BH MACRO LTD
BH MACRO LIMITED
MONTHLY SHAREHOLDER REPORT:
DECEMBER 2016
YOUR ATTENTION IS DRAWN TO THE DISCLAIMER AT THE END OF THIS
DOCUMENT
BH Macro Overview
Limited
Manager: BH Macro Limited ("BHM") is a closed-ended investment company, registered and
Brevan Howard incorporated in Guernsey on 17 January 2007 (Registration Number: 46235).
Capital BHM invests all of its assets (net of short-term working capital) in the
Management LP ordinary shares of Brevan Howard Master Fund Limited (the "Fund").
("BHCM") BHM was admitted to the Official List of the UK Listing Authority and to
Administrator: trading on the Main Market of the London Stock Exchange on 14 March 2007.
Northern Trust
International
Fund
Administration
Services
(Guernsey)
Limited
("Northern
Trust") Total $865 mm¹
Corporate Assets:
Broker:
J.P. Morgan
Cazenove
Listings:
London Stock
Exchange
(Premium
Listing)
NASDAQ Dubai - 1. As at 30 December 2016. Source: BHM's administrator, Northern Trust.
USD Class
(Secondary
listing)
Bermuda Stock
Exchange
(Secondary
listing)
Summary BH Macro Limited NAV per Share (Calculated as at 30 December 2016)
Information
Share NAV (USD NAV per
Class mm) Share
USD 216.3 $21.68
Shares
EUR 34.7 €21.87
Shares
GBP 613.8 £22.44
Shares
BH Macro Limited NAV per Share % Monthly Change
USD Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec YTD
2007 0.10 0.90 0.15 2.29 2.56 3.11 5.92 0.03 2.96 0.75 20.27
2008 9.89 6.70 -2.79 -2.48 0.77 2.75 1.13 0.75 -3.13 2.76 3.75 -0.68 20.32
2009 5.06 2.78 1.17 0.13 3.14 -0.86 1.36 0.71 1.55 1.07 0.37 0.37 18.04
2010 -0.27 -1.50 0.04 1.45 0.32 1.38 -2.01 1.21 1.50 -0.33 -0.33 -0.49 0.91
2011 0.65 0.53 0.75 0.49 0.55 -0.58 2.19 6.18 0.40 -0.76 1.68 -0.47 12.04
2012 0.90 0.25 -0.40 -0.43 -1.77 -2.23 2.36 1.02 1.99 -0.36 0.92 1.66 3.86
2013 1.01 2.32 0.34 3.45 -0.10 -3.05 -0.83 -1.55 0.03 -0.55 1.35 0.40 2.70
2014 -1.36 -1.10 -0.40 -0.81 -0.08 -0.06 0.85 0.01 3.96 -1.73 1.00 -0.05 0.11
2015 3.14 -0.60 0.36 -1.28 0.93 -1.01 0.32 -0.78 -0.64 -0.59 2.36 -3.48 -1.42
2016 0.71 0.73 -1.77 -0.82 -0.28 3.61 -0.99 -0.17 -0.37 0.77 5.02 0.19 6.63
EUR Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec YTD
2007 0.05 0.70 0.02 2.26 2.43 3.07 5.65 -0.08 2.85 0.69 18.95
2008 9.92 6.68 -2.62 -2.34 0.86 2.84 1.28 0.98 -3.30 2.79 3.91 -0.45 21.65
2009 5.38 2.67 1.32 0.14 3.12 -0.82 1.33 0.71 1.48 1.05 0.35 0.40 18.36
2010 -0.30 -1.52 0.03 1.48 0.37 1.39 -1.93 1.25 1.38 -0.35 -0.34 -0.46 0.93
2011 0.71 0.57 0.78 0.52 0.65 -0.49 2.31 6.29 0.42 -0.69 1.80 -0.54 12.84
2012 0.91 0.25 -0.39 -0.46 -1.89 -2.20 2.40 0.97 1.94 -0.38 0.90 1.63 3.63
2013 0.97 2.38 0.31 3.34 -0.10 -2.98 -0.82 -1.55 0.01 -0.53 1.34 0.37 2.62
2014 -1.40 -1.06 -0.44 -0.75 -0.16 -0.09 0.74 0.18 3.88 -1.80 0.94 -0.04 -0.11
2015 3.34 -0.61 0.40 -1.25 0.94 -0.94 0.28 -0.84 -0.67 -0.60 2.56 -3.22 -0.77
2016 0.38 0.78 -1.56 -0.88 -0.38 3.25 -0.77 0.16 -0.56 0.59 5.37 0.03 6.37
GBP Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec YTD
2007 0.11 0.83 0.17 2.28 2.55 3.26 5.92 0.04 3.08 0.89 20.67
