Kiron Sarkar’s Weekly Report

Reuters reports that the ECB is considering buying corporate bonds as early as Q1 (January) next year, with the decision to be taken in December. Mr Draghi has admitted that the only real option left for the ECB is to increase the size of its balance sheet and such a move makes sense. No doubt, the Bundesbank and German politicians will oppose such a policy, though without this and/or similar actions, the economic climate in the Eurozone (EZ) is set to worsen materially. Mr Weidmann of the Bundesbank states that the risk of deflation in the EZ remains low, which I have to say is optimistic. To date Draghi has succeeded in increasing monetary accommodation, despite the opposition of the Bundesbank and I expect he will continue to do so. However, a January start date seems optimistic in my view, as the ECB will want to assess the impact of its other programmes which have just started. The move will be Euro negative, though clearly positive for EZ equity and corporate bond markets. Mr Draghi will be quizzed on this matter at the next ECB meeting in November.

Whilst France once again disappointed, I must admit that the preliminary October EZ PMI reading came in better than I had expected, in particular for Germany. However, the more forward looking components suggests that the region is “teetering on the verge of another downturn”, according to Markit, the producers of the index. Businesses are reducing prices and employment levels to cut costs and boost sales.

Chinese Q3 GDP came in at +7.3%, despite a significant rise in fiscal and monetary stimulus. That’s the dilemma facing the Chinese authorities, who clearly want to avoid a further stimulus programme, though they will “encourage” the Central Bank, the PBoC to provide monetary stimulus.

There is growing evidence of portfolio outflows out of the EZ and into the US/US$. With negative yields in the EZ and particularly low inflation, the Euro is increasingly being used as a funding currency for carry trades. Furthermore, Central Banks globally appear to be reducing their Euro holdings. I remain particularly bearish on the Euro and EZ markets and favour the US$ and US markets. The UK remains the best economy in Europe, though the FTSE 100 is heavily weighted in the energy and mining sector, which will adversely impact the index, if, as I believe, commodity prices remain weak. However, I continue to believe that the Bank of England will be the 1st major central bank to raise rates and, as a result, believe that Sterling will appreciate, in particular against the Euro.

Investors have borrowed a near record amount to invest in US equities. Outstanding margin debt was US$463bn in August, well above the 2007 peak of US$381bn. An unwinding of these positions will have a material negative impact on equity markets. (Source FT).

Existing home sales rose by +2.4% to an annual rate of 5.17mn homes in September, above the forecast for an annual rate of 5.1mn homes and the highest rate in 1 year. New home sales came in at an annualised rate of 467k, as compared with the forecast of 470k and Augusts downwardly revised annual rate of 466k.

US September CPI rose by +1.7% Y/Y (+0.1% M/M), slightly higher than the rate of +1.6% expected. Core CPI came in at +1.7% Y/Y, in line with expectations. Food and housing cost increases offset lower energy prices.

Jobless claims (4 week moving average) declined to 281k, down from 284k and the lowest for 14 years.

The index of leading indicators rose by +0.8% in September M/M, as opposed to the unchanged level in August and better than the rise of +0.7% expected. 9 out of the 10 indicators were positive.

The Bundesbank has forecast that German Q3 GDP is likely to be similar or slightly higher than Q2, with Q4 no better. GDP in Q2 came in at -0.2% Q/Q. The German finance minister, Mr Schaeuble, warns that the economic outlook for Germany and the EZ is weak. The French finance minister, Mr Sapin, confirmed that economic conditions in the EZ are much weaker than expected. I’m not surprised by the statements and continue to believe that EZ economic data in coming months will be particularly weak, with the risks to the downside.

EZ government debt to GDP rose to 92.7% in Q2 2014, up from 91.9% in Q1.

Surprisingly, the EZ October manufacturing PMI came in at 50.7, above September’s 50.3 and the forecast of 49.9. Services PMI came in at an unchanged 52.4, as opposed to 52.0 expected.

German October preliminary manufacturing PMI came in at 51.8, much better than the 49.5 expected and 49.9 in September. Services PMI came in at 54.8, as opposed to 55.0 expected and Septembers 55.7.

As usual, France disappointed, with manufacturing PMI coming in at 47.3, worse than the 48.5 expected and 48.8 in September. Services came in at 48.1, slightly lower than the 48.3 expected and 48.4 in September.

The Bank of Spain forecasts +0.5% GDP growth for Q3, slightly lower than the rate of +0.6% in Q2. However, the Bank of Italy (BoI) states that GDP likely contracted slightly in Q3. It added, that the outlook for exports was uncertain and that household and business confidence was weak. Furthermore, the BoI believes that there will be a prolonged period of low inflation, which will increase the risks associated with a rise in debt to GDP, which was 133.8% at the end of Q2. Italian retail sales came in at -3.1%Y/Y in August much worse than the decline of -1.7% in August.

Bloomberg reports that 25 banks will fail the regulators Comprehensive Assessment. 105 banks are set to pass. 10 of the banks that failed have capital shortfalls. The results will be announced tomorrow.

The UK’s budget deficit rose in the 6 months to 30th September to £58bn, as compared with £52.6bn a year earlier. The government in March of this year forecast that the deficit would decline by £12bn in the fiscal year ending 31st March 2015 – the data suggests that it will rise.

