Overview
The speech by Premier Li at the NPC was highly important. Initially, the incoming regime wanted to introduce much needed economic, structural and financial reforms. However, such reforms will and has slowed growth, with the potential to create social unrest as unemployment rises. This has clearly worried the leadership, who seem to be reversing their initial plans.
I have been bearish on the base metal miners and the A$ on the basis of weaker Chinese growth. However, based on Premier Li’s speech to the NPC, it looks as if China will revert back to its fixed asset spending programme to try and maintain growth, which clearly has been declining, even based on officially sourced data. If that is the case and I suspect it is, the A$ and the miners should benefit, even though the miners did sell off on Friday. Furthermore, the governor of the Australian Central Bank stated that he saw no need to reduce rates further – clearly A$ positive. In addition, the Australian mining sector has cut back on capex, which will result in a stronger bottom line if Chinese demand increases. In terms of China however, additional spending on fixed assets will just add to its problems. The Yuan could also decline, though it has come off its lows over the last few days. Accumulated debt, already extremely high, will increase. Overall, Chinese risk will increase.
As expected, the ECB did not announce any changes, inspite of forecasting that inflation would be below the ECB’s target of 2.0% through to the end of 2016. Overall, Mr Draghi was not as dovish as I had expected and no unconventional measures were announced. Not surprisingly, the Euro strengthened as a result, which I would have thought is not what the EZ needs. Indeed, the Euro continued to strengthen into Friday, reaching its highest level against the US$ in over 2 years, though pulled back from its highs.
I had assumed that the problems facing emerging markets would have impacted developed markets. However, apart from an initial decline, developed markets have been unaffected, in particular US markets, which are trading around record highs. Over recent weeks, funds have flowed out of emerging markets and into developed markets. Economic data from the EZ has improved modestly. Italian and Spanish bond yields have declined materially. I remain concerned about China and Japan. However, it looks as if China will increase fixed asset investment to stimulate growth. Whilst this potential change of policy adds to risk, the result could be stimulative in the shorter term.
The main argument for equities seems to be that there is no other alternative. Whilst equity valuations are not cheap, market momentum suggests that the correction I expected is unlikely at present. In the coming month(s), US data should be free from weather related problems. At that stage, the state of the US economy will become clearer, which will impact markets. The US economic data is mixed, but on balance, it appears that the US economy continues to improve. The important February non farm payrolls report came in better than expected, inspite of adverse weather conditions. The 10 year bond yield rose to 2.79% in response. The tapering programme is set to continue.
US
The FT reports that margin debt (used to buy securities) has increased to a record US$451bn in January, as compared with the 2007 peak of US$381bn. Margin debt has risen by 20% in the past year. Higher margin debt is normally seen as a contrarian indicator.
The February ISM manufacturing index came in at a higher than expected 53.2, above the 52.0 expected and the reading of 51.3 in January. Importantly, the new orders component rose to 54.5, from 51.2 in January. The data suggests an improvement in coming months.
On the other hand, the ISM non-manufacturing index fell to 51.6, well below January’s 54.0 and the estimate of 53.5. The employment component declined sharply to 47.5, from 56.4 in January. Whilst just 1 month figures, the sharp decline suggests that it could not only be put down to weather.
US consumer spending rose by a stronger than expected +0.4% in January, much better than the downwardly gain of +0.1% in December. The core PCE deflator, the FED’s preferred gauge of inflation, declined to +1.1%, from +1.2% previously and well below the FED’s 2.0% target. Real consumer spending rose by +0.3%, mainly due to increased spending on services (up +0.8%). Spending on goods came in -0.6% lower.
Personal incomes rose by +0.3% in January.
President Obama revealed his US$3.9 tr budget. His proposals included additional expenditure on education and social welfare, to be funded by a reduction of tax breaks on the wealthier citizens. Furthermore, he proposes to increase the tax take from US multinationals.
The January trade deficit came in at US$39.1, virtually the same as December’s US$39.0bn – estimate US$38.5bn. Exports and imports both rose by +0.6%.
ADP reported that the US had increased payrolls by 139k in February, below the estimate of 155k.
Weekly jobless claims declined to 323k, lower than the forecast of 336k and the upwardly revised 349k the previous week. The less volatile 4 week moving average declined to 336.5k, from 338.5k.
The important non farm payrolls report stated that 175k jobs were created in February, above the estimate of 149k and also higher than the upwardly revised 129k jobs in January. Indeed, December and January payrolls were revised higher by 25k. The unemployment rate rose to 6.7%, up from 6.6%, as more people entered the workforce. The participation rate held at 63.0%. Average hourly earnings rose by +0.4% M/M, the most since June 2013.
Europe
As generally expected, the ECB kept interest rates unchanged. GDP forecasts were tweaked higher, though inflation was forecast to be below 2.0% through 2016 – the forecast is for inflation to rise from +0.8% at present to +1.7% in Q4 2016. 2014 inflation is forecast to be +1.0%. Mr Draghi stated that the ECB did not see the threat of deflation. There was very little else new in his statement, apart from comments about unutilised capacity, though he gave the impression that the ECB is unlikely to act anytime soon. There were expectations that the ECB would announce some unconventional measures.
The EZ final February PMI reading came in at 53.2, slightly below the 54.0 in January, though above the flash reading of 53.0. Spain and surprisingly France’s readings were revised higher, though France was still in contraction territory. Italian PMI was edged lower though still positive.
