. This makes it hard to ascertain a potential direction for EM equities in 2018.

Brent crude prices eased from the $70 mark in February and moved within the $60-70 range. Prices reached a low of $62.59 on the 12th. This was largely due to concerns about rising crude output, increases in US shale oil rigs and build ups in US stockpiles. In early March, oil prices have been weakened by concerns of a trade war affecting global growth following the US tariff proposals.

The Global Economy in December

December saw the US Federal Reserve carrying out its third rate hike for 2017, as expected, while increasing expectations for US economic growth and forecasting three further rate hikes for 2018. With US inflation remaining low, it appears that the Fed will continue down the current path of gradual monetary policy normalization despite the higher growth expectations, which has been helped by the passing of tax reforms by the Congress.

Looking ahead into 2018, analysts pointed to US tax reforms as possibly causing the US dollar to strengthen in the first quarter helped by US companies repatriating capital held overseas. While the Trump administration appears to see US growth jumping to 4% due to tax reforms, the Fed’s latest minutes show that it sees a much more moderate impact.

As 2017 came to a close the volatility in emerging market stocks seems to have increased, with the 30-day historical volatility on the MSCI EM Index climbing to its highest in almost 12 months. This could have been because investors were caught in a conundrum, stuck between the possibility of global growth driving further EM gains and the risk of tighter monetary policy affecting EM assets, leading some to take profit from the gains of 2017. Nevertheless, the Institute for International Finance noted that 2017 recorded $235bn in portfolio capital inflows to EMs; the highest since 2014.

Pakistan presented an interesting case in December, being able to comfortably raise $2.5bn in dollar debt despite the domestic political uncertainty and balance of payment imbalances, which have prompted foreign investors to move away from Pakistani stocks. Neighboring India has seen the budget deficit for the first eight months of the fiscal year jumping to 112% of the full-year target, prompting increased borrowing and reducing the space for the Modi government to adopt populist policies ahead of the 2019 elections, amidst slower growth.

Brent oil prices stayed above the US$60 mark, with a new two-year high of US$67.02 being reached on the 26th. Prices continued to be held up by hopes of the supply glut ending in 2018, as the OPEC-led group extended the production limitation at their November meeting. Helping prices has been the oil pipeline closures in UK and Libya, a strike by oil workers in Nigeria and promises by Saudi and Russia that any exit from production cuts would be gradual. But gains have been capped by concerns about rising US oil output amidst higher prices.

The Global Economy in September

September marked a resurgence in the US Dollar, as reflected in the Bloomberg Dollar Spot Index, after a prolonged weakening during the year so far. This resurgence was helped by the increasing likelihood of a December rate hike by the US Federal Reserve, positive US economic data and renewed optimism on tax cuts to be introduced by the Trump administration.

In addition, the dollar was helped by sudden weakness in a number of major currencies. The Euro weakened following the controversy around the independence referendum in Spain’s Catalonian region. The British pound was affected by renewed political uncertainty in UK over Brexit. The Yen weakened as Japan’s PM announced snap parliamentary elections.

Meanwhile, President Trump is to announce his nomination for the next Federal Reserve Chairperson in October. Analysts and betting markets have speculated on who it could be with Gary Cohn and Kevin Warsh among the names being discussed. Markets are concerned about the possibility of someone as hawkish on interest rates as Kevin Warsh having a fair chance of being nominated.

With both the US Fed and the European Central Bank (ECB) talking about reducing their quantitative easing measures amidst the US Dollar strengthening; emerging markets could see some of their gains chipped away. In fact, some report of caution by investors in emerging markets (EMs), with overall inflows slowing down. The Institute of International Finance (IIF) reported that September saw $14.5bn in overall inflows to EM stocks and bonds, the least since January. But many analysts expect to see the emerging market rally continuing.

