The Ally Pally Analyst

Since the beginning of the sovereign debt crisis,  we’ve been debating which country will leave the European Union and how it will happen.  Even where there’s been a vote and exit is a ‘certainty’, it isn’t really.  Yes, BREXIT, I’m talking to you.  But could Hungary and Poland’s move towards an ‘illiberal democracy’ and away from the EU’s advertised core values be what reshapes the EU?

At the height of the sovereign debt crisis I was more secure in the future of the EU than I am now.  The market pressure was widespread across the club and everyone was in crisis mode and circling the wagons.  Those days are gone, growth is back and unity is strained.    The EU’s motto remains “ever closer union” but no one is using it on the campaign stump.

It was market pressure, domestic financial hazards and the general economic downturn that united the countries. We know these are the things that won’t break the EU.  The countries know how to and choose to react to these challenges. Maybe its time to rethink your panic level on Italy.

What will eventually reshape the EU?  I would like to think that there are moral grounds on which the EU will not waiver,  forcing a reckoning in Brussels.  The refugee crisis did not support that assumption fully.  It didn’t completely dismiss it either.

 

The EU triggering the Article 7 against Poland may hold a key to the EU’s future.  But  first, the EU needs to decide if it will be more than just an agreement on how lettuce can be farmed and refrigerators built or a middling safety net for bond valuations. The EU has taken a stand by triggering Article 7 and referring Hungary to the courts over its immigration positions.  Now the EU will have to enforce its stand;  that takes a lot more decision and concerted action and effort than the EU has shown in a while.

It might help the EU’s nerve that it has some control over its own purse strings.  The new EU budget for the 2021-2027 might have taken the first step/warning shot by slicing funds to Hungary and Poland.  The EU bases the decrease in funds on improvements in Hungary and Poland’s economies while shifting resources to Italy and Spain, countries obviously in need.  And possibly more important in the EU’s eyes.   But Hungary and Poland can lose even more if the EU stick to its guns on its shared values statement.  That would also handily solve a couple of budget problems for the EU as well.

There aren’t any interesting market movements supporting the EU reshape in the short term so are these questions just academic in nature?

Short term you are better served to look at trade relationships, labour movement and technicals for a guide on valuation.  Local elections in Poland in October/November will shine light on whether the ruling PiS can consolidate power at the local level.  The consolidation in Hungary has already happened and there isn’t much on the horizon that can dent Fidezs and Orban’s grip on power in the country.

The one rogue element here is that the health of the leader of the PiS is cloaked in mystery.  Jaroslaw Kaczynski has been ill and he’s old and there’s not an heir apparent.  The PiS might flounder without his leadership and then the EU might be able to bring Poland back into the fold.  That might make Hungary look very isolated and vulnerable.  But there are several mights in that scenario.

Feel free to file under EVER CLOSER TO WHAT?

Monday: It’s the promise of a new week, new things to learn, new stories to share.  However, by the end of the week,  I also LOVE Friday afternoons.  There is the promise of no commute, time with the kids, no sleep, definitely not any sitting down or lounging . . hold on, wait . .Oh Monday, you aren’t ever too far away.

This week we’ve got Fed testimony in the US to look forward to.  The market doesn’t quiet believe we’ll get 2 more hikes so is it September or December?  Let’s see if Jay Powell says anything that might convince its both.  Either way, you can feel morally superior by watching and seeing how shockingly little the politicians actually understand about the economy and the role of the Federal Reserve.

If those politicians don’t scare you enough, we can look at the how united Westminster is in its dislike of the Chequers Proposal/recent White Paper on Brexit.  UK has a little self-harm issue going on right now but at least it is broad-based across the political spectrum.  We get news this morning of a former cabinet member calling for another referendum on Brexit to break the ‘stalemate.’  Good think the market only cares about the BoE and recent Brexit news isn’t getting any traction in the markets.

While equities look weak in Asia after disappointing China GDP for Q2, European equities look strong.  Everyone is still focused on trade wars but the market doesn’t really know how express that view.   For the sovereign space, in EM it will be about growth and in Developed Europe it will be about the political arrangements.  There will definitely be winners and losers but the time frame is hard to pin down.  Still early days but good to start doing more work on that topic.

We could talk a lot about what has happened in Turkey last week, let alone over the past 12 months but let’s look to the future. Actually, I don’t think the future looks all that great, either.   There are plenty other stories in EM that have been beaten up where there are at least domestic and global stories that make them look better than Turkey.  Mexico, Argentina, Peru and South Africa come to mind. We’ll have to put Turkey in its own penalty box for now.

Now we just have to wait for sound bites from the Trump/ Putin summit to introduce some volatility.

Let’s leave a little on the table to discuss further in the week.  I don’t want to cross everything off my list first thing Monday!!

Feel free to file under I DIDN’T MENTION THE WORLD CUP

It’s Mark Carney.

The BoE will raise rates and that’s supportive of Sterling. All the past week’s hoopla with the antics of Boris Johnson and the administration’s white paper on BREXIT are distractions.  When you want to know where GBP is going, ask the Canadian.

The last missive from the MPC was hawkish.  Slow growth in Q1 was blamed on the bad weather (let’s look at what they say about our mini heatwave!), inflation is expected to pick up despite the tick down earlier in the year and the labour market remains tight.  If the economy were to develop broadly in line with the May Inflation Report, tightening of monetary policy would be appropriate.  And that tightening is on the immediate horizon.  Market is pricing approximately 75% of a hike in August.  The 6-3 vote at the 21 June meeting tells us a bit too.  The 7-2 result has been standard but Andrew Haldane is now in the hawkish camp too.

