week in review

FED’S HAWKISH RATE HIKE 

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The Federal reserve raised its short term rate to a range of a 0.50-0.75% from a range of 0.25-0.50 % and signaled three increases in interest rates in 2017 instead of two and it expects to raise rates much faster in 2017 than previously anticipated. According to Federal Open Market Committee (FOMC), inflation has increased since earlier this year, but still below the Fed’s 2% longer-run target, partly reflecting earlier declines in energy prices and in prices of non-energy imports and labor market has continued to strengthen.

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The dollar reached the highest level since January 2003 after the Federal Reserve (FED) hiked interest rates in first move since 2015.

The US 10 year treasury yield curve has steepened further and climbed above 2,5 and reached the highest level since 2014 after the fed hawkish rate hike. After gains, US dollar and treasury  10 year yields fell from peaks today. As you see from the chart below, the treasury curve is steepening and flattening at the same time.

SELL-OFF TREASURIES 

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On the other side, U.S housing starts and building permits fell more than than expected, released today. US inflation rose to 2 year high and reached the highest level since October 2014. Moreover, according to Markit, US factory activity growth improved at 21 month high.

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FED RATE HIKE-RISING OIL PRICES-THE STRENGTHENING DOLLAR-VOLATILITY : DRIVE CAPITAL OUT OF THE EMEs?

Expectations of raising fiscal spending under Trump presidential and the price of oil rising will bring the inflation and the FED will increase the interest rates aggressively in 2017. Thus, emerging markets started to worry about rising interest rates, in other words, higher funding costs of debt. Some emerging markets are still suffering large external funding needs and macroeconomic imbalances which lead them to be vulnerable to capital outflows. For example, Turkey, Brazil, Indonesia, Mexico, Russia and South Africa are the most sensitive to high capital outflows, comparing to other EMEs. These countries also have high credit default spreads (CDS). In other words, they have high risk of default.

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Good news for Russia / oil producing country: Russia CDS spreads have tightened due to rising oil prices after the OPEC deal to cut production. (The risk of default is decreasing/will decrease in Russia)..

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LESS ROOM FOR FURTHER US DOLLAR APPRECIATION FOR EM CURRENCIES

EM currencies tumbled from 25% above fair value in 2011 to 30% below fair value in January of this year.

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Although EM currencies, represented by the JPMorgan Emerging Local Markets Index Plus, have rebounded since January 2016, they continue to trade near the discounts associated with the 1997 “Asian Contagion” and 1998 Russian debt default. EM currencies can certainly get cheaper before they revert toward historical norms, but they might just as easily snap back quickly to fair value.

EM RETURNS CONTINUE TO RECOVER UNTIL NOW 

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Source:http://www.valuewalk.com/2016/12/emerging-markets-hat-trick-time-throw-hat/

JAPAN – WEAK YEN = INFLATION

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Higher oil prices after OPEC deal and a weak yen since the Trump’s victory may help Bank of Japan (BoJ) reach its inflation target in 2017 even if it seems difficult. Japan CDS spreads are tightening and seems that the risk of default in Japan is very low.

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ABENOMICS AND GROWTH 

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China’s Currency Manipulation- Sharp falls in the value  of yuan-Hong Kong overnight costs 

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Source:http://www.wsj.com/articles/chinas-currency-manipulation-caught-in-two-cool-charts-1481804310

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China 10-year government bond yields keep moving higher and CDS spreads are widening..

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It is always good to be reminded about CHINA..

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EUROZONE 

Eurozone bond yields climbed to hit 11-month high in FED week. After climbed, they started to fall as fed price hiked in..

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RECAPITALIZATION OF ITALIAN BANKS-NEW PRIME MINISTER -NO PROBLEM AT ALL?

New Italy PM Gentiloni says ready to intervene to support banks. Unicredit: Italy’s largest bank is raising 13.8$ billion in the country’s biggest share issue and cut jobs in overhaul. Moreover, Unicredit sells Pioneer asset management arm to Amundi for more than 4.2$ billion..

GOOD NEWS BEFORE CHRISTMAS: Monte dei Paschi wins approval for debt-for-equity swap to retail investors is a crucial element of the plans to raise €5 billion in the coming weeks.

