Overview
Developed markets have regained most of their recent losses, with US markets around their record highs. However, I remain cautious, indeed bearish. The weaker Chinese, Japanese and emerging markets economies, together with an anemic EZ, suggests to me that risks are rising. Yes, the US is improving, but by not as much as necessary to take up the slack. In addition, markets look overbought. Funds continue to be withdrawn from emerging markets, though admittedly are being invested in developed markets. However, trading volumes are light. The FED looks intent on continuing with its tapering programme which is negative for emerging markets, across all asset classes. There seems little upside given current valuations, though the downside risks for equities are rising in my humble opinion.
US
The US Empire State index fell to 4.48 in February, sharply down from 12.51 in January and also below estimates of around 8.50. The new orders, shipments and inventories components were materially lower, though employment was stable. The bad weather must have had an impact, though the data was still very weak.
The NAHB’s US homebuilder index declined markedly to 46, from 56 in January. It was the largest decline since the index was started in 2006.
The FED has introduced regulations on the amount of capital that foreign banks with US assets of over US$50bn must have following a stress test. Some of the more onerous requirements are still being worked on, including the maximum that can be lent to 1 US business and the need to have additional capital buffers. The new rules, which come into effect in July 2016 (1 year later than previously proposed) will require foreign banks to increase the capital of their US businesses by several billions of US$’s. The rules effectively require the relevant foreign banks to be subject to the same rules as US banks. Banks will have 2 years to comply with the new regulations. The relevant banks, include large European banks such as Deutsche, which will need to increase its capital by an estimated US$2bn. In addition, Deutsche may have to shrink the total amount of assets on its US balance sheet, though Bloomberg states that this could be done by separating its Latin American assets. Barclays could have a much higher capital requirement.
The New York FED announced that household debt increased by US$241bn in Q4 to US$11.52 tr. It is the highest amount of household debt outstanding since Q3 2007. The main reason for the increase was due to mortgage debt.
US PPI, calculated on a new basis, rose by +0.2% in January, higher than the rise of +0.1% expected and the +0.1% in December. Core PPI rose by +0.2%.
US housing starts declined by 16% to an annualised rate of 888k, well below the rate of 950k expected and the revised rate of 1.05mn in December. It was the largest decline on record. However, building permits declined by just 5.0%, suggesting that the extreme cold weather played a major part in the decline.
Existing home sales declined by -5.1% to an annualised rate of 4.62mn in January. It will take a few months for weather related problems to not affect the numbers and get a better picture of the US housing market.
The FED minutes warned of turbulence in emerging markets and the risk of deflation in the EZ, both of which they believe could threaten the global economy. It is also clear that FED members are struggling with their forward guidance language. The minutes also suggested that the FED’s tapering programme would continue.
US weekly jobless claims fell to 336k, roughly in line with the 335k expected and below the 3339k the previous week. The less volatile 4 week moving average came in at 338.5k, as opposed to 336.75k the previous week.
January CPI came in at +0.1% M/M, in line with expectations and below the downwardly revised rise of +0.2% in the previous month. Y/Y, CPI came in at +1.6%, in line with expectations.
The Leading economic Index rose by +0.3% in January, better than the revised unchanged level in December.
However, disappointingly, the Philly FED index slipped to -6.3 from +9.4 in January, though the employment component came in lower but still positive. It was the 1st negative reading for 9 months.
It will take a few months to assess these numbers, once the weather effect has been excluded.
Europe
As expected, the Italian President has asked Mr Renzi to form a government. It will be Italy’s 4th government in 2 years. Mr Renzi will try and agree a deal with Mr Alfano’s centre right party, in particular, together with other smaller parties. There is speculation that the deals that Mr Renzi will have to do to form a coalition will result in Italy breaching its 3.0% budget deficit target. However, Italian bond yields declined to the lowest levels in 8 years on the news with the 10 year yielding around 3.61%, though yields have started to rise subsequently. Mr Renzi will have a lot on his plate to cope with and as his policies seem not very different from Mr Letta’s, the outlook has not changed in my humble opinion.
German investor confidence (the ZEW index) fell to 55.7, from 61.7 in January and well below the reading of 61.5 expected.
The EZ ZEW index declined to 68.5, lower than the reading of 73.9 expected.
The EZ manufacturing PMI declined to 53, from 54 previously and the forecast for an unchanged reading. The services sector rose to 51.7 from 51.6 previously, but below the rise to 51.9 expected. The composite index fell to 52.7, from 52.9 previously. The German manufacturing PMI fell to 54.7, from 56.5, though the services PMI rose to 55.4, from 53.1. The French data was bad, with both manufacturing and services lower, with services at 46.9, a 9 month low.
Disinflationary forces persist in the EZ. French inflation came in at +0.8% Y/Y in January, with core inflation just +0.1% higher Y/Y. German producer prices declined by -1.1% Y/Y. In addition, output prices declined for the 23rd consecutive month, though just marginally.
Better news from Spain. Exports rose by +2.9% in December, making a total of E234bn for 2013, with the trade deficit declining to E16bn. The Economy Minister has suggested that exports will increase by 7.0% this year.