2008 10.18 6.86 -2.61 -2.33 0.95 2.91 1.33 1.21 -2.99 2.84 4.23 -0.67 23.25
2009 5.19 2.86 1.18 0.05 3.03 -0.90 1.36 0.66 1.55 1.02 0.40 0.40 18.00
2010 -0.23 -1.54 0.06 1.45 0.36 1.39 -1.96 1.23 1.42 -0.35 -0.30 -0.45 1.03
2011 0.66 0.52 0.78 0.51 0.59 -0.56 2.22 6.24 0.39 -0.73 1.71 -0.46 12.34
2012 0.90 0.27 -0.37 -0.41 -1.80 -2.19 2.38 1.01 1.95 -0.35 0.94 1.66 3.94
2013 1.03 2.43 0.40 3.42 -0.08 -2.95 -0.80 -1.51 0.06 -0.55 1.36 0.41 3.09
2014 -1.35 -1.10 -0.34 -0.91 -0.18 -0.09 0.82 0.04 4.29 -1.70 0.96 -0.04 0.26
2015 3.26 -0.58 0.38 -1.20 0.97 -0.93 0.37 -0.74 -0.63 -0.49 2.27 -3.39 -0.86
2016 0.60 0.70 -1.78 -0.82 -0.30 3.31 -0.99 -0.10 -0.68 0.80 5.05 0.05 5.79
Source: Fund NAV data is provided by the administrator of the Fund,
International Fund Services (Ireland) Limited ("IFS"). BHM NAV and NAV per
Share data is provided by BHM's administrator, Northern Trust. BHM NAV per
Share % Monthly Change is calculated by BHCM. BHM NAV data is unaudited and net
of all investment management fees (2% annual management fee and 20% performance
fee) and all other fees and expenses payable by BHM. In addition, the Fund is
subject to an operational services fee of 50bps per annum.
BHCM shall waive its entitlement to a management fee in respect of any
performance-related growth of BHM from 3 October 2016 onwards. In addition,
BHM's investment in the Fund will not bear an operational services fee in
respect of any performance-related growth from 3 October 2016 onwards.
NAV performance is provided for information purposes only. Shares in BHM do not
necessarily trade at a price equal to the prevailing NAV per Share.
Data as at 30 December 2016
PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.
ASC 820 Asset Brevan Howard Master Fund Limited
Valuation
Categorisation* Unaudited as at 30 December 2016
% of Gross Market
Value*
Level 1 79.3
Level 2 20.2
Level 3 0.1
At NAV 0.4
Source: BHCM
* This data is unaudited and has been calculated by BHCM using the
same methodology as that used in the most recent audited financial
statements of the Fund.
Annual Manager Level 1: This represents the level of assets in the portfolio which
Review: 2016 are priced using unadjusted quoted prices in active markets that are
accessible at the measurement date for identical, unrestricted assets
or liabilities.
Level 2: This represents the level of assets in the portfolio which
are priced using either (i) quoted prices that are identical or
similar in markets that are not active or (ii) model-derived
valuations for which all significant inputs are observable, either
directly or indirectly in active markets.
Level 3: This represents the level of assets in the portfolio which
are priced or valued using inputs that are both significant to the
fair value measurement and are not observable directly or indirectly
in an active market.
At NAV: This represents the level of assets in the portfolio that are
invested in other Brevan Howard funds and priced or valued at NAV as
calculated by IFS.
