The ECB has kept the Eurozone (EZ) afloat to date. However, I can’t help feeling that it is running out of options. A QE programme, involving the purchase of EZ sovereign debt, remains unlikely primarily due to German opposition. The ABS/covered bond purchase programme, combined with the TLTRO’s will help, but will not be enough to stimulate the EZ economy, which is showing clear signs of slowing and is now impacting even Germany. Indeed, the likelihood that Germany was in recession in Q3 is rising, given the string of particularly weak August economic data.
The German government is to reduce its 2014/15 growth forecasts next week. With inflation, in particular core inflation, looking as if it will decline even further, the risks of deflation in the EZ are rising. Downside risks have risen materially, which suggests that the Euro has further to fall, despite the more dovish than expected FED minutes and its reference to a stronger US$ hurting the US economy. I continue to believe that the Euro is heading for US$1.20 this Q. Commodity currencies, such as the A$ and the
CAD, should also weaken further, given the slowing global economy.
Peripheral EZ bond yields have fallen, with the Spanish and Italian 10 year yielding 2.07% and 2.32% respectively. The ECB is unlikely to implement a QE programme and with the slowdown in the region, combined with the deteriorating fiscal position in both countries, yields at these low levels look far too low. I would expect that yields will rise in coming months.
The US Q3 earnings season is upon us. Generally, companies are expected to report positive results, though I would not be surprised if they refer to the negative impact of the stronger US$. However, the US remains the safer play and is likely to remain so for quite a while.
The continued weakness in global economic data looks set to continue. Furthermore, the FED is to cease its QE programme this month, though proceeds from maturing securities will continue to be reinvested. With reduced liquidity and greater uncertainty, I remain highly cautious of equity markets. The EZ, Japan and China look particularly problematical. Emerging markets are also vulnerable, as liquidity declines and the US$ rises.
US
The FED minutes suggested that members were concerned that US growth could be weaker than expected due to the stronger US$ and the weakness of the global economy. The minutes also revealed that members wanted the FED to emphasize tha?t the timing of an increase in interest rates was data dependent, rather than some form of time related commitment. A “couple” of members also expressed concerns that the stronger US$ would reduce inflation, whilst “several” members worried that inflation might persist below the “committees target” for “quite a while”. Overall, the minutes were particularly dovish, with a suggestion that the FED would not increase interest rates as soon as was thought previously.
The August job openings and labour turnover survey (JOLTS) reports that there were 4.84mn job vacancies, higher than the 4.7mn expected and the 4.61mn in July. Vacancies are now at their highest level since January 2001.Weekly jobless claims came in at 287k, below the forecast of 295k and last weeks 288k. The less volatile 4 week moving average declined to 287.75k, the lowest since February 2006. A pretty decent number.
The stronger US$ has reduced import prices for the 3rd consecutive month. They were down -0.5% M/M (-0.7% expected) in September and -0.9% lower Y/Y. Lower petroleum prices was the main reason for the decline.
EU
German August factory orders slumped by -5.7% M/M (-1.3% Y/Y, as opposed to an increase of +2.6% expected), much worse than the decline of -2.5% expected and the upwardly revised +4.9% in July. It was the largest decline since 2009. Export orders fell by -8.4% M/M, whilst domestic orders were down -2.0%. Investment goods orders fell by -8.5%, with basic goods down by -3.0%, though orders for consumer goods were up by +3.7%.
German industrial production collapsed by -4.0% in August M/M (-2.8% Y/Y, as opposed to -0.5% expected), much greater than the decline of -1.5% expected and the gain of +1.6% in July. It was the largest fall since January 2009. Output of investment goods declined by -8.8% M/M, with intermediate goods falling by -1.9%.
German exports declined by -5.8% in August, the most since January 2009 and well below the -4.0% decline expected and the increase of +4.8% in July. Whilst the summer holidays could have impacted, it does suggest that the German economy is slowing. Imports declined for the 2nd consecutive month. They were down by -1.3%, having fallen by -1.4% in July and well below the increase of +0.9% expected.
The steep decline in factory orders, industrial production and exports is yet more evidence of a sharp slowdown within the German manufacturing/export sectors, as the EZ economy deteriorates, global growth weakens (the slowdown in China is also particularly important for Germany) and geopolitical problems increase (Ukraine), though domestic consumption is holding up at present. The particularly weak data also increases the risk that Germany was in recession last Q, having declined by -0.2% in Q2.
Mrs Merkel is considering options to stimulate growth, including lowering the mandatory pension contribution by -0.6%, according to Mr Michael Fuchs, the deputy leader of Mrs Merkel’s CDU party. The measure, if implemented, would inject around E6bn into the German economy.
The EZ October investor confidence index, the Sentix index, declined for the 3rd consecutive month to -13.7, well below the -11.0 expected and the reading of -9.8 in September. It was the lowest reading since May 2013.
The ECB will release the results of its asset quality review and stress tests carried out on the largest banks in the region (130 in total) on 26th October. Some banks are expected to fail and will have to submit plans within 2 weeks to explain how they will raise the capital necessary (within 6 months) to meet the relevant criteria.
UK industrial production was unchanged in August M/M (+2.5% Y/Y), in line with estimates. Manufacturing production rose by +0.1% M/M (+3.9% Y/Y), also in line with forecasts.
