Emerging market sell-off: an untimely exit?

There is no doubt emerging markets have had a rough run since the start of the year, and it is easy to understand why investors are skittish. Events, such as Italian politics and Trump’s future behaviour on trade, could create negative shocks and are tough to measure or anticipate. However, we think the move away from EM may be premature; our global macro outlook actually supports the asset class.

We expect the main external drivers lead to a reversal of recent trends and bolster EM assets such as local currency debt. While US rates will likely continue moving a bit higher, the bulk of expected Federal Reserve hikes are already priced in forward curves. A relative healthy global growth outlook continues to support commodity prices, an obvious boon to many commodity exporters. Finally, we believe some fundamental drivers for US dollar depreciation remain intact. We also think the dollar is expensive, particularly when considering mounting twin external and fiscal deficits. As the dollar begins to slide, which we expect, it will create a tailwind for the asset class. While we may have to be more patient, we think the asset class will recover and likely post notable returns.

Federico Garcia Zamora – portfolio manager. Standish, BNY Mellon Asset Management North America

There is no doubt emerging markets have had a rough run since the start of the year, and it is easy to understand why investors are skittish. Events, such as Italian politics and Trump’s future behaviour on trade, could create negative shocks and are tough to measure or anticipate. However, we think the move away from EM may be premature; … read more

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The US$3.8trillion bond sector you might not even know about

This past year, 2017 leading into 2018, the US saw a lot of significant weather events and climate disasters. It saw three hurricanes: Harvey in Texas, Irma hit Florida and Hurricane Maria in Puerto Rico. The combined damage of those three hurricanes was around US$203bn. That has an impact on the economies of those states, the infrastructure of those communities and their tax and revenue bases.

The US also saw tornados, flooding, and on the east coast, serious winter storms. Forgotten vocabulary is coming back into the lexicon, like ‘bombogenesis’, which means bomb cyclone. The east coast of the US was hit with two of those in 2017/18 – the last time it had storms of that sort was several decades ago.

The states suffering from such climate crises really know the impact of climate change and what it can do to their communities. So in response to the Trump administration’s withdrawal from the Paris Accord, several states started the Climate Alliance. California, Washington and New York kicked it off, then were joined by 13 others (plus Puerto Rico). Their goal is to meet the Paris Accord targets – to decrease emissions by 26% to 28% from a 2015 base line by 2025.

The GDP of these states makes them comparable to many sovereign economies – California has a GDP approximately the size of France and New York is equivalent to Canada. They also have their own constitutions, law-making abilities and taxes. To fund infrastructure projects, which include climate change initiatives, they issue bonds.

These so-called municipal bonds are a diverse set and have already funded a huge amount of US infrastructure maintenance and renewal. At US$3.8 trillion, the municipal bond market is almost half the size of the US corporate bond market and we don’t see it getting smaller, particularly as the challenges of managing climate change continue or, potentially, intensify.

Dan Rabasco – Chief Investment Officer for Tax Sensitive Fixed Income. BNY Mellon Asset Management North America 

This past year, 2017 leading into 2018, the US saw a lot of significant weather events and climate disasters. It saw three hurricanes: Harvey in Texas, Irma hit Florida and Hurricane Maria in Puerto Rico. The combined damage of those three hurricanes was around US$203bn. That has an impact on the economies of those states, the infrastructure of those communities … read more

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Weaning China off credit addiction

The Chinese authorities are galvanised to lower the dependence on credit of its economic model so that less credit is needed to generate an increment of GDP growth. Notwithstanding recent efforts to infuse more durable liquidity in to the banking system, going forward, heightened financial oversight of the on- and off-balance sheet usage of credit and further state owned enterprise restructuring will be the norm. This is already achieving some headway. The share of bank deposits as a percentage of Chinese GDP and that of aggregate total social finance (a proxy for on- as well as off-balance sheet lending) have already begun to decline. This development highlights the effectiveness of financial tightening as well as the regulatory crackdown on shadow banking.

Aninda Mitra – Senior Sovereign Analyst. BNY Mellon Asset Management North America

The Chinese authorities are galvanised to lower the dependence on credit of its economic model so that less credit is needed to generate an increment of GDP growth. Notwithstanding recent efforts to infuse more durable liquidity in to the banking system, going forward, heightened financial oversight of the on- and off-balance sheet usage of credit and further state owned enterprise … read more

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Is Spain becoming semi-core?

From a pure economic perspective, we argue Spain has moved from the periphery to a semi-core member of the eurozone. The IMF estimates Spain’s potential growth to have improved from 0% in 2014 to 1.5% this year. In this sense, the structural reforms put in place starting in 2009 have contributed to a fair degree of competitiveness gains and higher potential growth.

More importantly, the market is likely to trade Spain favourably in the coming year. A potential catalyst is likely the S&P’s review of Spain, currently BBB+ with positive outlook, on 23 March 2018.

The growth outlook remains robust, and the Catalonia-Madrid tensions have dwindled; we believe the macro risks have receded sufficiently for the agency to upgrade Spain to A-. With two rating agencies in A-range (Fitch upgraded Spain to A- on 19 January), we believe the market is likely to price Spain as an A credit.

