Iran Set to Compromise?

Overview
The Euro has declined to around US$1.19. However, net short speculative positions have, once again, risen to extreme levels, which worries me. Tomorrow’s December EZ CPI inflation data is highly important. The Bloomberg forecast is for a reading of -0.1% Y/Y, as opposed to +0.3% in November.

Tomorrow’s FED minutes will also be very important. Personally, I believe that the minutes will be less dovish than the market expects, which is positive for the US$.

May be time to take some profits ahead of the EZ CPI data, with a view to increase the Euro short prior to the release of the FED minutes.

Equity markets are being hammered despite the material decline in oil prices which I believe, quite firmly, is unambiguously good news for developed and a number of emerging markets. US, European and Japanese bond yields continue to decline, which should force investors into equity markets. The current set back defies logic in my humble view and one which I believe will change shortly. I remain positive equity markets.

US
US 10 year bond yield has declined below 2.0% for the 1st time since mid October last year.

US services industries expanded by the slowest pace in 6 months. The ISM non-manufacturing index declined to 56.2 in December from 59.3 in November and below the forecast of 58.0. The non-manufacturing index covers a variety of sectors including utilities, retailing, health care, construction and agriculture.  The new orders component, together with the business activity index declined to the lowest since April/March respectively. Whilst disappointing, the genuine services sector should continue to improve.

EU
In a deliberate leak intended to sway the Greeks from reneging on their debt commitments (the Syriza party, which is currently leading in the polls, has threatened to default on Greece’s debt obligations), the German government/Mrs Merkel/Mr Schaeuble have suggested that an Euro exit by Greece would not represent a problem for the single currency, though will create significant prospective economic and financial pain for Greece. Apparently, the Germans believe that the threat of contagion has diminished materially !!!!. (Mmmmm, I am far from convinced). Scare tactics – of course it is – however, if Greece is to remain in the Euro (likely), it will never be able to repay its debts and some kind of debt relief will be necessary in the future. In addition, it is clear that the majority of Greeks are not convinced by the German viewpoint.

German inflation weakened materially in December to the lowest rate since October 2009. CPI declined to just +0.1% an an annualised basis, lower than the +0.2% expected and +0.5% in November. Spanish CPI declined by -1.1% on an annualised basis.

EZ December final services PMI came in at 51.6, slightly lower than the reading of 51.9 expected. German, Spanish and French data was better than expected, though Italian services PMI came in at 49.4 (in contraction territory), as opposed to the reading of 51.7 expected and 49.6 in  November.

UK December services PMI came in at 55.8, lower than the 58.5 expected and November’s 58.6. It’s difficult to understand why it came out so low. The data suggests that calender Q4 GDP rose by +0.5% Q/Q, as opposed to +0.7% in Q3. Personally, I believe that GDP will be better than the services PMI indicates. Indeed, I would be hugely positive Sterling (which has been particularly weak) if it was not for the upcoming general election in May.

Japan
Japanese tax revenues are increasing materially. Revenues hit a 6 year high in the fiscal year to 31st March 2014, coming in at Yen 47tr, as opposed to Yen 43tr expected. The forecast is for revenues to increase to Yen 50tr for the current fiscal year, rising to Yen54.5tr for the 2015/16 fiscal year, the highest in 24 years. Some good news for Japan. The Japanese budget is to be announced on 14th January.

Japanese 10 year bond yields have declined to just 0.28% – no it’s not a typo. This is insanity, though markets can be wrong for a lot longer than you can be solvent. Having said that JGB’s are now on my watch list.

China
Chinese authorities are set to ease credit restrictions on residential property purchases. Furthermore, additional monetary easing is highly likely. Clearly these measures are positive for Chinese equities and the property sector, though negative for the Yuan. My concern remains the value of the Yuan and potential capital outflows. I appreciate that the Chinese authorities want to keep the Yuan stable – to further the governments policy of promoting the Yuan as an international reserve currency – but with much easier monetary and fiscal policy and continued economic and financial problems, I have to say that the chances of meeting this policy objective is unrealistic in my humble view. Whilst Chinese equity markets (I follow the SHCOMP) are likely to rise further (however, the H share index, based in Hong Kong has not performed anything like as well as the SHCOMP, resulting in share prices of the same company trading materially higher in mainland China than in Hong Kong), the risks have risen to levels which I find unacceptable. Sold half my long China position and will sell the balance later this month.

My friend Andy Lees has written an excellent piece as to why the Yuan will depreciate and, furthermore, that China will export deflation. I firmly agree with Andy’s view.

Other
First there were leaks that the US and Iran had reached an agreement on the vexed issue of Iran’s nuclear programme. Now, the Iranian President, Mr Rouhani, states that the country cannot achieve sustainable economic growth whilst under the sanctions regime and, furthermore, that Iran needs foreign investment. Indeed, there is speculation that Mr Rouhani will call for a referendum on the nuclear issue and on seeking better economic ties with the West. There’s no smoke without a fire and clearly the collapse in the oil price impacts Iran materially. Furthermore, the US is not as committed to Saudi Arabia (which sees Iran as its deadliest foe) as it has been in the past and President Obama’s relationship with the Israeli PM, Mr Netanyahu, has deteriorated significantly. There have been many false dawns, but the ingredients for a deal are there this time around, though the next meetings between the P5+1 and Iran are not due until the summer.  The greatest impediment are the vested interests in Iran (the Revolutionary Guard) who are major beneficiaries of the sanctions regime.

For the 1st time in 5 years, Brent oil has declined to below US$55 – currently around US$51. I continue to believe it has further to go – to below US$50, though US$45 is quite possible. However, it must be said that the disruption risks from countries such as Libya, Venezuela and Nigeria are rising materially,though oil exports from Russia and Iraq rose in December and US shale oil production is not going to drop off as quickly as anticipated.

Mr Putin remains highly popular in Russia, with an approval rating of 85%. I also understand that Russian’s have the capacity to take more economic and financial pain than we do. However, the Russian middle classes (who have much more to lose these days) are now hurting and human nature suggests to me that Mr Putin’s popularity will wane markedly in coming months. The Rouble has depreciated to around 63 to the US$ – still believe it has further to fall – my target remains 70, though in a panic, I suspect if will decline even further. Having said that, France looks as if it is increasing pressure on Germany to reach an agreement with Russia. I continue to believe that EU sanctions on Russia (in the main) will not be extended beyond July this year.

The FT reports that ISIS is finding it difficult to administer the regions that it has occupied. The fall in oil prices has reduced its revenues materially. It looks as if the local population will become disillusioned, which is excellent news.