Kiron Sarkar’s Weekly Report 9.27.14

The US, together with 5 Arab nations, launched air strikes against ISIS in Syria. Whilst positive that a number of Arab states are participating, this is going to be a long campaign.

The Chinese finance minister, Mr Lou Jiwei, stated that growth faces downward pressure, though China will not make major policy changes to compensate. However, I suspect that at the end of the day the government will have to increase both monetary and fiscal stimulus, as the slowdown is far more severe than thought initially.

The Wall Street Journal reports that the Chinese leadership is considering replacing Mr Zhou as head of the Central Bank in the next month or so. Mr Zhou has pressed for financial and economic reforms, rather than the interventionist policies pursued by the Chinese leadership. If he is to be replaced, the chances of further monetary and fiscal stimulus increases, which should help the commodities based currencies and equities.

There are increasing signs that the Eurozone (EZ) economy is slowing. This has lead to speculation that the ECB will increase monetary accommodation. However, I suspect that the ECB will wait until its next TLTRO programme, together with its covered bonds/asset backed securities purchase programmes are launched before considering other options, which suggests no further changes this year. Next week’s inflation data will be important. Due to a further decline in energy prices and as a result of base effects, inflation may well fall further.

With the exception of the US and the UK, the other major economies seem to be weakening. Emerging markets are also under pressure. The weaker global economy is reducing inflationary pressures, in particular due to lower commodity prices and a stronger US$. Lower inflation reduces the pressure on the FED to increase interest rates, though, for the present, I continue to believe that the FED will raise rates in H1 next year.

The US 10 year bond yield declined to 2.50%, though the departure of Mr Bill Gross from Pimco, which bond investors believe will result in sales of US bonds by the firm as investor money follows Mr Gross to his new firm, resulted in yields closing at 2.53%. Global bond yields also declined.

President Obama has suggested that he may reduce sanctions on Russia if it cooperates in enforcing the recent ceasefire in the Ukraine. There is speculation that Russia may introduce legislation to nationalise assets owned by foreigners. The situation remains uneasy to say the least.

The US$ strength looks set to continue, whilst the Euro has weakened, a trend which I expect will continue.

US existing home sales came in at an annualised rate of 5.05mn in August, below the rate of 5.20mn expected and July’s 5.14mn. Purchases by investors declined to the lowest in almost 5 years. Furthermore, sales of lower priced homes are failing to gain traction. However, new home sales soared by 18% M/M to an annualised rate of 504k in August and well above expectations of an annualised rate of 430k and August’s 427k. It was the highest rate since May 2008.

The FED has warned banks that increasing the amount of high-risk assets on their balance sheets may well require them to hold additional capital. There have been a spate of “covenant-lite” high yield bonds issued this year, which Barclay’s estimates will amount to over 70% of total issuances. In addition, total leverage on new deals has reached 4.95 times Ebitda, exceeding the highs reached in 2007. (Source Bloomberg).

Capital goods orders (ex aircraft and defense) rose by +0.6% M/M in August, better than the increase of +0.2% in July and above the forecast for an increase of +0.4%.

US weekly unemployment claims came in at 293k, better than the 296k expected, though above the previous weeks 281k.

US Q2 GDP was revised higher to +4.6% on an annualised basis (the most since Q4 2011), in line with expectations and up from the previous estimate of +4.2%.

In testimony to the EU Parliament, Mr Draghi stated that the recovery in the EZ was losing momentum, with the risks clearly to the downside. The ECB was ready to use additional unconventional measures and may alter the size and/or composition of its present measures, if inflation remained too low for too long. Unemployment was unacceptably high. He added, the 1st trance of the TLTRO was within the ECB’s expected range, a bit of a fib, as most analysts expected a much higher amount. Furthermore, he added that the ECB had reached the lower bound on interest rates. Nothing really new other than confirmation that the EZ economy was stalling.

EZ September consumer confidence slipped to -11.4, from -10.0 in August and below the reading of -10.5 expected.

The German IFO business climate index declined to 104.7 in September (the lowest since April 2013), down from 106.3 in August and below the forecast of 105.8. The current conditions component came in at 110.5, slightly better than the 110.2 expected, though below 111.1 in August, whilst the expectations component declined to 99.3, down from 101.2 expected and 101.7 in August.