The information in this section has been provided to BHM by BHCM.
The NAV per share of the USD share class of BH Macro Limited
appreciated by 6.63% in 2016, while the NAV per share of the Euro
shares appreciated by 6.37% and the NAV per share of the Sterling
shares appreciated by 5.79% in 2016. The Fund's largest exposures at
the start of the year were long positions in European interest rates
and short positions in the Euro currency, held in anticipation of
further easing by the ECB. While these positions initially generated
gains, they reversed following the ECB's meeting in March as market
participants focused on President Draghi's comments downplaying the
prospects for further easing. Small gains across a wide range of
strategies including credit index, relative value, volatility and
emerging market interest rates trading were offset by losses from
short positions in US interest rates and equity trading, leaving the
Fund with a small loss by the end of the first half of 2016.
During the second half of the year, in what were largely trendless
markets, the Fund's performance slipped until November when,
following the US election results, market volatility increased
sharply. The Fund profited as US and European interest rates rose, as
did the US dollar and the level of implied volatility across a range
Performance of different asset classes. November's gain of 5.02% was the Fund's
Review sixth best-ever monthly return and followed a period of relatively
low VaR usage, highlighting not only the rapid adjustment in risk
levels but also the limits of the usefulness of VaR as a predictor of
upside potential.
The acquisition by BHM of 7,812,223 Sterling shares, 861,331 Euro
shares and 3,805,094 US Dollar shares pursuant to the tender offer
launched by BHM on 27 April 2016 (the "Tender Offer") was executed on
27 June 2016. The repurchase of shares under the Tender Offer
resulted in the NAV per share of the remaining USD shares
appreciating by 2.52%, the NAV per share of the remaining Sterling
shares appreciating by 2.38% and the NAV per share of the remaining
Euro shares appreciating by 2.14%.
2016 was a year of significant political developments. In the UK, the
Brexit vote was a shock to many and, in the US, Donald Trump won the
presidential election against expectations. Although it is possibly
an oversimplification, voters seem eager to repudiate the status quo.
This is important because the institutions and policies that have
shaped market outcomes since the Great Recession may, as a result,
face additional challenges going forward.
The good news is that while the world faces significant uncertainties
in 2017, the global economy looks to be on a reasonably sound footing
with the prospect of additional fiscal spending combined with
accommodative monetary policy. Recent economic developments are
covered later in this report but broadly, the ECB and Bank of Japan
are continuing their unconventional monetary policy of quantitative
easing combined with negative rates (and, in the case of Japan,
explicit yield caps), while the Federal Reserve is removing
accommodation at a measured and gradual pace. These policies were
part of the landscape last year and will continue to be important in
2017. In summary, investors can expect some of the trends from 2016
to continue in 2017, some new initiatives to emerge, and potentially
plenty of surprises.
We look forward to exploiting any opportunities that these factors
may create.
The information in this section has been provided to BHM by BHCM.
Towards the end of December, the Fund gave back some of the gains
generated earlier in the month. These moves were primarily driven by
short positioning in US interest rates, long exposure, via options,
to the S&P as well as long positions in the US dollar against a range
of currencies including the Euro and the Yen. Additional gains came
from credit trading while short positions in European and GBP
interest rates detracted modestly from performance.
The performance review and attributions are derived from data
calculated by BHCM, based on total performance data for each period
provided by the Fund's administrator (IFS) and risk data provided by
BHCM, as at 30 December 2016.