Italy CDS Spreads continue to tighten significantly as recapitalization of banks, but still has high risk of default more than Spain, Germany and France.

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Lastly, S&P warned that Italy GDP growth to fell below %1 over next two years after banking pressures.

EURO – UNDER PRESSURE/THE REACTION TO THE FED’S HAWKISH RATE 

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EUR/USD dropped 1 % after the fed rate hike.

The Euro area economy has improved in the third quarter and inflation is increased by 0.6% yoy in November 2016. According to Markit, businesses across the euro zone ended the year on an upbeat note as expected and weaker euro boosts price growth and manufacturing.

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UNITED KINGDOM 

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Pound had fallen sharply against the dollar on Thursday as Fed hike priced in. FTSE100 closed above 7000 on Friday as rising energy stocks. UK inflation hit 1.2% yoy in November 2016 as jump in oil prices during 2016 and Bank of England leaved UK interest rates on hold at 0.25% . Source: ONS

UK risk of default probability continues to decrease after Brexit shock..

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OIL: CONCERN ABOUT POTENTIAL PRODUCTION INCREASES IN THE US AND LIBYA 

Oil prices have risen after OPEC cut deals with non-OPEC member countries. However, continued dollar strength can reduce the demand for oil, especially in emerging economies.

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 SUMMARY: LATEST CDS 5 YEAR SPREADS 

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Source:Markit CDX credit default swap indexes cover North America and emerging markets. Markit iTraxx credit default swap indexes cover Europe, Asia, Australia and Japan. The indexes are owned, calculated and administered by Markit. For more information visit www.markit.com/cds

Source:Marketwatch /Deutschebank/Investing.com

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week in review

ITALY 

Referendum? No, Grazie !  And No won!

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Italians rejected the support reforms and political uncertainty began over markets as expected. The referendum showed that populism are on the rise in Euro area.

The Italian anti-establishment Five Star Movement (M5S), which is led by the comedian Beppe Grillo, wants another referendum on euro in future. This might cause of great concern  about the euro’s future. However, exit from the euro is not easy as it seems ..

Five Star Movement top official Alessandro Di Battista added:”The euro and Europe are not the same thing. We only want for Italians to decide on the currency”.

After the referendum result and Prime Minister Renzi’s announcements, the euro fell sharply in value against the dollar. Italy’s referendum didn’t create a huge effect on markets like Brexit shock and Trump’s unexpected victory.

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The problem of Italian banks still continue and they threaten the eurozone. For example, Germany credit default spreads (CDS) have blown out immediately after the Italian referendum while Italy CDS spreads tightened. Thus, Germany are becoming ever more concerned about Italy. On the other side, Moody’s has cut Italy ratings outlook to negative and Monte dei Paschi di Siena shares plummeted again today after the European Central Bank (ECB) rejected MPS’s bailout extension. All these might have caused credit spread widening to accelerate in Europe in the coming weeks.

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ECB’S TAPER DECISION – THE STRONG DOLLAR 

The ECB held interest rates steady and decided to extend its programme of quantitative easing (QE) before the U.S Federal Reserve (FED) is expected to raise interest rates. In other words, the bank will continue stimulus as planned at €80 billion a month until the end of March, but from April 2017, it will begin to taper the stimulus by reducing it to €60 billion a month until December 2017.

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After the ECB’s announcement, euro fell against the dollar again and Italy 10y government bonds jumped to 2.04%.

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Unfortunately, Italy will face much higher debt if the yields continue to go up. This means that ECB’s decision will be very useful and attractive for Germany bonds during this time, so Germany is running a 0.75% budget surplus in 2016 and will continue to budget surplus through 2020.

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On the other hand, Germany trade surplus narrowed to 9-month low. It was the smallest trade surplus since January, as exports fell more than import. Rising protectionism on trade and the pressure on the euro and the pound will not be good for the demand of the Germany’s export in future.

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GLOBAL BOND YIELDS ON THE RISE 

The US and the Japan 10 year bond yields jumped as ECB’s taper decision and stronger Chinese inflation data. Gold prices fell on stronger US dollar and treasury yields surrounded by the US Federal Reserve’s meeting next week. US stocks rise with US treasury yields as US consumer sentiment positive data. (positive expectation of Trump’s new economic policies.)

