Kiron Sarkar Global Weekly Report (17th May 2014 )

The evident weakness of the Chinese housing market remains a major concern. The PBoC has asked banks to increase mortgage lending to support the housing sector. With the Chinese economy slowing and, as a result of previous excessive price increases, the housing sector remains a material problem for the authorities. As the economy slows, the Yuan looks as if it will weaken further and as the central bank, I suspect, is taking measures to allow it to depreciate.

The prospect of the ECB announcing further measures to increase monetary accommodation in June (very likely) helped European equity markets, which were trading around a 6 year high, though the weaker Eurozone (EZ) GDP data resulted in a sell off subsequently. The report in the WSJ that the Bundesbank would support the ECB to ease monetary policy further at the next meeting in June resulted in the Euro weakening. In addition, a number of ECB members have hinted at policy action at the June meeting and the weaker than expected GDP data, combined with confirmation that inflation was +0.7% Y/Y in April, provides further reasons for the ECB to act. A rate cut is most likely, though there’s also speculation that the ECB will adopt a negative deposit rate. Whilst the prospect that the ECB will act in June has largely been priced in, I continue to believe that the Euro will weaken further in coming months, which should provide additional support for European markets, though gains are likely to be modest.

The likelihood of a rate cut by the ECB, combined with expectations that the FED and the Bank of England are in no hurry to raise interest rates resulted in US, UK and German bond yields declining. Investors are also concerned that US and EZ growth will be weaker than current forecasts. The US 10 year bond yield closed at 2.52%, having been below 2.50% on Thursday. Whilst US Q1 GDP is likely to be revised lower and into contraction territory of around -0.5%, I believe that the US economy will improve from the weather affected poor Q1 and that US bond yields will rise in coming months. Furthermore, recent US data (PPI and CPI) suggests that inflation is creeping back.

US corporate earnings have been lackluster to date. However, there are signs that as the economy improves, with higher employment and increased consumer spending, earnings should improve. Admittedly, the April retail sales data was weak, through the March numbers were revised noticeably higher, which made the April comparison more difficult. Furthermore, other data suggests that consumer spending should continue to rise and housing data, which was weak in earlier months, finally came in better than expected in the April housing starts and building permits report. However, US bond yields declined following the release of the retail sales data and fell further on the prospect of the ECB easing monetary policy in June and with fears over US growth. With the FED remaining particularly dovish, as are the other major central banks, and with bond yields low, US markets should appreciate, though, once again, I expect gains to be modest. However, the Ukrainian risk continues and I remain particularly concerned about China and Japan.

The April small business optimism index increased to 95.2, up from 93.4 in March and better than the rise to 94.5 expected. Importantly the employment and the optimism over earnings components rose. Small businesses are also expected to increase inventories in anticipation of increased consumer demand.  The survey also indicated that businesses were finding it increasingly difficult to find qualified workers which is leading to higher wages, which in turn is resulting in businesses increasing prices.

US retail sales rose by just +0.1% in April M/M, much lower than the rise of +0.4% expected. However, the March data was revised higher to +1.5%, from +1.1% previously. Core sales declined by -0.1%, much weaker than the upwardly revised increase of +1.3% in March. The upward revisions of the March data made the forecast increases in April more difficult to achieve.

US producer prices rose by +0.6% in April (+2.1% Y/Y), much higher than the +0.2% rise expected and as compared with the rise of +0.5% in March. It was the largest increase since September 2012. Food prices rose by the most in 3 years. Core prices (excluding food and energy) rose by +0.5%, above the rise of +0.2% expected and as compared with the rise of +0.6% in March, which indicates that price rises are becoming more widespread.

CPI rose by +0.3% in April, in line with estimates and higher than the rise of +0.2% in March. It was the largest increase since June last year. CPI was up +2.0% Y/Y, above the +1.5% in March. Core CPI (excluding food and energy) rose by +0.2% (+1.8% Y/Y), higher than the rise of +0.1% expected. The FED maintains that inflationary pressures remain contained, but there is growing evidence that inflationary pressures are building.

US jobless claims declined to 297k, less than the 320k expected and the 321k the previous week. It was the lowest since April 2007. The less volatile 4 week moving average declined to 323k, from 325k previously. The data is further confirmation that employment is increasing in the US, which should result in the economy continuing to improve.

US industrial production declined unexpectedly by -0.6% in April as opposed to the rise of +0.9% in the previous month and the unchanged rate expected. The warmer weather in April resulted in a decline in utilities, though other sectors also fell. However, both the Philly Fed and the Empire State reports came in better than expected.

US April housing starts rose by 13.2% to an annualised rate of 1.072mn, much better than the 980k expected and as compared with the 947k starts in March. Furthermore, building permits rose by 8.0% to an annualised rate of 1.08mn, higher than the 1.01mn expected and the 1.0mn in March. Finally better numbers after a string of softer housing data.

The WSJ reports that the Bundesbank will support a host of stimulus measures from the ECB if inflation is expected to remain low as is expected. These could include reducing its benchmark interest rate, setting negative deposit rates and buying packaged loans. Updated inflation forecasts to 2016 will be released by the ECB in June and Mr Draghi hinted strongly that the ECB would be prepared to act at that time. The Euro weakened on the report.

Eurozone (EZ) GDP rose by just +0.2% in Q1 Q/Q (+0.9% Y/Y), well below the rise of +0.4% expected. German GDP rose by +0.8%, exceeding forecasts for a rise of +0.7% and above the +0.4% in the previous Q, though GDP is expected to decline materially in Q2. However, France was flat, below the rise of +0.1% expected and the increase of +0.2% in the previous Q, with Italy declining by -0.1%, as compared with a forecast for a rise of +0.2%. CPI in the EZ was just +0.7% Y/Y in April. The weaker than expected GDP in the EZ, combined with the low inflation rate, will increase the likelihood that the ECB eases monetary policy at its next meeting in June. The Euro declined following the report. In addition peripheral bonds sold off with yields rising as investors moved into the more secure countries such as Germany.

