FAST FACTS ABOUT TODAY’S ECONOMIC DATA:
- Brazil macro picture continues to brighten, but we prefer Brazil debt over equity.
- Chicago Fed National Activity Index flipped back into negative territory.
- S. Tax Receipts off to slow start in August, down -5% Y/Y.
MACRO DATA IN BRAZIL CONTINUE TO IMPROVE:
Macro data in Brazil remain in an improving trend as retail sales are now up +3.0% Y/Y, unemployment has fallen for three straight months to 13%, PMI’s continue to trend higher, and GDP is about to turn positive on a Y/Y basis.
MEANWHILE INFLATION IS FALLING IN BRAZIL:
With inflation trending substantially lower, the Brazilian central bank has had room to cut rates. We believe Brazil is in a position to cut rates substantially further. This dovish backdrop has been a positive for Brazilian equities.
WITH BRAZILIAN EQUITIES AT ALL-TIME HIGHS, BRAZILIAN 10-YEAR YIELDS SHOULD MOVE LOWER STILL:
Of all the major global bond markets, Brazilian 10-year bond yields are the richest in the world at 10%. As the economy improves, and inflation cools, we would expect to see investors reach for yield in Brazil. It is notable that while Brazilian 10-year yields still offer 10% returns, Brazil Credit Default Swap rates are trending lower. In a sense, the bonds still offer investors a “default premium” return, whereas default protection is declining in price.
HOW LIKELY IS DEFAULT RISK IN BRAZIL?
Certainly the deep recession/depression from Q2 2014 – Q1 2017 has taken its toll on Brazil’s fiscal/financial condition. The deterioration is clearly witnessed in Brazil’s fiscal accounts and debt to GDP. The below charts may appear alarming at first blush, but in absolute figures, Brazil’s Primary Budget Deficit was less than 1% of GDP in 1H 2017 and Debt to GDP is not egregious at 75%. Meanwhile, we should not overlook that fact that tax receipts are turning higher (+6% Y/Y) and appear to have bottomed in late 2016.
Not only are tax receipts on the rise, but there is a silver lining to the fact that Brazilian President, Michel Temer has escaped corruption charges as Mr. Temer is considered a fiscal hawk. Immediately upon his escape from suspension, Mr. Temer stated “With the support the lower house has given me, we will pass all the reforms that the country needs…Now it is time to invest in our country. Brazil is ready to start growing again.”
All this being said, today we are instituting at Long Brazil 10-Year Sovereign Bond view (with fiscal tightening, we’d rather be long Brazilian debt than inflated equities at this point). However, we have concerns that a reversal in the recent weak U.S. Dollar trend could limit potential upside on this view. As such, we will also institute a Long USD/BRL hedge as well.
CHICAGO FED NATIONAL ACTIVITY INDEX FLIPPED BACK TO NEGATIVE IN JULY:
According to the Federal Reserve Bank of Chicago, the Chicago Fed National Activity Index (CFNAI) fell -0.17 points to -0.01 in July. Moreover, the three-month average fell -0.14 points to -0.05. In the month, Production & Income declined -0.05 points to -0.02, Employment & Hours declined -0.04 points to +0.09, and Sales & Inventories declined -0.07 points to -0.01; however, PCE & Housing improved +0.01 points to -0.06.
U.S. TAX RECEIPTS DOWN -5.0% Y/Y IN 1H AUGUST:
According to the U.S. Treasury, tax receipts are down -5.0% Y/Y through August 17th and they are up +5.3% Calendar YTD, which corresponds to a slowing since July (+6.2% at the end of July). Income and Employment Withholdings Taxes fell -4.8% Y/Y and slowed to +6.0% Calendar Y/Y (+7.0% Y/Y at the end of July). It should be noted that Income withholdings may be boosted due to the +7.3% increase in the maximum amount of earnings subject to Social Security tax ($127,200 in 2017 vs. $118,500 in 2016), which may be distorting the Y/Y amounts (bonuses had higher FICA taxes withheld earlier in year). Furthermore, Excise & Other Taxes fell -5.2% Y/Y and slowed to +6.1% Calendar Y/Y (+6.5% Y/Y at the end of July) and Corporate Income Taxes fell -14.1% Y/Y and -0.8% Calendar YTD (versus -0.5% Y/Y at the end of July).
