Overview
There are some dangerous signals coming out of China, which should be watched very carefully indeed. The Yuan is depreciating (due to PBoC actions) and credit spreads are widening. Banks appear increasingly reluctant to lend to each other. Furthermore, the property sector looks vulnerable. Exporters have been hit by the stronger Yuan and the amount of credit in the system is well above danger levels – a weaker Yuan will help, though will cause losses for businesses that bought structured products in anticipation of an appreciating Yuan, if it continues. The wealth management sector (basically much worse than the worst junk bonds) looks scary, with well over US$0.5tr due for repayment this year. This is not a situation that is easily resolved and has the potential for a material negative outcome.
US markets at record highs, given Mrs Yellen’s dovish testimony, though other markets were mixed. The weaker US GDP data has been interpreted by markets that the FED may remain accommodative for longer. US bond yields rose from their lows as inflation data was higher than expected, with the US 10 year bond currently yielding 2.69%. EZ bond yields declined on the week, though came off their lows following the slightly higher inflation read.
The potential for problems in China, combined with much weaker capex has impacted the A$, which is off its high. I would expect the A$ to weaken further. The Euro bounced higher on the higher than expected inflation data, though I continue to believe it will decline against the US$ this year. The Yen has benefited from a “flight to safety” trade, though for how long. I continue to favour the US$.
The situation in the Ukraine has impacted European markets. Whilst there will be continued tension, the threat of Russia intervening seems highly unlikely. A fragmentation of the country is a possibility though.
US
The Case Shiller index on home prices rose by +13.4% in the year ending December, lower than the rise of 13.7% in the year to November, though in line with forecasts. It was the largest gain since 2005. However, there are some signs that the rate of price appreciation is set to decline.
New home sales increased unexpectedly by +9.6% to an annualised rate of 468k in January, well above the forecast of 400k, inspite of the adverse weather conditions. It was a 5 year high. The December’s annualised rate was also revised higher to 427k, from 414k previously.
US consumer confidence declined to 78.1 in February, lower than the estimate of 80 and the downwardly revised 79.4 in January. The expectations component declined to 75.7, down from 80.8 in January, though the present situation component rose to 81.7, the highest since the Lehman crisis. Pretty confusing report.
US January durable goods orders declined by just -1.0% M/M, better than the decline of -1.7% expected and the downwardly revised -5.3% in December. Non defence, ex aircraft, a much better and less volatile data point, orders rose by +1.7% M/M, much better than the decline of -0.2% expected and the decline of -1.8% in December.
Weekly jobless claims rose to 348k, up from 334k the previous week and higher than the estimate of 335k.
US Q4 GDP was revised lower to +2.4%, below the rate of +3.2% initially reported and the rate of +4.1% in Q4. Expectations were for the rate to decline to +2.5%. Lower inventories, consumer spending, government spending and exports were the main reasons for the decline. However, positively, business capex was revised higher (from 3.8% to 7.3%), though consumer spending was revised lower to 2.6%, from 3.3% previously.
Europe
The important German industry survey, the IFO index, rose to 111.3 in February, the highest since July 2011, and up from 110.6 in January. The reading was above forecasts, which assumed that the index would decline marginally to 110.5. German data, in particular its manufacturing/export data, has been remarkably resilient. I would have thought that exports to emerging markets, which German companies have expanded into, would have been affected, though no signs as yet.
German Q4 GDP rose by +0.4% (+1.3% Y/Y) in line with previous estimates, lead by exports which were the highest in 3 years. However, private consumption came in lower, with government spending flat. Exports rose by +2.6% in Q4, Q/Q, with capex up +1.4%.
Unemployment in Germany declined for the 3rd consecutive month in February. The decline of 14k, was marginally better than the decline of 10k expected. The adjusted unemployment rate came in at 6.8%, unchanged from the previous month.
French unemployment rose to a record high in January. The unemployment rate came in at 11.0%. Furthermore, January consumer spending was down -2.1%, as compared with expectations of +0.2%.
The EZ January unemployment rate came is unchanged at 12.0%, though the rate in Italy increased to a record high of 12.9%, as opposed to the 12.7% expected.
The EU has forecast that GDP growth in the EZ will come in at +1.2% this year (up from +1.1% previously) and +1.8% next. GDP was a negative -0.4% in 2013. However, it reduced its inflation forecast to +1.0% this year (+1.5% previously) and to +1.3% next, well below the ECB’s target of 2.0%. In addition, the Commission warns that accumulated sovereign debt (expected to be around 96% of GDP for the EZ) and low inflation could threaten its forecast. Frances budget deficit is expected to amount to 3.9% of GDP in 2015 (4.0% this year), higher than the 3.8% previously estimated and above the target of 3.0% it was supposed to achieve. French GDP growth is forecast at 1.0% for the current year. German 2014 GDP is expected to come in higher than initially forecast at +1.8%. Interestingly, the EU raised Spain’s GDP forecast to +1.0% this year (+0.5% previously) and +1.5% next, though its budget deficit is expected to come in at 5.8% this year and 6.5% for 2015. However Spanish Q4 GDP came in at +0.2%, as opposed to +0.3% estimated previously. Italy is forecast to grow by +0.6% this year, previously 0.7%.