Performance by Asset Class
Monthly, quarterly and annual contribution (%) to the performance of BHM USD
Shares (net of fees and expenses) by asset class as at 30 December 2016
2016 Rates FX Commodity Credit Equity Discount Total
Management
& Tender
Offer
January 1.14 -0.15 -0.15 -0.13 -0.22 0.22 0.71
2016
February 1.08 0.27 -0.02 -0.12 -0.63 0.16 0.73
2016
March 2016 -1.04 -0.93 0.03 0.27 -0.29 0.19 -1.77
April 2016 -0.48 -0.27 -0.04 0.06 -0.11 0.01 -0.82
May 2016 -0.28 0.03 0.01 0.04 -0.09 0.02 -0.28
June 2016 0.77 0.15 0.06 -0.05 -0.19 2.87 3.61
July 2016 -0.25 -0.84 -0.04 0.02 0.00 0.12 -0.99
August 0.11 -0.18 -0.01 0.06 -0.19 0.04 -0.17
2016
September -0.38 -0.53 0.05 0.12 -0.15 0.52 -0.37
2016
October -0.20 0.46 -0.02 0.04 -0.02 0.11 0.77
2016
November 3.15 1.75 0.01 0.10 0.01 0.00 5.02
2016
December -0.17 -0.07 -0.02 0.37 0.08 0.00 0.19
2016
Q1 2016 1.17 -0.82 -0.14 0.02 -1.14 0.57 -0.35
Q2 2016 0.01 -0.09 0.03 0.05 -0.39 2.90 2.47
Q3 2016 -0.52 -1.55 0.01 0.20 -0.34 0.68 -1.52
Q4 2016 3.18 2.15 -0.03 0.51 0.08 0.11 6.04
YTD 2016 3.85 -0.35 -0.13 0.78 -1.78 4.31 6.63
PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.
Methodology and Definition of Contribution to Performance:
Attribution by asset class is produced at the instrument level, with
adjustments made based on risk estimates.
The above asset classes are categorised as follows:
"Rates": interest rates markets
"FX": FX forwards and options
"Commodity": commodity futures and options
"Credit": corporate and asset-backed indices, bonds and CDS
"Equity": equity markets including indices and other derivatives
"Discount Management & Tender Offer": buyback activity for discount management
purposes and repurchases under the tender offer launched on 27 April 2016.
Monthly VaR of the Fund by asset class as a % of total VaR*
Rates Vega FX Equity Commodity Credit
January 41 15 20 15 4 4
2016
February 25 18 35 11 3 7
2016
March 2016 39 19 26 7 5 4
April 2016 40 22 23 4 6 5
May 2016 34 26 22 2 9 6
June 2016 31 22 28 9 5 2
July 2016 20 27 23 13 11 7
August 28 26 16 15 8 6
2016
September 37 21 22 6 6 9
2016
October 42 19 28 2 3 6
2016
November 33 16 42 5 2 3
2016
December 26 15 35 20 2 2
2016
Source: BHCM. Data as at 30 December 2016.
* Calculated using historical simulation based on 1 day, 95% confidence
interval. Sum may not add up to 100% due to rounding.
Performance by Strategy Group
Monthly, quarterly and annual contribution (%) to the performance of BHM USD
Shares (net of fees and expenses) by strategy group as at 30 December 2016
2016 Macro Systematic Rates FX Equity Credit EMG Commodity Discount Total
Management
& Tender
Offer
January -0.11 0.02 0.86 0.01 -0.00 -0.12 -0.17 -0.00 0.22 0.71
2016
February 0.41 0.01 0.32 -0.00 -0.00 -0.14 -0.03 -0.00 0.16 0.73
2016
March -1.38 -0.02 -0.62 -0.03 -0.00 -0.08 0.17 -0.00 0.19 -1.77
2016
April -0.62 -0.01 -0.39 -0.04 -0.00 0.05 0.18 -0.00 0.01 -0.82
2016
May 2016 -0.48 -0.01 -0.00 0.06 -0.00 0.06 0.09 -0.00 0.02 -0.28
June 2016 0.66 0.02 0.15 -0.01 -0.00 -0.02 -0.05 -0.00 2.87 3.61
July 2016 -0.77 0.00 -0.07 -0.13 -0.00 0.01 -0.15 -0.00 0.12 -0.99
August -0.36 -0.01 0.10 -0.04 -0.00 0.04 0.06 -0.00 0.04 -0.17
2016
September -1.02 -0.01 0.10 -0.10 -0.00 0.11 0.03 -0.00 0.52 -0.37
2016
October 0.60 -0.02 -0.04 0.06 -0.00 0.12 -0.05 -0.00 0.11 0.77
2016
November 3.89 0.00 0.98 0.13 -0.00 0.08 -0.07 -0.00 0.00 5.02
2016
December -0.40 0.01 -0.03 0.07 -0.00 0.40 0.14 -0.00 0.00 0.19
2016
Q1 2016 -1.10 0.01 0.56 -0.02 -0.01 -0.34 -0.02 -0.00 0.57 -0.35
Q2 2016 -0.44 -0.01 -0.24 0.01 -0.01 0.08 0.21 -0.00 2.90 2.47
Q3 2016 -2.14 -0.01 0.13 -0.28 -0.00 0.17 -0.06 -0.00 0.68 -1.52
Q4 2016 4.10 -0.00 0.90 0.26 -0.00 0.60 0.02 -0.00 0.11 6.04
YTD 2016 0.31 -0.01 1.35 -0.02 -0.01 0.51 0.15 -0.00 4.31 6.63
PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.