Rebecca Braeu – head of Sovereign Credit and strategy, BNY Mellon Asset Management North America 

From a pure economic perspective, we argue Spain has moved from the periphery to a semi-core member of the eurozone. The IMF estimates Spain’s potential growth to have improved from 0% in 2014 to 1.5% this year. In this sense, the structural reforms put in place starting in 2009 have contributed to a fair degree of competitiveness gains and higher … read more

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Which US states have greater GDP than other nations?

Unlike many countries where public infrastructure is planned, financed, construct and maintained by national governments, the majority of US infrastructure is the responsibility of states, cities, counties and public agencies. Each can issue their own bonds, which gives investors opportunities to invest in quasi-sovereign debt from jurisdictions whose economic output rivals that of many countries. This map shows how the individual states’ GDP equals the national GDP of various countries. With sovereign debt yields around the world remaining stubbornly low, higher yielding US municipal bonds can present an attractive, higher yielding, quasi-sovereign option for global investors.

Standish, a BNY Mellon company

Unlike many countries where public infrastructure is planned, financed, construct and maintained by national governments, the majority of US infrastructure is the responsibility of states, cities, counties and public agencies. Each can issue their own bonds, which gives investors opportunities to invest in quasi-sovereign debt from jurisdictions whose economic output rivals that of many countries. This map shows how the … read more

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Tracking Frexit fears: Overblown or underestimated?

Investors are on alert for French election risk. It’s a medley of scandal, gaffes, and general uncertainty which is spooking markets as polls show Marine Le Pen and Emmanuel Macron neck and neck in the first round of what is one of the most unusual French elections in modern history. French spreads are largely tracking Le Pen’s chances of securing the presidency.

The scenario may be unlikely, but it is not impossible for Marine Le Pen to win this election. We currently assign an 85% probability of Le Pen losing the presidency with our base case being that either Macron or Francois Fillon will take the presidency. Nevertheless, we consider the 15% alternative: Le Pen wins the French presidential election.

In the wake of her shock win, market volatility would surge. She may first call a European Summit and make nationalistic demands to the European Union (EU) but such demands would not likely be well received. While she has threatened a referendum on EU membership, support from the parliament would not likely legitimise any such vote. Even so, the threat of EU/eurozone breakup would be be quite real as the eurozone’s second largest economy and founding nation could stumble toward Frexit.

Therefore, a Le Pen victory would likely result in a spike in sovereign credit spreads across much of Europe, as negative sentiment spills over into vulnerable periphery markets.  On the other hand, if Macron or Fillon were to win, then we would expect French sovereign spreads to fall roughly 30 bps, as the expectation of economic reform would raise potential output growth.  Any spike in spreads is likely to present alpha opportunity in either France or related markets once the election outcome is known.

Rebecca Braeu – Standish, a BNY Mellon company

Investors are on alert for French election risk. It’s a medley of scandal, gaffes, and general uncertainty which is spooking markets as polls show Marine Le Pen and Emmanuel Macron neck and neck in the first round of what is one of the most unusual French elections in modern history. French spreads are largely tracking Le Pen’s chances of securing … read more

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2016’s best and worst performers

The past year has presented something of an up-and-down ride for investors.

Despite a China-led sell-off at the start of 2016, equities over the course of the year benefited from a combination of central bank support and reduced volatility. A November/December rally was driven largely by events in the US and the perceived pro-corporate policies of President Trump. A lot of this optimism has now been priced in, especially for financials and the energy sector. Nevertheless, we retain a generally positive outlook for global equities on the assumption that central banks can continue to maintain the current stable policy environment. In the US this means slow but steady increases in the interest rate rather than sudden moves in either direction.

In commodities, there were two significant factors at play in 2016. In China, the ability of the Chinese Communist Party to engineer stability even in the face of decelerating growth was a crucial tailwind for demand. On the supply side, OPEC’s tentative agreement to curb production helped oil return to the US$50-a-barrel range, a level of support we expect to extend into 2017 assuming output can be curtailed.

In debt markets, a post-US election government bond sell-off was interpreted by some as part of a “great rotation” into higher risk assets. Nonetheless, we would note the sell-off was largely restricted to sovereign debt while niche areas such as inflation-linked bonds actually performed well. Looking forward, we would highlight long-term structural factors such as pension deficits and global ageing that argue for sustained demand for fixed income products.

Meanwhile, political risk remains key – with uncertainty over everything from US trade policy to rising Chinese capital outflows, European elections to the need for continued reform in emerging market economies.

Raman Srivastava – Standish, a BNY Mellon company

The past year has presented something of an up-and-down ride for investors. Despite a China-led sell-off at the start of 2016, equities over the course of the year benefited from a combination of central bank support and reduced volatility. A November/December rally was driven largely by events in the US and the perceived pro-corporate policies of President Trump. A lot … read more

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Power to the people: What Italy’s referendum means for markets

Italy will hold a much-anticipated referendum on constitutional change on the 4 December. While the passing of the referendum would bring greater electoral stability in the future, there is an increasing risk that the referendum will result in a ‘No’ vote as the populace use it to declare their dissatisfaction with Prime Minister Renzi and his Partito Democratico (Democratic Party) led government.

