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The Global Economy in May 2018

Global markets in May experienced the continuation of the pressure being felt by emerging markets (EMs) as the US Dollar strengthened and US 10-year yields crossed the 3% mark, with the Federal Reserve certain to hike rates in June. Many emerging market currencies weakened significantly against the dollar. Argentina, Turkey and Indonesia were among the most affected. Indonesia avoided the worst of it by proactively hiking interest rates, while Argentina negotiated a $50bn standby facility with the IMF. However, Turkey’s rate hikes were a delayed response thanks to political interference in the central bank.

Net foreign portfolio flows to emerging markets continued to be negative in May, following on from April, with $12.3bn in net outflows from the EMs monitored by the Institute of International Finance (IIF). However, the IIF is keen to point out that a broader measure of foreign investor sentiment – which includes capital investment in property, factories or other assets – is more encouraging for emerging markets investors. Accordingly, net capital flows into EMs of $32 billion in April was well above the 2017 average inflows of $7 billion a month.

The month came to an end with concerns about Italy due to its continuing political issues. The prospect of a euro-skeptic, populist governing alliance in Italy spooked investors about the likelihood of another Eurozone crisis, causing a short-lived risk off sentiment in global financial markets. Those concerns have tapered off since then, but the situation has raised the question about the financial impact of the end of monetary policy easing on countries like Italy which struggle from high indebtedness.

Trade related tensions continued to simmer, with President Trump criticizing the outcomes of negotiations with China and re-imposing steel and aluminum related tariffs on the EU and Canada. This has again raised the possibility of a spiral of retaliatory tariffs, impacting global growth. In such a scenario, most analysts think the US Dollar will weaken, like during previous bouts of US protectionism. But a contrarian view is that it could make US growth -and thereby US assets – standout relative to the rest, putting emerging market currencies under pressure.

Brent crude oil prices moved within the $70 to $80 range through the month, with prices reaching a high of $79.80 a barrel on the 23rd of May. This was driven by concerns over supply reductions following the US announcement of re-imposing sanctions on Iran and the reducing supplies from crisis-ridden Venezuela. However, prices moderated slightly in the latter part of the month with Saudi Arabia and Russia pushing the OPEC-led group of oil producers to increase output to offset these supply reductions.

The Global Economy in April 2018

Global markets in April were marked by a resurgent US Dollar, increasing crude oil prices, rising US Treasury yields and doubts over the sustainability of the synchronized global growth that underpinned market performances at the start of the year. Even as the US Federal Reserve held rates at its recent meeting, markets appeared to be certain of a hike in June with the Fed pointing to higher inflation. Markets appeared to be less focused on US-China trade tensions as other headlines took over in the month, including the dialogue between the two Korean leaders pointing to a reduction in geopolitical tensions in the East Asian region.

Foreign inflows to emerging markets appeared to have ground to a halt in April with $200mn in outflows from the EMs monitored by the Institute of International Finance (IIF). Further, the IIF stated that $5.6bn left EM stocks and bonds in the week to April 23. This could help explain why the JPMorgan Emerging Market Currency Index ended April with its biggest loss in 17 months. Given the broad weakness in most EM currencies, central banks in Argentina and Indonesia, in particular, were seen resorting to interventions in forex markets to stabilize their currencies.

Despite these figures, analysts have continued to stress that this is not a repeat of the 2013 ‘Taper Tantrum’ – where EMs suffered major outflows and deceleration in growth – which also happened in the context of rising US yields and a strengthening US dollar. Analysts point to improved fundamentals, like smaller current account deficits and higher foreign currency reserves, as evidence of EM resilience compared to five years ago.

Furthermore, it appears that the optimistic expectations for global growth persist with some arguing that growth will bounce back from the soft patch experienced in recent months. This is in line with the IMF’s April update to its economic outlook. However, the IMF did note that global growth could slowdown beyond the next two years as advanced economies close their output gaps.

Brent crude oil prices continued to rise in the past month, reaching the highest levels since November 2014. A major factor in this rise has been concern that President Trump will reimpose sanctions on Iran, which he did on the 9th of April, leading to a possible reduction in crude supplies from the country. In addition, supplies from Venezuela continued to contract amidst the country’s continued social and economic turmoil.

