Further US dollar weakness

Market analysis - 1/19/2018

This week’s key features were the continued rise in government bond yields and further US dollar weakness amid optimism on prospects for growth and inflation.

There are increasing signs that inflation is starting to recover in developed countries. Not only has Brent crude moved back above $70, its highest level since December 2014, but underlying inflation has been climbing in recent months, both in the US and in Europe. 

The increase in US bond yields looks warranted given the vote on tax reform and the strong bounce in oil prices, but the failure of the US dollar to react is puzzling. Despite the strong US economy, it has fallen in the last year against all G10, Asian and Latin American currencies apart from the Mexican peso. 

There appear to be several explanations:

- First, by leaving its inflation and benchmark forecasts unchanged in December 2017 -despite its upward revision in growth forecasts- the Fed has managed so far to numb investor reactions to rate hikes.  

- Second, the improvement in growth/inflation prospects in the eurozone and Japan, has fuelled expectations of an acceleration in benchmark rate normalisation and that has had a direct impact on the short end of the eurozone yield curve. Assuming that the US is much more advanced in the cycle than Europe or Japan, markets are pricing bonds as if the monetary policy gap with the US, which had reached a peak, will probably contract from here on. 

But in our view, investors might be underestimating the Fed’s capacity to tighten further. Recent comments from New York Fed chairman William Dudley support our opinion. At the same time, the US dollar’s decline has been too fast and gone too far. And we also think the ECB might want to calm down euro bulls. That, at least, is the impression we get from recent comments from ECB governors like Ewald Novotny and Jens Weidmann and the governor of the Bank of France. 

  European equities

Definitive eurozone inflation for December showed prices rising at an annualised 1.5%. There have been indications that the ECB will remain accommodating until inflation hits 2%. 

Tech outperformed on excellent semiconductor figures from ASML which dragged up STM and Infineon. Media plays like ProSiebenSat1 and Publicis gained on Facebook’s decision to limit advertising, a move that could help traditional businesses.

In stock news, BASF's preliminary 2017 results beat expectations and helped the DAX outperform. Stocks exposed to the Grand Paris project like Vinci and Eiffage gained ahead of government announcements. EDF rose on the likelihood of a rise in regulated prices following a recommendation from the Energy Regulation Commission. Alstom’s order book rose more than expected as did like-for-like sales (+8%, or above the targeted annual 5% cruising speed). The group confirmed its 2020 objectives and the merger with Siemens which is scheduled for the end of this year. Rémy Cointreau’s third quarter sales came in slightly better than expected and, once again, the Cognac division was the driving force. 

Auto companies released data on 2017 new registrations. Renault enjoyed record sales and became the biggest global player, thanks primarily to its drive to expand internationally. 

In company transformation stories, the EU commission gave the green light to Qualcomm’s acquisition of NXP Semiconductors. Cevian, an activist fund, raised its stake in thyssenkrupp to 18% in an attempt to put pressure on the conglomerate to reorganise and deconsolidate its steel business. Rolls Royce said its marine activities were to be restructured ahead of a possible sale. Siemens rose on news that its healthcare division was to be listed. Continental is mulling a spin-off into 3 divisions (tyres/powertrain/autonomous vehicles) with a minority stake in the first two being listed on the stock exchange. FCA said it could spin off Magneti Marelli by the end of 2018. Nestlé is to sell its US confectionery businesses to Italy’s Ferrero

  US equities

Markets were largely unchanged in a short week due to Martin Luther King Day. There were no major economic indicators and the only event of note was the continued decline in the US dollar. Housing permits increased while starts were less buoyant. The Empire Manufacturing Index was broadly in line with expectations.

True, January estimates came in at 17.7 or lower than the 19 expected but the previous month was revised higher. 

The real earnings season kicked off with Citigroup, JPMorgan and Bank of America reporting solid results (excluding exceptional items) due to the economic environment. Retail banking continued to perform well with loan growth up and defaults still low. But investment banking was hit by low market volatility with Goldman Sachs particularly affected. In tech, IBM returned to modest growth after several years of decline and restructuring. 

Over the last 5 days, healthcare and consumer discretionary led advances. Property and utilities lost further ground. 

  Japanese equities

Tokyo was almost flat this week despite the dive in bitcoin prices and the stronger yen. Traders were nervous ahead of a potentially mild adjustment to the BoJ’s monetary easing stance and due to the strong currency but expectations for solid earnings growth offset concerns. Over the week, the TOPIX edged 0.03% higher.

By sector, the best performers of the week included Rubber Products (+2.29%), Electric Appliances (+2.12%), Other products (+1.77%), Metal Products (+2.35%) and Precision (+0.77%) sectors. In individual stocks, Keyence gained 7.51%, Mitsubishi Electric advanced 5.98% and Nidec put on 5.67%. Accelerating earnings growth from these well-known names attracted overseas buyers.

On the other hand, laggards that had been recovering in sectors like Iron & Steel (-5.48%), Oil & Coal Products (-3.70%) and Non-ferrous Metal Products (-2.77%) were weak. Nippon Steel & Sumitomo Metal (-6.28%), JFE Holdings (-5.64%) and Sumitomo Metal & Mining (-4.96%) all saw heavy profit taking. Air Transportation (-2.619%) and Marine Transportation (-1.77%) also underperformed. 

  Emerging markets

In India, the main news of the week was that the finance ministry was thinking about hiking the FDI cap in the banking sector from 74% to 100% for private banks and from 20% to 49% for state banks. If the news were to be confirmed, it would significantly increase India’s weight in the MSCI Emerging Markets index.