Methodology and Definition of Contribution to Performance:
Strategy Group attribution is approximate and has been derived by allocating
each trader book in the Fund to a single category. In cases where a trader book
has activity in more than one category, the most relevant category has been
selected.
The above strategies are categorised as follows:
"Macro": multi-asset global markets, mainly directional (for the Fund, the
majority of risk in this category is in rates)
"Systematic": rules-based futures trading
"Rates": developed interest rates markets
"FX": global FX forwards and options
"Equity": global equity markets including indices and other derivatives
"Credit": corporate and asset-backed indices, bonds and CDS
"EMG": global emerging markets
"Commodity": liquid commodity futures and options
"Discount Management & Tender Offer": buyback activity for discount management
purposes and repurchases under the tender offer launched on 27 April 2016.
Manager's The information in this section has been provided to BHM by BHCM
Market Review
and Outlook US
The year ended with modestly above-trend growth, a tightening labour market and
tame inflation. Real GDP growth appeared to have moderated to approximately 2%
in the fourth quarter, and forward-looking indicators pointed to a similar pace
in the first quarter. Business investment has improved after having been a
strain on growth for much of the last year. Inventories are being restocked,
which added to growth in the second half of the year. Outlays on equipment have
finally flattened out after having contracted for four consecutive quarters.
Structures investment is moving up as energy investment picks back up.
Residential investment also has bounced. The most notable hindrance has been
from a decline in exports that reversed the one-time surge in agricultural
exports seen in the third quarter. Overall, the growth outlook looks solid.
The unemployment rate ticked up to 4.7% in December following the surprising
drop to 4.6% in November. December was the second month of readings below most
observers' estimate of the long-run sustainable rate of labour-market
utilisation. Broader measures of labour market underutilisation continue to
improve as well. As would be expected when the economy is operating in the
neighbourhood of full employment, wages are accelerating. In particular, the
latest year-over-year gain on average hourly earnings was 2.9%, the fastest
pace of the expansion. Payroll employment gains slowed in the fourth quarter to
a still-solid average increase of more than 150,000 job gains per month.
Core Personal Consumption Expenditure inflation rose 1.6% in the year ended in
November, little different from the pace seen during most of 2016. With a
strong US dollar exerting downward pressure on import prices and tighter labour
markets translating only weakly into consumer prices, consumer inflation trends
appear restrained.
Monetary policy took a back seat to political developments in Washington. The
Federal Reserve raised rates in December and pointed to a somewhat faster pace
of rate hikes in 2017 and beyond, partly because of the prospects for fiscal
stimulus. Meanwhile, President Trump appointed most of his cabinet and Congress
turned its attention to an ambitious legislative agenda, which includes
repealing and replacing Obamacare, corporate and personal tax reform,
infrastructure spending, additional defence outlays, immigration, and
de-regulation. As Chief Executive, the President has direct control over the
trade agenda, parts of immigration policy, and some regulation. President Trump
has promised to act quickly in these areas over the coming months.
UK
A continuation of the recent trends in the UK economy has been observed.