U.S. GDP: Our GDP model points toward stronger growth in the quarters ahead (+2.8% Real GDP growth in 2H 2017, and 3% growth in 2018) given improvements in workforce population growth, workforce participation, and low interest rates and energy prices. However, given that 1H 2017 GDP is currently estimated at just 2.0% growth, it will be difficult for GDP to achieve our official forecast of 3.0% for 2017.
U.S. Inflation: U.S. CPI appears to have peaked and the Fed’s preferred inflation metric, the Core PCE Deflator, increased +1.5% Y/Y in June (away from the Fed’s 2% inflation target). As we anniversary the drop in commodities prices, we expect headline inflation has hit a near-term peak, taking pressure off of the Fed’s current hawkish rate stance.
U.S. Federal Reserve: Given our belief that U.S. inflation peaked for the year a few months ago, we believe the FOMC will become increasingly more data-dependent. We believe the odds of another Fed hike in 2017 have come down given recent declines in inflation. The odds of balance sheet reduction should also decline as well, although the street expects balance sheet action to begin in September.
U.S. Treasuries: With headline CPI having hit a near-term peak of 2.7% Y/Y, we believe the 10-year U.S. Treasury is now range-bound through the end of the year. We would be inclined to be buyers of Treasuries if the 10-year yield were to approach its recent high of 2.63%.
U.S. Equities and Earnings: S&P 500 operating earnings will rise materially in 2017, but our yearend S&P 500 target of 2400 has already been attained. In fact, we believe the S&P is now fully valued. We continue to favor the homebuilders, given the demographic tailwind and lack of inventory and are encouraged by the improvement in pending home sales.
Argentina: In short, the economic data out of Argentina remains bad (but less bad than it was a year ago). Industrial Production increased +6.6% Y/Y in June (+2.7% Y/Y prior), CPI is up +22.9% Y/Y in June (+23.4% Y/Y prior), Consumer Confidence remains depressed in June, and GDP is up just +0.3% Y/Y.
Brazil: See above.
Canada: Given concerns about Canada’s housing market (Existing home sales fell again in July and Building Permits are slowing) and potential fallout from lower oil prices, we added Canada to our downside risk watch; however, so far Canada’s economic data remain healthy. Consumer Confidence remains at high levels, manufacturing PMI’s remain strong, unemployment has been in a declining trend, retail sales have been improving, and Canada’s monthly GDP continues to improve (+4.6% Y/Y in May).
Mexico: Unemployment rate improved to 3.3%, Consumer Confidence continues to improve, and Retail Sales appear to be turning up as well (+4.1 Y/Y in May versus +1.4% prior). Furthermore, Manufacturing PMI and Orders indicated slower growth in July and Inflation is still in a rising trend.
Venezuela: We will leave this as a placeholder in the event that Venezuela ever becomes an investible market again. We are hopeful …
United Kingdom: The U.K. economy remains resilient. Consumer Confidence has deteriorated and Q2 GDP slowed to 1.7% Y/Y (+2.0% prior); however, Unemployment continues to decline, Retail Sales have improved, home price gains are steady, inflation is in an uptrend, and PMI’s improved in July. We are watching the U.K. for further deterioration.
European Union: Economic data has recently slowed in Europe. PMIs indicate slower growth, Industrial Production fell -0.6% M/M, and Consumer Confidence remains negative. However, we are seeing improvement in Southern EU nations as well (including Greece). As such, we remain bullish on the Euro STOXX 50 Index.