In the past, I liked to wax lyrical about the complexities of Brexit and unrealistic reconciliations the administration was attempting.  It was fun listening to the administration try to square the circle on the Irish border question as well as every other point of contention.  Also love that it is all still outstanding!! But let’s get serious because while that is entertaining, its not driving the market anymore.  The resignations of David Davis and Boris Johnson put some pressure on both the currency and gilts but it was ephemeral.  The market is interpreting it as it should:  personal grandstanding.  No one cares about Boris but markets (and me) do worry about Jeremy. 

 

 

 

Comfort levels are increasing around the volatile news flow on Brexit and Prime Minister May’s tenuous grip on Downing Street.  What does concern them is any action that leads directly to a general election.  However as long as that direct line has some time horizon to it, it will be all Mark, all day, all night.  The whims and wishes of politicians are losing out in market importance to the whims and wishes of central bankers.

Next MPC meeting is 2 August and we should see 25 bps hike.

Feel free to file this under RELIABLE BOYFRIEND

Mexico is stealing the spotlight but its Brazil you’ve got to keep your eye on (just not for the World Cup, they are as good as gone there . . . its URUGUAY all the way)

Every one loves an election in Latam if for only the reason they get to use the tired phrase of ‘ Is X like Chavez  or like Lula?’ That was at least what they use to say.  Now that Lula 1) is in jail and 2) everyone has realized he drove Brazil to the bad spot its in, there’s a struggle to use that phrase.  Unfortunately its hard to find a leader to balance out the comparison spectrum with Chavez.

I have lots of respect for AMLO.  You can’t say ‘third times a charm’ enough regarding this man. But like so many countries around the world, its change the electorate is after. Which is a ironic given his long history on the Mexican political stage.

AMLO isn’t the status quo though so there’s your change.  His party did well and the electorate will get change.  But its unlikely to be of the magnitude that alters investors’ perception or appetite for Mexican assets or radically change the economic profile of the country.

One thing to watch will be how AMLO and Trump get on.  There will be fights when it politically serves either side of the border.  Mexico views will continually to be intrinsically linked views on the US.  This election doesn’t change that.

Focus the Gaze

Now I am usually a Brazil football fan but they have lost the magic.  And I think they’ll be out of the Cup soon.  I’ve got high hopes for the country with the best steak of the whole southern cone:  Uruguay.

But you can still hope and pray for Brazil; just channel it into their electoral process.  At the end of the day, the Brazilian Congress is almost incompetent on every level and thus constrains whoever makes it to the Planalto.  But that fact won’t stop markets from getting riled up about who its going to be.  Just like Mexico, Brazil wants change.  It will definitely be a bumpy road road to the October elections and that’s Brazil and globally driven.  But I have little hope for any meaningful reform afterwards which will push the protesters back out onto the streets eventually.

Brazil looks good compared to a lot of other problem children in the EM space right now.  Just like I expect the Seleção to disappoint/ not deliver, I’m expecting Brazilian assets to take a hit too.

Feel free to file under LET’S STOP TALKING ABOUT CHAVEZ

Brexit, Poland, Hungary, refugees, Merkel’s livelihood and where’s Macron in all of this despite the promises of his early days.  Don’t forget about Italy!  What Brussels has on its plate makes my little to-do list look easy-peasy.

Poland is currently burning the brightest.  Protests erupted in Warsaw as new laws come into effect basically purging the supreme court by enforcing the new retirement law which sees those over 65 yrs old pushed out.  That clears 40% of the judiciary and the head of the supreme court, Malgorzata Gersdorf.  She’s not going quietly and showed up to work this morning as if the law,  which the Council of Europe says is in direct violation  anti-corruption standards, didn’t exist.  The new judiciary laws also forced the European Commission to put Poland under Article 7 proceedings.  Sounds scary, and in theory it is.  However the EU does great theory but falls woefully short on practical.

Developments in Poland have been negative for a while now. Just like with Brexit, Hungary, refugees and Italy, the EU has a chance to be bold but I doubt it will.  Protests in Warsaw make good TV and matter a ton for the Polish people but Brussels does nothing without a bit of pressure.  Bond markets and the currency aren’t conveying any.

I love the European Parliament’s flow chart on how Article 7 works.  I’d love if they could implement it.

Feel free to file under   WISHFUL THINKING

 

Hey, every country has some Emerging Markets (EM) characteristics right? Its whether those countries see them as beneficial or not!  News that JP Morgan may have to tweak the inclusion criteria for the Gulf Cooperation Council (GCC) countries – Saudi Arabia, Bahrain, Kuwait, Oman and Qatar is only shocking in how some people jump the queue at the airport aka not shocking at all.

EM desks are already the ones looking at issuance from GCC countries so whether the idiosyncrasies of the countries’ economies inflate per capita income shouldn’t matter to their inclusion in the index.  But here’s where things get tricky, what if everybody jumps the queue, I mean what if the criteria is no longer sacrosanct?

Well I would suggest that other off-index plays might get included in the index.  If they have enough pull to get JPM to do it!

Index business is serious and there is a lot of passive and active money bound by its moves; the ability to gauge those movements can translate into performance.  So then the rules matter if you are constrained by them.  But really if you are in EM you know the countries that trade like EM already, right?  So who might be next at the party? Maybe some former DM countries? Or some up-and-coming Asia? LatAm looks tapped out and nothing in Africa looks to be close to ready.

 

EMBI constituents in grey

Feel free to file under THINK ABOUT AFTER DRINKS