Minutes of the Bank of England’s (BoE) meeting on 7/8th October revealed that 2 of the 9 members voted to raise rates, as was expected. Members were increasingly concerned about the slowing global economy and, in particular the “loss of momentum in the euro area”, which will impact the UK economy. Furthermore, members expected weak price pressures and low wage growth. A particularly dovish report, which resulted in sterling declining. The market is pricing in a rate hike in Q3 2015, though I continue to believe that rates will be raised in Q1 2015. Annual wages and salaries reviews in this Q should result in a rise in January, which I believe will be greater than currently predicted.

UK retail sales declined by -0.3% in September M/M, worse than the decline of -0.1% expected and August’s rise of +0.4%. It was the weakest since January.

UK Q3 GDP rose by +0.7% Q/Q,(+2.8% on an annualised basis) in line with expectations, though below the rise of +0.9% in Q2. Growth in the important service sector slowed to +0.5%, down from +1.0% in Q2, whilst business services growth eased to +1.0%, down from +1.5%. Manufacturing increased by +0.4%, the slowest rate of growth since Q1 2013. The UK economy has grown by +3.4% since the pre-recession peak in Q1 2008.

The Government Pension Investment Fund (GPIF) will increase its allocation model in respect of domestic equities to around 25%, more than double the current 12% weighting. The GPIF will also raise its holdings of foreign bonds and equities to around 30%, up from 23% at present. Its holdings of domestic bonds will decline to 40%, down from 60% at present. Japanese equity markets rose materially following the announcement, as the 25% weighting into domestic equities was higher than expected.

The Japanese government has lowered its economic assessment for the 2nd consecutive month. It cut its output assessment, together with its view on private consumption.

Japanese exports rose by +6.9% in September Y/Y, higher than the rise of +6.5% expected and the most in 7 months. Imports rose by +6.2%, far higher than the rise of +2.7% expected. The trade deficit came in at Yen 958.3bn, higher than the Yen 780 bn deficit expected, though better than August’s deficit of Yen 949.7bn. Lower energy and commodity prices should have reduced imports and the trade deficit, but the much higher than expected increase in imports suggests that the April’s sales tax hike is finally having less of an impact.

The Japanese government sold 3 month bills at a negative yield for the 1st time ever. However, investors who bought the debt will sell it to the BoJ at a profit !!!.

Excluding the impact of the April’s sales tax hike, the Bank of Japan states that there is a greater chance that inflation will fall below +1.0% in coming months. An increase in the size of its asset purchase programme looks more likely. The Yen weakened on the news.

Q3 GDP rose by +7.3% Y/Y, slightly above the forecast for a rise of +7.2%, though the slowest rate of growth since Q1 2009. Industrial production rose by +8.0% in September Y/Y, higher than the rise of +7.5% forecast and August’s increase of +6.9%. Retail sales rose by +11.6% Y/Y, slightly below the rise of +11.7% forecast and as compared with August’s rise of +11.9%. Fixed asset investment, ex rural households, rose by +16.1% in the 9 months to 30th September Y/Y, the slowest rate since 2001.

The preliminary HSBC manufacturing PMI came in at 50.4, slightly higher than the 50.2 expected. However, output, orders and export orders increased at a slower rate, whilst input and output prices declined at a faster rate. PPI fell to -1.8% in September Y/Y, the 31st consecutive monthly decline.

The Chinese finance minister announced that the central authorities would allow local governments to issue new debt to replace maturing debt. Clearly an exercise of can kicking.

Chinese annual deposit growth has slowed to below 10%, a record low. The lower rate of deposit growth is forcing banks to raise very expensive money (around 16%) from the shadow banking market, which clearly will impact profitability at a time when non performing loans are rising.

The FT reports that Chinese outbound direct investment this year is set to exceed inward investment for the 1st time ever.

Chinese new home prices fell in 69 out of 70 cities in September M/M, up from 68 cities in August and the 5th consecutive monthly decline. The property sector continues to decline, with average prices down by -1.3% Y/Y, the 1st annual decline in almost 2 years.

The Indian PM’s (Mr Modi) party, the BJP, won elections in 2 states. The gains will enable the BJP and its allies, who controls the Lower House of Parliament, to have greater influence over the Upper House. Importantly, it also helps Mr Modi to pursue economic and structural reforms, including reducing fuel subsidies, encouraging foreign investment and introducing a goods and services tax.

Australia’s core inflation rose by +0.4% in Q3 Q/Q (+2.5% Y/Y), below the rise of +0.5% expected. The lower than expected inflation rate allows the Central Bank, the RBA to keep rates lower for longer.

The Brazilian Real has fallen to its lowest level since 2008 in anticipation of Ms Rousseff winning in this weekends Presidential elections. The equity markets have also been weak.

This weekends Parliamentary elections in the Ukraine should result in Mr Poroshenko’s party, together with allies controlling Parliament. It that does happen, a deal with Russia and the West becomes much more likely. To date, the problem has been that Mr Poroshenko has not been able to get Parliamentary support to do a deal which will involve offering concessions to pro-Russian separatists. German sources report that Mrs Merkel, Mr Putin and Mr Poroshenko seek to do a deal on gas supplies on the 29th of this month, if Mr Poroshenko and his allies win.

Kiron Sarkar
25th October 2014

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