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For every cloud engenders not a storm

The world remained a stormy place in October. A diplomatic row over the killing of a journalist and the election of a far-right candidate in Brazil added to a long-standing Chancellor in Germany saying “no more” and a rout in the global equity markets.

Nov 2018

THE WORLD IN FIVE BULLET POINTS

  • Saudi Arabia attracted international condemnation for the killing of a dissident journalist, Jamal Khashoggi, in its Turkish embassy. Initially, the Saudis denied all knowledge, then said he had died in a fight inside the embassy before admitting that he had died in a chokehold after resisting attempts to return him to Saudi. A complicated diplomatic aftermath ensued with much in the way of condemnation but no sanctions followed. Meanwhile the Saudis ordered a shake up of its security service.
  • Equity markets around the world tumbled as the sum of the year’s fears reached its zenith. There appeared little end in sight to the Sino-US trade dispute while the US economy continued to grow, sending the dollar higher. But weak housing sales data triggered a rethink on the strength of the economy there, which, together with the Fed saying there would be no let up in its rate-raising cycle, sent US equities into a tailspin. Emerging Markets – ex Brazil – followed suit and fell sharply.
  • Germany’s Chancellor Merkel said she would not seek re-election as leader of the ruling Christian Democratic Union in December, and thus the Chancellorship in 2021, after her party’s allies in the state of Bavaria suffered their worst election result since 1950. Chancellor Merkel’s popularity has been slipping for some time but following a very narrow general election win in 2017, and a number of state-level defeats, pressure on her to go had become overwhelming.
  • Brazil elected a far right candidate to be its next President. Jair Bolsanaro secured a 17% advantage over his opponent in the first round of voting in early October before winning with 55.1% of the vote in the second round. Despite being elected on an agenda of confronting corruption and stamping out endemic violent crime in the country, his first speech emphasised policies to end austerity and tackle the fiscal deficit, while his new Finance Minister said social security reform remained a priority. The equity markets took this well - Brazil’s MSCI index was one of only a handful to record a positive return for October.
  • A caravan of immigrants from one of the most impoverished and violent nations on earth – Honduras – crossed the border into Mexico from Guatemala en route to claim asylum in the US. In the lead up to the mid-term elections in early November, several candidates used the caravan to stoke fear of immigrants coming into the US, even suggesting that ISIS terrorists from the middle east were among the caravan of around 7,000 people. By the end of the month, the column had reached Mexico City.
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EQUITY MARKETS

  • Global equity markets fell sharply during October including the hitherto strong US market. Asian markets led the way lower with many hitting multi-year lows by the end of the month after seeing double-digit percent losses. Drivers for the sell off included deteriorating headlines surrounding the US-Sino trade dispute, weaker economic data from China, and a spike in global yields with the subsequent appreciation of the US dollar.
  • Third-quarter earnings also proved to be a key negative driver, especially with companies missing on analysts’ estimates being punished by the market. Within Asia, Korea underperformed to lose more than 14% - its worst monthly sell off in ten years – but this was on the back of weakening economic data emanating from China that hinted at the tariffs and squeeze on liquidity beginning to affect the greater economy. A series of stimulus programmes from Beijing led to a relief rally in equities throughout the region however it failed to detract from what was a very weak month for the equity markets.
  • The MSCI Asia ex Japan Index fell almost 11% with the heavyweight China index falling 11.5% - the worst monthly loss for the country’s stock market since January 2016. The specific catalysts for the fall included lower-than-expected Q3 GDP figures that hinted the economy was beginning to feel the impact of trade tariffs. Lower economic figures for September also pointed to a slowdown (see Economics section below) while the increased volatility in equity market globally added to the jitters.
  • With Taiwan also underperforming on worries surrounding the technology supply chain, it was left to South-East Asia and India to outperform, albeit with all bourses showing losses. The Philippines was the region’s best performer after inflation data finally showed signs of stability, the currency plateaued, and the trade balance improved marginally.
  • The rest of the world had little to cheer about in the equity market although Brazil bounced back strongly with an 18% gain after Jair Bolsonaro, seen as the market-friendly candidate because his potential Finance Minister is supportive of private sector reforms, won the country’s presidential election. The gain was enough to pull the Latin American indices higher despite every other country in the region seeing a sharp decline, including Mexico, which fell 17%. Here, the peso fell sharply after the government cancelled a major airport project, sending dollar earners down.
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FIXED INCOME

  • Volatility of global interest rates rose in October; US Treasury yields surged at the start of month on the back of hawkish comments from the Fed Reserve Chairman Powell, as well as a record-high ISM non-manufacturing index. Consequently, the 10-year US Treasury yield breached 3.2% - its highest level since 2011. But yields subsequently retraced lower to end the month at 3.14% (+8bps) as ongoing US-Sino trade tensions and a correction in the equity markets drove an investor flight to safety.
  • The risk-off mode also led lower yields of safe-haven assets such as Japanese government bonds and German Bunds during the month. However, peripheral Eurozone bonds such as Italian government bonds experienced selling pressure amid concerns over Italy’s budget plan.
  • In Asia, performance of USD-denominated credits was weighed by the moderate rises in US interest rates and a widening of credit spreads. Asian high yield sovereign and corporate bonds took the brunt of the market decline as concerns over tightening funding conditions and the equity market sell off dampened investor sentiment.
  • Weakness in Asian currencies versus the US dollar was also seen this month. However, direction of Asia’s domestic interest rates was divergent over the month; Higher inflation prints in the Philippines drove yields higher, while in India, the central bank’s decision to keep policy rate unchanged against market expectation of rate hike sent government bond yields down.

