Last week we saw China’s official manufacturing PMI dip slightly. It was hardly a significant movement especially when the non-manufacturing PMI edged higher. The Caixin manufacturing PMI also edged higher but interestingly, the new exports sub index showed a significant decline to below 50. These could be early signals that trade could be falling back into its declining trend of the last 8 years, and this is before recent tariffs have had any time to take effect. We think trade will indeed retrench as a percentage of GDP but that China and the US, the main actors in the trade war have actually prepared themselves well ahead and are more resilient against slowing trade. The challenge for investors is avoiding the large export oriented index components and finding growth and value in the small and mid-cap population. China investment opportunities will not easily be captured by passive ETFs.

In the US. The ISM manufacturing index fell to 57.3, below a forecast of 58.5. Its still a high number indicating continued expansion, but it is also a sharp deceleration and will be closely monitored. Production, new orders and employment sub-indices all fell sharply while prices increased. The non-manufacturing ISM was similarly disappointing falling by 2 pts to 56.8 against forecasts for 58.

And in India, the manufacturing PMI rose slightly driven by robust domestic demand. Input and output prices fell moderating recent inflationary pressures.

The Fed:

The PCE inflation indicator most favoured by the Fed rose from 1.6% to 1.9% in a month. There was some small probability of the Fed raising rates on May 2 but it held firm and is very likely to stick to its original script for the rest of the year. So far the volatility in global markets has been constrained to equity markets with credit markets being relatively unfazed. This is fortunate for the Fed. If credit markets sell off, funding costs could rise out of hand confounding the Fed’s plans to reset policy to more normal levels. We reiterate our view: that the Fed will stay on script and continue to hike rates resolutely if not aggressively while communicating gradualism.

US national debt:

The US Treasury announced that nominal coupon auction sizes will increase by a total of $27bn in the May-June quarter and that it will introduce a new 2-month bill later in the year. Increased supply will be focused on the 2 to 3 year sector. Issuance is likely to increase going forward as it appears that the Treasury has under estimated the current deficit and may need to compensate later in the year. Further, Treasury appears to have under estimated funding needs in subsequent years. The focus of issuance will impact the shape of the curve but overall, it’s clear that total supply will increase impacting the general level of the curve. Definitely grounds for caution on duration.


FX is one of the most ill-behaved asset classes where fundamentals can be ignored or confounded for months, even years. We have long held that the USD should be strong for the following reasons:

  1. Growth rate differentials between Europe, Japan and the US. Europe did outrun the US in 2017 but it remains to be seen if this is sustainable.
  2. The interest rate differential with EUR and JPY.
  3. The direction of interest rates. The Fed has been raising rates for over 2 years and has also begun to shrink its balance sheet. Given conditions in Japan and Europe, it is unlikely that their central banks will be able to materially reduce accommodation beyond signalling and optics.
  4. Global trade has been in retrenchment since 2009, and the 2017 rebound excepting, appears to be resuming, this with or without any escalation in trade war.

Yet for an entire year, the USD was weak in the face of the above factors. This appears to have changed. USD strength is only 2 weeks old and could strengthen and lengthen. Fundamentals certainly support a stronger USD but given how FX markets behave, it’s not a trade to put too much capital behind.

Emerging markets:

Emerging markets have in the past been vulnerable to rising USD rates and exchange rate, this stemming from large current account deficits and reliance on USD funding. The situation today is somewhat different. 20 years ago, governments were the main borrowers in USD, whereas today they borrow in local currency. Corporate borrowing was via bank loans in local currency with only larger borrowers having access to USD funding. Today, corporates have cheap access to USD funding via bond markets. While sovereign balance sheets are relatively safe against a rising dollar and dollar interest rates, corporate issuance of USD debt has been rising significantly, importing Fed policy to local economies. EM growth rates remain robust but global growth is slowing from cycle highs. For local currency bond investors, FX variability could dominate yield and duration and a strong USD would certainly detract. For USD corporate bond investors duration would be a concern.