Brent crude oil prices increased in the month reaching a two year high of $59.02 a barrel on the 25th. This was caused by increased optimism over the OPEC-led oil producers extending their production limitations beyond March 2018 and optimistic demand outlooks by the International Energy Agency and OPEC. Aiding bullish sentiment was the possible shut down of the Kurdish oil pipeline via Turkey amidst controversy over its independence referendum. However, prices have moderated to the mid-$50s since then, with Kurdish supply continuing and the possibility of increased US shale oil supply amidst higher market prices. In fact, US oil exports have increased as the spread between Brent and US crude futures expanded.

The Global Economy in July

July began with a scare of a potential selloff  in emerging market (EM) assets. This was triggered by talk of developed market Central Banks starting to end the era of monetary easing. Alongside the US Federal Reserve’s interest rate hikes and balance sheet unwinding, the Canadian central bank raised rates and the European Central Bank signaled willingness to consider changes to its bond buying program. However, the switch in market sentiment was short lived thanks to Fed Chairwoman Janet Yellen’s dovish statements in her testimony to the US Congress. The outflows reversed and the Institute of International Finance (IIF) reported $20 billion in portfolio inflows to EMs in July.

To some market commentators the episode of EM weakness signaled that international investors were ready to let go of their EM debt investments as soon as global markets wobble. This has prompted fund managers to be cautious of their investments especially in terms of market liquidity giving them space to exit. However, analysts saw the episode as a short period of time in which asset prices adjusted to reflect the hawkishness of developed market central banks.

While Emerging Markets were helped by a weakening US dollar, developed markets were helped by an improving Eurozone economy. In the IMF’s July World Economic Outlook report, it highlighted that global growth in 2017 was being driven by the EU alongside Japan and China. In the meantime it also downgraded US growth outlook slightly, citing the failure of the Trump administration to deliver on its promised fiscal stimulus. The IMF also indicated that the US dollar and British pound were overvalued, relative to fundamentals, while the euro, yen and yuan are seen as being in line with fundamentals.

Brent oil prices made gains in July and increased above the $50 mark reaching $52.65 on July 31st. This was largely driven by higher US demand and reductions in crude oil stockpiles in the US. It was also helped by outcomes of a meeting among major oil producers in St. Petersburg on the 24th, where Nigeria agreed to cap its output and Saudi indicated limits to their exports. But the gains were capped by high OPEC production, primarily due to Libyan and Nigerian output.

The Global Economy in June

The major highlights of the month of June were the events that unfolded around the isolation of Qatar by its Gulf neighbors, developments in the oil market and signs that major central banks were beginning to end monetary easing. Despite these developments, global markets continued the upward trend even as analysts continued to raise questions about its sustainability.

The US Federal Reserve hiked interest rates, as expected, on June 14th for the second time this year and signaled that it will start to unwind its massive balance sheet. However, doubts have been raised whether the Fed will go for a third rate hike this year amidst US economic data falling below expectations in the second quarter. Taking cues from the Fed, the European Central Bank (ECB) and the Bank of England have also signaled that they will begin to end the era of easy money. Emerging Market investors are watching this development closely to see how it affects risk appetite.

Emerging markets continued to see positive investor sentiment, as reflected by a seventh consecutive month of foreign portfolio inflows, up to June. According to the Institute of International Finance (IIF), June saw US$17.8 billion in inflows to EM debt and equities, the majority of which went to the Asian region. Volatility in commodity prices, especially oil, did not appear to trouble EM equities. Analysts have pointed to increasing weight of technology shares relative to commodities-based shares in the MSCI Emerging Markets Index as making this possible. However, some have pointed to robust demand for debt from Russia, Argentina and Ivory Coast as evidence of an investment bubble in high yielding EM assets.

China’s A-shares were finally able to gain entry to the MSCI Emerging Markets Index, from next year. China also opened up its US$9 trillion debt market to foreign fund managers through its new ‘Bond Connect’ service through Hong Kong. Meanwhile, India finally put into force its new Goods and Services Tax (GST) on the 30th of June, promising to simplify the country’s tax regime.