The final EZ services PMI index rose to 52.6, a 32 month high and well above the initial reading of 51.7. Germany was revised higher, with its index rising to 55.9, from 53.1 in January and the initial estimate of 55.4. Even the French index declined by less than the initial estimate. However, the most surprising was the Italian services PMI, which rose to 52.9, up from 49.4 in January and the forecast of 49.8. Spain came in lower than expected, though at 53.7 remains in expansion territory. The composite index (services and manufacturing) increased to 53.3, the highest since mid 2011. Recent data from the EZ has come in better than expected.
EZ retail sales rose by +1.6% in January, well above both the forecast for an increase of +0.8% and the decline of -1.3% in December.
German factory orders, seasonally adjusted, rose by +1.2% (forecast +0.9%) in January up from a revised -0.2% in December. Orders were up +8.4% Y/Y. Non EZ area orders rose by +7.2%. Industrial output increased by +0.8% in January M/M, on better construction activity as a result of the mild weather conditions.
The January PMI index for the UK services sector came in at 58.2, slightly less than the 58.3 in January, though above the estimate of 58.0. It was the 14th consecutive monthly increase. The services sector is overwhelmingly the most important in the UK and suggests that Q1 2014 GDP will increase some +0.7%.
As expected, the BoE left interest rates and its asset purchase programme unchanged.
Japan
Overall pay declined by -0.2%, the 1st decline in 3 months, though basic pay (excluding bonuses and overtime) rose by +0.1% Y/Y in January, the 1st increase in 22 months. With inflation running at +1.3% Y/Y, real wages are declining, which will negatively impact consumption. Wage negotiations for the year beginning April are currently underway.
Japanese exports declined by -5.8% Y/Y, with imports down -3.5%. The trade deficit came in at around US$430mn.
The Yen declined following a report by the advisers to the Japanese Government’s Pension Investment Fund that the fund did not have to focus on owning just domestic bonds, in particular as inflation was rising.
China
At the National People’s Congress, Premier Li announced that the expected growth target for the current year would remain at 7.5%, the same as last year. Official GDP came in at 7.7% in 2013. He added that China will “declare war” on pollution, which has blighted the country. Inflation was expected to come in at 3.5% for the current year. The 7.5% GDP target seems ambitious to say the least, especially if the authorities want to reduce lending, curb the shadow banking sector and rising property prices, deal with high debt levels and speed up economic and financial reforms. Indeed, I would argue that it can only be achieved if the central authorities revert to their traditional public sector capital expenditure programmes, which the current regime has said that it won’t do unless the relevant projects are economically viable. However, the authorities state that fixed asset investment is forecast to grow by 17.5%, the slowest pace in 10 years!!!!. Military spending is to be increased. The Finance Minister later suggested that GDP may come in marginally lower – around 7.2% to 7.3%.
As was expected, a Chinese solar manufacturing company, Shanghai Chaori defaulted, as if failed to meet its interest payments. It is the 1st default of an onshore bond. With high levels of accumulated debt, dubious wealth management products and a slowing economy, further defaults are inevitable.
The final HSBC February PMI manufacturing index declined to 48.5, down from 49.5 in January, though slightly higher than the preliminary reading of 48.3. It is the 2nd consecutive month in contraction territory, with 50 being the neutral number. The employment component declined at the fastest pace since March 2009, due to a reduction in output and new orders. The input and output costs components also declined. The official PMI reading declined to 50.2, as compared with 50.5 in January, though slightly above the estimate of 50.1. It was the lowest reading since June.
The services sector index however rose to 55.0, up from 53.4.
Other
The Russian Central Bank raised rates by 150 bps to 7.0% on Monday, as the Ruble declined following Russia’s intervention in the Crimea. The US$ reached an all time high of 37 Rubles, with the Central Bank intervening heavily. The Russian equity index, the RTS, declined by over 10%. Furthermore, there has been a significant flight of capital out of Russia in recent months. With a less hawkish Putin, markets recovered subsequently.
President Putin announced that he had recalled some of his troops, which is a conciliatory gesture and seen as such by the markets, which rallied on the news. He added that there was no need to send troops to the Ukraine yet.
As expected, the Australian Central bank, the RBA, left interest rates unchanged. The Governor warned about the increase in house prices and, in addition, stated that the A$ “remains high by historical standards”. He added, that interest rates were likely to remain stable for a while. The RBA expects unemployment to rise and investment in the mining sector to decline – no great surprise. Inflation is expected to be between 2.0% to 3.0% over the next 2 years. However, Q4 GDP rose by +0.8% Q/Q, better than the +0.7% expected and the rise of +0.6% in Q3. Consumption was the main reason for the improvement, though the savings rate declined to 9.7%, the 1st time it has fallen below 10.0% since 2010. The January trade surplus rose to the most in 2 1/2 years and retail sales were up by +1.2%, much higher than the +0.4% rise expected. Generally, positive news for the A$.
General elections have been called in India. At present, Mr Modi’s BJP party, which is seen as more business friendly, is expected to win more seats than the Congress Party lead by Mr Gandhi, but by not enough to form a majority government on its own. However, the markets have responded positively to a potential government lead by Mr Modi, rising to a record high.
Kiron Sarkar
8th March 2014