UK inflation (CPI) declined unexpectedly to 1.9% in January lower than December’s 2.0% and below the unchanged level forecast. The stronger Sterling should reduce inflation further in coming months. CPI was below the BoE’s target of 2.0% for the 1st time since November 2009. Furthermore, the BoE has stated that it believes there is more unutilised capacity than thought previously.
UK unemployment edged up to 7.2% in the 3 months to December, higher than the previous rate of 7.1% and the unchanged forecast expected. However, the number unemployed declined by more than expected and it is anticipated that the unemployment rate will decline below 7.0% in Q1 of this year.
UK retail sales declined by -1.5% in January M/M, the largest decline since April 2012 and worse than the -1.0% decline expected. The data is surprising, given the +2.5% rise in sales in December.
Surprisingly, taxes raised by the UK government fell below expectations, with the surplus after outlays coming in at Sterling 6.42bn, as opposed to Sterling 9.0bn expected.
Japan
The Japanese economy grew by just 1.0% on an annualised basis in Q4 (+0.3% Q/Q), well below the forecast of +2.8%. The widening trade deficits as Japan imports energy following the closure of its nuclear reactors, combined with limited growth in exports, contributed to the weakness, though domestic consumption was also lackluster. It was thought that the weaker Yen would spur exports, but it does not seem to be the case. Business investment rose by +1.3% Q/Q and consumer spending up by +0.5%. Exports increased by just +0.4%, whilst imports rose by +3.5%. Furthermore, the sales tax hike in April is likely to force consumers to buy in Q1, with Q2 GDP likely to come in with a negative figure. In addition, Japanese companies are unlikely to award inflation matching pay increases, which suggests that consumption will decline this year. Basic wages declined for the 19th consecutive month in December. Not a pretty picture. In addition, the trend seems to be for Japanese companies to hire temporary workers, whose compensation package is well (over 50%) below that of full time workers. The weak GDP growth suggests that the BoJ may have to do more, which will be Yen negative.
The BoJ left its asset purchase programme unchanged (though did say that asset purchases would range between Yen 6tr to Yen 8tr, rather than the Yen 7 trn previously), but doubled its 2 special lending facilities, which they say could amount to Yen 30 tr. These programmes were set to expire next month. The move helped equity markets rise above 3.0% and the Yen weakened. There is continued speculation that the BoJ will increase its stimulus programme later this year. However, the money multiplier fell in January to the lowest level since 2003, which suggests that the BoJ’s policy is not working.
The Japanese January trade deficit soared to Yen 2.79 tr, above the Yen 2.49 tr expected and the deficit of Yen 1.3 tr in December. Imports rose by a massive 25% (+8.0% in volume terms), with exports up +9.5%, though by volume, exports declined by -0.2%. Export growth declined for the 3rd consecutive month. Import and export prices were up +15.7% Y/Y and 9.7% Y/Y respectively. The widening trade deficit will decrease GDP.
China
Aggregate financing rose to a record Yuan 2.58 tr in January (US$425bn), much higher than the forecast of Yuan 1.9bn and an increase of 23% Y/Y. New lending came in at Yuan 1.32 tr, the highest since 2010 and above the forecast of Yuan 1.1 tr. The increase in lending will be a blow to the Chinese Central Bank which has been trying to curb lending. However, there was a dramatic reduction in sales of wealth management products, given the recent problems affecting such products.
In reaction to the increase in credit, the PBoC drained Yuan 48bn (US$7.9bn) from the money markets early in the week, the 1st time it has used repos to reduce liquidity. Such operations are likely to continue, which indeed was the case later in the week, when a 2nd repo operation drained US$9.9bn from the markets, as rates charged by banks to eachother declined to the lowest level in 10 months. It is clear that the PBoC wants to tighten monetary conditions, including raising interest rates.
The PBoC announced that it intends to widen the Yuan trading range by more than the current +/- 1.0% of the daily fixing in “an orderly manner”. However, it also appears that the PBoC wants to reduce the Yuan’s value – the Yuan declined to its lowest level in 2 months mid last week and continued to do so through the week. The offshore Yuan declined by the most since September 2011 last week. The PBoC is also experimenting with Yuan convertibility. It will be interesting to see whether the official data shows that imports increase in coming months data, as capital outflows are disguised as imports – in the past capital inflows were disguised as exports, but with the weaker Yuan that could well reverse.
The preliminary reading of the HSBC February PMI index came in at 48.3, a 7 month low and lower than the 49.5 in January and forecasts of 49.5. The output, new orders, exports and employment components all declined. The employment component fell for the 4th consecutive month to the weakest in 5 years. The data indicates that the manufacturing sector is contracting, with the reading below the neutral 50 level. The data also suggests that the previous trade numbers was inflated – no great surprise.
Other
Informed sources suggest that a comprehensive deal with Iran on its nuclear programme may not be achievable by the July deadline. Iran is refusing to dismantle its centrifuges, which are used to enrich uranium to a weapons grade level.
Capital expenditure in Russia declined by a massive -7.0% in January Y/Y, inspite of spending on the winter olympics. A gain of +0.5% was expected. It was the worst fall since February 2010. The main reason for the decline appears to be weaker domestic demand.
Kiron Sarkar
24th February 2014