In Europe, Brexit negotiations got underway, while Prime Minister May managed to come to an official agreement with the coalition partner from Northern Ireland. The coalition gives her government a slim majority in parliament. Despite some stability in the parliament, the British economy showed signs of trouble as consumer spending dipped considerably for the first time since Brexit. The Sterling pound also continued to remain weak.

Brent oil prices were rather volatile in June, seeing a drop to the mid-US$40s on fears of a rising supply glut amidst increased OPEC output in May. Despite an OPEC agreement to limit production, the countries excused from it – mainly Nigeria and Libya – have continued to increase output. However, as of the first week of July, prices saw seven consecutive days of gains, rising to near US$50 due to a slowdown in the growth of the US shale oil sector, reduction in US crude oil reserves.  But analysts do not see any support from fundamentals for a sustained rise, reflected in the sharp drop seen on July 5th to US$47.79 a barrel.

The situation over Qatar’s isolation by its Arab neighbors did not have a major impact on oil prices. While the risks of the escalation seem to have reduced, analysts say the crisis is likely to be protracted in its current form. The Saudi-led coalition sent a list of 13-demands, which included ending relations with Iran and shutting down Al Jazeera. Despite Qatar’s rejection of these demands, the Saudi-led coalition have not yet taken any retaliatory measures, raising hopes of the tensions gradually easing out.

The Global Economy In August

Throughout most of August global markets were about the continuation of the Emerging Market rally from July as the yield search carried on. Emerging market debt might even reach record levels by end 2016. But the month end was marked by concern that positive US economic indicators would push the US Federal Reserve to hike interest rates in September. The Jackson Hole Symposium on 25th August was expected to provide indications of the direction of monetary policy of the US Federal Reserve’s (Fed), where Fed Chairwoman, Janet Yellen, stated the Fed saw reason to raise rates in 2016. The statement rattled the emerging market rally, as investors became averse to riskier assets. However, the August US non-farm payroll data released on 2nd September has reduced chances of a hike in September, improving sentiment and allowing markets to move up again.

 

Economic indicators, especially Purchasing Managers Indices (PMI), have improved in the Euro region and the UK over the last month, providing some breathing space for Central Bankers and Policymakers. Yet, economic growth in Europe continues to be underwhelming and analysts expect the Pound to depreciate further by the end of the year, due to long term structural issues and uncertainty.

 

Oil prices continued to be volatile within the $40 to $50 range, with July’s fears of supply disruption being replaced by fears of a supply glut building up owing to Saudi Arabia reaching a record summer output. The issues caused by low oil prices were reflected in the Saudi Arabia’s commitment to reaching an OPEC and non-OPEC consensus for an oil production freeze. Russia and Saudi Arabia used the recent G20 summit to come to an agreement to work towards stabilizing the market and the end-September OPEC meeting in Algeria is expected to produce an outcome in this regard. The talk of a freeze created a rally in prices but some analysts are divided as to whether a freeze is feasible or even effective.

 

Within Emerging Markets, the issue of political risk was highlighted by recent uncertainty over the policies of Philippine’s new President, Duterte. Philippines stocks have tumbled following his harsh remarks against President Obama which prompted the US President to cancel a visit to the island nation. Meanwhile, analysts continue to worry about the debt problem in China and see a pattern of investors avoiding Chinese assets to reduce exposure to a possible future crisis. India is going through a transition period as its much respected Central Bank Governor, Raghuram Rajan, hands over the reins to his successor. Some are concerned about reversals in reforms and policies taken by Rajan, but his successor, Urjit Patel, is known to be an avid supporter of his policies.

The Global Economy in July

In the immediate aftermath of the Brexit vote, global market volatility has fallen and the global economy is now steadier than it has ever been. While not everyone will survive the fallout unscathed, Europe shrugged off the Brexit vote, as economic confidence in the EU rose during the month. However, despite the markets’ recovery, some say the uncertainty it created is still a concern. The Bank of England (BOE) cut interest rates for the first time in over seven years, while expanding its bond-buying program, noting that economic indicators had “fallen sharply”.

