Welcome 2019: First Quarter Wrap

It has been 3 months since our year end macro wrap and 2019 outlook “Farewell 2018: Welcome 2019”. So, let’s see where we are:

Starting with the US:

The 2018 fourth-quarter GDP report (which was delayed due to the partial government shutdown) was released by the Commerce Department. GDP growth came in at 2.6%, better than forecasts of 2.2%. Full year 2018 GDP now stands at 3.1% (higher than the 2.9% in our year end update). Going forward, growth has been marked down to 2.1% (from the earlier forecast of 2.3%).

In a major change in stance, the Federal Reserve left key interest rates (2.25% to 2.5%) unchanged and said rates were likely to remain where they are for the rest of this year (potentially only one rate increase in 2020). The outlook for inflation is 1.8% this year (2.0% for the next 2 years). Low inflation and interest rates are good news. The Fed also stated that further bond sales would slow down and perhaps possibly end in September. Bond buying increased and pushed up prices for ten-year U.S. government bonds. Rising prices pushed the yield down to 2.40%, slightly below the 2.41% yield on 3-month Treasury bills – technically an inversion of the yield curve, but not meaningful enough in our view. 

On the U.S. China trade front, while U.S. and China extended the March 01 deadline, significant progress has been made. The currency dispute is largely settled and the two sides were working towards the larger trade deal. Trade tensions are beginning to subside. The U.S. remains an attractive investment destination as interest rates and GDP growth forecasts are still higher than much of the rest of the developed world…which is suffering from low to negative interest rates. The S&P 500 4Q companies earnings were up 13% from last year…!!

Moving on to Europe:

We questioned if the Brexit saga can get any worse? Well apparently it can (and has). The takeaway remains the same – a weak British pound. Brexit has created a big mess for the U.K. and Europe and is now negatively impacting economic growth in the entire region. Italy is now officially in recession with two-straight quarters of negative growth. The German economy has also continued to deteriorate with new export orders for German manufactured goods falling for the seventh-straight month, and at their fastest pace since 2012. Countries like Austria, France and Germany will likely have negative rates for a few years. According to IHS Markit, the Eurozone’s PMI fell to 51.3 in March, down from 51.9 in February. This was the weakest reading in six years and below the 51.8 reading that economists expected. Given Italy and Germany account for nearly half of EU GDP growth, the EU failed to deliver any meaningful growth – full year EU GDP will be at a low 1.8%.

China – a quick primer:

There have been a lot of questions around China and the U.S. China Trade negotiations. So here is a quick primer. China has a growth problem. China’s official growth rate slowed last year to 6.6% (Beijing wants the economy to grow 6%). A research paper (University of Chicago in cooperation with three professors from the University of Hong Kong) showed that China’s actual growth rate has been 2% lower than official reports from 2008-2016. The problem is not Beijing, but provincial leaders whose promotions depend on economic success who have exaggerated industrial output and investment to look better. President Xi needs a boost for China’s economy. The Wall Street Journal on March 15, 2019, published the following: “The details and enforcement will be crucial, but the reforms the U.S. is seeking would do more to help China’s long-term growth rate than anything coming out of Beijing. Believe it or not, Mr. Xi needs a Donald Trump reform push.” 

Closer home in India:

Amidst all the other happenings an interesting piece of data came out which you may have missed, so we want to highlight it. The MCLR i.e. minimum marginal cost of fund-based lending rate of public sector banks stood at 8.5%. This is almost at par with AAA rated corporate or NBFC market borrowings. So, what are the implications of this? As long as we do not experience any major economic disruption we should prepare ourselves for a softer interest rate environment. Expect bank rates to come down and if the RBI reduces rates, an even greater reduction in rates. Move the FDs to “fixed”, borrow “floating” and increase the tenure of debt funds to capture yields. 

The equity markets also showed some interesting data. In March 2019 DIIs (Domestic Institutional Investors) were net sellers of c. INR 14k crores, while FIIs (Foreign Institutional Investors) were net buyers (cash segment) of c. INR 32k crores. The FII data is the highest since Jan 2008 – so does this mean they are back with a vengeance? Just 6 months ago in October 2018 FII net outflow was also the highest at INR c. 29k crores. The point to note is that FII money can move fast and investors should be careful not to get caught in the “Fear of Missing out” feeling. Starting May 2019, the MSCI Emerging Markets Index China A shares weight of 0.72% will increase and is targeted at 3.3% by November 2019; and India weight will decline by 50bps in this re-balancing. We could see phased outflows ranging from c. USD 3.5-6.5bn during this 6 month period. 

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