The wording changes in the Chinese National People’s Congress annual keynote speech suggest more currency liberalisation, thus increasing currency volatility. We expect more risk aversion towards Chinese assets in the short run. What the Chinese authorities can do next?
The Chinese National People’s Congress dropped the pledge to ensure that the Renminbi “remains generally stable at an appropriate and balanced level”. Chinese officials also said “the Renminbi exchange rate will be further liberalised, and the currency’s stable position in the global monetary system will be maintained”. In our opinion, these changes in the statement increase the risk of higher currency volatility while a one-off devaluation seems less likely at this stage. We also believe the currency liberalisation is more likely than another devaluation of the Yuan as the latter would complicate further the Chinese relationship with the US who relentlessly accused China of currency manipulation.
The Yuan fell 7% against the US dollar last year as the Chinese economic growth slowed and capital outflows rose. In an attempt to slow down the drop of the yuan, the PBOC sold its FX reserves (almost US$3bn in 2016) and implemented stricter capital controls (capital account fell to -US$200mn at the end of last year).
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The latest hawkish comments from FOMC’s member suggest higher US rates sooner rather than later. These comments might have had an impact on Premier Lu Keqiang’s decision to change the statement, giving more flexibility to the Chinese authorities in conducting economic policy. The latest keynote speech also signals that Chinese authorities would be unlikely to divest their FX reserves at the current pace for long if the dollar appreciates further.
Overall, we believe the Chinese authorities could move toward more currency liberalisation, meaning more currency risk for investors. They could also implement stricter capital controls to reduce capital outflows, which would likely increase risk aversion from foreign investors. Finally, the PBOC could decide to tighten its monetary policy, which is potentially too accommodative now taking into account the explosive trend on the Chinese credit market (China’s total debt reached 250% of GDP in late 2016 from 160% before the financial crisis). However, the PBOC would face a great challenge in tightening monetary policy to reduce capital outflows, slow down credit growth and limit the depreciation of the Yuan without triggering a credit and banking crisis and ultimately a recession.
We expect more risk aversion towards Chinese assets in the short run alongside increased currency volatility and bond risk contingent on the next PBOC’s policy move. Over the longer term, China’s economic growth will slow down gradually as the country continues its convergence toward more developed economies, which favours Chinese bonds over equities.
Morgane Delledonne, Fixed Income Strategist at ETF Securities
Morgane Delledonne joined ETF Securities as Fixed Income Strategist in 2016. Morgane has an extensive experience in Monetary policy, Fixed Income Markets and Macroeconomics gained at the French Treasury’s Office in Washington DC and most recently in her role as Macroeconomist and Strategist at Pictet&Cie in Geneva. Morgane holds a Bachelor of Applied Mathematics from the University of Nice Sophia Antipolis (France), a Master of Economics and Finance Engineering and a Master of Economic Diagnosis from the University of Paris Dauphine (France).
Macron’s centrist ideas are increasingly appealing to a French electorate that is used to frequent and sclerotic shifts in the government between the left and right. We believe the French OAT – German Bund 10-year spread is likely to tighten further as Macron the centrist-populist rises in the polls.
The centrist candidate for the French presidential election, Emmanuel Macron, finally outlined his policy platform. His programme is liberal, pro-growth and pro-European. In our opinion, Macron’s strongest advantage is the coherence of his proposed reform of the labour market, including the relaxation of the 35-hour law. However, some of his proposals are broadly a compilation of the most popular left, right and center parties’ ideas. Taken from the left, Macron proposes a universal unemployment benefit to independent workers, financed by taxes. Taken from Republicans, Macron wants to cut corporate taxes from 33.3% to 25% closer to the European average. Even taking ideas from the Front National, Macron addresses national security issues proposing to increase the police force and creating specific penitentiary for “foreign fighters”. His goal is undoubtedly to unite the French people against the corrupt political elite, with the timing of the Fillon’s scandal generating an increasingly receptive audience. While Fillon is struggling to clear his name after being accused of fictitiously employing his wife and children, Macron proposes to forbid parliamentarians from hiring members of family.