The Bank of Japan (BOJ) also announced further stimulus measures, albeit less than what was expected by markets. Some say the lackluster measures may mean the BOJ has acknowledged the limits on monetary policy. In addition, the Japanese government announced a 28 trillion yen fiscal stimulus package earlier in July, of which 4.6 trillion yen has been budgeted for the current fiscal year. Analysts say the modest monetary stimulus raises the pressure for the government to deliver on its promise of fiscal stimulus.

The US Federal Reserve (Fed) left rates unchanged last month, while highlighting that risks have diminished. Analysts say this could indicate that economic conditions could warrant further rate hikes in the US.

The constant flow of monetary stimulus has depressed yields in many developed nations, pushing investors to riskier assets in the search for greater returns. Investors have poured a record amount of funds into emerging market bonds and have even turned to emerging market stocks. Indonesian stocks, for example, have benefitted from the investor confidence, amid optimism for growth and reform. Yet, the Bank of America (BofA) notes that it may not be a search for yield, but a search for safety. They note the recent outperformance of government debt even as their yields fell as evidence of this phenomenon.

However, a failed coup in Turkey served as a reminder that the higher yields on emerging market assets come at the cost of greater economic and political challenges. The Malaysian Ringgit has also come under pressure recently, as the nation contemplates further rate cuts to boost growth, amid a political scandal and low oil prices.

Demand for commodities has grown this year, fueled by safe-haven demand, particularly with gold. Yet oil prices have fallen into bear market territory in July, weighed by a revival in concerns that the supply glut in crude oil has returned. While many expect prices to recover by the end of the year, some say they could fall as low as $30 a barrel again. The OPEC has scheduled an informal meeting in September, while stating that it expects the recent price drop to be temporary. Many do not expect much to come from the meeting.

The Global Economy in June

Global markets were shocked on the 24th of June when the results of the UK’s referendum on its EU membership – dubbed ‘Brexit’ – saw a majority in favor of leaving the EU. The volatility and uncertainty that had persisted in the run up to the ‘Brexit’ vote spiked as markets around the world fell dramatically.

However, the market drop did not last long. Emerging and North American markets recovered their ‘Brexit’ losses in the weeks following the vote. This was aided by a number of other factors affecting investor sentiment. Investors favored Asian and Emerging markets as they were seen as being sheltered from the uncertainty affecting European markets, with Jakarta’s stock market leading the rise in South-East Asian stocks.

Europe is expected to remain mired in uncertainty, however, with no clarity on when – or even if – ‘Brexit’ would actually happen. Odds makers still show a significant chance for Britain being a part of the EU by 2020.

Uncertainty over ‘Brexit’ also played a part in the US Federal Reserve’s (Fed’s) decision to hold out on an interest rate hike in June. Analysts now put a greater possibility of a rate cut as opposed to the previously anticipated hike. This has also brought relief to emerging market companies that were expected to find it difficult to pay back $800 billion in maturing debt over the next few years.

In the Middle East, Saudi Arabia has taken steps to sell bonds to foreign investors for the first time. The decision was pressured by the increasing budget deficit created by low oil prices. Meanwhile, Nigeria decided to abandon the peg on the Naira and adopt a free float system, amidst an economic recession due to the oil price plunge. The currency depreciated immensely. But it was accepted by markets gleefully with stocks rising and bond yields falling.

Oil prices were volatile, rising above the $50 mark several times this month. The volatility was caused by fears of supply disruptions in Nigeria and Canada, amid some risk-off sentiment following the ‘Brexit’ vote. Oil traders expect the current price range to persist till the end of the year.

China continues to remain a major concern for markets with a large number of bad loans affecting the banking system in the country. Analysts predict a bailout of about US$ 500 billion might happen over the next two years to recapitalize the banks. It could drag down Chinese markets and the yuan, while increasing government borrowing costs and credit risk. Accordingly, many warn that investors should be warier of China’s economy than Britain’s.