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 January

Global markets started off 2018 on a positive note in January with global stock markets continuing to make gains and emerging market inflows continuing amidst major sovereign debt issuances earlier in the year. However, the month ended giving way to what has been a global equity sell-off in early February, sparked by higher US Treasury yields that have reached multi-year highs. The sell-off started on February 2nd when US yields increased after US payrolls data indicated the highest wage growth since 2009, opening the door for higher inflation and thereby justifying US rate hikes.

On 8th February, the benchmark S&P 500 and the Dow industrials confirmed they were in correction territory, both falling more than 10% from the Jan. 26 record highs. While some analysts have called this sell-off the start of a new era, ending the period of low volatility enjoyed by markets, others see it as closing the gap between elevated asset prices and more sluggish fundamentals.

Emerging markets experienced $4 billion in outflows, mostly from equities, since January 30th according to the Institute for International Finance (IIF) – the largest outflow since the election of President Trump in 2016. South Korea, Indonesia, Thailand have suffered the worst losses so far as of 6th February. However, compared to previous global sell-offs most emerging markets have been faring better, despite the fact that higher US yields make EM risk assets less attractive.

These market movements are in the context of a US Federal Reserve that confirmed its projected rate hike path last week and Jerome Powell being sworn in as the new chairman on the 5th of February. Powell now faces the challenge of ensuring that the economy neither overheats nor goes cold. Moreover, January was also the first full month since the European Central Bank implemented the promise to halve the quantity of its monthly bond purchases to Euros 30 billion.

Brent crude prices were near four-year highs as prices reached $70 a barrel mark early in the year driven by continued optimism that the supply glut was ending this year and due to drops in US stockpiles. However, prices moderated slowly throughout the month, leading to prices reaching $62 a barrel on the 9th of February amidst the ongoing stock market turmoil and a scare about rising global supplies. Iran has announced plans to increase production and US production has surpassed 10 million barrels per day; a level surpassed only by Saudi Arabia and Russia.

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 November

Global markets in November were affected by a number of noteworthy developments. The latest US Federal Reserve meeting minutes reconfirmed the high possibility of a December rate hike, while Deutsche Bank, Goldman Sachs and JPMorgan Chase have altered their forecasts to the possibility of four Fed rate hikes in 2018. In Europe, some political uncertainty has crept in again due to the failure of Germany’s Angela Merkel to form a governing coalition, opening up the possibility of fresh elections in Europe’s largest economy. In Britain, the Bank of England’s first rate hike in a decade has been followed by renewed optimism about Brexit negotiations after last week’s talks with the EU turned out to be fruitful.

Political risk continued to influence Emerging Markets during the month. Dozens of royals and high officials in Saudi Arabia were detained, which was seen as a centralization of power by Crown Prince Mohammed bin Salman, and raised concerns about the Kingdom’s internal stability. It also coincided with increased tensions between Saudi and Iran in the region. In addition, Venezuela finally defaulted on some of its debt repayments bringing into focus the need for investors to be mindful of the risk they take on. During the end November/ early December period, EM equities have sustained some loses, mainly driven by the technology and energy sectors.

In Asia, analysts have pointed to South Korea’s rate hike as the start of what could be a gradual tightening pattern by Asian central banks taking advantage of the healthy growth rates. Meanwhile, the Indian economy received a boost in the month when Moody’s upgraded India’s sovereign credit rating for the first time since 2004.

Brent oil prices stayed above the US$60 mark, with a two-year high of US$64.27 being reached on November 6th. Driving prices up were geopolitical tensions in the Middle East and optimism on an extension to the OPEC-led production limitation agreement. However, prices have moderated since early November, standing at US$61.22 on December 6th. The moderation has been due to the lack of any major market-moving geopolitical events in the Middle East and on concerns about increasing US oil output amidst higher prices.

