The mood at last week’s Spring meetings of the IMF and World Bank was quite upbeat, as anticipated (see my preview here) though there were considerable concerns that near-term strength, exacerbated by U.S. fiscal stimulus and still supportive global monetary stimulus might be masking medium-term vulnerabilities. Many major economies are growing above potential, and are likely to experience some slowdown in growth, the question is how far, and whether the issues remain chronic or turn acute. Moreover, the fading sugar rush of the U.S. fiscal stimulus is likely to wear off while Chinese and several other countries continue their slowdown from the recent trend of above potential growth.
U.S. policy – fiscal, monetary, trade and sanctions dominated many. mostly unofficial discussions – and constituted the most common potential future negative catalysts, though most believed that trade wars were unlikely. My baseline includes a drag on private investment from trade and investment uncertainty, offsetting some of the other positive trends and exacerbating some of the impact of FX and commodity moves. Many global consumers may begin to face some challenges from the rising energy costs, admittedly offset by the recycling via import demand from oil exporting regions internationally and within countries (watch for an upcoming post on this).
Across many issue areas (notably trade, Russia, Iran), it remains hard to discern what the Trump administration or rather the president might see as a success, a state of play that leaves things more uncertain for business, risks accidents and may amplify related market volatility.
Overall views from investors were mixed on the pathway for the dollar, cautiously optimistic about EM bonds, local and hard currency, and more constructive on non-US equity. Investors continue to be worried about the valuation of US assets particularly equities and higher yielding corporate bonds. Turkey stood out as a weak link – perennially exposed to negative shocks,
Looking ahead, the next few weeks are peppered with a variety of policy catalysts including the Iran deal deadline (May 12), public hearings on several proposed US tariffs (mid May), self-imposed if moving NAFTA deadlines, just to name a few.
The rest of the post highlights what I learned about the following:
- US-China Trade
- US-Russia relations and sanctions
- Iran deal risks
- Upcoming EM elections (Turkey, Brazil and Mexico)
A more constructive tone on NAFTA, maybe, for a minute
The outlook on the NAFTA talks remains hard to read and subject to gyrations in market sentiment. The negotiators continue to work overtime and seem to be taking seriously the self-imposed political timeline of the coming weeks, but those close to the talks highlight significant ground that is not yet met. While some risks on the Mexican side were dampened as poll-leading presidential hopeful AMLO suggested his government would implement any deal that was passed by July 1. The statement was part of a broader pragmatic view. However, any positive sentiment was offset by President Trump’s post meeting statements calling for an immigration side deal, one that would be unlikely to be limited as the FX side deal in the new Korus. Overall its hard to predict.
Some signs from the negotiations seem positive, including some compromises on the auto trade, but the devil remains in the rather sizeable list of details. One of the more positive scenarios is one in which an agreement in principle is reached, but little voted on for more than a year. Unfortunately, a bait-and-switch tactic now being considered would involve withdrawing from the agreement to force a vote, a policy that would be fraught with issues.
Canadian policy makers, especially BoC governor Steven Poloz remain very concerned about the uncertainty’s impact on business investment (a 0.2ppt) drag), which might exacerbate other concerns about business investment in the country, which has been a source of angst for many policy economists. The ongoing pipeline dispute in Western Canada can’t help, especially as many (Asian) foreign investors in the energy space are increasingly questioning Canada’s investment review process, which is being stream-lined. Watch this space for more on the topic and in the interim, the MXN is likely to remain a key sentiment indicator, followed by CAD, dampening moves from the central bank.
US-China: Bark to Shifting to Bite:
The rhetorical tit-for-tat from China remains a key global risk, though actual implementation is modest. The U.S. authorities may begin to look for a face-saving solution but I doubt that it will come quickly. Implementation of the tariffs could cause significant distortions across global supply chains.
It remains to be seen what the President and economic team would see as a win in this area, and its worth noting that being tougher on China is a view that is shared on a bipartisan basis, though the approach (multi-lateral band-waggoning vs direct threats) varies. Given the administration’s interest in using tariffs as a tool to get countries to the table, we could see some ongoing talks, especially if the NK summit seems to go well. U.S.-China trade tension is likely to be with us for some time. Several commentators also noted the lack of a strong business lobby arguing China’s case – which may reflect both the U.S. political climate and the Chinese reform environment that is less supportive of foreign business.
Overall, investors seem sanguine about Chinese growth risks and feel comfortable about the authorities ability to generate growth in 2018, with views that the credit trends will remain controlled. Recent evidence suggests a drag on export growth, which was a meaningful driver in 2017 and efforts at rebalancing seems mixed.
U.S. Russia: Dangerous Relations
Bilateral ties with Russia have reached new lows in the post-cold war era, with the two sides seeing markedly different views of events. This is complicated by the fact that there are no less than three Russia policies among the U.S. including Congress, a complicated inter-agency process and the White House which are often publically at odds and may become more so as the midterm elections approach.
The April 6 round of sanctions came in for much discussion, particularly among the representatives from Europe – and there were already signs of a small modification allowing more time to adjust to the sanctions on Rusal. OFAC has long made adjustments when guidance was unclear, especially when spillovers internationally are more extensive.
