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Macro Roundup – January I

By Colin Lloyd

December marked the end of an extraordinary year for financial markets. Despite weakness during the latter half of 2016 for the major bond markets, JGBs, helped by the Bank of Japan’s (BoJ) “Yield Curve Control” policy, were among the best performers in absolute terms. The weakening of the GBP as a result of the Brexit vote was not far behind. For many markets, however, the combination of volatility and sharp reversals in trend made 2016 a zero sum game.

On the geo-political stage 2016 was tumultuous. Aside from the UK vote to leave the EU, there was a continued swing towards right-wing “nationalist” parties around Europe. The Syrian conflict, which has embroiled the West since 2011, provided an opportunity for Russia to demonstrate it military prowess. OPEC, after protracted negotiations agreed to reduce oil output – although Saudi Arabia has borne the brunt of production cuts. But, perhaps most importantly for the coming year, the US presidential elections caused a shift in financial markets around the world. We wait to see what a triumvirate of Republican dominance of Congress, Senate and the White House means for free trade and economic growth.

 

Currencies

The US$ Index continued to rise in the wake of the November election result, taking out the previous month’s 102.12 high to reach 103.62 on 20th.

The expectation of a US tax cut and fiscal spending improves the near-term prospects for the US economy: longer term the threat of protectionism may prove less sanguine but, should this lead to inflation, bond yields are likely to rise, making the US$ attractive from a carry perspective.
Whilst EURUSD remained range-bound during December, the USDJPY marched higher. Having closed November just off month highs at 114.47 it rallied a further four points to 118.63 on 15th. The next major technical resistance is at 125.86 – the high of June 2015. USDCNH also strengthened, taking out the November high to reach 6.9882 on 29th. Trump rhetoric about China can only be expected to increase, but , on a trade-weighted basis, the Chinese currency is broadly stable – this move is about USD strength rather than CNY weakness.
Bonds
The US bond market continues to decline with 10yr yields breaking above the November high of 2.43% to reach 2.64% on 15th of the month. As I mentioned in last month’s Macro Round-up, we now have an interesting technical pattern known as an “outside year reversal”. The Federal Reserve raised rates as expected but, with “reflation” in the air, further rate increases are anticipated during 2017. A stronger US$ may disappoint the interest rate bears making a steeper yield curve even more likely as expectations of rate increases will be reflected in longer maturities.
German Bunds, begrudgingly, followed the tone of the US bond market but the rise in yield was tempered by concerns surrounding Italy. Whilst BTP 10yr yields consolidated after PM Renzi lost his confidence vote, the 10 year yield spread with Germany remains elevated. It closed the month at 1.60%.
JGBs remained subdued – although they touched 0.09% on 16th they closed at 0.05%. The BoJ policy resolve, which entails keeping 10yr JGB yields at around zero, has yet to be tested by the markets. During the last two years the yield has vacillated between 0.55% in June 2015 and -029% in July 2016 – an 84bp range. It remains to be seen what tolerance the BoJ is prepared to permit. 2017 may well prove a challenging year for the Japanese bond market.
Stocks
The S&P500 continued to rally making new all-time highs at 2,277 on 13th. The strength of the US$ has less impact on US stocks than on other international equity markets since 70% of earnings are derived from the domestic economy.
The EuroStoxx50 Index followed the lead of the US market closing the year at 3,291 – its highest since December 2015. The next target is to retest the April 2015 high at 3,836. The weakness of the EURUSD is supportive – since the beginning of 2014 EURUSD has declined by 23.5% although throughout 2016 it has been range-bound.
From a technical perspective the Nikkei225 Index, which I discussed in November’s Macro Round-up, strengthened again last month, closing the year at 19,114, the highest since December 2015. The next target to breach is the June 2015 high at 20,950 which would imply a technical target of 27,035.
The chart below looks at the Nikkei225 Index since its all-time high in 1989. An official Central Bank policy which is tantamount to infinite QE is likely to undermine the JPY, this, in turn, will drive equity markets higher.

 

Commodities
Gold continued to decline in December testing the lowest levels since February at $1,124/oz on 15th – it has since rebounded but trading remains subdued. Copper, consolidated after rallying in November. Chinese demand remains uncertain since the recent recovery in the construction sector appears to have been a short term fiscal stimulus measure. Rebalancing towards domestic consumption remains the official economic policy of the Chinese administration.
Oil rallied after the OPEC deal, testing the highest levels since July 2015 at $54.51/bbl on 12th. So far these levels have been maintained into the New Year. The question for the energy markets is how quickly US producers can increase production to take advantage of these higher prices. The US Baker-Hughes Rig Count increased from 477 on 2nd to 525 on 30th December – the highest since December 2015: yet this is still far below the 1,609 high of October 2014.
Emerging Markets
There are two emerging market currencies which warrant comment. Firstly, USDMXN which strengthened again last month to close at 20.73 as the pre-election rhetoric of the US president-elect begins to appear less than rhetorical. The Mexican Peso has now fallen by 58% since the beginning of 2014. Once the new US administration has clarified its position in relation to Mexico there will be a buying opportunity for the Mexican currency, bonds and stocks.
The second market is USDTRY. The Turkish Lira weakened again last month after the Russian Ambassador to Turkey was assassinated. Since the beginning of 2013 the USDTRY has risen from 1.78 to 3.54 (+ 99%) Turkish exporters have a significant competitive advantage. If a Syrian peace deal be negotiated in 2017, the Lira together with Turkish stock and bond markets should perform strongly.

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