European Central Banks: The ECB is doing exactly what we thought they would do by favoring asset purchases over furthering lowering rates into negative territory and now the ECB is facing rising inflation. The ECB has now begun to taper its asset purchases and certainly a discussion will begin on the process of how/when to raise rates. We will watch to see if ECB tapering has any meaningful impact on zero (or near-zero) interest rates throughout the continent.
Eastern Europe: We continue to believe risks remain for Eastern Europe given high Debt/GDP levels, most notably Cyprus (104%), Croatia (88%, up from 66% at the end of 2013), and Slovenia (81%). Yet, economic data have been robust this year across most of Eastern Europe.
South Africa: Political chaos and debt downgrade risk aside, South African data improved in Q2 (higher PMI’s, higher retail sales, lower inflation, and improving business confidence), however, Unemployment remains persistently high at 27.7%.
Turkey: Despite the political situation, the macro backdrop has been strong. Consumer confidence has been rising for months, business confidence increased in June, Unemployment is turning lower again, and inflation has reversed its recent rising trend. One area to watch for signs of weakness is housing as Home Prices slowed slightly in May (still up +12.6% versus +13.1% prior) followed by a sharp decline in home sales thereafter (-8.1% Y/Y in June). Furthermore, industrial production declined -3.6% Y/Y in June. Note that July manufacturing PMI slowed slightly as well.
ASIA / PACIFIC:
Australia: The RBA has cut rates twice in the past year and Australian data is holding up. So far, business and consumer confidence have been strong, and PMI’s have held up, despite weakness in commodities prices. So far, housing data remains steady, but recent data have shown some weakness. We remain neutral on Australia at this time, on concerns about China exposure but so far China is still posting strong data.
China: Recent data suggest some modest improvement in China’s manufacturing sector. Note that China Industrial profits appear to be reaccelerating, and China’s consumer and services sectors remain resilient. We continue to believe China has the levers necessary to stimulate ahead of the National Communist Party Congress later this year, but we are watching for further signs of stress within China’s credit and housing markets.
India: Indian economic activity took a nosedive in July following the new Goods and Services Tax (GST) as PMI’s fell into contractionary territory. This downturn in activity follows months of weakening durable goods sales and slowing industrial production. With the SENSEX index just off its all-time high and up 21% this year, we are monitoring India for further deterioration. Given declines in inflation, the central bank cut rates this month.
Indonesia: Indonesia’s GDP and Private Consumption Expenditures have been stable at 5% Y/Y, but Consumer Confidence and inflation appear to be turning higher. As a result, it is reasonable to assume that the central bank’s dovish policy stance (six rate cuts in 2016) may revert to a more neutral stance this year.
Japan: We have a bullish view on Japan’s Nikkei 225 given improvement in Japan economic activity, employment, and small business confidence, although the weakness in PMI’s over the past two months raises concern. Bank lending is improving on a Y/Y basis in Japan, unemployment continues to improve, industrial production remains elevated, and consumer confidence remains in a slow up-trend.
Russia: Russian economic data continue to suggest economic growth as GDP accelerated in Q2, although PMI’s slowed in July on the back of lower oil prices. However, Retail Sales have rebounded, Real Disposable Income and Wages have turned up, and Unemployment rate improved to 5.1% in June (4 straight months of improvement). Meanwhile, inflation is moderating, which allowed the Bank of Russia to cut rates once again. Russian equities remain the cheapest in the industrialized world and we remain bullish.
GLOBAL CENTRAL BANK SCORECARD:
MACRO TRADING IDEAS:
WEEK IN REVIEW – BEST & WORST PERFORMERS:
S&P 500 SECTOR PERFORMANCE:
BEST/WORST PERFORMING GLOBAL STOCK MARKETS:
BEST/WORST PERFORMING WORLD BOND MARKETS:
COMMODITIES MARKET PERFORMANCE:
MAJOR GLOBAL STOCK MARKETS:
MAJOR GLOBAL BOND MARKETS:
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