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Wait and see

Following the risk rally, markets take stock of a good-news glut.

 

Risk assets continued their solid run despite a lack of resolution to many of the key issues that roiled markets for much of 2018. 

On trade, China promised to buy more US goods in an apparent concession designed to advance talks between the two countries, even though this may ultimately run afoul of WTO rules. The trade data release in China also disappointed, with both exports and imports contracting sharply, confirming the slowdown in domestic and global demand that markets have been pricing for the last few months.

In developed markets, the week’s events may make one wonder whether the word ‘developed’ is a little too generous, as there were no signs of a resolution to the US government shutdown or the Brexit negotiations.

Performance wise, emerging market (EM) equities had another positive week, while returns on the fixed income side were more subdued as certain FX pairs came under pressure. 

In EM hard currency, high yield credit continued to compress versus investment grade.

In EM news:

  • The US Senate blocked a bid by the Democrats to maintain sanctions on three Oleg Deripaska-linked companies, effectively lifting the sanctions that have been in place since mid-2018.
  • The South African central bank held interest rates at 6.75%, trimmed its inflation forecast and struck a slightly dovish tone, which led to underperformance from the rand.
  • In Turkey, presidents Trump and Erdogan worked towards reconciling their differences after only a week prior had President Trump threatened Turkey with ‘economic devastation’ if it were to attack the Kurds in Syria. The Turkish central bank also left rates unchanged at its recent meeting. In combination, these events led to positive performance from the Turkish complex.
  • In China, the PBOC has been injecting large sums into the market in a bid to ease interbank borrowing costs. This follows recent RRR and tax cuts which were designed to stabilise activity following a run of poor data.
  • In Lebanon, the president, prime minister and other top ministers met and sent a unified message to the market that there would be no restructuring. The bond curve staged somewhat of a recovery, but the market still appears to be pricing a reasonably high likelihood of restructuring in 2020 or 2021. Qatar also promised USD500 million of assistance for the country over the weekend.

Outlook

The outlook remains mixed as many key issues await resolution. 

On the data front, this week’s Chinese GDP print confirms the slowdown in activity there, but we have also begun to see some stabilisation in the total social financing numbers, which may be an early signal of a stabilisation in Chinese growth.

RRR and tax cuts have also been enacted and the base case is that these measures will all combine to arrest the slowdown in growth, but markets will want to see the proof in the data before pricing out much more risk premium here. 

The trade negotiations are also ongoing, with China making concessions on trade but seemingly little progress on intellectual property issues, which are likely to be a sticking point for the US.

With equity markets having unwound some of the excessive recession risk that was priced in and with US earnings season now upon us, the onus will, in our view, be on the results to justify the early year rally. Thursday’s PMI data will also be closely watched. 

We think the start-of-year rally in risk markets is justified, but it is also fair that they have moved to price in a lot of good news recently; in our view, markets seem set for a period of consolidation as they enter ‘wait-and-see’ mode.