Daily Note – Don’t bet against Russia



Emerging Markets: Don’t bet against Russia

China: Yuan drop is making headlines

Eurozone: Better growth data boosts the Euro but gains are eased as deflation fears come to the fore

Eurozone: Deflation concerns persist ahead of Friday’s key CPI data


Good morning,

Normally  we wouldn’t be so hung up on one country, but the details coming from Turkey have the potential to destabilise the government there, triggering another bout of emerging market wobbles.

Last week, when I was in Turkey, my Turkish friends were full of gossip about the leaks regarding the financial affairs of the Prime Minister. It has  become apparent that Turkey is an equal opportunity snoop – ie everyone is spying on everyone else and there are sordid details emerging about the government and the opposition in equal measure.

On the far side of the Black Sea, the idea that Russia would take what it called a “violent coup” in Ukraine lying down has been put to bed by comments from Russia’s Prime Minister this morning. He reminded the world that  the fugitive Yanukovych is still the elected leader of Ukraine.

Now that the Olympic spirit of Sochi is out of the way, its back to business – and the business is geo-political influence. My view is never bet against the Russians in their own back yard. Certainly don’t bet on the EU. Remember the colourful language of  America’s leading diplomat in the region, “Fuck the EU” – and this come’s from the EU’s ally in Ukraine the USA!

These geopolitical tensions are making themselves felt on the US markets.

While the S&P 500 moved to a new all-time high yesterday (1858) it then reversed to finish well off its high. The reemergence of emerging market concerns, big geo-political confrontation in the Ukraine and  the still weak growth in the US,  should slow equity market progress from here.

On Monday, Turkey`s Prime Ministry said that an alleged wiretapped phone conversation between the Prime Minister Recep Tayyip Erdogan and his son, which is circulating on the web, is fabricated.

“The voice records, which were put on the web on Monday night, have been unscrupulously fabricated, and are totally false,” the statement said.

“Legal actions will be taken against those who devised this dirty plot against the Prime Minister,” it added.

The Turkish lira weakened sharply  through the $2.2200 level (see chart below).

Figure 1: Turkish Lira

Chart 1 25 feb

With European stocks lower this morning, an exchange rate of $2.18 in the Turkish lira is now very much the line in the sand for broader EM risk.

China: Yuan drop making headlines

Overnight, the Yuan slide by 0.35% to 6.12 – the biggest drop in two years. Market chatter is that the PBOC is trying to narrow the spread between onshore and offshore Yuan rates to try to bear down on speculative inflows.

Mainland China stocks remain under pressure overnight because of  concerns around both the property bubble and the weakness in the Yuan.  The negative property headlines continued with the Chinese bank, IBC saying it would delay loans for property projects until the end of March.

Here is the mainstream financial media’s take on it.

The Wall Street Journal:

  • A sharp and sudden slide in China’s Yuan is forcing investors to rethink one of the most reliable trades in financial markets over the past four years: betting on gains in the Chinese currency.
  • Edmund Harriss, at Guinness Atkinson Asset Management: “China’s central bank is reminding us all that the stronger currency is not a given in the short term”.
  • Analysts say China may be trying to shake out short-term speculators as part of a broader effort to reduce the amount of cash sloshing around the country’s economy. The move could also be a signal to investors that they should prepare for more volatility in the Yuan’s exchange rate.

And from the Financial Times (Fast FT):

  • Onshore renminbi has staged its biggest drop in over two years, leading analysts to guess that the central bank, which carefully manages the currency’s moves, is experimenting with introducing some volatility, as a precursor to allowing more flexibility.
  • Other analysts have speculated the central bank engineered the drop in order to deter expectations of a further rise in the renminbi and stop speculators illicitly moving money into China.


  • China’s Yuan tumbled by the most since December 2012 on speculation the central bank wants an end to the currency’s steady appreciation to ward off speculators before a possible widening of the trading band.

How long will it go on? It isn’t easy to figure out the PBOC and China’s government. So it is very difficult to tell.

When things are fluid, it is crucial to gain altitude. China has too much liquidity in the system. The sources of this liquidity are internal (domestic money supply growth) and external (foreign inflows).

If it raises rates to stem internal money supply growth, foreign inflows will accelerate. So it doesn’t want to do that. The overall objective in introducing risk into the foreign exchange position is to slow foreign exchange inflow without changing interest rates. If this can be done at the same time as money supply is reigned in (via the central bank shutting the discount window), thereby limiting the supply of cash to the banks, the central bank can drain liquidity out of the system gradually – or at least it can try!

That’s what the central bank is trying to do.

Eurozone: No ECB QE this year say economists

When considering any investment, one of the components I look at is market positioning and expectations. I was very interested to see 19 out of 24 economists polled by Reuters say that there will be no QE because the ECB is banned from buying government bonds and assets outright. The other five say that QE will come in via the ECB ending sterilisation of the SMP.

Saying the ECB is banned from QE is not strictly true because with the SMP it can buy all the bonds and this will expand the balance sheet of the central bank; and if you take QE to mean the expanded balance sheet of the central bank, than that’s what it is. The point for us is that there is a liquidity trap in the Eurozone, so creating the conditions for “potential” money supply increases and executing “actual” money supply increases are two very different things.

Eurozone: Better data boosts the Euro but gains are erased because deflation fears come to the fore

Table 1 25 feb

This important survey of German business confidence (Ifo) increased further in February. Together with the February PMIs released last week, business sentiment suggests a further acceleration of activity in Germany during the first quarter of this year.

Among the sectors covered, manufacturing and retail saw an increase in sentiment in February, while wholesale and construction recorded a decline (from a high level). Overall, the latest numbers coming out of Germany remain consistent with a pickup in growth of the economy at the beginning of the year, albeit from a very low level in the last quarter of 2013.

What is concerning for the Germany economy is that this pickup in growth is not being reflected in the fixed income markets where, as I showed you yesterday, the German yield curve (proxy for growth) has barely moved.

This is because deflation stalks the Eurozone.

Eurozone: Deflation concerns persist into Friday’s key CPI data

At the last ECB press conference, Mario Draghi made a couple of observations with regards to euro area inflation. The first point Draghi made was that “much of the decline in core inflation, actually comes from the four programme countries: Spain, Ireland, Portugal and Greece. All in all, this would signal more of a relative price adjustment than of a deflation phenomenon.”

The second point Draghi made is that “during the period of deflation in Japan, over 60% of all commodities experienced a decline in prices; the percentages for the euro area average are much lower”.

Essentially, the argument Draghi put forward is that falling inflation is limited to just a handful of countries and that the euro area is seeing far less evidence of outright deflation than Japan. So are these statements consistent with the data?

No! He is talking his own book!

Yesterday’s final CPI figures for the Eurozone show that in January the biggest declines in inflation came in France and in the Netherlands – neither in an EU programme.

In fact, at 0.2% YoY, France is now running lower inflation than either Italy or Spain. In terms of individual countries, France, Italy and Spain are all showing further signs of disinflation.

I will leave you this morning with a chart of the liquidity trap. It shows EZ bank lending vs Core CPI. With little prospect of a sustained pickup in bank lending ahead of the ECB stress tests later this year – in fact banking hoarding rather than lending is most likely – I anticipate core CPI has scope to move a little lower.

Figure 2: Welcome to the liquidity trap  

Chart 2 25 feb

We wait for Friday’s flash February  inflation data.

Portfolio: Volatility the name of the game with little movement in the overall portfolio 

 Table 2 25 feb

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Global Macro 360-Daily Note-Don’t bet against Russia


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