Adrien Pichoud Economist
Maurice Harari Multi Asset Portfolio Manager
Wanda Mottu Portfolio Manager
Christophe Buttigieg Portfolio Manager
01

US - Unemployment rate at record low but…

The US economy is still expanding at a steady pace, benefiting from the support of tax reform. But this expansion relies first and foremost on the main fundamental driver of US growth: private consumption, underpinned by a strong employment market.

Indeed, in May, the US unemployment rate fell to 3.8%, a level only reached once during the past 45 years – in April 2000. Job creation has been averaging 200,000 per month during the past six years, which eventually triggered a mild acceleration in wage growth earlier this year.

However, one might expect such a low unemployment rate to fuel higher consumption and wage growth than we are currently seeing. One explanation concerns the share of the working age population who are actually working or looking for a job. This participation rate has shrunk in the past two decades and remains stuck at a low level, despite the fact it usually rises when the unemployment rate falls. This may explain why the historically-low unemployment rate appears at odds with a good, but not spectacular, economic expansion.

An historically low unemployment rate without increasing labor force participation

Sources : Factset, SYZ Asset Management. Data as at : 6 June 2018

01

Rising US rates drive mortgage refinancing to a 17-year low

Sources : Factset, SYZ Asset Management. Data as at : 6 June 2018

02
02

US - Rising rates weigh on mortgage refinancing activity

US government long-term rates rose in May amid a continuous flattening of the USD yield curve. While the ten-year US treasury rate was at its highest level since 2011 at 3.11%, the 30-year rate reached a four-year high at 3.25%, more than 100bps above its summer 2016 trough.

However, US government rates matter little to households. What matters to them is the rate they effectively pay, especially the rate on their housing debt. Logically, mortgage rates have also been trending higher, and even faster than US treasury rates in 2018.

Rising interest rates negatively impact households’ purchasing power in two distinct ways. They obviously make the debt servicing of a house purchase more expensive, possibly one reason for the stabilisation in home sales witnessed recently in the US. But they also imply that the opportunity to use mortgage refinancing to reduce debt service and monetise an increase in home prices becomes limited. Such refinancing has occasionally been a strong tailwind for household consumption and the housing market in the past two decades, but it is not at the moment.

03

Eurozone - France released from the EU’s excessive deficit procedure

As the new Italian government reawakens the debate about fiscal discipline in Europe, the European Commission recommended in May that the excessive deficit procedure against France be closed. Such a procedure is opened when an EU country’s public deficit exceeds 3% of its GDP.

France had navigated the turmoil of 2011-2012 relatively unscathed, despite its deficit consistently exceeding the 3% limit. It avoided the bitter austerity potion administered to Greece, Spain, Portugal and Ireland, designed to rapidly reduce their public deficits. Only Spain, because of a bad starting point, remained under the procedure alongside France until this year.

Based on a 2.6% deficit in 2017, and growth and public spending cuts projected for the next two years, France is now freed from it. Spain should follow soon, thanks to a strong growth dynamic, provided the new government sticks to its commitment to not drastically modify the budget trajectory. All eyes are now on Italy, at risk of bucking the trend if the Conte government implements its expensive fiscal promises.

French public deficit finally comes back within the 3% limit

Sources : Factset, SYZ Asset Management. Data as at : 6 June 2018

03

Japanese growth is expected to rebound after Q1 GDP soft patch

Sources : Factset, SYZ Asset Management. Data as at : 6 June 2018

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04

Japan - A growth rebound expected after Q1 GDP decline

The Japanese economy posted its first quarterly GDP decline in more than two years in Q1 2018, caused by a contraction in capital expenditures and stagnating consumption. Yen strength (+6% vs the USD over the quarter) may have played a role, but such a slowdown is most likely an after-effect of the sustained growth dynamic exhibited in 2017. The 2% of real growth per annum recorded last year is twice Japan’s potential growth rate!

Looking forward, a rebound in capital expenditures is to be expected. Even if uncertainties around trade tariffs hover above the industrial sector, a growing global economy and a reversing yen dynamic should favour a rebound. In the meantime, unemployment at a 25-year low is fuelling household consumption, even if real wages are yet to meaningfully increase.

Monthly indices such as the PMI suggest a GDP rebound is on the cards for the second quarter. This sums up the ongoing macro-dynamic in the Archipelago: a resilient and sustained expansion, but a lack of capacity to accelerate decisively and break out definitively from the deflation quagmire.

05

Venezuela - Inflation explodes further

The re-election of Nicolas Maduro as the president of Venezuela will certainly not help the country escape its worst economic crisis in history. The inflationary spiral the country is experiencing is not easing with hyperinflation getting worse month after month.

Since Venezuela plunged into a deep recession in 2016, basic statistics about the state of the economy have not been published. But according to Bloomberg’s Venezuelan Café con Leche Index, the price of a coffee has increased from 20,000 bolivars at the end of last year to 550,000 bolivars recently, indicating a year-over-year inflation rate of 23,800%.

Without clear and deep reforms, the future of Venezuela is in jeapordy. The flux of people getting away is massive and it will certainly take more than a generation to recover from the great depression the country is facing.