Overall, the trend is skewed to tighter sanctions in the coming months, and greater integration between the different sanctions (Ukraine, Syria, election meddling). This consolidation might make it even harder to eventually lift sanctions, even though that looks to be a very premature thing at this point.
Views on the macro impact of the sanctions varied dramatically, with many in U.S. government highlighting the damage done to Russia from sanctions, but private sector generally pointing to resilience. My view has been closer to the latter with sanctions limiting long-term investment and reinforcing the role of domestic and foreign (China, GCC) governments, but limited downside in the near-term. Many of the inefficiencies in Russia’s economy and relative lack of sovereign and overall external debt keep it surprisingly resilient than many peers. It remains to be seen what the impact of raising risks on oligarchs will be in terms of policy change. I’m not very optimistic given that recent trends may reinforce the role of the government.
Iran Deal: Not Enough Contingency Planning?
Views on the Iran deal varied, but most expected some sort of fix, especially given the full-court press of the back-to-back Macron and Merkel visits this week. Some oil analysts suggests that a “fix” decision might take a little air out of what is looking like a heated oil market, though some degree of Iran specific risk premium would likely persist.
I’m increasingly concerned about one tail risk stemming from a lack of coordination. In the risk scenario that the deal is not deemed sufficiently fixed to remain or to kick decisions on reimposing sanctions out until later in the year, lack of planning might exacerbate the impact. Several officials signaled that there had been little effort to coordinate with allies about either providing more supply if Iranian crude were to be pushed offline or to encourage them to reduce imports. Both were subject to active diplomacy in 2010 and other sanctions periods, and which could increase uncertainty among buyers and the oil market more generally. In fact not planning for May 13 decisions was cited as a negotiation tactic, one that seems to be working with the Europeans (France, Britain, Germany) but is less likely to be successful with major buyers like China and India, both of which reduced purchases at the early part of the decade or even Japan and South Korea, who are more likely to follow the U.S. lead. Still, it seems unlikely that the complicated sanctions and escrow regime would be re-established.
As Richard Nephew has laid out, there are a wide range of decisions that would have to be made in the days, weeks and months after a decision for the U.S. to become non-compliant with the deal. These may be risk scenarios but ones worth considering. The best way to avoid further macro volatility would be to work with allies and co-suppliers.
Meanwhile the financial outlook within Iran, particularly the currency, continues to weaken as vulnerabilities in the local banks (and especially non-bank institutions) have increased demand for safe assets. With the UAE cracking down on allowing hard currency to Tehran based money lenders (something circulating when I was in Dubai last month but which seems confirmed by a recent UAE CB circular), the government is struggling to stabilize the currency. Clarity on the nuclear deal and provision of some FX (from the government’s reserves) into local market and/or further tight monetary policy may be necessary to provide more confidence.
In addition to the U.S. midterms, upcoming elections in Brazil, Mexico, Turkey were dominant topics, with investors particularly concerned about the lack of middle ground and clarity on macro policy in Brazil, where anti-establishment candidates from all sides seem to be splitting the polls amongst themselves. Few have any meaningful vision on the economic policy side and one risk is continued inaction. The commodity trend and disinflation continues to support a macro revival and bounceback from recession, but there is limited long-term investment, and credit remains far too costly for households and business. These may limit the further revival and suggest BCB may look for additional space to ease.
Turkey is again analysts choice for weakest EM balance sheet, with double digit inflation, widening fiscal and external deficits and sizeable corporate debt liabilities, all exacerbated by the quasi-fiscal stimulus of 2017. The snap elections are likely to result in another victory by Erdogan who may be trying to take advantage and keep opposition parties very divided. Despite hopes from some Turkish policy makers at the meetings, I’m less optimistic about meaningful policy change in Turkey post-election, but I expect that the central bank will again tighten the effective interest rate to limit capital outflows. Another round of quasi-fiscal stimulus looks in the offing to avoid too sharp a growth slowdown.
Venezuela: Still Sinking
The implosion and deterioration continues in Venezuela and looks set to worsen in the lead up to local elections, with a risk of tighter sanctions if Maduro clings on as still seems likely. The international community continues to look for opportunities to support the sizeable diaspora with ideas ranging from seizure of property assets from official actors in the U.S. or neighbours like Colombia and Brazil applying for emergency funding from the IMF to provide support for refugees, but those don’t seem to have progressed.
There still seems to be a disconnect between some bondholders and those in the official sector who might be responsible for funding and the needed debt restructuring. Several factors would make this a particularly difficult program: lack of contact between the authorities and Venezuela, damage to the energy sector, involvement of key bilateral lenders and need to rebuild many parts of the society and economy. While expectations of the creditors may be becoming more realistic, I’d expect that things will continue to get worse before they get better, including recovery values. The upcoming elections, remain key catalysts.
In the interim, the drop and unpredictability of oil production will likely add pressure to oil prices and make the job of OPEC+ easier. Expect a long road ahead.