German flash manufacturing PMI declined to 50.3 in September, down from 51.4 in August and the forecast of 51.2. It was the weakest reading since June 2013. The new orders component declined to 48.8, from 51.1 previously, the 1st reading below the 50.0 neutral level since June 2013. However services PMI rose to 55.4, up from 54.9 in August. The composite PMI rose to 54.0, up from 53.7 in August.

French flash September manufacturing PMI came in at 48.8, better than the 47.0 expected and above August’s reading of 46.9. September flash services PMI came in at 49.4, lower than August’s 50.3 and below the forecast of 50.1.

EZ flash September manufacturing PMI came in at 50.5, slightly lower than 50.6 expected and August’s 50.7. It was a 14 month low. EZ flash September services PMI declined to 52.8, slightly lower than the reading of 53.0 expected and down from 53.1 in August. The EZ flash September composite PMI declined to a 9 month low of 52.3, down slightly from 52.5 in August and below the forecast of 52.5. The decline suggests that the EZ economy slowed in Q3.

The Spanish economy has improved materially over the last year. However, the Bank of Spain warns that private consumption and new job creation are weakening, which will result in Q3 growth slowing. However, the government has raised its 2015 GDP forecasts to +2.0% (+1.3% for 2014), from +1.8% previously.

Japanese September PMI declined to 51.7, down from 52.2 in August. Both the new orders and exports components declined. Yet more data which suggests that the Japanese economy is weakening.

CPI, excluding fresh food, rose by +3.1% Y/Y in August (+3.3% in July), below the rise of +3.2% expected. However, excluding the impact of the sales tax rise, CPI came in at just +1.1%, as opposed to +1.3% in July. Unless the Yen weakens materially, the BoJ is unlikely to meet its target of 2.0% target in the fiscal year beginning next April, which suggests that the BoJ will have to increase its monetary stimulus programme. Indeed, there is a risk that inflation will decline even further.

The HSBC September flash manufacturing PMI came in at 50.5, up from 50.2 in August and above the forecast for a decline to 50.0. The new orders and export components rose to the highest since March 2010, though the employment component declined to 46.9, the lowest since February 2009.

Chinese banks are likely to ease mortgage restrictions for 2nd home buyers, who will be eligible for a 30% reduction in mortgage rates. Yet another sign that the government is highly concerned about the property sector.

The Australian Bureau of Resource and Energy Economics (ABREE) reduced its 2014 forecast for iron ore prices down to US$94 a metric ton, lower than the US$105 which it forecast in June. The ABREE 2015 forecast was reduced to US$94, from US$97 previously. Private sector forecasts are even lower than the ABREE forecasts at around US$85 for 2015/16. Excess supplies will keep prices under pressure for many years, with a number of high cost mines closing, though supplies are still expected to exceed demand. Chinese demand is key. One bad sign was that Chinese steel consumption declined by -0.3% Y/Y in the 8 months to August, with the decline accelerating to -1.9% in August M/M. Weaker commodity prices has resulted in the A$ declining further, in particular against the US$.

A further sign of the weaker global economy is the decline in copper prices, which are at their lowest in more than 3 months. Clearly reduced demand from China is impacting.

Crop prices have also declined and are near their lowest since 2010.

The World bank reports that consumption in Russia, which is roughly 50% of the US$2 tr economy, will slow to +0.5% next year and +0.6% in 2016, down from +2.0% this year. They forecast that GDP will come in at +0.5% this year, lower than the +1.3% in 2013. GDP is forecast to reduce further to +0.3% in 2015 and +0.4% in 2016. Lower oil prices are also hurting the economy.

The IMF warns that Saudi Arabia could face a budget deficit of -1.4% of GDP next year, significantly below its previous forecast for a surplus of +4.0%. Domestic expenditures have rocketed and the country has provided material aid to a number of other countries, a trend which is set to continue. Furthermore, the country is to increase infrastructure spending and welfare payments.

S&P raised India’s credit rating outlook to stable from negative, whilst maintaining its BBB- rating. The government has promised to reduce the budget deficit to 4.1% of GDP for the year ending 31st March 2015, down from 4.5% the previous fiscal year. That, I suspect, seems highly unlikely.

Kiron Sarkar
27th September 2014

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