Daily Note -The Next Move

Lennin 3Summary

Global “risk” assets are getting hammered but we are sticking with our positive US growth outlook

IMF says it is watching emerging market turmoil  “very carefully”

China: Fear of economic “hard landing” is gaining momentum

Japan: BOJ’s Kuroda says Japanese inflation should hit the Bank of Japan’s target of 2 percent

United Kingdom: BOE’s Carney says “I am not signalling an exit of UK monetary policy here just to be clear”

Eurozone: ECB head Draghi reaffirms rates to remain low or lower for an extended period

Eurozone: European banks have €84 billion capital shortfall; German IFO number comes in marginally better than expectations

Week ahead: A packed week with Federal Reserve meeting and EZ inflation data

Portfolio: Close to adding to our US 5 Year note trade


Good morning,

 “There are decades where nothing happens; and there are weeks where decades happen.”

What better way to start our whistle stop tour around a global economy that has rarely been so capitalist in nature than with quote from that great free marketer, Vladimir IIyich Lenin?

Lenin’s observations about decades happening in weeks could easily apply to the week ahead, and the tail end of last week. Across the board we have moved from “more of the same” state, to a “tipping point” state. The question now is what will be the next move?

Will China be gripped by a hard landing? Is it the end of Cristina Kirchner in Argentina? If so, what does it mean for Latin America? Will the Fed put the taper on hold to ease pressures in the emerging markets?  Will the Germans cough up to recapitalise European banks?

These questions have been on the back burner for a long time, simmering away, but are now squarely on the front burner and events this week will offer some answers.

Global “risk” assets remain under pressure but we are sticking with our positive US growth story

Global stock markets remained under pressure on Friday and this morning as concerns around the financial sector in China and the bizarre decision-making in the Casa Rosa in Buenos Aires, spooked investors. Add to this riots in Ukraine, the fall of the Turkish lira and a sharp sell off in the Gulf and you have quite the toxic mix.

On Friday, U.S. stocks had their worst performance since June. The Standard & Poor’s 500 Index retreated 2.1%  to 1790 to close at the lowest level since December 17th. The benchmark index declined 2.6 % last week and is now down 3.05% YTD.

Given the strong performance of risk assets in the final weeks of 2013, we have been warning  (see launch note) that such a pull back was on the cards and as a result, have kept out of the market.

Timing a correction like the one we are going through now is difficult and can be triggered by unusual fetishes. For example, why the emerging markets fetish last week? For nearly six weeks, emerging markets were ignored, then bang, they are all over the screens.

We talked on Friday  about the “tipping point” where concerns are hard to ignore and China Premier Li’s comments on Thursday were such a tipping point.

But what does all this mean? And are there opportunities presented by all the movements?

The relationship between US stock, bonds and the $ has been a bit strange in recent days which indicates to us, that there are opportunities, in all this chaos.

On Friday (after a big move on Thursday) both the US fixed income market and US$ were reasonably stable (USD eked out a small gain), while stocks sold off aggressively.

Why should this be?

To us, this move implies that market moves are more of a function of the leverage in the stock market as opposed to the “re-pricing” of the US growth outlook.

Readers will know that our medium-term outlook for the US is based on five central pillars, which are not changed by events in either China, emerging markets or Europe.

The Five US Pillars

(1) The recovery is improving. GDP in the US is accelerating as fiscal drag fades and monetary policy remains extraordinarily accommodative.

(2) The unemployment rate will continue to trend down.

(3) Inflation and wages will be tame initially but will definitely start edging up.

(4) As wage pressures emerge, markets will start to second-guess the Fed, putting further upward pressure on bond yields.

(5) Equities are not as cheap as they were, but they are not ridiculously expensive.

For the moment, we stick with the call.

As a result, we were very close to adding to our core US 5 year note position on Friday but unfortunately we didn’t get the entry level we were looking for (1.49%). We may get it later today.

IMF says they are watching emerging market turmoil  “very carefully”.

IMF deputy- director Min Zhu is firmly in the camp that blames bond tapering by the US Federal Reserve for causing global liquidity to dry up.

Mr Zhu said this had combined with a slow structural crisis in a number of developing countries and warned that those that resist market reforms “will face trouble”.

In Latin America, Brazil’s President Dilma Rousseff sought to reassure investors that this week’s currency collapse in Argentina would not spread to the Brazilian real. She insisted that all contracts would be honoured and that foreign funds would be “treated well”and said ,

“Today, the stability of our currency is a central value of our country.”

The real has weakened by 20% against the dollar this year, breaking through the crucial line of 2.40 in trading yesterday.

The Telegraph has more here: 

In Argentina is a country I have a special interest in, as I part-own a small business down there, which is going surprisingly well. It seems from our contacts in Buenos Aires, that we are looking at the beginning of the end for Cristina. Argentina will now suffer from a period of stagflation, but it has a much better chance of getting on a better track in the next few years, when we see the back of Cristina.

China: People are only worried now about the “hard landing”

From this morning’s  South China Morning Post

“The risk of a hard landing for China’s economy and the threat of military conflict with Japan were among the top concerns for experts gathered at the World Economic Forum.”

Have a read of  this  for more.

