Overview
The (unintended, I believe) remark by Mrs Yellen that the FED could raise interest rates 6 months following the end of the tapering programme has had ripple effects worldwide. US bond yields (the 10 year is yielding 2.78%) and the US$ have appreciated, with the Yen and the Euro lower. The weaker Euro (around US$1.38) has certainly come as a relief to the ECB, who had been trying (unsuccessfully) to talk the currency down, though at some stage the ECB will have to act I suspect. Markets also sold off, with emerging markets faring the worst, though the Nikkei closed -1.6% lower on Thursday. However, with low inflation in the US and no signs that it will rise materially in coming months, the market response to a possible earlier rise in rates by the FED looks premature. Generally, the most recent data suggests that the US is doing better than currently thought, which should support US markets, though risks internationally are rising.
My real concerns remain with China and Japan and most emerging markets generally. Investors are reducing their investment in China by record amounts, together with emerging markets in general, a trend which I believe will continue. The Chinese authorities did indeed announce plans for a fixed asset programme and are likely to ease lending restrictions in an effort to stimulate growth. However, the speed of their response I suspect reflects their heightened concern about the Chinese economy. Chinese markets did rise on Friday on the news, though I believe that such rallies will be relatively short lived. I have been bearish on China for many years now, but recent data/news has taken a decided turn for the worse. Analysts have reduced their 2014 GDP growth forecasts to around 7.0%, though I believe that the Chinese economy will be hard pressed to achieve these forecasts.
Based on recent comments and economic data, it looks as if Abenomics and the BoJ’s policy has not delivered as expected. Q2 GDP is likely to come in materially negative. I believe that the Yuan and the Yen will decline, which could result in both countries exporting deflation.
Whilst there are some signs that the economies of the EZ have stabilised, growth is at very low levels. The increasing sanctions on Russia have the ability to hurt clearly Russia, but countries such as Germany as well. Furthermore, there is also the possibility of political turmoil as local and EU elections are due over the coming months, with more nationalist parties gaining support – French municipal elections are coming up.
I remain cautious of equity markets. The risks, especially from major economies such as China and Japan are rising. As a result, I continue to believe that it is better to sit back and wait.
US
Mrs Yellen’s 1st Press conference as Chair of the FED has caused a stir in markets. Whilst most analysts expected that the FED would reduce its tapering programme by a further US$10bn and move away from a numerical unemployment rate before the FED would consider increasing interest rates, she did suggest that interest rates could possibly be increased as early as 6 months after the end of the tapering programme. That statement came as a total surprise to markets, which had assumed that rates would remain on hold for 12 to 18 months after the tapering programme had ended. Assuming the tapering programme continues at US$10bn per month (very likely, based on the current situation), it should end in October this year. A rate rise 6 months thereafter would be in Q2 2015, whereas the market was assuming an increase in interest rates would not be until late Q3 2015 or even Q4 2015. US bond yields rose materially, the US$ rallied and markets sold off. I would not be surprised if the FED “clarifies” these comments, as I believe that Mrs Yellen’s comments were unintended.
Industrial production rose by +0.6% in February, mainly due to a pickup of the auto sector. The increase was well above estimates of +0.2%. Factory production rose by +0.8%, the largest rise since August.
Inflation remains contained. Consumer prices rose by just +1.1% Y/Y in February. Core prices rose by +1.6% Y/Y.
US housing starts came in at an annualised pace of 907k, roughly the same as the upwardly revised rate of 909k in January. More importantly, building permits rose by +7.7%, which suggests an improvement in coming months. However, existing home sales declined by -0.4% to an annual rate of 4.60mn homes in February, the lowest level since mid 2012, though in line with expectations. Weather could well have impacted. Prices were +9.1% higher Y/Y
The US current a/c deficit declined by more than forecast to US$81.1bn in Q4 2013. It was the smallest deficit since 1999 and mainly due to an increase of more than US$5bn in income earned from overseas.
US weekly jobless claims came in 320K, slightly higher than last weeks 315k, though better than the forecast of 322k. The less volatile 4 week moving average declined to 327k, down from 330.5k. The data is yet more confirmation that the US economy is improving.
The Philly Fed index came in at 9.0 M/M, well above the 3.2 expected and the -6.3 in February. Whilst employment and prices paid came in lower than expected, importantly the new orders component rose materially. In addition, capex plans rose to near pre recession highs, as firms indicated that they expected to replace equipment and, in addition, forecast increased sales.
The US leading economic index came in at +0.5% in February, higher than the +0.2% expected.
Following a stress test, the FED reported that 29 out of 30 banks had enough capital to cope with an economic downturn, with core capital exceeding 5.0% under the stress test assumptions. However, there is a threat that some banks could be restricted from paying dividends.