Contrary to certain expectations, the vote to leave the European Union has not
dented economic activity. Growth has proved remarkably resilient, with
companies continuing to invest and consumer spending remaining buoyant. More
recently, a pick-up in global demand has also provided a more constructive
backdrop. The relevant question going forward will be to what extent consumer
spending will slow in response to the deceleration in real incomes, as
inflation is expected to pick up materially. So far, some of the outperformance
in consumption over real income growth can be explained by faster credit growth
and rising house prices. It is possible that this trend continues and
consumption spending defies the upcoming slowdown in real incomes, but it is
also possible that some adjustment is finally seen. This has also been
identified as one of the key judgements by the Bank of England ("BoE"). The UK
labour market has remained broadly stable in recent months. So far, no clear
signs of the rise in unemployment that the BoE expects for 2017 have been
detected.
Inflation has started to move higher, driven by energy-price base effects and
the weaker Sterling exchange rate. In November, the Bank of England forecast a
material overshoot of inflation relative to its target in the next few years,
largely on account of the sharp depreciation of Sterling over the past year,
prompting the Monetary Policy Committee to abandon its easing stance and move
to a more neutral policy stance. The BoE could be forced to tighten monetary
policy if the exchange rate resumed its downward trend or inflation
expectations started to move higher in an environment where consumption
spending remains resilient. For the time being, however, the BoE has adhered to
its forecast for a gradual slowdown in economic growth, which should in turn
bring inflation back to target over the medium term.
On 17 January, Prime Minister Theresa May outlined her 12-point plan for Brexit
during a speech at Lancaster House. As expected, May took the hard Brexit
stance, announcing the UK would leave the Single Market. Although, attempts to
maintain "the greatest possible access to it" by negotiating an ambitious Free
Trade Agreement with the European Union. However, the Government lost the
appeal at the Supreme Court on 24 January. The ruling means the Government
cannot trigger Article 50 without an act of Parliament, although this is
expected to happen in time for the Government's 31 March deadline. Further
information on the Brexit process will be released in the coming weeks.
EMU
2016 began with increasing downside risks in view of emerging market
uncertainties and financial market volatility. Given these risks and weak
inflation dynamics the ECB decided upon further measures in March, having
disappointed financial market expectations in December 2015. In March 2016, the
ECB cut the deposit rate by a further 10bp to -0.4% and the main refinancing
rate by 5bp to 0%. The Asset Purchase Programme ("APP") was increased to €80bn
per month (from April 2016) from the initial pace of €60bn per month, although
purchases were still intended to run until the end of March 2017, or beyond, if
necessary. The ECB also added investment grade euro-denominated (non-bank)
corporate bonds to the APP (purchases started in June 2016) and launched four
targeted longer-term refinancing operations (TLTROII), each with a maturity of
four years and the opportunity for banks to secure a negative funding cost in
line with the deposit rate if net lending exceeded a benchmark. Euro area GDP
growth remained relatively strong at the start of the year (0.5% q/q) before
moderating in Q2 as uncertainty increased ahead of the main risk event - the
UK's EU membership referendum at the end of June. While the vote for Brexit was
unexpected, it caused only a transitory dip to confidence indicators over the
summer. The German IFO business climate index dropped cumulatively around 2.5
points in July and August but then rebounded over 3 points in September and
continued to increase in Q4. The euro area composite Purchasing Manager's Index
dipped marginally during the summer before reaccelerating throughout Q4 to
reach its highest level (54.4) since May 2011 by the end of the year. Euro area
GDP seems poised to end the year growing back at a 0.5% q/q pace which will
result in GDP growth of 1.7% in 2016 after 1.9% in 2015. During the year the
euro area unemployment rate continued to decline, falling from 10.4% at the end
of 2015 to 9.8% in November 2016. However, wage growth has yet to pick up
despite this improvement in the labour market in recent years. Euro area
negotiated wage growth remains low at just 1.4% y/y in Q3 2016, its slowest
annual growth rate since Q4 1991. As a result, core inflation has remained
sluggish throughout 2016, averaging just 0.85% in 2016, barely up from 0.83% in
2015 (and compared to the December 2015 ECB staff core inflation forecast of
1.3% for 2016). Headline inflation averaged just 0.2% in 2016, albeit up from
0.0% in 2015.
