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Markets continue to be tested with global events..

Weekly Investment View | 11th June 2017

Claude-Henri Chavanon | Head of Products & Services. Wealth & Private Banking, First Abu Dhabi Bank

Markets have been fixated this week by various events taking place around the world. The UK general election, the blockade of Qatar by a number of GCC states as well as the US Federal Reserve’s outlook on US interest rates in the coming week. The European Central Bank (ECB) sounded a cautionary tone on future inflation expectations out to 2019. It suggested inflation would dim further due to lower energy prices. This quelled speculation that the tapering of Quantitative easing would happen soon in the Eurozone. At a news conference in Tallinn last week, ECB president Mario Draghi told a news conference ‘Economic expansion has yet to translate into stronger inflation’. He reiterated patience on any change to ECB monetary policy. The Euro promptly pulled back from the week’s highs closing the week at 1.1195 after testing 1.13 versus the USD at the beginning of the week. Global equity markets continued their march upwards with America’s Dow Jones index closing at another record to 21272 points. The technology based NASDAQ composite also reached an intra-day high of 6341 before pulling back to close -1.79% lower at 6207 after a record breaking run in US technology shares this year finally saw some profit taking. US Financials energy shares outpaced gains on the Dow. The repeal of the ‘Dodd-Frank’ act in a House bill last Thursday bred a sigh of relief for financials that have lagged the market in recent weeks. European stock markets also joined the party with the Euro Stoxx 50 closing marginally higher for the week at 3586 after being down around 1% intra week. The UK’s FTSE 100 index was broadly lower most of last week on election jitters. It also closed marginally higher after a hung parliament was declared after Thursday’s general election. A fall in the Sterling improves USD earnings for the major constituents of the index. The next European event are the German and Italian elections that take place on the 26th September.

‘May – ‘hung’ out to dry’
The UK election result Thursday left the ruling Conservative party with a reduced 317 seats in UK’s parliament of the 650 seats being contested leaving no clear majority voting majority, a so called ‘hung parliament’. Theresa May the prime minister will now have to form a coalition with Northern Ireland’s Democratic Unionist Party (DUP) where the DUP has agreed to support the government on finance and a few other key measures. Opinion polls just before the result initially suggested that support for incumbent Prime Minister Theresa May was already waning. The often-contentious debates that took place in the run up to the general election were suspended after the terrorist incident on London Bridge two weeks ago. Shortly after this, the popular vote suggested that her lead was starting to extend again. But in similar fashion to the vote for Brexit that took place exactly a year ago, many UK voters remained unconvinced at the eleventh hour of the incumbents policies that included more taxes along with what seemed to be a less popular ‘hard Brexit’ stance with the European Union. A measure now that may have no majority in parliament to go ahead. Some have called for Theresa May’s resignation with the latest poll conducted by Survation suggesting this morning that 49% of the UK electorate think she should resign versus 38% who want her to stay. Boris Johnson, UK’s Foreign Secretary has denied reports that he stands to challenge for the leadership. This caused Sterling to drop from the weeks high of $1.2978 against the USD to close at $1.2746. In the short-term pressure remains on the currency due to the result that could derail the while idea and process of Brexit. UK economic performance has been robust. The currency has recovered from last years lows but we now enter the corridor of uncertainty with respect to Brexit negotiations and how this will play out in the months ahead. German Chancellor Angela Merkel has been quick to rule out a stay of execution while the leadership gets its house in order. This after the DUP have not confirmed that they are ready to form a coalition. Something that had been intimated by May’s administration.

‘Normalizing expected to continue – The US Fed this week’
All eyes will be on Janet Yellen this week and the US Federal Reserve bank Wednesday 14th June. It is expected US interest rates will be raised again by 25 basis points that would take the Fed Funds rate to 1.25%. Recent economic data continues to be ‘steady as she goes’. Near full employment in the US, along with US CPI now above the Fed’s 2% target should see this happen. Recent events concerning US president Donald Trump brought on by former FBI director James Comeys testimony last week, left some to speculate that the Fed might pause on an increasing rates if Trump were to be impeached as a result. In James Comeys testimony that was submitted to the senate Intelligence Committee last Friday, he outlined that US President Donald Trump had asked him to drop an investigation into former National Security advisor Michael Flynn who had been dismissed over his misleading account of contacts made with a Russian ambassador. This of course related to potential interference by Russia on last year’s US election process. James Comey left no doubt that he believed Russia had interfered in the election. This initially caused some unease in markets that was later swept aside and viewed as having no lasting impact on the president. The Dollar has been on the back foot since the allegations including being worried about a follow through in Trump’s re-inflation policies that were dealt a blow after a watered down USD $1.1 trillion budget was passed through Congress last month. The situation in North Korea continues in the background with all these events that saw the Dollar index (DXY) test the year lows at 96.80 level. It recovered somewhat at the end of the week closing at 97.274. The recent risk off sentiment eased with US Treasuries selling off along with gold. The 10-year US Treasury note closing at 2.20% and the yellow metal failing to breach the $1300 an ounce resistance. It closed at $1266.