Unofficial measures to gauge inflation reach critical territory

Sources : Bloomberg, SYZ Asset Management. Data as at : 31 May 2018

05

The Bank Indonesia hikes interest rates two times in a month

Sources : Bloomberg, SYZ Asset Management. Data as at : 31 May 2018

06
06

Indonesia - The BI turns hawkish to defend the Indonesian rupiah

The Bank Indonesia (BI) has ended the extended monetary policy easing cycle it started in 2015. Within two weeks, the BI hiked its policy rate two times, from 4.25% to 4.75%, reversing the two rate cuts implemented last year. Following the first rate hike on 17 May, the new governor Perry Warjiyo scheduled another meeting on 30 May to raise rates again, pre-empting the expected Fed hike in June and preventing a further Indonesian rupiah depreciation.

In the context of a more challenging environment for emerging countries – the ten-year US treasury yield breaking the 3% threshold and the US dollar getting stronger are both headwinds – the BI prioritised exchange rate stability over domestic growth. The global risk-off sentiment in emerging markets has particularly penalised the Indonesian rupiah in recent weeks. Indonesia is among the most fragile Asian economies due to its reliance on foreign inflows to finance its current account deficit.

The last time the BI raised rates by 50bps in a month was after the Taper Tantrum in 2013. However, the health of the Indonesian economy is quite different today, with a smaller current account deficit and lower inflation.

07

FX - Turkish assets under pressure

The Turkish economy is characterised by a toxic mix of slowing growth, high inflation and deteriorating external imbalances coupled with geopolitical and political uncertainties. These elements continue to put pressure on the Turkish lira, which reached a new low versus the US dollar in May (-10.3% and -16.0% on a YTD basis). The Turkish ten-year government bond yield also spiked by 172bps in May and 264bps since the beginning of the year.

Moreover, the oil price edging higher is not good news for the country, as it means higher imported inflation, and it’s a clear negative for the current account deficit.

At the same time, the outlook for Turkey continued to darken as President Erdogan suggested he would take more control of monetary policy if he wins the presidential election on 24th June.

Finally, the Central Bank of the Republic of Turkey decided during an emergency meeting at the end of May to hike the late liquidity window rate by 300bps to 16.50%. This helped relieve the pressure on the currency at the end of the month. However, to see a sustainable rebound of the lira, the economy would need more structural adjustments to correct its large macro imbalances.

USD/TRY FX Rate and Turkish Government Bond 10Y Yield

Sources : Bloomberg, SYZ Asset Management. Data as at : 7 June 2018

07

Temporary pauses amid structural appreciation

Sources : Factset, SYZ Asset Management. Data as at : 6 June 2018

08
08

FX - The Swiss franc bounces up amid Italian political stress

As the Swiss people prepare to vote on the Vollgeld initiative, the Swiss franc appreciated against most currencies in May. However, the rebound of a currency that had been under downward pressure, mostly versus the euro, over the past year probably has little to do with the vote.

Instead, the Swiss franc’s evolution in the past months reflects the underlying drivers of the currency. Over the long run, the Swiss franc strengthens structurally due to Switzerland’s large external surplus and inflation differential. In times of crisis, the Swiss franc is a safe haven of choice and can experience sudden bursts of appreciation, especially if neighbouring Europe is experiencing turmoil. Only in a very blue-sky scenario does the Swiss franc get penalised for its low relative interest rate level. The Swiss currency indeed had temporary phases of decline during the global expansion phases of the late 1990s and mid 2000s.

More recently, another period of positive global growth has engineered a pullback of the franc from its post-floor peak. But its sudden rebound in May, triggered by the revival of political risk in the Eurozone, is a reminder that a very positive global environment is required to – temporarily – counter the structural appreciation trend of the Swiss franc.

09

Fixed Income - Italian rates undermined by political uncertainty

Last month, Italian politics remained in the spotlight. The fragile populist coalition between the two leading parties (Five Star Movement M5S and the Lega) has put Italian assets under pressure – especially rates, which spiked to their highest levels since the 2013-2014 period.

The fact that the anti-establishment M5S party was aiming to ask the ECB to write off as much as €250bn of Italian debt, coupled with its much-discussed desire to exit the euro, added fuel to the fire.

During May, the BTP two-year yield and the BTP ten-year yield increased respectively by 137 bps and 101 bps, while the ten-year spread with the bund widened by 123 bps. The contagion effect also impacted, to a lesser extent, the spread of other peripheral countries such as Portugal and Spain.

Finally, at very end of the month, Italian government bonds prices jumped back to erase some earlier losses on the prospect that new elections could be avoided.

BTP - Bund 10y Spread and Italy Government Bonds 2Y Yield

Sources : Bloomberg, SYZ Asset Management. Data as at : 8 June 2018

09

A weaker pound fueled the equities rally

Sources : Bloomberg, SYZ Asset Management. Data as at : 31 May 2018

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10

UK Equities - Strong returns thanks to the exchange rate

May was marked by an impressive divergence across European equity markets as the Eurostoxx closed with a loss of 3.6%, while the FTSE 100 registered a solid gain of 2.2% in May and 8.8% over the past two months. A brighter economic outlook is not the reason for this recent rally as uncertainties continue to surround the fate of the British economy after Brexit. Investors should look elsewhere to find the most likely cause of this surge.

The FTSE 100 is very much skewed toward companies that make their revenues abroad, hence companies that are very sensitive to exchange rates. With a lower pound, profits of those companies are worth more in sterling terms.

Finally, there has been an increase in corporate activity globally, with a number of companies looking to make acquisitions. In this context, a weaker pound made UK assets cheaper for international investors, pushing the stock market higher.