Elsewhere, India’s IT companies continued to release weak results (-0.3% YoY for Infosys and -0.8% for TCS), due to persistently weak demand in banking and financial services. Ultratech (cement) reported lower-than-expected results due to a 23% drop in pricing. However, the worst seems to be over for cement prices.

Thanks to the introduction of GST and premiumisation of its products, Hindustan Unilever reported a strong 28% jump in results. Private banks continued to report strong results: +20% for HDFC Bank, +24% for Indusind Bank, and +22% for Yes Bank with stable asset quality. In industrials, Adani Ports saw operating profits rise 18%.

In China, the PBoC issued a notice last September to grant a 50bp targeted RRR cut to banks with at least 1.5% of their outstanding loan stock or new net loans to ‘inclusive finance’. This RRR cut will be implemented on Jan 25. China’s December retail sales rose 9.4% YoY or lower than the +10.2% expected.

In Taiwan, TSMC revised up its sales guidance by 10/15%. This is better than its long-term target of 5/10% thanks to booming AI, cryptocurrency mining and the internet of things. The fourth quarter operating margin was better than expected at 39.2% vs expectations of 38.5%. The Bank of Korea raised its GDP forecast from 2.9% to 3% for 2018, but maintained its 1.5% benchmark rate as inflationary pressure remains modest.

Thai banks continued to report weak results: a drop of 3.8% for Bangkok Bank with low loan growth, -9.4% lower for Siam Commercial Bank and a 44% plunge for Kasikornbank with higher provisions.

In Indonesia, Astra’s car fourth quarter sales fell 20%. The Bank of Indonesia held its policy rate at 4.25% as expected. Credit growth remained sluggish at 8%. In Argentina, the primary fiscal deficit for 2017 was 3.9%, or lower than the official target of 4.2%.

We remain upbeat on emerging markets with a preference for China, Brazil and Argentina. 


After 8 up weeks, oil prices consolidated with Brent crude trading at $68-69 and WTI at $64. This was primarily due to a recovery in US drilling with the rig count up by 10 for the first time in 4 weeks. We should, however, put this in perspective as output had been hit recently by a severe cold spell in the US. Nevertheless, WTI’s recent move above $60 should encourage US producers to restart facilities. In its drilling productivity report, the IEA expects shale oil to increase by 111,000 b/d in February to 6.55 million. In coming weeks, we should get a clearer picture of the situation with fourth quarter results from exploration and production companies and their comments on the outlook for 2018. If producers show some discipline, Brent crude should stabilise at around $65. 

Donald Trump eventually extended nuclear sanction waivers against Iran, saying it was “for the last time”. He warned European signatories to the agreement that this was their last chance to take a hard line with Tehran and its supposed nuclear programme. 

Oil fundamentals are still looking good. According to the US Department of Energy, crude inventories fell by a further 6.9 million barrels last week and by 7.2 million including oil products. 

SQM, the second largest lithium producer in the world eventually reached an agreement with Chile’s regulator on extending its license. The agreement allows SQM to increase its annual production quota to 216,000 tonnes over 13 years (compared to current annual capacity of 63,000t). News of the deal triggered sharp falls in the sector on fears the lithium price would tumble.

But we believe the news should be put into perspective as (i) SQM’s intentions on production increases have yet to be clarified, (ii) the deal will require $1bn in investment and (iii) construction will take some time. It takes 3 years to build a purifying factory and 12-18 months to produce the final product, so the market impact will not occur before 2021 or 2022. We remain upbeat on Lithium prices over the short term. 

  Corporate debt



Corporate yields continued to tighten in Europe due to limited new issuance. 

In news on our universe, food retailers Carrefour and Casino both issued profit warnings. Carrefour’s fourth quarter sales were slightly better than expected but management revised down EBIT guidance for 2017. Casino said it expected around 20% growth in consolidated EBIT in 2017, down from “above 20%” previously, and revised down guidance for France where it now expects EBIT to rise by more than 10% rather than by 15+%. 

Elsewhere, Moody’s downgraded Teva from Baa3 to Ba2, sending it firmly into the high yield bracket. But its stable outlook makes a further downgrade unlikely in the short term. S&P put the B+ rating for Altice NV and its subsidiaries on negative watch. AG2R LA MONDIALE and the Matmut group gave more details on their tie-up which was announced at the end of 2017. The deal could be finalised by January 1st 2019. 


There were 6 new deals over the week. In Europe, Russian gold producer Polyus unveiled a $250m 3Y convertible bond with a 0.5%-1% pricing range for refinancing purposes. 

In China, real estate developer Country Garden came to market with a jumbo HKD 15.6bn 1Y zero coupon convertible for debt repayment and working capital purposes. Another deal in Asia came from a serial convertible issuer, Malaysia’s sovereign wealth fund Khazanah. It raised $320m over 5 years at 0% to fund working capital requirements. The bond is exchangeable into shares of HK-listed Chinese brokerage firm CITIC Securities. The third Asian deal came from the holding company Canopus International, a $200m zero coupon 1-year maturity exchangeable into the shares of the Thai chemical company, Indorama Ventures.

In the US, cloud platform company Nutanix raised $500m over 5 years with a zero-coupon convertible. The proceeds will go on financing working capital, capex and potential acquisitions. The second deal in the US came from Patrick Industries (building products). It issued a 5-year $150m convertible at 1% to be used on acquisitions and capex.

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