The lack of sufficient progress towards achieving a sustained adjustment in
inflation resulted in the ECB announcing on 8 December 2016, a nine month
extension to Quantitative Easing ("QE") until the end of December 2017 (or
beyond, if necessary), albeit at a slower pace of €60bn from April 2017 (as
deflation risks had diminished). This nonetheless will add a further €540bn of
purchases, taking the total intended stock of QE to €2.28trn (or 21% of GDP).
In order to achieve this expansion, the ECB also changed some of the parameters
to accommodate an expanded QE programme, notably expanding the maturity of
eligible bonds by decreasing the minimum remaining maturity to 1yr from 2yrs
and allowing purchases with a yield to maturity below the deposit rate "to the
extent necessary". There was also a dovish warning that the ECB intends to
increase the programme in terms of size and/or duration should the economic
outlook deteriorate or financial conditions tighten unduly, although for now
the forward guidance around the potential for lower rates seems surplus to
requirements as the deposit rate looks to have reached its effective lower
bound at -0.4% (with the ECB seemingly content to see a steeper yield curve in
order to reduce the negative impact of its monetary policy on the banking
sector). More recently, the combination of stronger oil prices following the
OPEC agreement and energy price base effects has resulted in an increase in
euro area inflation to 1.1% y/y in December. Looking forward, inflation is
expected to continue to rise at the beginning of 2017. Core inflation, however,
is likely to remain more sluggish, falling short of the ECB's forecast for a
more robust pick-up, as the weakness in wages will continue to weigh on core
inflation. The ECB's account of the 8 December policy meeting confirms
divergent views on the Governing Council regarding inflation risks. The dovish
camp has warned of the over-prediction of inflation in recent years (with the
largest forecast error said to be on wages and still no clear signs of labour
market pressures), while the more hawkish camp noted some indications of
stronger headline inflation, which they believe could be expected to have an
influence on future wage dynamics. These arguments will persist for some time
to come, hence why the minutes confirm that both downside and upside risks to
the inflation outlook warrant close monitoring.
Part of the ECB's explanation for a nine month extension of QE was also to
ensure a sustained market presence and source of stability in an uncertain
environment. The region managed to broadly weather political risks in 2016.
This was especially the case in Italy where there was no significant market
fall-out from the resignation of Prime Minister Renzi after his heavy loss in
the constitutional referendum (59.1%-40.9%). Furthermore, the new Government
under Prime Minister Gentiloni was able to secure Parliamentary approval for
borrowing of up to €20bn (1.2% of GDP) for the banking sector to facilitate a
bailout for Monte dei Paschi (estimated at €8.8bn, of which €6.6bn is expected
to be at the cost of the Italian state) after it finally requested a
"precautionary" capital increase (with bond/equity burden-sharing and some move
to compensate mis-sold retail bondholders). The other task for the new
Government will be to approve a new electoral law ahead of new elections.
Looking ahead, the focus in 2017 turns to politics and the electoral surprises
delivered in the UK with Brexit and in the US election will likely keep
uncertainty and fears over the rise of populism high. General elections are on
the horizon in The Netherlands (15 March), France (Presidential elections on 23
April/7 May) and Germany (likely September). Elections in Italy could be as
early as Spring 2017 but may also be delayed until its natural deadline (i.e.
Spring 2018). In addition, Greece has to conclude the second review of its
bailout programme. Having announced its intention to continue QE at a reduced
pace of €60bn from April 2017 until the end of 2017 (or beyond, if necessary),
it is not expected the ECB will contemplate any further policy changes until
the second half of this year when focus on tapering will likely build again.
Core inflation is expected to remain subdued (and below ECB forecasts), which
seems likely to result in the ECB maintaining a market presence via QE well
into 2018.
China
During 2016 growth has somewhat stabilised at around 6.7% due to the
Government's easing effort. Policy easing before Q4 was mainly in the form of
growth, i.e. credit-driven investment, especially in construction and
infrastructure, which led to a continued rise in leverage. GDP growth in 2016
slowed further from 6.9% to 6.7%, the lowest level in 30 years, although
broadly in line with the Government's target.