The German ZEW index (investor confidence index) declined for the 5th month in May. The expectations component declined to 33.1 in May, down from 43.2 in April and below the decline to 40.0 expected. It was the lowest reading since January 2013. The current conditions component rose to 62.1 however, the highest since July 2011. German GDP is expected to slow materially in Q2.

The confederation of British industry (CBI) has raised its growth forecasts for the UK to +3.0% this year and +2.7% next, up from +2.6% and +2.5% previously. In addition, it expects interest rates to start rising in early Q 2015.

The UK unemployment rate declined to 6.8% in the 3 months to March, down from 6.9% in the 3 months to February and the lowest since the 3 months to February 2009. However, unemployment in April declined by 25.1k, somewhat less than the decline of 30k expected. For the 1st time since 2010, wage growth rose by more than inflation. Wage growth, including bonuses, rose by +1.7%, above the +1.6% inflation rate in March, though below the rise of +2.1% expected. Wages, excluding bonuses, rose by +1.3%, also less than expected.

The Bank of England’s released its quarterly inflation report. In general, it was more dovish than was expected to be the case. The Governor emphasised the spare capacity in the economy, which the BoE estimates is around 1.0% to 1.5% of GDP and, in addition, stated that there was still significant room for improvement in the labour markets, both of which factors he expected would allow the economy to grow faster without increasing inflation. Inflation was forecast at +1.8% for this year and next, rising to +1.9% in 2016. Unemployment is expected to fall to 6.1% in a year’s time. The BoE expects the economy to grow by +3.4% this year and by +2.9% next. The markets expect that the 1st increase in interest rates to be in Q1 2015, with the BoE suggesting that a modest and gradual tightening of monetary policy would be sufficient to keep inflation below the BoE’s 2.0% inflation target over the next 3 years. Sterling declined following the report.

The referendum in Eastern Ukraine was held with pro-Russian elements stating that around 90% of the votes cast were in favour of autonomy, based on a 70% turnout. The US, EU and the Ukraine have called the ballot illegal. France and Germany have warned that they will impose further sanctions if the Ukrainian presidential election is not held as planned on 25th May. However, the separatists have stated that they will not go ahead with the presidential elections. Russia has been threatened with further sanctions if the presidential elections are disrupted. The Ukrainian authorities have continued to mount operations against the separatists.

The Japanese current account surplus for the fiscal year ending March declined to Yen 790bn (US$7.75bn), the lowest on record. A rise in investment income offset a trade deficit, as imports rose and exports were weak. The current a/c surplus for March came in Yen 116.4bn, much less than half the Yen 347.7bn expected and well short of the Yen 1.28tr surplus the year before. On a seasonally adjusted basis, it came in at a deficit of Yen 782.9bn. A slide into current account deficits should weaken the Yen, with bond yields rising.

The Japanese economy grew by an annualised rate of +5.9% in Q1 (+1.5% Q/Q), much better than the increase of +4.2% expected and the fastest rate since Q3 2011. Consumer spending rose materially ahead of the sales tax increase in April, with capital spending also increasing. However, the economy is expected to contract this Q by around 3.0%, as the impact of the sales tax hike takes its effect, though increase to around 2.0% in Q3.

The Chinese President Mr Xi stated that the country should accept the “new normal”, where growth is below historic levels. His statement follows other reports which suggests that China will not embark on a large scale stimulus programme. However, the central bank, the PBoC, is likely to loosen monetary policy, especially if the property sector weakens further, which certainly seems to be the case at present. In addition, Mr Xi stated that the government would increase the limits on foreign investment, increase quotas on capital flows and establish commodity trading systems. Chinese markets responded positively to the prospect of further reforms of capital markets.

A slew of economic data just reconfirmed that the Chinese economy is slowing. Factory production rose by +8.7% in April, the slowest pace since May 2009 and below the forecast of +8.9%. Retail sales rose by +11.9%, below the rise of +12.2% expected. Fixed asset investment rose by +17.3% in the 1st 4 months of the year, as compared with the estimate of +17.7%, the slowest pace since 2001. The value of home sales in April declined by -18% M/M and were down -9.9% in the 1st 4 months of this year, as compared with last year. Lending also declined. Aggregate financing came in at Yuan 1.55 tr in April, below the Yuan 2.07 tr in March, though above the forecast of Yuan 1.48 tr, with new loans at Yuan 774.7 bn, lower than the Yuan 1.05 tr in March and the forecast of Yuan 800 bn.
The central bank is requesting lenders to increase their mortgage lending to the residential property sector, which has shown definite signs of weakening materially in recent months.

Chinese banks were hit by a significant increase in bad loans in the 1st Q, with nonperforming loans now at the highest level since September 2008, according to the China Banking Regulatory Commission. No great surprise and I would expect that the actual level of bad loans is much higher than reported and will increase further.

The Australian government announced its budget which, as expected, is to cut spending, though will also raise taxes on the better off. The budget deficit is expected to decline to A$29.8bn for the year to June 2015, down from A$49.9bn for this fiscal year. It also raised its GDP forecast to +3.5%, for the next 2 years, up from +3.0% this year.

The BJP coalition, lead by Mr Modi, has won a clear majority of seats in parliament in the Indian general election. It was the largest win in 30 years. The Congress party has conceded defeat. Mr Modi is seen as more business friendly and Indian markets have risen to record highs in anticipation of his victory. The Indian Rupee also gained.

Kiron Sarkar
17th May 2014

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