Macron’s centrist ideas are increasingly appealing to a French electorate that is used to frequent and sclerotic shifts in the government between the left and right. The latest polls see Macron gathering 24% of the votes in the first round – just 1 point behind Marine Le Pen – and winning in the second round with a large majority (65%). We believe his newly published policy programme, while a bit light on details, could attract undecided and disappointed voters from the other camps, notably from the Republicans. That would dramatically increase his chances of winning the election. From a market perspective, the rise of Macron’s probability of winning the election is perceived as a positive development. The French OAT – German Bund 10-year spread tightened almost 20bps since the beginning of last week, while remaining elevated from an historical perspective. We believe the spread is likely to tighten further as Macron rises in the polls.
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Populism or clever political move? Whether Macron is seen as a populist or a demagogue will depend on the feasibility of his proposals. So far, Macron’s programme is missing details on its implementation and the impact on public finance, growth and employment. There is also a lot of uncertainty around who will form Macron’s government.
Morgane Delledonne, Fixed Income Strategist at ETF Securities
Morgane Delledonne joined ETF Securities as Fixed Income Strategist in 2016. Morgane has an extensive experience in Monetary policy, Fixed Income Markets and Macroeconomics gained at the French Treasury’s Office in Washington DC and most recently in her role as Macroeconomist and Strategist at Pictet&Cie in Geneva. Morgane holds a Bachelor of Applied Mathematics from the University of Nice Sophia Antipolis (France), a Master of Economics and Finance Engineering and a Master of Economic Diagnosis from the University of Paris Dauphine (France).
Thematic equities such as Robotics and cyber security saw US$27.3m inflows last week. Robotics remain in favour, with inflows year-to-date totalling US$81m from which US$52m of inflows month-to-date.
Energy ETPs saw US$23.3m flows withdrawal last week as investors took profits. The International Energy Agency (IEA) said on Friday that oil supplies fell by around 1.5m barrels per day (bpd) last month, including by 1m bpd reduction from OPEC. The OPEC cut compliance of 90% of pledged oil output curbs in January. However, the massive increase in US crude oil imports (to a four and a half year high) and the trend increase in rig count in the US partly offset the reduction in oil supply, suggesting energy prices overextended recently. Investors took profits as there is a limited upward potential in prices over the medium term.
Inflows into gold ETPs continue as price returns to November 2016 levels. We saw US$8.2m inflows into gold ETPs as the price of gold briefly touched US$1240/oz (up from US$1220/oz the week before). The 10bps decline on 10yr US Treasuries yields at the beginning of last week supported gold. We believe that the high degree of geopolitical uncertainty will limit downward pressures on gold prices.
Strong inflows in cocoa of US$6.4m last week suggest tactical buying as price fell to a five-year low. The 6.3% price decline last week brought cocoa price to a five-year low at US$2338/ton. This price drop reflects a correction after a larger-than-expected production while the threat of the Harmattan (a dry and dusty wind) – initially expected to disrupt 50% of global production – did not materialise. We believe the current multi-year low in cocoa’s price is perceived as a buying signal by contrarian investors.
European corporate bonds ETFs saw US$4.3m outflows. We believe the ECB’s decision to reduce the amount of monthly bonds purchase by EUR20bn after April coupled with the highly uncertain outcomes from the upcoming presidential elections have weighed on investor interest in European corporate bonds. The French far-right Presidential candidate, Le Pen, who is currently in second place according to recent polls, has promised the return of the French franc, threatening a redenomination of EUR1.7bn of French debt into francs if she were elected with the potential to default.
Video Presentation
Morgane Delledonne, Fixed Income Strategist at ETF Securities provides an analysis of last week’s performance, flow and trading activity in commodity exchange traded products and a look at the week ahead.