COMMODITIES

  • Oil prices fell from their multi-year peaks as concerns about the slowdown in the global economy, and a promise by Saudi Arabia to produce more oil to offset falls caused by the re-imposition of sanctions on Iran, eased fears of a shortage. The continuing US-Sino trade dispute also weighed on sentiment. Oil products continued to see-saw; profit margins – known as “cracks” – for Asian fuel oil and gasoil soared while Asian and European gasoline cracks fell abruptly.
  • Almost all main metal prices fell over the month with many touching multi-year lows as worries over the strength of the global economy weighed. The sell off in the equity markets also pressured metal prices. Gold, which had slumped to 19-month lows in August , staged a modest recovery in October as it partially regained its crown as the safe-haven asset class of choice on the volatility in the equities market. Reuters reported that an analyst poll pointed to a further recovery next year while the same poll predicted higher prices for copper and palladium (the latter reached record highs during October). Reuters also said analysts were expecting a drop in platinum and zinc prices.
  • Among soft commodities, soybean prices fell to six-week lows on a USDA report that showed harvest volumes ahead of expectations at the same time tariffs from China were cutting demand. Farmers were reporting that they were starting to sow corn and wheat for next year given the current surplus.

CURRENCIES

  • The US dollar strengthened against all G10 currencies except the Japanese yen during the month. The Scandinavian currencies, the Swedish koruna and the Norwegian krone also lost nearly 3% as falling oil prices, concerns over the trade war, and the equity market correction weighed heavily. A failure to solve the Italian budget impasse and uncertainty over who will succeed Chancellor Merkel in Germany both pressured the euro, which lost more than 2%. Meanwhile, the Japanese yen, still regarded as a safe haven currency, was the only outperformer against the dollar within the G10 group of countries.
  • Currencies in Asia remained under pressure. The low-yielding Korean won and Thai bhat both lost more than 2% against the dollar as Q3 growth in Korea disappointed, and weak economic data also pointed to Thailand’s central bank keeping rates on hold. The Indonesian rupiah and Indian rupee both declined nearly 2%. In India, the government signaled its intent to invoke a rule in which it could dictate to the central bank what to do on policy, escalating tensions between the RBI and government, sending the rupee lower. The Philippine peso was the best performing Asian currency for the month, rising nearly 1% despite posting the largest balance of payment deficit since January 2014; a stabilising inflation print was to thank for the tick higher.
  • Elsewhere the star emerging market performer was the Brazilian real that gained nearly 9% against the dollar after Jair Bolsonaro’s victory in the presidential elections. The Argentine peso and Turkish lira, which have also been under severe pressure this year, made 15% and 8.5% gains against the dollar respectively. Investors are regaining confidence in Argentina as they comply with the IMF conditions set against its loan.
  • In Turkey while the fundamentals remain weak, the current account improved and tensions with the US eased. The Mexican peso was the worst performing currency among the emerging markets, declining by nearly 8% thanks to a referendum by the new administration to halt the construction of the new airport. This weighed on investor confidence over the new government.
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ECONOMICS

  • In the US, the Federal Reserve meeting minutes from September showed agreement between members on the need to raise borrowing rates further, as well as universal agreement to raise rates by 25bps at its September meeting. GDP growth for Q3 beat expectations and grew 3.5% with strength in consumer and government spending offsetting fixed investment and net exports, which dragged on growth slightly. September data showed new home sales declined 5.5%, and existing home sales fell 3.4%. Manufacturing activity in the September ISM survey also slowed to 59.8 although this still reflects expansion.
  • The Bank of Japan trimmed its inflation forecast for this year and the next two, and kept its rates at close to zero. Japan retail sales fell 0.2% in September and export data also showed a slight drop of 1.2% and as a result some analysts were beginning to predict the country’s GDP would show a slight contraction in Q3.
  • The European Central Bank kept rates on hold and reiterated it would end its asset purchasing programme by year end. ECB President Draghi also said interest rates would be on hold until next summer with his cautious tone reflecting some weak data including manufacturing PMI which dropped to 52.1, its lowest reading since 2016. The UK also kept its rates on hold despite inflation staying stubbornly above the BoE’s target rate with the bank balancing this with Brexit uncertainty.
  • China GDP grew 6.5% in Q3, the slowest rate since 2009, and confirming the slowdown in growth. The service sector PMI fell to 50.8 from 53.1, while the sub-index for new business orders slowed to 50.1 from 52.4 in September, its worst level since November 2008. The manufacturing PMI slipped to 50.1 from 50.8 and export orders fell to 46.9 from 48.0. In response to the soft data and weak equity markets, the PBOC said the bank had plenty of room for interest rate and reserve requirement adjustments to offset the weakness stemming from the trade dispute with the US.
  • Elsewhere, South Korea’s exports fell 8.2% in August and imports fell 2.1%, reflecting the continuing weakness in the economy. Turkey’s inflation reached 24% in September to signal further rate rises there and while Russia kept its rates on hold in October, it acknowledged inflation was rising there too.
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