‘Qatar – The rift with the GCC’
On Monday 5 June, four Gulf States announced the severing of ties with Qatar. Saudi Arabia, UAE, Egypt, and Bahrain issued a joint statement that not only suspended diplomatic relations, but would also cut off, land, sea and air travel to and from the state. In addition to these measures, Qatari citizens have been given 14 days to leave from Mondays date from these countries with top diplomats who were given 48 hours to exit. The blocking of certain websites as well as air traffic from Doha through various airlines was also imposed. The Maldives, Mauritania and Jordan joined the GCC in also taking action. In the background, Turkey’s President Erdogan and Kuwait’s Emir Sheikh Sabah Al-Ahmed Al-Sabah offered to mediate in the crisis. The US issued a statement suggesting that practical negotiations should be the order of the day while applauding the actions that led by Saudi Arabia.

What was the reason?
The action taken by GCC member states this week stems from reports suggesting Qatar had been sympathetic to controversial organizations such as the Muslim brotherhood, Hamas as well as regional rival Iran. US president Donald Trump’s recent visit to Saudi Arabia touched on discussions about regional geopolitical risk. With all the events taking place in Qatar, we have seen a prompt sell off in Qatar’s stock market that so far totals -8.7% since the beginning last week. In the bond markets, spreads have widened, credit default swap protection now costs 108 basis points from the 59 basis points being quoted before the crisis. Other bonds in the region have been more resilient. The sell-off has been largely in Qatari paper for now led by corporate paper, perpetual and the financials and less so on shorter duration sovereign bonds. Given the rapid nature of events it remains unclear which direction Qatari markets will take next. Saudi Arabia last week spoke of stopping its local banks from trading Qatari Riyal swaps that saw swap prices rise on liquidity fears. Russia threw its hat into the ring today by announcing that they too were willing to mediate in the crisis after a high-level discussion had taken place with US secretary of state Rex Tillerson. Headline risks continue to dominate sentiment from the lack of food provisions available in the state due to the Saudi border blockade to the suspension of airspace. It would be best to be on sidelines until clarity prevails.

Global Emerging Markets News:
After weak Chinese manufacturing data in the prior week along with a stronger Yuan focus turned to China’s insatiable appetite for US Treasury buying that saw the yield on the 10-year note sink to 2.13% before retracing as high as 2.225% before settling at Friday’s close of 2.20%. Chinese foreign reserves remained above USD $3 trillion, registering a balance of USD $ 3.0536 for the month of May in a continuing sign that depletion of its foreign exchange reserves witnessed in recent times is abating. China’s trade balance for May fell slightly short of the USD $47.8 Billion expected to a figure of USD $40.81 Billion. Year on Year inflation in consumer and producer price inflation published last Friday remain steady at 1.5% and 5.5% respectively. Overall, it was a good week for China in what is now being seen a s a patchy recovery after stalled data since early last year. In Brazil, President Michel Temer survived the electoral court last Friday in a motion that would have ended his current term of office. He has been battling to regain control after allegations of a corruption linked with the Batista family who control Brazil’s largest meat company JBS Foods. Temer had been accused of hush money to former house of congress speaker Eduardo Cunha who is in prison for corruption and accused of being the mastermind behind last year’s impeachment of Brazil’s former president Dilma Rousseff. Brazil’s stock market the Ibovespa was down -2.3% for the week. It remains up +3.29% year to date. In Venezuela, huge anti-government protests continue to take place that have been going on since 1st April. Venezuela’s bond markets have been oscillating wildly as the spectre of default raised its head after an apparent non-payment to Russia on an outstanding USD $1 Billion loan for oil contracts was revealed. It comes at an interesting time where US bank Goldman Sachs stands accused by Venezuela’s opposition party of funding Nicholas Maduros regime by purchasing USD $2.8 Billion of face value the state oil company’s bonds PDVSA for an average price of 31 cents on the dollar. A deep discount to the last traded prices of 56 cents. The opposition party has approached US President Donald Trump to investigate the purchase with a view to rescind the deal. Goldman’s made a statement that there was nothing illegitimate about the deal and the bonds were not purchased directly from PDVSA. The bank hoped the situation in Venezuela would improve for the people in what the opposition has described as the purchase of ‘hunger bonds’ by the bank.

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