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ECB’s minutes reveal concerns over Eurozone bonds scarcity
ECB’s minutes reveal concerns over Eurozone bonds scarcity. The minutes of the ECB’s December meeting, published yesterday, revealed that the increasing scarcity of high quality government bonds such as German bunds, was at the centre of the two main decisions taken by the Governing Council. Overall, the ongoing deleveraging of the public and the private sectors, coupled with the ECB’s purchases and the elevated demand for high quality Eurozone government bonds have aggravated the shortage of supply. We believe that this is a warning signal that QE in its current form has reached its practical limit in Europe. While some Eurozone governments have procrastinated in using fiscal stimulus, they will soon no longer have the choice but to implement structural reforms to support the economic recovery. Consequently, we believe the rotation from monetary to fiscal stimulus has not been fully priced into the market yet. Thus, we expect Eurozone yield curves to gradually steepen in 2017. Regarding the extension of the Asset Purchase Programme (APP), the minutes revealed that Governors debated over two options: a 6-month extension at a constant monthly pace of EUR80bn and a 9-month extension at a slower pace of EUR60bn. While the first option would have resulted in a smaller total amount of additional purchases (EUR480bn against EUR540bn for the second option), liquidity-related challenges drove the discussion toward the latter option. The first option would have necessitated an additional modification of the parameters of the programme, namely a change in the capital key – the proportion of bonds the ECB can buy from each country defined as the capital participation of the country to the ECB balance sheet. The ECB’s APP has supported bond valuations and reduced the supply of high quality bonds, making government collateral more expensive, leading daily volumes and rates in the European repo market to decline. In order to reduce these unintended consequences on the repo market, the ECB provides a securities lending programme (SLP) where the holdings of securities purchased under the Public Sector Purchase Programme are available for securities lending. The minutes revealed that the relaxation of the conditions to borrow collateral from the SLP was primarily to address the increasing scarcity of high quality bonds and collateral. Accordingly, ECB’s Governors announced in December that cash would be accepted as collateral against securities (no longer exclusively high quality bonds). Despite the marginal revisions of the parameters of the QE to smooth its implementation, the ECB’s monetary stimulus seems close to its practical limit, suggesting the Eurozone yields have reached their floor.
Morgane Delledonne, Fixed Income Strategist at ETF Securities
Morgane Delledonne, Fixed Income Strategist at ETF Securities
Morgane Delledonne joined ETF Securities as Fixed Income Strategist in 2016. Morgane has an extensive experience in Monetary policy, Fixed Income Markets and Macroeconomics gained at the French Treasury’s Office in Washington DC and most recently in her role as Macroeconomist and Strategist at Pictet&Cie in Geneva. Morgane holds a Bachelor of Applied Mathematics from the University of Nice Sophia Antipolis (France), a Master of Economics and Finance Engineering and a Master of Economic Diagnosis from the University of Paris Dauphine (France).
Co-author: Martin Arnold – FX & Macro Strategist The ECB: To infinity and beyond?
We believe the ECB decision to extend its Asset Purchase Programme (APP) while reducing the monthly amount by EUR20bn is extremely prudent and forward looking, reflecting rising inflation risks on the back of higher oil prices and the increasing prospect of higher fiscal spending next year. What’s more we believe the ECB is applying a precautionary approach to the potential inflationist risks associated to the rise of populist parties in Europe.With over 70% (by GDP) of the Eurozone having scheduled elections in 2017/18, political uncertainty is likely to keep gains for the Euro limited. Such political uncertainty, and in the absence of genuine economic reform, is also likely to force the ECB to do more in terms of yield curve management in order to buttress failing banks.
Both external and internal factors have been exerting pressures on the ECB to extend its quantitative easing. While the bond rout that followed the victory of Trump led more Eurozone government bond yields to exceed the deposit facility rate (-0.4%) – the minimum rate to be eligible for the ECB’s APP – increasing the amount of bonds available for purchase, the changes over the APP technical aspects (namely, widening the maturity range from 2yr-30yr to 1yr-30yr and accepting bonds yielding below the deposit rate) reveal the ECB’s concern that the bond rout could reverse.
After extending its QE policy until December 2017 and broadening the base of assets the central bank can buy, the ECB has further enhanced its commitment to supporting growth in order to engender inflationary pressures. Although the inflation picture has improved, there is significant uncertainty, and the ECB is likely to continue to use different stimulus measures to help boost demand, putting further downward pressure on the Euro.
Although late to the QE party, the ECB has shown a strong desire to strengthen the transmission mechanism that would allow the ‘easy money’ to get to the real economy, by buttressing bank balance sheets. In this way, yield curve targeting, like the Bank of Japan can further support bank balance sheets by steepening yield curves, and help funding get to the areas of the economy that need it most.
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Morgane Delledonne, Fixed Income Strategist at ETF Securities
Morgane Delledonne joined ETF Securities as Fixed Income Strategist in 2016. Morgane has an extensive experience in Monetary policy, Fixed Income Markets and Macroeconomics gained at the French Treasury’s Office in Washington DC and most recently in her role as Macroeconomist and Strategist at Pictet&Cie in Geneva. Morgane holds a Bachelor of Applied Mathematics from the University of Nice Sophia Antipolis (France), a Master of Economics and Finance Engineering and a Master of Economic Diagnosis from the University of Paris Dauphine (France).