EU area economic confidence rose to 101.2 in February (up from 101.0 in January), the highest level since mid 2011 and above forecasts of 100.7. The industrial confidence indicator whilst still negative improved to -3.4, from -3.8 previously and the services indicator rose to +3.2, from +2.4.
Mr Draghi stated that the ECB was ready to act if deflation is a risk, which he believed was not the case. He added, that deflation was limited to the peripheral EZ countries, in particular, Spain, Greece, Portugal and Ireland. However, data suggests that inflation in France, Italy and Holland are all showing signs of disinflation, with French inflation lower than that in Spain and Italy. Nothing really new from Mr Draghi during the G20 meeting. February’s EZ estimated CPI came in at +0.8% Y/Y, the same rate over the last 2 months, though slightly ahead of the initial estimate of +0.7%. However, EZ inflation over the last 6 months has been around negative -0.8% on an annualised basis. Furthermore, inflation in Germany in February came in at just +1.0% Y/Y, lower than the +1.2% expected and a 3 1/2 year low. The market will be analysing the upcoming inflation forecasts by the ECB.
Mr Matteo Renzi won a confidence vote in the Italian Senate, though with a smaller majority than his predecessor Mr Letta. He also won support from the lower house. He now becomes the 4th PM in 2 years and the 3rd unelected PM.
UK business investment rose by +2.4% in Q4 2013 Q/Q and up +8.5% Y/Y. In the past, the UK has depended on consumer spending, though that rose by just +0.4% in Q4 Q/Q. Whilst its early days, it looks as if the recovery in the UK is broadening, which is certainly positive.
Japan
Japan will try and recommence its nuclear electricity programme, which was shut down following the Fukushima incident, according to a “Basic Energy Plan” published by the government. Japan has had to rely on energy imports to compensate, which has resulted in major trade deficits. If some of the nuclear plants are reopened, the impact on Japan’s trade, and current a/c deficit could well be material. It is thought that there will be less opposition to reopening some nuclear plants than had previously been thought. Clearly energy prices (coal and nat gas, in particular) will be affected, as Japan has been importing these commodities to generate electricity.
Japanese core consumer prices (ex fresh food) rose by +1.3% Y/Y in January, higher than the +1.2% expected. Household spending rose by +1.1% in January, much higher than the rise of just +0.5% expected. Retail sales were +4.4% higher in January Y/Y, once again ahead of expectations of a rise of +3.8%. However, the increased spending is likely to been caused by consumers buying ahead of the proposed sales tax increase in April. Industrial output rose by 4.0% M/M, much higher than the rise of +2.8% expected and the highest since 2011. Generally, much better data than expected, though should be treated cautiously as it is likely impacted by the impending sales tax hike.
China
Residential prices in the tier 1 cities rose by just around +0.5%, the slowest rate of increase since last October. Local governments are trying to curb property price rises and bank lending to the sector is declining, with a number of banks curbing lending. The Chinese market closed down on the news, with property shares clearly the worst affected – the property index closed over 5.0% lower on Monday. The property sector has risen to unsustainable levels and, in my humble opinion, is likely to correct. Interestingly, the Yuan continues to decline.
Fears over the Chinese property market continue with the Shanghai Composite Index down over 2.0% on Tuesday. The Yuan also continues to depreciate and fell by the most since 2010 on Tuesday. On Friday, the Yuan declined by -0.9% against the US$, the largest decline since 2005 and around -1.2% lower for the week. There is speculation that the PBoC was buying US$’s and selling Yuan and that the Central Bank will widen (double?) its trading band. The PBoC has engineered the decline of the Yuan though its daily fixing, having previously increased its value to combat inflation. In addition, they continue to drain money from the system. Analysts argue that the PBoC wants to increase 2 way volatility in an attempt to curb currency speculation, as the Yuan had previously just appreciated for several months, which resulted in capital inflows, disguised as exports. Whilst that may be the case, I believe that it also reflects fears that the Chinese economy is slowing and that exporters are facing problems. A weaker Yuan also helps in the deleveraging process that China has to go through. However, a weaker Yuan could result in material losses for mainly Chinese businesses who bought structured products on the belief that the Yuan would continue to appreciate. Chinese officials reported that the decline in the Yuan should not be misinterpreted. Hmmm. Bloomberg reports that banks are becoming wary of lending to other banks, as can be seen from certain key credit indicators – not a good sign. The National People’s Congress meets next week, which should result in the announcement of new policies.
Other
South Africa has reduced its 2014 GDP growth forecast to +2.7%, from +3.0% previously. Further downgrades are likely. The problems affecting emerging markets look set to continue this year.
The problems besetting China has resulted in mining companies cutting back on their capex programmes aggressively in Australia. Private sector capex declined by -5.2% in Q4, Q/Q, much worse than the decline of -1.3% anticipated. It was the 1st decline in 3 Q’s.
Kiron Sarkar
1st March 2014
