Upbeat data and US policy expectations boost global equities; European government bonds fall amid higher inflation
January saw a host of upbeat global economic activity data lift Global equities higher, whilst continued expectations of Trump-led fiscal stimulus and deregulation also supported sentiment. The MSCI AC World index finished 1.5 per cent higher over the month, whilst the S&P 500 rose 1.8 per cent (in local currency terms). However, in Japan, a stronger yen against a broadly weaker US dollar weighed on the export-sensitive Nikkei (-0.4 per cent). Meanwhile, following a strong December, European stocks underperformed, with the Euro Stoxx 50 declining 1.8 per cent, dragged lower by utilities and consumer staples. Energy shares also declined amid slightly lower oil prices as investors continue to assess the likelihood of pledged OPEC production cuts. Elsewhere, emerging market equities significantly outperformed (the MSCI EM index rose 4.0 per cent), supported by US dollar weakness. Brazilian stocks performed particularly well, aided by an unexpectedly large cut in domestic interest rates. Finally, US Treasuries were little changed over the month, but European equivalents fell amid higher inflation expectations and ahead of a number of political risk events this year (all data above as of close of 31 January in local currency, price return, month-to-date terms).
Our Nowcast indicates continued US activity acceleration as PMIs and consumer sentiment remain elevated
In the US, recent data releases continue to paint a picture of broad economic strength. December’s better-than-expected ISM non-manufacturing PMI (57.2) was complemented by a two-year high in the ISM Manufacturing PMI (54.7). Meanwhile, the NFIB small business optimism index (105.8) rose to the highest level since December 2004. And although the Conference Board measure of consumer confidence edged marginally away from its December 15-year high, it remains consistent with robust consumer spending. Overall, US activity remains encouraging, with our US Nowcast measure of underlying activity rising in January to its highest level since July 2014. This remains consistent with the Fed’s expectation of three rate hikes in 2017. However, given the robustness of activity amid potential Trump-led fiscal stimulus, there is a material risk of a faster-than-expected Fed tightening path.
Eurozone economic activity remains upbeat; ECB strikes a dovish chord at its January meeting
Recent data in the Eurozone suggests that economic activity remains resilient, with the first estimate of Q4 GDP growth accelerating to 0.5 per cent qoq, 0.1ppts higher than Q3’s upwardly revised figure. Meanwhile, the increase in the manufacturing PMI has been pronounced, with Markit citing recent euro weakness as having boosted industrial orders. Generally speaking, confidence in the region remains very strong, with a tightening labour market providing the key underpinning of activity growth. Looking ahead, further gains in employment should also offset the headwind of gradually higher headline inflation – CPI inflation accelerated to an almost 4-year high of 1.8 per cent yoy in the flash January estimate. For now, these inflationary pressures are predominantly being driven by oil price effects, with ECB president Draghi striking a dovish chord at the January ECB policy meeting, arguing that “there are no signs yet of a convincing upward trend in underlying inflation”. Importantly, this implies monetary policy should remain highly accommodative in the short-to-medium term, further supporting future activity growth.
Chinese growth in 2016 meets government target; Bank of Japan upgrades growth forecasts
China’s GDP grew 6.7 per cent in 2016, meeting the government’s 6.5-7.0 per cent target, supported by resilient consumption on the back of fiscal stimulus and strong credit growth, as well as a recovery in output prices. Recent moves by the People’s Bank of China (PBoC) such as raising the Medium-term Lending Facility rate by 10bps, reinforce a focus on financial deleveraging amid other macro-prudential measures, whilst maintaining broadly stable funding conditions. In Japan, the Bank of Japan (BoJ) maintained its ultra-loose policy at its January meeting, as the bank cited risks to both economic activity and prices as skewed to the downside, despite recent signs of a cyclical economic upturn. The BoJ implicitly acknowledged that stronger global growth and a weaker yen are likely to be the primary engines of growth for Japan, whilst subdued domestic demand dampens the inflation outlook.
EM assets are still attractively priced, although post-Trump, selection is crucial
Emerging market assets have recently recovered some of their losses following Trump’s election victory, but investors remain concerned about the ‘Trump effect’ of a potentially stronger US dollar, increased global trade protectionism and rising geopolitical uncertainty. Some of these concerns of course have been self-inflicted, for example in Turkey (post-coup) and India (demonetisation efforts). In this environment, a selective approach is key, and we prefer to focus on markets with a high carry, relatively shielded from a shift towards protectionism (e.g. Brazil, India and Indonesia) and have currencies poised for medium-term appreciation (Taiwan, Brazil, Poland). Those economies with low dollar-denominated debt levels (China, Poland, Indonesia) are also attractive.
In terms of recent economic developments, Brazilian data has continued to surprise to the upside, albeit remaining in contractionary territory in yoy terms (e.g. retail sales and monthly GDP estimates). Nevertheless, this improvement combined with a greater than expected decline in inflation saw the Central Bank of Brazil cut 75bps to 13.00 per cent at its January meeting. Meanwhile, amid increased political uncertainty, Mexico’s January’s data releases showed a continued weakening of growth momentum. However, continued peso volatility and related inflationary pressures will likely maintain a hawkish bias at the Bank of Mexico. India’s Fiscal Year 2018 Union Budget highlights the government’s commitment to gradual fiscal consolidation as it increases spending on rural areas and infrastructure; offers tax and credit relief to the poor, farmers and small companies; and promotes affordable housing.
The recent compression of global risk premia implies a more selective and cautious use of risk budgets
For DM government bonds, although the recent selloff has improved prospective returns, they still look low relative to competing asset classes. Furthermore, the economic environment remains bond unfriendly amid robust global growth dynamics, rising headline inflation rates and the prospect of fiscal stimulus in a number of major global economies. Assuming global growth remains resilient, we anticipate DM government bond yields to climb higher still, and therefore retain our underweight position in this asset class. We also continue to prefer an overweight exposure to a diversified basket of risk assets, including equities (in particular Europe, Japan and selective parts of EM with resilient fundamentals) and local currency EM debt, within the context of a well-diversified multi-asset portfolio, from a strategic and long-term perspective. The key challenge, however, is that global risk premia have compressed at a time of elevated (mainly political) uncertainty, justifying a more selective and cautious use of risk budgets.