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BH MACRO LIMITED
MONTHLY SHAREHOLDER REPORT:
DECEMBER 2016
YOUR ATTENTION IS DRAWN TO THE DISCLAIMER AT THE END OF THIS
DOCUMENT |
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BH Macro Limited |
Overview |
Manager:
Brevan Howard Capital Management LP (“BHCM”)
Administrator:
Northern Trust International Fund Administration Services
(Guernsey) Limited (“Northern Trust”)
Corporate Broker:
J.P. Morgan Cazenove
Listings:
London Stock Exchange (Premium Listing)
NASDAQ Dubai - USD Class (Secondary listing)
Bermuda Stock Exchange (Secondary listing) |
BH Macro Limited (“BHM”) is a closed-ended investment
company, registered and incorporated in Guernsey on 17 January 2007
(Registration Number: 46235).
BHM invests all of its assets (net of short-term working capital)
in the ordinary shares of Brevan Howard Master Fund Limited (the
“Fund”).
BHM was admitted to the Official List of the UK Listing Authority
and to trading on the Main Market of the London Stock Exchange on
14 March 2007. |
Total
Assets: |
$865 mm¹ |
|
1. As at 30 December 2016. Source: BHM's administrator,
Northern Trust. |
Summary
Information |
BH Macro
Limited NAV per Share (Calculated as at 30 December 2016) |
Share
Class |
NAV
(USD mm) |
NAV
per Share |
USD
Shares |
216.3 |
$21.68 |
EUR
Shares |
34.7 |
€21.87 |
GBP
Shares |
613.8 |
£22.44 |
|
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 Valuation Categorisation*
Annual Manager Review: 2016
Performance Review
|
Brevan Howard
Master Fund Limited |
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.
Level 1: This represents the level of assets in the portfolio
which 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 of different asset classes. November’s
gain of 5.02% was the Fund’s 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 Management & Tender Offer |
Total |
January
2016 |
1.14 |
-0.15 |
-0.15 |
-0.13 |
-0.22 |
0.22 |
0.71 |
February 2016 |
1.08 |
0.27 |
-0.02 |
-0.12 |
-0.63 |
0.16 |
0.73 |
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
2016 |
0.11 |
-0.18 |
-0.01 |
0.06 |
-0.19 |
0.04 |
-0.17 |
September 2016 |
-0.38 |
-0.53 |
0.05 |
0.12 |
-0.15 |
0.52 |
-0.37 |
October
2016 |
-0.20 |
0.46 |
-0.02 |
0.04 |
-0.02 |
0.11 |
0.77 |
November 2016 |
3.15 |
1.75 |
0.01 |
0.10 |
0.01 |
0.00 |
5.02 |
December 2016 |
-0.17 |
-0.07 |
-0.02 |
0.37 |
0.08 |
0.00 |
0.19 |
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
2016 |
41 |
15 |
20 |
15 |
4 |
4 |
February 2016 |
25 |
18 |
35 |
11 |
3 |
7 |
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
2016 |
28 |
26 |
16 |
15 |
8 |
6 |
September 2016 |
37 |
21 |
22 |
6 |
6 |
9 |
October
2016 |
42 |
19 |
28 |
2 |
3 |
6 |
November 2016 |
33 |
16 |
42 |
5 |
2 |
3 |
December 2016 |
26 |
15 |
35 |
20 |
2 |
2 |
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 Management & Tender Offer |
Total |
January
2016 |
-0.11 |
0.02 |
0.86 |
0.01 |
-0.00 |
-0.12 |
-0.17 |
-0.00 |
0.22 |
0.71 |
February
2016 |
0.41 |
0.01 |
0.32 |
-0.00 |
-0.00 |
-0.14 |
-0.03 |
-0.00 |
0.16 |
0.73 |
March 2016 |
-1.38 |
-0.02 |
-0.62 |
-0.03 |
-0.00 |
-0.08 |
0.17 |
-0.00 |
0.19 |
-1.77 |
April 2016 |
-0.62 |
-0.01 |
-0.39 |
-0.04 |
-0.00 |
0.05 |
0.18 |
-0.00 |
0.01 |
-0.82 |
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 2016 |
-0.36 |
-0.01 |
0.10 |
-0.04 |
-0.00 |
0.04 |
0.06 |
-0.00 |
0.04 |
-0.17 |
September
2016 |
-1.02 |
-0.01 |
0.10 |
-0.10 |
-0.00 |
0.11 |
0.03 |
-0.00 |
0.52 |
-0.37 |
October
2016 |
0.60 |
-0.02 |
-0.04 |
0.06 |
-0.00 |
0.12 |
-0.05 |
-0.00 |
0.11 |
0.77 |
November
2016 |
3.89 |
0.00 |
0.98 |
0.13 |
-0.00 |
0.08 |
-0.07 |
-0.00 |
0.00 |
5.02 |
December
2016 |
-0.40 |
0.01 |
-0.03 |
0.07 |
-0.00 |
0.40 |
0.14 |
-0.00 |
0.00 |
0.19 |
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 Market Review and Outlook |
The information in
this section has been provided to BHM by BHCM |
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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