The UK’s Chamber of Commerce warned that companies have reported the weakest export growth in 2 years, with a material slowdown in manufacturing. The UK economy is slowing, mainly due to the weakening EZ economy, though GDP growth should come in at around +0.7% last Q.
As expected the BoE left interest rates unchanged. The minutes are to be published on 22nd October. Other than Mr Weale and Mr McCafferty, it is unlikely that any more members of the 7 person committee voted to hike rates.
Japan
As expected, the BoJ kept the size of its stimulus programme unchanged, though stated that they were prepared to do more if necessary. Furthermore, the governor, Mr Kuroda, did not object to the Yen’s weakness and stated that inflation (ex the impact of the sales tax hike) would be around +1.25% for some time.
Importantly, the BoJ did reduce its assessment on industrial production, which suggests that it will cut its growth forecasts this month. Furthermore, a majority of board members want the BoJ to abandon its 2 year timeframe to reach their 2.0% inflation target, which ends in April 2015. With inflation, ex the impact of the April sales tax hike, at just +1.1% Y/Y in August and slowing, I believe that the BoJ will have to increase the size of its monetary accommodation policy, leading to a weaker Yen.
The August trade deficit widened to Yen 831.8bn, above forecasts of Yen 770.7 bn. Furthermore, the seasonally adjusted August current account surplus came in at Yen 130.8bn, as opposed to Yen 186.8bn expected.
Japanese investors are selling German, French and Italian bonds and investing in US, UK, Australian and Canadian bonds. Seems a far more sensible policy.
China
Chinese authorities announced plans which will allow its citizens to invest in foreign stocks and property, as well as allow companies to sell Yuan-denominated shares abroad.
The Chinese Academy of Social Sciences, the main government supported research organisation, forecast that GDP for 2014/15 would come in at +7.3% this year and just 7.0% next. They added that the governments 2014 forecast of +7.5% would be “hard to meet”. In reality, actual Chinese GDP is very likely to be significantly below these numbers. (Source Bloomberg).
Other
Global banks will have to hold more capital and liabilities which can be used to absorb losses in a financial crisis, according to a draft document prepared by the Financial Stability Board (FSB). Furthermore, the ability to double count capital, which banks use to meet existing rules, will be limited. The draft rules suggest that the capital that banks will be required to hold will exceed the basic requirement of between 16% to 20% of risk weighted assets and may well rise to between 21% to 25%. The new rules are expected to become effective next year.
The IMF reduced its 2014/15 global growth forecasts marginally to +3.3% and +3.8% respectively, down from their previous forecasts of +3.4% and 4.0% respectively. They add that there is an increased risk of a correction in financial markets. In addition, they believe that the risk of the EZ falling into deflation (30%) and heading into recession (40%) are the major issues facing the world economy. EZ 2014/15 GDP was cut to +0.8% and +1.3% respectively, down from +1.1% and +1.5% previously. Furthermore, they have cut their forecasts for Japanese 2014/15 GDP growth to +0.9% and +0.8% respectively, down from +1.6% and +1.1% previously. US 2014 growth has been revised higher to +2.2%, from +1.7% previously and to +3.1%, from +3.0% for 2015.
The governor of the Australian Central Bank, the RBA, stated that whilst the A$ had declined (down around 7.0% against the US$ in the last month), it “remained high by historical standards, particularly given the further declines in key commodity prices in recent months”. As usual, the RBA is trying to talk down the currency. The RBA kept interest rates unchanged at 2.5%. Analysts believe that the RBA will hike interest rates next year, though I believe that the RBA will clearly try and avoid such a move. However, the key remains property prices, which continue to rise and which is a major concern for the RBA. The RBA recently suggested that they were discussing options with regulators to introduce measures to slow down property price rises. I continue to believe that the A$ will decline further and to below US$ 0.85 this Q.
Russian inflation rose to +8.0% Y/Y (+0.7% M/M) in September, above the +7.6% rate in August and the highest in 3 years. Furthermore, inflation is expected to rise further, which will increase pressure on the Central Bank to raise rates yet again, despite having increased interest rates from 5.5% in February to 8.0% this year. The Rouble was one of the worst performing currencies in Q3, having declined by -14% against the US$, which has contributed to the increase of inflation. Bloomberg reports that the Russian Central Bank spent just over US$3bn this month to try and stem the Rouble’s decline. It has also widened the Rouble’s trading band. Russia’s forex reserves fell to a 4 year low of US$456.8bn last week, the 6th consecutive weekly decline. Servicing and repaying US$ debts will increasingly become a major problem for Russian corporates.
The incumbent Ms Dilma Rousseff won the most number of votes, but failed to achieve the majority needed to be re elected President in the 1st round of the Brazilian elections. Surprisingly, she now faces the more business friendly Mr Aecio Neves in the 2nd round on 26th October, rather than Ms Marina Silva, who was thought to be her main competitor. Ms Rousseff and Mr Neves are tied is the most recent polls.
Oil prices continue to decline with November Brent around US$90 and in a bear market having fallen to the lowest level in over 2 years. Both Saudi Arabia and now Iran have discounted their prices by the most in 6 years. Furthermore, Saudi Arabia announced that it had increased production in September !!!. With supply rising and demand weak, as a result of the global economic slowdown, prices look as if they will remain under pressure. However, at around US$80/85, US shale oil becomes uneconomic, which could suggest a floor for prices around those levels.
Kiron Sarkar
11th October 2014
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