Linear Talk – Macro Roundup – February 2017
By Colin Lloyd
Perhaps the most striking feature of the markets last month was the Trump effect. This was most evident in currency markets but also influenced the direction of bonds.
The old market adage, buy the rumour sell the fact, applied to the Trump inauguration as much as any event in recent times. The chart below shows the price action of the US$ Index over the past three months:-
The low occurred on the morning of the election result and the high came on the first trading day of January. I suspect this is a temporary correction, but several commentators believe the protectionist agenda of the new administration bodes ill for the US$.
Unsurprisingly, in light of this chart, the US$ fell against the Euro and the Yen. EURUSD opened close to its low for the month (1.0339) and closed a fraction off its highs (1.0798). This is an impressive performance given the political uncertainty surrounding the EU this year. USDJYP followed a similar trajectory, opening near its high (118.61) and closing at 112.80.
Sterling also rebounded against the US$ but weakened against the Euro, mid-month, ahead of PM May’s Brexit address. EURGBP made its high on 16th at 0.8860 but closed at a more robust 0.8584.
The Chinese Yuan also rebounded, USDCNY closed at 6.83 having tested recent highs at 6.98 on the first day of trading. It is more interesting to look at the Yuan against its major trading partners. There are three indices one could look at: the SDR Basket, the BIS RMB Index or, China’s own CFETS RMB Index, which is calculated by the China Foreign Exchange Trade System. The CFETS RMB was recalibrated in January. The weighting of the UD$ has been reduced to 22.4% from 26.4%, similar declines have been seen in the Euro and JPY, with smaller reductions in the weight of the HK$ and Sterling. This has made way for the inclusion of several new currencies, most notably a 10.77% weight to the Korean Won.
Last year saw a significant decline in the Yuan versus the US$, but since July the CFETS RMB Index has been stable, as the chart below reveals:-
Since July the Yuan has traded in a range of 1.7% against the basket and 5.5% against the US$. Against the basket, it finished December at the same level as July, whilst the US$ strengthened by 4.5%. Contrary to what has been written by several commentators, during the second half of 2016 currency markets were driven by US$ strength rather than Yuan weakness.
US 10 yr yields, which peaked at 2.64% during December, were subject to reversals, in line with the weakening of the US$. They started the year at 2.45% and finished the month at 2.47% but retraced to 2.30% on 17th only to push to 2.56% on 26th. From a technical perspective this looks like a typical period of consolidation. From a political perspective it may be seen as a rather muted response to the new US order.
Europe has its own agenda this year and the German Bund market expressed concern about a potential end to ECB accommodation. 10 yr yields rose from 0.15% on 2nd to test 0.50% on 26th. They closed the month at a more modest 0.44%, perhaps due to the widening of credit spreads between
Eurozone countries. French 10 yr OATs widened 11bp versus Bunds over the course of the month, whilst Italian 10 yr BTPs widened by 23%, closing the month to yield 2.27% (183bp over Germany).
Interestingly Spanish 10 yr Bonos were remarkable stable relative to Bunds – actually narrowing by 1bp to close 120bp over the Eurozone benchmark. Whilst Bunds have broken to new yield highs, Bonos remain within their recent range, as the political uncertainty which dominated 2016 subsides.
Spain has the strongest GDP growth in the Eurozone (+3.2% – 2016). Unemployment at 18.63% may not sound like cause for celebration but it is at the lowest level since Q3 of 2009.
The one year chart below looks at the relationship between 10 yr Bonos and BTPs:-
Bonos have traditionally traded at a discount to BTPs, so this may be viewed as a normalisation, however, the financial and political position of Spain is improving relative to Italy. Any pullbacks in the spread present an opportunity to buy Bonos and sell BTPs.
JGBs were range-bound, which, given the BoJ “yield curve control” policy, is hardly surprising. They closed at 0.09%, the top end of their very narrow trading range.
Unlike the US$, US stocks have taken The Dawn of the Trumpian Era in their stride. The S&P500 made a new all-time high on 26th at 2,300 and the Dow 30 breached 20,000.
Stock market euphoria was not confined to the US. The Canadian TSE Index closed the month at 15,287, the highest since August 2014, despite the threat of an utterly renegotiated NAFTA agreement. Mexico’s IPC Index has also shrugged off the Wall of Worry. Since making its post-
election low at 43998 it has rallied, in part due to the weakness of the Peso, to close January at 47,002 up 6.8%. That is not far behind the S&P500 (+8.8%) over the same period.
European equities appear more spooked by Trump. The EuroStoxx 50, opened near the upper end of the month’s range (3,317) but closed the month on its lows at 3,230. Technically, this looks more like a period of consolidation after a strong November and December, but the political climate in Europe looks set to be very changeable in the months ahead.
The Nikkei 225 Index backed-off from pre-inauguration highs of 19,299 on 5th to close the month on the low at 19,041. Concern about US protectionism in the wake of their shelving of the TPP agreement, combined with a rebound in the Yen, despite the policy of the BoJ, has taken its toll. Nonetheless, I remain optimistic for Japanese stocks in the longer term.
Gold rebounded from December lows of $1,150/oz. It opened at $1,155 and closed $10 off its high at $1,209. Technically this looks like a correction of the euphoric decline in the wake of the US election result, rather than the clamour for a safe-haven as the huddled masses are sent home. Time will tell.
Brent Crude punched to a post-OPEC high of $58.37/bbl on the first day of the year. Within five trading sessions it had fallen to $53.58. Since then it has remained locked in a tight range, closing at $55.70/bbl. I believe the up-side will be capped. The Baker Hughes Rig Count rose 41 to 566 in the last month – a rapid supply-side response to the higher price of oil.
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