Kiron Sarkar’s Weekly report 5.25.14

Chinese manufacturing shows some signs of stabilisation, with the HSBC May manufacturing PMI coming in better than expected, though still in contraction territory. The weaker Yuan has helped, as has the modest government stimulus programme. However, the property sector looks increasingly vulnerable and employment is declining. I continue to believe that the Chinese economy faces significant headwinds. The FED minutes referred to the risks associated with a slowdown in China.

Peripheral Eurozone (EZ) bond yields have risen from excessively low levels, as the market believes that the ECB will not announce a QE programme in June, but rather reduce rates (both the refi and the deposit rate), which does seem to be the way the ECB are going. The outcome of the European Parliament elections is also a concern. A protest vote in a number of EU countries (likely) will favour the more radical parties, which could well pose a problem for the region. The Euro weakened and looks as if it will decline further.

Whilst US Q1 GDP is likely to be revised lower than the initial reading of just +0.1% and into negative territory (around -0.7% expected), the economy is set to rebound in Q2. The S&P closed at record levels on Friday. US equity markets are not cheap, though better prospective economic data (housing data is finally improving), combined with a lack of alternatives (the 10 year bond is yielding just 2.54%) and dovish central banks, suggests that markets should grind higher.

Whilst the minutes disclosed that FED members had discussed procedures to raise interest rates, they indicated that increases in interest rates were not likely anytime soon. In addition, the FED did not see an inflation risk as employment rises, due to low wage growth, which FED members suggested was due to slack in the labour market. In addition, members believed that growth would rebound in Q2. (Q1 GDP is expected to be revised lower to around -0.5%). Members did discuss potential risks to the US economy, which included a weaker housing market, continued problems in the Ukraine and a slowdown in China.

Weekly jobless claims came in at 326k, somewhat higher than the forecast of 310k and the previous weeks 298k.  Continuing claims came in at 2.653mn, the lowest since December 2007.

Following 3 consecutive months of declines, US existing home sales rose by +1.3% to an annualised rate of 4.65mn in April, though slightly below the annualised rate of 4.69mn expected. The number of homes for sale rose by +16.8%. The median price of homes rose by +5.2% Y/Y.
New home sales rose by +6.4% in April to an annualised rate of 433k, above the forecast for a rise to 425k and as compared with the upwardly revised annual rate of 407k in March.
The Bank of Spain reported that the percentage of bad loans in financial institutions declined marginally to 13.63% (E192.8bn) in March from 13.67% (E195.2bn) in February. Whilst very slightly better, the numbers remain extremely high and suggests that Spanish financial institutions will have to raise new capital, in particular as the ECB conducts its asset quality review and stress tests.

Spain’s credit rating was upgraded by 1 notch to BBB by S&P with a stable outlook and follows similar upgrades by Fitch and Moody’s. Spanish bond yields declined.

The IFO business confidence index declined to 110.4 in May (110.9 expected), from 111.2 in April and to the lowest level this year. Both the current conditions and expectations components came in below forecasts. The Bundesbank has stated that Q2 GDP will be much lower than Q1’s +0.8% Q/Q – the IFO institute believes it will come in at +0.3%.

EZ May composite PMI came in at 53.9, slightly below the 54.0 in April, though in line with estimates. The services component came in at 53.5, better than the 53.0 expected and the 53.1 in April and the highest in nearly 3 years. However, the manufacturing component fell to 52.5, lower than the 53.2 expected and 53.4 in April. Much better than expected German services PMI (56.4, as opposed to 54.5 expected and 54.7 in April) was the major reason for the better overall data. However, German manufacturing PMI came in at 52.9, lower than the 54.0 expected and the reading of 54.1 in April. Once again France disappointed in both services and manufacturing. Services PMI came in at 49.2, lower than the forecast of 50.4, whilst manufacturing came in at 49.3, as opposed to 51.0 expected. Both the services and the manufacturing components were lower than in April and in contraction territory.

UK inflation rose by +1.8% Y/Y in April (+0.4% M/M), up from +1.6% in March and above the forecast for a rise to +1.7%. The main reason was due to much higher transportation costs, which rose materially over the Easter holidays. However, the BoE, states that inflation is benign and that the strength of Sterling will keep inflation under control.
Factory input prices declined by -1.1% in April, the largest decline in almost 1 year and much more than the decline of -0.2% expected. Y/Y input prices declined by -5.5%, the 6th consecutive annual decline. Output prices were unchanged M/M, below the rise of +0.2% expected and up +0.6% Y/Y.