Our base case scenario is for a narrow ‘No’ vote and rejection of the electoral and constitutional changes, and while Renzi has said he will resign, we will likely see the President seek to install a caretaker prime minister to lead a technocrat government until scheduled elections in May 2018. We believe this is currently priced into Italian spreads, although we would likely see a widening in spreads if a significant defeat for Renzi leads to increased speculation regarding early elections (particularly given the significant gains recently of the populist Five Star Movement).

Rowena Geraghty – Standish, a BNY Mellon company

Italy will hold a much-anticipated referendum on constitutional change on the 4 December. While the passing of the referendum would bring greater electoral stability in the future, there is an increasing risk that the referendum will result in a ‘No’ vote as the populace use it to declare their dissatisfaction with Prime Minister Renzi and his Partito Democratico (Democratic Party) … read more

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US election: Winner takes all?

Elections matter, especially when the choice offers distinct and unpredictable governing outcomes. Here, we consider four election outcomes following 8 November and how they might affect the US political, regulatory and economic landscape.

(1) President Clinton and a Democratic House and Senate

A uniformly Democratic Congress will probably reveal how quickly the gears of the government can mesh. The last time this happened, President Obama signed the American Recovery and Reinvestment Act the month after his inauguration in February 2009. Capitol Hill most likely tugs the White House left of the president’s more centrist leanings, a process that already began during the nomination contest.

(2) President Clinton and a split Capitol Hill

Given the advantage of incumbency, the most likely outcome is a divided government, where President Clinton has to work with a Republican House. An advantage is that she will have leverage that comes from a Senate run by a Democratic majority. Control of the Senate provides the president with some freedom in nominating appointees to her liking, but the voting margin there seems likely to be sufficiently slim that procedural manoeuvring will make some of those nomination battles dramatic. Expect progress on corporate tax reform, some spending on infrastructure, and a preservation of the regulatory infrastructure erected over the past eight years.

(3) President Clinton and a solidly Republican Capitol Hill

With Capitol Hill run by the opposition party, President Clinton will have to curb her party’s ambitions on appointees and compromise on legislation. Look to key appointees, whenever they are finally confirmed, to be well right of the Clinton campaign’s talking points. The major legislative initiatives of the White House may well be the exercise of veto power. Tighter gridlock than we have known before makes it likely that there will be no meaningful progress on tax reform nor an increase in infrastructure spending.

(4) President Trump and a Republican House and Senate

Under an all-Republican outcome, the same party controls the White House, the House of Representatives, and the Senate, but the president, speaker, and majority leader are not really on the same page about policy. The need to show progress will drive them to some compromises, picking the low-hanging fruit common to all involved.

Fiscal stimulus kicks in quickly, with more spending on defence and infrastructure and a restructuring of corporate taxes. After that, expect the slow crawl of tax reform, designed by the speaker to be acceptable to the president. Meanwhile, the White House will be using its executive authority to scale back the nation’s position in international trade.

By Vincent Reinhart – Standish, a BNY Mellon company

Elections matter, especially when the choice offers distinct and unpredictable governing outcomes. Here, we consider four election outcomes following 8 November and how they might affect the US political, regulatory and economic landscape. (1) President Clinton and a Democratic House and Senate A uniformly Democratic Congress will probably reveal how quickly the gears of the government can mesh. The last … read more

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Revving up for Fed action

Domestic economic momentum has been re-established, the UK shock has been distributed through global financial markets with little apparent consequence for the US, resource margins have mostly been eliminated, and inflation is on a modest incline. A 25 basis point higher nominal funds rate, even a 50 basis point higher one, by year end keeps the real federal funds rate negative and monetary policy accommodative even as it reassures investors that the Fed has not mislaid the keys to the monetary-policy-tightening machine.

We think that Chairwoman Yellen accedes to tightening this year because she recognizes that a one-quarter-point hike reminds the world that the Fed is on duty and reassures her colleagues that they are all on the same page. As for timing, Fed planners probably gravitate to December. For the dovish Fed leadership, an action postponed might never happen. Waiting until December gets a free look at the election results, which are surely material to understanding the other sources of policy impetus in 2017 and beyond. Any committee hurt about delaying in September can be salved by reporting in the Summary of Economic Projections that the preponderance of the FOMC prefers a one-quarter point higher policy rate at the end of the year, making the dots matter. After all, if they are willing to publish that, they are virtually contracting on a December move.

Vincent Reinhart – Standish, a BNY Mellon company

Domestic economic momentum has been re-established, the UK shock has been distributed through global financial markets with little apparent consequence for the US, resource margins have mostly been eliminated, and inflation is on a modest incline. A 25 basis point higher nominal funds rate, even a 50 basis point higher one, by year end keeps the real federal funds rate … read more

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