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Portugal 10-year government bond yields jumped as ECB taper decision. Meanwhile, IMF raised Portugal near-term growth forecasts; economy stronger on exports, but mid-term still hoobled by high debts. Italian bond yields rose, while safe-haven German bond yields declined today as concerns about the future of troubled Italian lender Monte dei Paschi.

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CHINA 

China’s trade data showed sign of industrial recovery in November (because of the China’s export and imports rose). As you can see the graph below, China play a major role in export and import for the global economy. Moreover, China producer prices rose the most in five years as cost went up for most categories (also oil prices), so its inflation rate rose to seven month high in November.

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AND Copper advanced as hopes rise on China’s economic recovery..

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Oil prices are trying to find the balance after the OPEC deal to cut production.

Source: Investing.com/DeutscheBank/Trading Economics/Bloomberg

week in review

THE OPEC DEAL 

OPEC reached a deal to cut output for the first time since 2008 and will cut production by 1.2m barrels per day. Oil futures gained more than 10% after OPEC output cut deal. We will start to see the real effects of OPEC deal in 2017.

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Source: Investing.com / OPEC

KEY MESSAGES ABOUT OECD’S ECONOMIC OUTLOOK :

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This week, OECD expected global growth to raise in coming months and are optimistic about US growth and the President Trump’s fiscal stimulus plans in future. OECD focus on that world trade protectionism is rising and trade growth is exceptionally weak. According to them, the key is to deploy the right kind of fiscal initiatives that support demand in the short run and supply in the long run and address not just growth challenges but also inequality concerns.

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Datasource: OECD

You can reach the full presentation here :

http://www.oecd.org/economy/outlook/economicoutlook.htm

BRAZIL-TURKEY 

Brazil Central Bank lowered its benchmark interest rates to 13.75% as expected due to growing market and political uncertainty after Donald Trump’s victory and rising expectations of FED rate hike in December. Brazil industrial output fell 1.1% mom in October of 2016. Therefore, Brazil’s economy continue to drop into recession in 2017..

Brazil Q3 economic growth declined to 0.8%, the economy contracted 2,9 % compared to the same period of 2015. After seeing all the negative data, Brazil Central Bank may cut its interest rate again, but it depends on its inflation..(Brazil inflation saw the lowest November rate since 2007.)

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Turkish lira fell to a record low against the dollar again as concerns about the rising oil prices on energy imports after the OPEC deal and the President Erdogan said that there is no option other than cutting interest rates and he called Turks to sell dollar and buy gold or liras. As a result of this, the Borsa Istanbul converted all cash reserves into lira. (Turkey Central Bank increased the benchmark interest rates after the lira hit a record low last week.)

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Forza Italia

Italian bonds fell and reached the lowest yield in three weeks before the constitutional referendum on Sunday. If no vote wins, this will widen the spreads (as a key indicator of political risk) between yields on italian and its peers in the short-term.

Italian banks share continue to decline as rising concerns about recapitalization plans for banks if no vote wins. The bank Monte dei Paschi di Siena has high risk of collapse in the next months after the referendum if political risk will increase. As you can see in the chart below, sentix Euro-break up Index shows that Italy is the most likely to exit eurozone than Greece.

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Turkey, Brazil and Argentine CDS spreads have blown out. Therefore, these countries are more susceptible to external shocks. Italy CDS spreads have widened in recent months due to rising concerns about political risk and they reached the highest level in November after the Brexit vote, but before the referendum, they are going to decline with Italian bonds..

Source: MarketWatch/Markit/The CDS indices are owned, calculated and administered by Markit. For more information visit http://www.markit.com/cds. Index levels are closing levels from the previous day’s trading.

CHINA 

China added new restrictions on pulling money out of the country/capital flows in order to defend exchange rate before a likely US rate hike next month. In other words, China Central Bank worried about the yuan because it is significantly affected by the strong dollar after the Trump’s victory. Moreover, China’s foreign exchange reserves faced a big drop in October and they continue to decline. As  you can see from the chart below, China’s international assets are also unattractive compared to Asian countries. (Japan, Korea and Taiwan)

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Source: http://www.valuewalk.com/2016/12/china-capital-controls/