Minutes of the Monetary Policy Committee of the Bank of England (BoE) minutes suggested that some members were in favour of increasing interest rates earlier than previously expected. However, they agreed that they needed to see more evidence that the slack in the system was being reduced, though they remained divided as to the actual level of slack – currently believed to be between 1.0% to 1.5% of GDP. The BoE members agreed that the UK economy was “less fragile” than thought previously. There was also concern about the rise in house prices, in particular in London, though the BoE agreed that such issues would be dealt with by the Financial Policy Committee in the 1st instance. Sterling rose as a result of the more hawkish than expected minutes and as a result of better than expected retail sales data. April retail sales, including petrol, rose by +1.3% (+6.9% annually – the fastest since 2004) from March (just +0.4% increase expected), where they rose by an upwardly revised +0.5%, from the +0.1% reported previously.

The Kremlin reported that Mr Putin has ordered Russian troops, who were stationed near the Ukrainian border, to return to their bases. The Ukrainian presidential elections will be held on Sunday, which could well result in further violence, with pro Russian separatists trying to stop voting in the regions where they have control. However, Mr Putin has stated that he would work with the next elected Ukrainian President.
Gazprom has signed a long term gas supply agreement with China, with an estimated value of US$400bn over 30 years. The pricing details were not released. The agreement will reduce the leverage that can be applied by the US and Europe in the future, as Europe looks for alternative supplies of gas from countries, other than Russia. However gas sales to Europe by Gazprom will still remain the largest by far.

Japanese March core machinery orders rose by +19.1% M/M, the most since 1996 and well above the rise of +5.8% expected. Y/Y, orders rose by 16.1%. The Cabinet office forecasts that orders will rise by +0.4% in the April to June Q, though the March data suggests that this may well be a conservative estimate.

As expected the Japanese Central Bank, the BoJ, kept its bond programme at between Yen 60 tr to Yen 70 tr per month. It did raise its views on the level of business investment, even though GDP is expected to contract by over 3.0% this Q, reflecting the impact of the April sales tax increase. Analysts expect the BoJ to increase its bond buying programme in the 2nd half of this year, though the governor, Mr Kuroda, stated that he did not expect to have to increase the bond buying programme anytime soon.

The trade deficit declined by 7.8% in April Y/Y to Yen 809bn (US$8bn), as imports rose by the least in 16 months, as a result of the sales tax increase, though the deficit was higher than the Yen 646.3 bn expected. Imports increased by +3.4% Y/Y, whilst exports were up by +5.1%

Chinese April home prices were relatively flat, though the trend is clearly downwards. Indeed there is a high risk that prices will fall materially. The National Bureau of Statistics reported that prices rose by just +0.1% from March in Beijing and by +0.3% in Shanghai. Prices rose in 44 of the 70 cities in China, as opposed to 56 in March and were unchanged in 18 cities. The property sector remains a major problem for the Chinese economy, given previous excessive price gains. The PBoC has provided fresh funds to the China Development bank to build additional low cost housing.

The Chinese authorities announced that they will allow local governments to issue municipal bonds, whilst phasing out their reliance on local government financing vehicles. The move will allow the regions to be less reliant on land sales for revenues. The change will alter the credit risk of such bonds, from a semi sovereign obligation (as the Ministry of Finance (MOF) had paid the interest and capital on behalf of the provinces previously) to a local government risk, as the local governments will be responsible for paying the interest and repaying the capital. The MOF has asked local governments to obtain credit ratings and to disclose some financial information.

The HSBC May Chinese manufacturing PMI came in at 49.7, above the forecast of 48.3 and the reading of 48.1 in April. It was the highest level in 5 months. Whilst better, the reading below the 50 neutral level indicates that manufacturing is contracting, though there seems to be some signs of stabilisation. The weaker Yuan is helping the manufacturing/export sector, as is the mini government stimulus programme. The new orders and the export orders components improved, with both back into expansion territory. Furthermore, disinflationary pressures eased, as output prices increased for the 1st time since November 2013.  However, the employment component was weaker and HSBC warns of the impact of the property sector slowdown. The better data did not help the Chinese markets, with the Shanghai index ending the day marginally lower.

Minutes from the last meeting of the Australian Central Bank, the RBA, states “that the current stance of policy was likely to be appropriate for some time yet”. They added that growth was likely to below trend in coming quarters, as growth in exports slowed, mining investment was reduced and as a result of the government’s plans to reduce spending. The A$ declined following the release of the minutes and looks as if it will weaken further. Another negative is the decline in iron ore prices, which is reflecting the slowdown of the Chinese economy.

Kiron Sarkar
24th May 2014
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