Europe
As expected, the Crimea voted overwhelmingly to join Russia. Mr Putin has supported the request and has signed the relevant legislation which annexes the Crimea. The EU agreed to freeze assets and impose visa restrictions on a number of Russians and Ukrainians. The US has ratcheted up the pressure adding further sanctions, in particular on Mr Putin’s inner circle, together with Bank Rossiya, which is believed to act as the personal bank for a number of senior Russian officials. Further sanctions are quite possible, with lawyers warning that European and US companies should protect themselves from the effects of possible additional sanctions. Russia responded, by imposing restrictions on a number of US individuals. The Russian economy is in trouble, with the Deputy Economy Minister stating that there were “clear signs of a crisis”. It is likely that the economy will be in recession later this year. Further sanctions on Russia will just aggravate the situation. Fitch followed S&P and downgraded its credit outlook on Russia to negative from stable. The Russian market closed sharply lower on Friday.
The forward looking German investor confidence index, the ZEW, declined to 46.6, from 55.7 in February and well below the forecast of 52.0. Investors are concerned about the situation in the Ukraine, together with the slowdown of the Chinese economy, the low level of growth in the EZ and the strong Euro. It was the 3rd monthly decline. German exports to a number of emerging markets remains a real threat.
The EZ agreed on legislation to create a single agency to deal with problem banks. Once the legislation has been approved by the EU Parliament, it will establish a EZ wide Single Resolution System, together with a E55bn fund to be paid for by banks over a period of time. The E55bn fund will be able to be fully accessed by any EZ country earlier than had previously been the case (down to 8 years from 10 previously) and, in addition, the ability of a country’s finance minister interfering in the process has been curbed somewhat. However, the bottom line is that the complexity of the proposed system could well delay the ability to close down and subsequently reopen banks quickly and until the fund can be accessed fully by any EZ country, the onus remains on the individual country. Whilst better than previous proposals, the current agreement still poses significant risks.
UK unemployment declined by 34.6k in February, better than the decline of 25k expected. The unemployment rate remained unchanged at 7.2%. Average earnings increased by +1.4% in January – there are some indications that earnings are picking up.
The UK budget was announced on Wednesday. The 2014 growth forecast was revised higher to 2.7%, from 2.4%, in line with expectations. The higher growth rate will reduce the budget deficit, which is forecast to decline to 6.6% in 2014/15, from 6.8% previously. Budget deficits in subsequent years are also forecast to be lower. Employment is forecast to increase.
Japan
The Japanese February trade deficit narrowed to Yen 800.3bn (US$8.0bn), from January’s record of Yen 2.29 trn. However, the deficit came in higher than estimates of Yen 600bn. Imports rose by +9.0%, with exports up by a lower than expected +9.8% Y/Y. The volume of exports were up +5.4%, with export prices just +3.1%, inspite of the much weaker Yen. Over the next few months, export data is likely to deteriorate due to the impact of base effects. However, imports may well decline in coming months as the sales tax hike kicks in.
The ex deputy governor of the BoJ suggested that the Central Bank will ease policy further in the next few months. He added that further fiscal stimulus was likely. At present, the BoJ buys the equivalent of around 40% of bonds issued by the government. There have been calls to increase that percentage !!!!!
China
The Chinese Central Bank (PBoC) doubled the daily limit on the Yuan’s moves against the US$. The Yuan will now be allowed to trade up to +/- 2.0% of the daily rate fixed by the PBoC. The Central Bank argues that the move is to make the Yuan’s exchange rate more market based. Whilst that may well be the case, I believe the PBoC is trying to depreciate the currency, given the problems facing the Chinese economy and its exporters. The Yuan declined to a near 1 year low following the announcement.
The Chinese authorities announced that they would spend Yuan 1tr (US$160bn) on redeveloping shantytowns. In addition, they intend to build more transport links and ease some residence registration rules. Furthermore, local governments will be entitled to to issue bonds to help pay for further urbanisation. I suspect the spending is more to help the Chinese economy, which has been slowing at a fast pace. In addition, property prices are slowing rapidly – yet another sign of the weaker economy. A property developer has defaulted. Later in the week, the Chinese authorities confirmed that they would “accelerate preliminary work and construction on key investment projects”. In addition, the authorities have announced a trial programme for companies to sell preferred shares, which is thought to help banks meet stricter capital requirements. Whilst these measures will help in the short term, I do not believe that they will be sufficient.
The Yuan declined to 6.20 against the US$ on Wednesday, a level which if breached could result in material losses on derivative products taken out by Chinese companies in anticipation of a stronger Yuan – estimated at US$3.5bn by Morgan Stanley. The Yuan continued to decline on Thursday, following Mrs Yellen’s comments referred to above. At one point it reached over 6.23 to the US$, the weakest for over 1 year. Chinese markets (the CSI 300) declined to their lowest level in 5 years on Thursday but recovered sharply on Friday on speculation that the government will loosen credit restrictions for property developers and banks.
Kiron Sarkar
21st March 2014
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