Kiron Sarkar’s Weekly Report

Overview

Markets have rallied, inter alia, on dovish comments by Mrs Yellen and better(?) Chinese data, with the VIX declining and the US 10 year bond yield back up to 2.73%, though off its highs. However, the reality is that Chinese growth is much less than reported officially and credit risks remain prominent. The Japanese experiment is fraught with problems and with the country facing a current account deficit this year, investors are likely to reconsider the merits of the country and the Yen. Yes, EZ GDP is better, but disinflationary pressures persist and the regions banks are certain to require significant capital to meet the upcoming stress tests. Certainly, it looks as if US interest rates will remain lower for longer. However, as Credit Suisse puts it, equities seem to be the default investment of choice, given the lack of alternatives. That may be so, but markets in developed economies are not cheap and risks are rising. Admittedly, most analysts expect single digit returns from developed market equities this year, though I remain sceptical. As the FED continues with its tapering programme, emerging markets are likely to face continued pressure and I remain bearish across all EM asset classes, namely equities, bonds and currencies.

In terms of currencies, Sterling outperformed. The testimony by the Governor, Mr Mark Carney suggests that UK interest rates will rise in Q1/Q2 2015, making the UK the 1st of the major developed countries to raise rates. The US$ was marginally lower across most currency pairs on weaker data and a dovish Mrs Yellen. The Yen strengthened as their stock market declined and investors remain cautious on emerging markets. Whilst this may continue for a while, the prospect of, inter alia, current account deficits in 2014 suggests to me that the Yen will depreciate further. The A$ strengthened on better? Chinese data and the statement that the RBA would be on hold in terms of interest rates. However, I believe the trend remains for a weaker A$. Once again, I believe that the US$ will outperform this year. The Euro rose from its lows, but I believe there is a strong possibility that the ECB will cut interest rates next month.

I remain bearish on equity markets generally given the risks and believe that markets are likely to correct at which time, investors can consider their options.

US
The US small business confidence index, the NFIB, came in at 94.1, better than the previous reading of 93.9 and the 3rd consecutive monthly increase. Businesses expected higher sales and suggested that they would hire more staff, though believed that the economy would remain relatively weak.

The FED Chair, Mrs Yellen reiterated the FED’s dovish stance and pledged to continue with the previous policy. She stated that monetary accommodation would remain in place well after both the asset purchase programme had ended and the unemployment rate declined to 6.5% and that the FED would look at other data when evaluating the labour market, forward guidance and its overall monetary policy. She added that the recovery in the labour market was far from complete. Her remarks suggested that the FED’s tapering programme would continue and repeated that the FED was mandated to focus on the US, rather than other countries –  a response that EM’s would have to look after their own interests. Essentially, there were no real surprises in her remarks. However, her dovish comments helped US markets.

The US Congress voted to increase the US debt ceiling unconditionally until March next year. The Senate also approved the increase.

US weekly jobless claims  rose by 6k to 339k, higher than the 330k expected.

US retail sales declined by -0.4% in January, the most in 10 months and worse than the unchanged figure expected. December was revised lower to a decline of -0.1%, from a previously reported rise of +0.2%. November was also revised down. The bad weather could have impacted, but the number remains weak. The data suggests that Q4 GDP will have to be revised lower, to around +2.7%, from the +3.2% previously reported. In addition Q1 GDP is likely to come in around 2.0%, or even lower.

Import prices rose by +0.1%, as opposed to the decline of -0.1% expected. Y/Y, import prices declined by -1.5%, though less than the decline of -1.8% expected.

US industrial production was -0.3% lower in January, as opposed to the rise of +0.3% expected.  Manufacturing declined by -0.8%, as opposed to the rise of +0.1% expected and the downwardly revised increase of +0.3% the previous month.

US consumer sentiment rose to 81.2 in February, unchanged from January, though better than the decline to 80.2 expected. The expectations component rose to 73.0, from 71.2.

Europe
The EZ future inflation gauge declined to 91.7, in December from 92.0 the previous month. The data suggests that disinflationary pressures will persist in the EZ.

The EZ’s chief banking regulator Ms Nouy has suggested that banks would have to be closed down if they fail the stress tests and cannot raise the capital necessary. Ms Nouy added that the link between banks and the sovereigns, which has been the problem, must be severed. Tough talk – it’s likely that some EZ banks will indeed have to be wound up.

The French national auditor warned that France will miss its budget deficit  target of 4.1% for 2013 and that the 3.6% forecast for this year was “not at this point guaranteed”. Furthermore, the auditor warned that France risked losing its financial credibility. France had pledged that it would reduce its deficit to 3.0% in 2015, which has already been delayed by 2 years. Frances debt to GDP is set to exceed 95% this year.

German CPI declined by -0.6% in January, as opposed to the increase of +0.4% in December. The ECB has dismissed the idea of significant and persistent disinflation, but the numbers speak for themselves.