The Global Economy in October

October was marked by the implementation of a number of steps towards monetary policy normalization by major central banks and speculation on who President Trump would nominate as the Federal Reserve chairman. The month ended with markets pricing in the nomination of current Fed Governor Jerome Powell, which was confirmed on November 2nd ahead of Trump’s tour of Asia. Powell’s nomination is seen as marking the continuity of Yellen’s gradual rate hike policies and the possible relaxation of some US banking and financial regulations. In the meantime, progress on Trump’s promised tax reforms has increased the optimism for tax cuts happening in 2018 and boosting US growth. These factors helped push markets higher following the nomination.

The month saw the start of the Fed’s balance sheet shrinking process and further confirmation of a December rate hike as US economic data painted an optimistic picture even though inflation continued below the 2% target. The European Central Bank (ECB) cut its bond purchases by half to 30 billion euros on the 26th as expected, but its tone in doing so was very dovish. The ECB kept its options open by continuing the purchases till the end of September 2018 and stating that an extension beyond that is possible if needed.

Meanwhile, the Bank of England hiked interest rates by a quarter percentage point for the first time in a decade to 0.5%, despite weak economic growth in the UK. The Bank has a dovish outlook on future rate hikes and has retained its bond purchasing programs.

China’s Communist Party Congress also occurred in the month, where President Xi Jinping laid out his vision for China up to 2050. With the outgoing central bank governor warning about the level of debt, some are concerned, now that the congress is over, authorities will launch a concerted effort at deleveraging that could slow down the Chinese economy.

Emerging markets saw the return of political risk affecting performance during the month. This was mainly on the back of South Africa’s budget woes, Turkey’s diplomatic row with USA and Germany and Brazil’s tenuous politics. However, according to initial estimates, the Institute of International Finance (IIF) has recorded US$13.8bn in overall portfolio inflows to emerging markets in October. The moderation in inflows from previous months could also be due to rising US yields and a strengthening US dollar.

Brent crude oil prices continued to increase in the month passing the US$60 mark at the end of the month for the first time since July 2015. This was driven by continued optimism over the major oil producers seeking an extension to their production limitation beyond March 2018. Also helping the movement were geopolitical tensions, surprise drops in crude stockpiles and Chinese demand.

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 August

The highlight during the month of August was the growing tensions and uncertainty created by North Korea’s aggressive actions; threatening the US pacific territory of Guam, firing a missile over Japan and carrying out its sixth nuclear test – claimed to be a hydrogen bomb. Their actions were met by President Trump’s rhetoric when he threatened North Korea with “fire and fury”.

The rising tensions caused major stock markets to dip while there was increased demand for ‘Safe Haven’ assets like the Yen and Gold. However, markets as a whole have not moved dramatically. As some analysts put it, markets cannot price in an existential situation like a North Korea focused nuclear exchange.

According to the Institute of International Finance (IIF), emerging markets have seen a slowdown in capital flows during August with a $4bn drop from the previous month and the lowest since January. IIF earlier said that while EM investors continue to take on credit risk in search for yield, they appear to have turned slightly negative on EM currency risk despite recent U.S. dollar weakness. US dollar weakness has allowed most EM currencies to appreciate vis-à-vis the dollar.

The search for yield in fixed income assets has seen Tajikistan issuing its first ever international dollar bond with a yield of 7.125%, while the yield on Mongolia’s 2021 dollar bond dropped below 6%. This risk appetite continues even as certain bearish market commentators see EM trades as being crowded and due for a correction.

Markets also focused on the minutes of the US Federal Reserve meeting, which showed that there was disagreement on whether the weak inflation was transitory or not. While some officials claimed that the inflation numbers do not support further rate hikes, others, including the Chairperson, insisted on its transitory nature. September 6th saw the Fed Vice Chair, Stanley Fischer, resigning – effective from mid-October – due to ‘personal reasons’ and increasing the empty seats on the Board of Governors to four.

Brent crude oil prices stayed above the $50 a barrel mark during the month and was majorly affected by three factors. First, prices reduced early in the month as the July OPEC output reached record highs. Second, prices were helped up by supply disruptions in Libya and drops in US stockpiles. Finally, the end of the month saw Hurricane Harvey creating an interesting situation. Despite affecting US oil infrastructure in Texas, crude oil prices reduced due to the reduced demand for crude as refineries shutdown.