BofAML Global Research: Europe Economic Weekly | Global Emerging Markets | Global Rates Weekly | European Credit Strategist

Redacción - Sabado, 16 de Diciembre

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Europe Economic Weekly: Losing heart before the holidays • No ECB surprises, but not quite a expected 'victory lap' either. Interpreting this as 'dovish' would be wrong, we think.
•   Low 2018 forecasts mean big policy decisions can be made before inflation is re-established. That could empower the hawks.
•   UK: Risks shift towards a softer Brexit but the path could be volatile. We expect UK economic underperformance to continue

ECB: First (dovish) looks can be deceiving

Taken at face value, that Mario Draghi this week chose not to declare victory on inflation should normally be taken as a dovish signal.  This holds however only to the extent that the ECB could be credible in delivering, as it continues to pledge, more and/or longer QE. Since we believe that this has become technically and politically impossible, a lack of conviction on the inflation outlook should actually be taken as a signal that the Governing Council is losing heart on its capacity to deliver its mandate. The ECB would not be the first central bank to stop QE and then start hiking rates before inflation is actually re-established. The Fed sent a powerful precedent. This week again the FOMC continued to signal a continuation of rate hikes while incorporating very little effect of a stronger cycle on inflation. Only the BOJ so far has resisted the pressure.

Come spring, communication is likely to change

In practice, while we think the ECB will first check how the market reacts to the actual halving of its purchases in January, and how the run-up to the Italian elections shape up, before changing the message. But come spring we think that the open-ended nature of QE will be removed. We expect strong inflation conditionality on policy rates, but the risk is that the hawks seize the occasion of another strategic discussion at the Governing Council to demand a quicker exit from negative rates. We expect the deposit rate to reach zero and the refi to be hikes to 25bps in Q4 2019. Unusually, we are above market pricing - more in our ECB Review.  

A more 'confident' ECB doesn't change our inflation views

This does not mean that we are revising our views on inflation. Quite the opposite. We continue to see very little wage pressure in the system, and we take another look at the German developments in our weekly view. While there is no denying that the Euro area data flow continues to exceed our forecasts, the spill-over to price dynamics remains very limited.

UK: The timeline for Brexit

With 'sufficient progress' in Brexit talks likely to be declared at Friday's EU Council summit we examine what happens next in talks. Formal talks about a 'transition' deal seem unlikely to start until February. Talks about an 'end state' trade deal may begin in April but will not be (anywhere near) finalised by the time the UK leaves the EU in March 2019. This could be politically important. We need to watch how business and consumer confidence reacts to 'progress', but we assume transition is necessary to prevent a further economic downturn and not enough to provide an economic boost. So we do not think it will be a game changer for the BoE (the subject of our UK hot topic). The UK-EU 'sufficient progress' agreement seems to have shifted the balance of risks towards a softer Brexit 'end state'. But we expect UK economic underperformance to continue in the near- however. The long-term outlook remains challenging, while the path the UK is taking to that long-run is not conducive to strong growth in our view. Firms can have little certainty about the UK's destination yet.

Global Emerging Markets Weekly: 1,000 views on EM 2018

•   Investor feedback on our Year Ahead outlook suggests the consensus is somewhat more bullish than we are.
•   The most contrarian of trade recommendations appear to be: short MXN, long USD/CNH, long HUF and receiving 2y SA rates.
•   Sov Strategy: we look into Venezuela and PDVSA bonds ownership.

The View - 1,000 views on EM 2018

Investor feedback on our Year Ahead outlook suggests that consensus is somewhat more bullish, essentially due to a less bearish view on duration in the US. The most contrarian of our current trade recommendations appear to be: short MXN, long USD/CNH, long HUF and receiving 2y SA rates. ─ D. Hauner

Asia Economics - India: Inflation risks are over done

Inflation risks are overdone, in our view. High November CPI inflation was on account of a temporary vegetable price spike. Like La Niña, weak growth is yielding poor pricing power to keep 2018 inflation within RBI's target range. ─ I. Sen Gupta, A. Gudwani

Asia Strategy - contingency plans

CNH price action shows tentative signs of change in risk premia: spot-vol correlation is rising and diminishing beta to risk-off. ─ A. Sinha

EEMEA Economics - Russia: fiscal to cushion oil moves

Fiscal policy through the Wellbeing Fund should be able to absorb a large part of oil volatility in 2018, as reserves accumulation could resume with oil above $55/bbl. Pass-through of oil to macro is mainly through corporate profits and investment. ─Osakovskiy

EEMEA Strategy - linkers in Turkey & nominals in S. Africa

In Turkey, the recent stress episode should keep inflation high in 2018. In S. Africa, FX vol won't be eating into inflation. Our outlook vs valuations makes 5y linkers attractive in Turkey, nominals better in S. Africa. In SA we receive 2y. ─ G. Foa

LatAm Economics - Argentina: why inflation is so high

We expect inflation will decline to 17% next year, still above the 10%+-2% target. We forecast the Central Bank of Argentina (BCRA) will keep the policy rate unchanged at 28.75% until March amid strong utility price hikes. ─ S. Rondeau

