Kiron Sarkar’s Weekly Report (5.31.14)

Whilst US Q1 GDP was revised sharply lower to an annualised rate of -1.0%, down from the initial reading of +0.1%, Q2 GDP should rebound strongly to around +3.5%. The inventory contraction in Q1 should reverse in Q2 and the better weather will also help. Furthermore, growth in consumption was revised higher to 3.2%, from 3.1%, suggesting that the economy is healthier than that suggested by the Q1 GDP data. Generally recent economic data indicates that growth is picking up, though April’s consumer spending data was disappointing admittedly.

Bond yields in developed countries around the world continue to decline. The US 10 year bond yield declined to 2.47%, having been as low as 2.40% during the week. The decline suggests that future growth will be sub par following the serious recession (around 2.0% to 2.5%), inflation will remain contained (though recent data suggests that inflation is picking up) and that central banks can remain accommodative for longer, with interest rates lower than expected currently. However, a reduced supply of Treasuries, as the US fiscal position improves at present, combined with lower German bund yields are the more likely reasons for the decline in yields.

The Euro has been drifting lower in anticipation of the ECB announcing a reduction in both its refi and deposit rate next week. Whilst the Euro’s weakness suggests that the likely announcement is mainly priced in, I continue to believe that the Euro will trend lower in coming months. German Q2 GDP is likely to be much weaker than that reported in Q1 and, I would expect Mr Draghi to continue to talk the Euro lower.

Markets edged higher on the week with the US and Europe trading at record levels. Whilst not cheap, I continue to believe that markets will grind higher.

Durable goods orders rose by +0.8% in April, much better than the decline of -0.7% expected, mainly due to surge in defense orders. The March data was revised higher to +3.6%, from +2.6% previously. Excluding defense and aircraft, a better proxy for business spending, orders declined by -1.2%, after rising by an upwardly revised +4.7% in March.

The Case-Shiller index reported that property prices in 20 US cities rose by +12.4% in March Y/Y, lower than the +12.9% in February, though higher than the +11.8% expected.

The Conference Board’s consumer confidence index rose to 83 in May, in line with estimates and up from 81.7 in April.

Initial jobless claims declined to 300k, below the 318k expected and the 327k the previous week. The 4 week moving average fell to 311.5k, the lowest level since August 2007, before the start of the last recession.

US Q1 GDP was revised much lower to an annualised rate of -1.0%, down from a modest gain of +0.1% initially reported and worse than the decline of -0.5% expected. The severe weather conditions, combined with a significant decrease in inventories were the major reasons for the decline. However, better employment, retail sales, earnings, business investment and, most recently, housing data should result in Q2 GDP rising by around +3.5%.

US consumer spending declined unexpectedly by -0.1% M/M in April, below the rise of +0.2% expected and as opposed to the rise of +1.0% in March. It was the 1st decline in a year. Incomes rose by +0.3% M/M, as opposed to the rise of +0.5% in March, though in line with expectations. The PCE deflator came in at +1.6% Y/Y, in line with expectations.
Whilst the more radical parties did well in the European Parliament elections in the UK, France and Greece, the overall the results were not as bad as was feared. In Germany, Mrs Merkel’s party won, as did Prime Minister Mr Renzi’s party in Italy. Bond rose, in particular in a number of the peripheral EZ countries, with yields declining sharply following the results, in particular in Italy and Spain.

In the Ukraine, Mr Poroshenko won the Presidential elections in the 1st round. Whilst seeking to ally more closely with Europe, Mr Poroshenko has indicated his willingness to start a dialogue with Russia, with Mr Putin stating that he would work with the newly elected President. European markets rose following his election as President, as the threat of additional sanctions has dissipated.

German unemployment rose by 24k in May, much worse than the decline of 15k expected. However, the adjusted jobless rate remained at 6.7%. The German economy is forecast to slow to around +0.3% in Q2, well below the rise +0.8% in Q1.

French household consumption declined by -0.3% in April M/M, much worse than the rise of +0.5% expected. Whilst the March data was revised higher (+0.6%, as opposed to +0.4% reported initially), the data confirms the problems facing the French economy and consumers. In addition, unemployment continues to increase, rising by 14.8k to a record high of 3.36mn. The growth forecast of 1.0% for this year looks increasingly optimistic, as is the budget deficit target.

Spanish data continues to improve. Mortgage lending rose by +16.0% Y/Y in March, well above the decline of -11.6% in February and at the highest level since early 2007. Furthermore, adjusted retail sales rose by +0.7% Y/Y, well above the decline of -0.5% in March and better than the unchanged level expected.

EZ April M3 money supply increased by just +0.8%, lower than the downwardly revised increase of +1.0% in March and the lowest since September 2010. M3 was expected to rise by +1.1%. Credit to the private sector continues to decline. The Euro weakened following the release of the data. Furthermore, the weak data just reinforces the likelihood that the ECB will act next week.

The Japanese Prime Minister is set to announce further measures to restructure the economy. In particular, analysts are looking for measures that will improve labour market flexibility, reduce corporate taxes, together with progressing trade talks. Whilst corporate tax rates looks set to be reduced, the government will have to find alternative revenues to make up the shortfall, given the country’s large budget deficit. Other than the tax issue, the fear is that the measures that will be announced will not be sufficient to improve the growth potential of the country.

Japanese April retail sales slumped by -13.7% M/M, worse than the decline of -11.7% expected and the rise of +6.4% in March. The sharp decline in April was a result of the increase in the sales tax at the beginning of the month, as consumers bought ahead of the tax rise. However, the government believes that the effect will be relatively short in duration, which seems optimistic to me.

Core consumer prices rose by +3.2% Y/Y in April, the fastest increase in 23 years and up from +1.3% in March, though the sales tax increase on 1st April added approximately +1.7% to the annual inflation rate. Industrial production declined by -2.5% M/M, higher than the decline of -2.0% expected. Household spending fell by -4.6% Y/Y, more than the decline of -3.4% expected. The Japanese authorities expect that consumption will pick up, though with basic wage mostly flat or less than +1.0% for around half the companies, disposable income will be lower, which suggests that consumption will decline.

Premier Li suggested that there would be more policy easing to counter the slowdown in China and to provide more credit to smaller companies. The central bank has been providing additional liquidity and, in addition, has allowed the Yuan to weaken. Furthermore, the Ministry of Finance reported that it would speed up spending to support economic growth, which they admitted was under pressure and should not be underestimated. The increasing concerns expressed by the central authorities suggests that the slowdown in China is much greater than suggested by the official data. Whilst the central authorities have been reluctant to increase their stimulus programme, they may well be forced to do so. Furthermore, the Chinese cabinet announced that they would cut the reserve requirement ratio for certain banks who have made loans to rural borrowers and small companies.

As the economy weakens, banks are facing increasing levels of bad debts. Bloomberg reports that bad debts rose by 21% at the end of 2013, as compared with the previous year and at the highest level since 2009. The actual level of bad and doubtful loans is very likely to be much higher than reported, as banks resist having to make additional provisions.

Kiron Sarkar
31st May 2014

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