MENA MARKETS REVIEW: July 2019

Kuwait: August 08, 2019

HIGHLIGHTS

• After a relatively quiet month, volatility spiked at the end of July driven by monetary policy actions and a surprise return of trade tensions.
• The Federal Reserve cut interest rates in its July meeting for the first time since the financial crisis. Financial markets’ initial reaction was negative after Powell’s press conference comments.
• Shortly after the Fed decision, threats of new trade tariffs on China caused financial markets to tumble across the globe after month-end.
• Most GCC central bank followed the policy action of the Fed and reduced their benchmark rates by 25 bps, while Kuwait left rate unchanged.
• In the GCC the picture was mostly positive in July. Dubai and Abu Dhabi led the pack with monthly gains of 9.77% and 6.79%. They were followed by Bahrain and Kuwait with 5.21% and 4.88% respectively. Kuwait’s Premier Market Index is now up 28% since the beginning of the year, by far leading its GCC peers.

FED CUTS INTEREST RATES FOR THE FIRST TIME IN A DECADE

The Federal Reserve cut interest rates in July for the first time since the financial crisis, lowering the Fed Funds target range 25 bps to 2.00-2.25%. The move was seen as a precautionary step in light of risks to the global economy, including slowing global trade, as well as below-target inflation, which stood at 1.6% y/y in June on the core PCE measure. Financial markets reacted negatively to the cut on news that two FOMC members had voted against the move and then Fed Governor Jay Powell’s comments that it was a “mid-cycle adjustment” and not the start of a broader easing cycle. President Trump also continues to pile pressure on the Fed to act to support growth, claiming that Powell had “let us down” by avoiding a larger cut in July. News of the US’s latest tariff hikes on China have subsequently put rate cuts firmly back on the agenda however, with futures markets now fully pricing-in a cut at the Fed’s next meeting in September.

The Fed’s task is made still more challenging by data showing mixed signals on the economy. GDP growth came in at an annualized 2.1% in 2Q19, beating the consensus though down from 3.1% in Q1. Consumer spending surged 4.3% and remains well-supported by a strong labor market, as unemployment was steady and close to record lows at 3.7% in July, and wage growth edged up to 3.2% y/y – well above inflation. But private investment (-0.8%) and exports (-5.2%) contracted in Q2, reflecting a weak housing sector and softening external conditions, and PMI survey measures show the manufacturing sector at or close to recession territory. GDP growth is forecast to be broadly steady at close to 2% in 3Q19, which is slightly below its long-term trend. But in our view, the risk of a major slowdown that might justify much more aggressive Fed easing remains low, although the risk may have increased with latest tariff news.

EUROPEAN GROWTH FALLS, ECB MULLS INFLATION TARGET SHIFT

Meanwhile weaker international demand in particular continues to heighten concerns over growth in the Eurozone. GDP growth slowed to just 0.2% q/q in 2Q19 from 0.4% in Q1, with worries that the German economy may be tipping towards recession. Germany’s manufacturing PMI fell to a seven-year low of just 43.1 in July amid falling export orders, and while the service sector is proving comparatively resilient, industrial weakness could yet spread to other parts of the economy and contrasts earlier hopes of a revival in 2H19. GDP growth also decelerated in other Eurozone countries including Spain (0.5%), France (0.2%) and Italy (0.0%) – growth in the latter having been positive in only one of the past five quarters. The Eurozone labor market remains encouragingly solid, with the unemployment rate ticking down to an 11-year low of 7.5% in June. But the pace of decline was the smallest since October, hinting that the fallout from softer economic growth may be growing.

The European Central Bank (ECB) left policy on hold in July as expected but signaled a bias towards future easing in a bid to tackle the economic slowdown and stubbornly-low inflation. The bank’s forward guidance stated that interest rates would remain “at their present or lower levels” until at least mid-2020, implying that the policy deposit rate could be cut from its current level of -0.4% at the next meeting in September, while a restart of the asset purchase program may also be on the cards. Fueling anticipation of looser policy, the bank is mulling a shift in its long-standing inflation target from “below but close to 2%” to a more symmetrical 2% target, implying greater tolerance for higher inflation, which slipped to just 1.1% in July in the Eurozone. But a target shift may not have unanimous support among ECB Governing Council members and with bank president Mario Draghi set to leave his post at the end of October, the decision is likely to fall upon his successor, Christine Lagarde.

In the UK, former foreign secretary and London Mayor Boris Johnson was elected leader of the Conservative Party and Prime Minister, promising to take the UK out of the EU at the end of October “come what may” and if necessary without a withdrawal agreement, with parliament having rejected former PM Theresa May’s negotiated deal with the EU three times. Johnson has set as a precondition to talks on a new deal the removal of the ‘Irish Backstop’ component, which so far, the EU is refusing. Johnson’s room for maneuver is limited by precarious parliamentary arithmetic and a rebel group within his own party, who could eventually bring the government down and force a general election. The uncertainty is piling pressure on the British pound, which fell 4% versus the US dollar in July to a more than two-year low, and GDP may have flat-lined in 2Q19. In the event of a ‘no deal’ Brexit, the Bank of England is likely to cut interest rates from their current 0.75% while a government budget mooted for early October could announce a sizeable fiscal loosening on top of money already announced to prepare for ‘no deal’.

CHINESE GROWTH SLOWS TO 27-YEAR LOW, YUAN FALLS

Chinese economic growth eased from 6.4% y/y in 1Q19 to a 27-year low of 6.2% in 2Q19 against a backdrop of softer domestic as well as external conditions. Better-than-expected industrial output (6.3% y/y) and retail sales figures (9.8%) for June offered some solace however, reflecting pockets of strength in the domestic economy, perhaps supported by pro-growth measures laid out over the past couple of months. Indications are the economy continues to weaken bolstering the case for more support to shore up growth especially after the latest flaring up of the trade dispute with the US. The government is likely to roll out further stimulus in the months ahead, having announced that it will remove some foreign ownership limits in the financial sector in 2020 (a year earlier than initially planned) to prop up foreign investment inflows.

Meanwhile, the yuan has felt the pressure from slower growth and the latest US tariff measures, falling past RMB7/US$1 in early August for the first time in 11 years. There is a view that the authorities may tolerate a weaker currency as a further stimulus measure, as well as a countermeasure against the US. Indeed, the fall led the US to formally designate China a “currency manipulator”.

Read the rest of the report here.