Looking forward, 2017 is a unique year due to the scheduled leadership change
every five years. In the baseline scenario, five out of the seven Central
Politburo will have to retire, leading to an unprecedented reshuffle of power,
especially given President's Xi's power consolidation. In that setting, the
Government will likely focus on the political issues for 2017, meaning that
risk aversion of policy makers will likely rise accordingly. That would lead to
policy mainly targeting a stabilisation scenario in growth and finance markets.
The official GDP growth target for 2017 is likely to be maintained at
approximately 6.5%, with the rising probability of it being lowered to 6-6.5%.
Fiscal policy is likely to be expanded further, but the major lift will have to
rely on quasi-fiscal deficit, i.e., investment financed by local governments
which is not included in the official fiscal deficit.
Japan
During 2016, the Bank of Japan ("BoJ") slowly rejected its reflation project.
The Bank began the year with one last shot, pushing short rates into negative
territory. Markets, however, did not co-operate. The yen appreciated sharply
against the dollar. Inflation slowed to the point where consumer prices
excluding food and energy were essentially flat, and consumer inflation
expectations continued to deteriorate. For half a year, the BoJ kept policy on
hold. In September, the Bank then switched tactics again, announcing its
so-called yield-curve control policy, no longer targeting a fixed quantity of
asset purchases but setting its bond buying to keep the ten-year Japanese
Government Bond ("JGB") rate around zero. The BoJ's operative theory is that
when inflation starts to move up, the suppression of the long rate will become
extra stimulative as real long rates fall; knowing that will happen sometime in
the future, investors and consumers should raise their inflation expectations
now. In the event, BoJ bond purchases have slowed somewhat and the ten-year
rate is now a little higher than when the Bank announced the new policy. While
inflation expectations have recently flattened out, they remain at a relatively
low level.
Despite the BoJ's capitulation, external events set up 2017 for some pick-up in
inflation. Since the election of Donald Trump as President of the United
States the yen has depreciated almost 10% against the US dollar. At the same
time, oil prices have moved up, some of which should be passed on generally.
Altogether, inflation won't approach the BoJ's 2% target, but western core
inflation should lift off the current 12-month rate of 0.1%.
While US election results have helped Governor Kuroda, they have created a new
set of challenges for Prime Minister Abe. Obviously, the Trans-Pacific
Partnership is dead; Japan's ratification of the deal in December was a gesture
to what looks increasingly like the peak in globalisation. The President's
campaign promises to raise tariffs or Congressional Republican plans for tax
reform with a border adjustment, if enacted, will bite into the global trading
system and risks setting off responses elsewhere in Asia that Japan will have
to manage. Moreover, geopolitical risks, whether they are in the East China
Sea or on the Korean peninsula, feel like more of a wildcard than before. For
his part, Abe's party did well in the upper-house elections over the summer.
Along with smaller like-minded parties, the Prime Minister has the necessary
two thirds supermajority necessary to amend the country's constitutional
restrictions on the military, though it will still take a lot of effort to push
that project forward. Altogether, the Prime Minister will have his plate full;
that reduces the bandwidth and political capital needed to guide additional
structural reforms this year. At least he won't have to contend with the
fallout from a second hike in consumption taxes. Last summer, Abe announced a
delay until October 2019.
Prime Minister Abe should benefit from decent momentum in economic activity.
Last year GDP rose slightly faster than expected, closing some of the output
gap. The latest survey data are satisfactory. The appreciation in the yen
over the first half of 2016 will probably cut into net exports, though the most
recent reversal should help limit that drag to activity. Meanwhile, although
the stimulative effects of the spending package passed over the summer were
probably overemphasised, it will still be supportive of growth this year.
Enquiries Northern Trust International Fund Administration Services (Guernsey) Limited
Harry Rouillard +44 (0) 1481 74 5315
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BH Macro : Monthly Shareholder Report - December 2016
January 31, 2017 at 11:40 pm IST
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