Political turmoil continues in Italy. The PM, Mr Letta has resigned. New elections are unlikely and Mr  Renzi, the head of Italy’s largest party is likely to take over as PM. His policies are essentially the same as that of Mr Letta’s. If Mr Renzi does take over, it will be Italy’s 3rd unelected government in just 2 years.

Some positive news for the EZ. The economic sentiment index, the Sentix index, rose to 13.3, from 11.9 in January. The economic expectations component rose to the highest level since February 2006.

The EZ Q4 GDP increased by +0.3% (+1.1% on an annualised basis), higher than the rise of +0.2% expected and as compared with the growth of +0.1% in Q3. German GDP rose by +0.4%, with French GDP up by +0.3%, both beating expectations. Indeed, there was a risk that France would post negative growth in Q4. France’s previous Q’s GDP was revised higher to unchanged from -0.1%. Italy posted a rise of +0.1%, the 1st positive growth since Q2 2011. The Italian economy contracted by -1.9% last year. Only Greece reported negative growth. Whilst not great, certainly better than expected growth from the major EZ countries.

Moody’s rated the outlook on Italy’s bond rating to stable from negative – a surprise I must say.

The British Retail Consortium reported that retail sales rose by a massive +3.9% Y/Y in January, well above the +0.8% expected and the small rise of just 0.4% in December. Sterling appreciated on the news.

The Governor of the Bank of England (BoE) reiterated that the BoE would keep interest rates unchanged and adjusted the forward guidance criteria. He added that the BoE would not raise rates until employment, incomes and spending were growing “at sustainable rates”. The previous guidance that rates would remain low until unemployment fell to 7.0% is likely to be met this Q, according to the BoE. Mr Carney accepted that a rate rise in H1 2015 was possible, clearly positive for Sterling.

Japan
The Japanese current account deficit increased to a record Yen 639bn (US$6.3bn) in December, higher than Novembers Yen 592.8bn, though was less than the deficit of Yen 685 bn forecast. The weaker Yen has not really translated into higher export volumes and, furthermore, companies have not increased prices. However, imports, in particular energy costs, have risen materially. Whilst the recent trend has been for Japan to report current a/c deficits, Japan posted a current account surplus of Yen 3.3 tr for 2013, mainly due to surpluses earlier in the year, though the 2013 surplus was the lowest on record. I would expect that this year, Japan will post a current a/c deficit.

Core machinery orders collapsed by -15.7% in December, much worse than the decline of -4.0% expected, with growth at just +6.7% Y/Y. It was the worst decline since 1998. Companies are cautious ahead of the sales tax rise in April. This kind of data just reconfirms my view that Abenomics  and the BoJ’s policy will not work.

Japanese wholesale prices rose by +2.4% Y/Y, mainly to to higher import prices as the Yen has weakened.

The Japanese stock market has been the worst developed economy market this year. However, the decline in the stock markets has resulted in a rally in bonds with the 10 year yielding just 0.59%, well below prevailing inflation. I just wonder how much longer the bond market can yield these very low levels, though 3 year future inflation swap rates do indicate that inflation will decline to around 0.4% from February 2016, according to Bloomberg.

China
China reported a current a/c surplus of US$188.6bn and US$242.7 increase in its capital a/c. The numbers should be treated with a great deal of caution.

The Chinese Central Bank warned that volatility in money market rates will continue and that interest rates will rise. The PBoC has been trying to curb excessive credit growth and it is clear that the PBoC intends to tighten monetary policy. The PBoC also warned of the risks relating to local government finances. The reduction in financing, whilst necessary, will negatively impact economic growth.

Chinese January official data rose by 10.6% in January, well above the unchanged level expected. Imports rose by +10.0%, with the trade surplus coming in at US$31.9bn. Once again, I would treat these numbers particularly cautiously, as the data is impacted by capital inflows which are recorded as exports. Indeed, data from neighbouring countries do not tie up with the Chinese trade data.

China’s inflation (CPI) came in at +2.5% Y/Y, the same as December. However the producer prices continued to decline with prices down by -1.6% Y/Y, worse than the decline of -1.4% in December and the 23rd consecutive monthly decline, extending the longest series of declines since the 1990’s. Forecast GDP growth of +7.5% this year looks impossible, even if you believe the official data.

There are possible further problems relating to the so called wealth management products to the coal sector. This issue is going to be a major problem for the Chinese authorities and one which is extremely large in size. The amount invested in wealth management products is estimated  at US$ 1.7tr in total, around 1/3rd of which is due for repayment this year, according to the FT.

Other
The Australian unemployment rate rose to 6.0% in January, up from 5.8% in December, a decade high. With further job cuts likely, the unemployment rate is expected to increase. The Central Bank has suggested that rates would be on hold, though with a slowing China and rising unemployment, it seems that they may well have to think again – however, inflation has been rising as the A$ has weakened.