LatAm Strategy - MXN: peso problems

We expect the peso to trade at 20.5 before the end of 1Q18. Economic fundamentals are weak. NAFTA negotiation and presidential elections are large, underpriced risks. We recommend trades to express our bearish MXN view. ─ C. Irigoyen, G. Tenorio

Sovereign Strategy - Venezuela and PDVSA ownership

We think the high coupon bonds are more widely held in private client retail accounts, based on Bloomberg HDS data. Real money investors are still focused on lowest dollar price bonds. We provide an update about bonds' coupon payments. ─ Brauer, Rondeau

Technicals - USD/BRL on cusp of breakout and rally

A three-week rally may result in a bullish breakout that confirms a technical bottom, with a Friday close above the 100wk SMA at 3.32. This is in line with our long position and initially targets 3.50 with 3.65 likely. ─ P. Ciana

The week ahead

There are monetary policy meetings in Hungary, Czech Republic, Thailand, Taiwan and Hong Kong. We forecast Czech's CNB will hike 25bp.

 Global Rates Weekly: Hurdling towards the end

•   Conventional wisdom about the 'safe haven' and diversification attractiveness of USTs will likely be challenged in 2018.
•   We still believe current Bund levels are too low, but see US investors and positioning as two hurdles to be short.
•   Legislation on MMF reform was delayed but is not dead. We also look at at 5s20s flatteners in the UK and the Brexit timeline.

The View: near term versus long term

While the immediate reactions to the central bank meetings this week were perplexing, we think they set the stage for curve steepeners in the US and front end shorts in Europe.
 ─ R. Preusser, S. Rajan

Rates: moving on from the safe house

US: conventional wisdom about the 'safe haven' and diversification attractiveness of USTs will likely be challenged in 2018. The possible increase in deposit betas and history suggests equity corrections in a high growth+high inflation environment are not hedged by Treasuries.

EU: We highlight two short-term hurdles for short Bund positions, discuss how the ECB meeting reinforced our bearish front-end view, and reiterate our long Portugal vs Italy.

UK: we were surprised by the rally post-BoE and suspect positioning exacerbated the move. We continue to like 5s20s flatteners and take a look at the Brexit timeline.

AU: a reduction in the benefits of holding AU duration could limit any sustained increase in foreign demand. We position via steepeners and wider geographical spreads.
 ─ S. Rajan, O.Lima, S. Salim, E. Satko, S. Cross, R. Wood, P. Sam, T. Morriss

Front end: MMF rules & year end funding pressures

US: a bill overturning key aspects of MMF reform appears delayed, not dead. USD unsecured funding pressures will likely persist into year end.

US II: A bill to overturn key aspects of MMF reform would likely lead to accelerated prime inflows & tighter LIBOR-OIS / narrower front-end swap spreads.
 ─ M. Cabana, R. Axel

Technicals: Bonds continue to underperform metals

The downtrend in bond prices (TY1) and uptrend in metals prices (BCOMIN) remains, with bond prices still underperforming industrial metal prices. We prefer buying metals like copper into this dip and selling bonds into this strength
 ─ P. Ciana

 

This is the last Global Rates Weekly for 2017. We will resume publication on January 5.

The European Credit Strategist: The gift that keeps on giving

•   Draghi highlighted yesterday the desire of the ECB to buy large amounts of corporate bonds again in 2018.
•   The risk, however, is that the Steinhoff situation reduces the ECB's efforts to buy very low rated credit.
•   The ECB's language towards Fallen Angels has become more tentative of late. Fallen Angels could become Falling Knives in '18.

Early holiday gift from the ECB to credit

2017 has ended up being another favourable year for credit markets, with excess returns of 3.4% for high-grade and 7.2% for high-yield. All the more impressive is that these returns come almost nine years into a bull market for corporate bonds…a bull run that is now close to double that of the 2002-2007 era. One consistent feature of the last year and a half, however, has been the ECB buying copious amounts of corporate bonds. And Draghi reiterated yesterday that CSPP remains a flagship policy. Thus, we think the ECB will again create a "scarcity of product" problem for the Euro credit markets in 2018, pushing spreads even tighter.

Will events change the ECB's approach?

2017 is ending on somewhat of a sour note, in the form of rising idiosyncratic risk, the most distinctive of which has resulted from the Steinhoff bonds. While Draghi emphasized that the ECB's exposure to the name is a lot less than the consensus has been suggesting, the volatility on the name is far worse than anything the ECB has experienced to date. In fact, Draghi indicated some reflection on the events could be forthcoming. If this reduces the ECB's efforts to compress spreads, then clearly the compression trade in credit would be less powerful next year.

From Fallen Angels to Falling Knives

Moreover, it looks like the ECB's language towards owning Fallen Angels has become more tentative of late. If true, we think that this has the potential to make the spreads of Fallen Angels behave more like Falling Knives. Credit investors should anticipate more pronounced price drops in names that migrate from IG to HY. Although the good news is that this will mean a source of technically cheap BBs for high-yield investors.

The year that was

We finish by saying goodbye to 2017 with a quick wrap-up of credit market trends and statistics. We recap some important themes on biggest issuers, best performers, largest credit market growth and the "big" credits heading into 2018.

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