Meanwhile, the Wall Street Journal’s Chinese website reports this morning that China Credit Trust has reached agreement with investors (see Friday’s and Thursday’s note).

Investors are being asked to contact their wealth manager for details, the short report said.

China Credit Trust and Industrial & Commercial Bank of China have been in talks with local governments in Shanxi province over the CNY 3 billion trust product. It had been reported that this trust would fail to pay out its dividends on Jan 31st

The news overnight that a deal has been done to avoid default, helps account for a little more risk appetite with stocks and yen crosses higher, but there had been growing expectation that an agreement would be reached.

The major worry is that this is the beginning of something. As I have argued here time and again, the upshot of years of excessive credit growth is rarely years of sustainable economic growth but years of defaults, dodgy banks and massive State intervention to bolster the financial system.

This process brings to mind the wonderful quotation from the English economist John Stuart Mill about crises.

“The crisis itself does not  destroy wealth, but merely evidences the extent to which wealth has already been destroyed by stupid financial investments made in the boom”

China remains the biggest risk (stocks were down 1% again overnight) to our positive developed market growth outlook. We like Chinese stocks at today’s prices, but will wait till well after the China New Year before considering any investment because there could be more unexploded bombs buried deep in the Chinese banking system. They could go off any time.

Japan: BOJ’s Kuroda says Japanese inflation should hit the Bank of Japan’s target of 2 percent within two years

Kuroda spoke at the World Economic Forum :

  • He was quite optimistic about economic growth
  • He stressed that Japanese inflation and growth targets  “will be achieved but we are only half way; there’s still a long way to go”.
  • With one eye on geo-political events, he warned “We have to be mindful that there could be downside risks or upside risks from inside the country or abroad.”

The Yen has strengthened in line with the “risk off” move over the last few trading days. As we flagged after the BOJ press conference last week, in the short term the likelihood of further policy action from the BOJ is limited. We like USDYEN but would like to pick it up sub 100 for 3/6 month investment. At the moment it is a very crowded consensus trade.

United Kingdom: BOE’s Carney says “I am not signalling an exit of UK monetary policy here just to be clear”

Poor old Mark Carney had to clear up comments he made  at the World Economic Forum. Maybe he was suffering a bit of altitude sickness which all that social climbing.

  • He reiterated, that the exceptional policy stimulus remains very relevant for the British economy
  • He cautioned even when the central bank raises interest rates it will do so gradually

“I have already given some additional guidance on monetary policy and said there is no immediate need to raise interest rates. Even when that point comes which could be, well I won’t put a timeline, the increase would be gradual.”

After the  FT piece on Friday suggesting Carney had binned forward guidance, the head of the BoE tried to give the market further colour over the weekend.

We still feel there is a material chance of an interest rate hike in the UK at some point in Q4. The GBP remains a buy, particularly against the Euro. We are stubbornly sticking to our target entry level of above 0.8400

Eurozone: ECB head Draghi reaffirms rates are to remain low or lower for an extended period of time

In response to Christine Lagarde’s comments (Eurozone inflation is “way below target”, deflation is a potential risk), ECB head Draghi said that he:

Reaffirms rates to remain low or lower for an extended period of time.

Asked about the possibility of the ECB adopting quantitative easing policies, he said,

“I’m not saying it should be done or it shouldn’t be done.”

The comment about rates remaining “low or lower” is new and indicates that the ECB is closer to acting than many in the market have priced in. We remain of the view that further policy accommodation will be needed by the March ECB meeting.

As an aside this “tit for tat” between the ECB and the IMF once again shows the worsening relationship between the two institutions.

Eurozone: OECD estimates that European banks have 84 billion euro capital shortfall

Europe these days is a cacophony of noises and various national position-taking when it comes to the likely bill for the banks and who will pay it. The Dutch and the Germans are digging their feet in. The Dutch taking the view that only through bankruptcies can the stress tests be meaningful. In the same way as you can’t have Catholicism without hell, you can’t have stress tests without bankruptcies.

This may well be true, but it the raises the question who pays for bust banks?

This morning, Reuters give us an indication of just how big the bill is likely to be. Quoting OECD reports, Reuters claims that European banks have €84 billion euro capital shortfall.

European banks have a combined capital shortfall of about 84 billion euros ($115 billion), German weekly WirtschaftsWoche reported, citing a new study by the Organisation for Economic Cooperation and Development (OECD).

Financial regulators have been pushing banks to hold more capital to weather potential financial headwinds and this is causing capital hoarding which is dragging the real economy throughout the EZ. The slow growth is complicating the picture, adding to the deflation which is exacerbating the banks bad debts problems.

Dutch Finance Minister Dijsselbloem – a key player in the game – commented that

  • He hopes the stress tests do reveal some unpleasantness in banking sector
  • This bad news would  give confidence that the review process is being done properly

In addition, we got some detail on the German view  when German Finance Minister Wolfgang Schaeuble said:

Without a sound legal basis the bank resolution fund “will be destroyed” by courts.

This of course is a reference to the fact that the ECB’s actions are still being deliberated by the German constitutional court in Karlsruhe. See our Punk Economics take on this here.

The EU’s Olli Rehn weighed in this morning  adding,

“EU banking resolution mechanism may still be improved in talks with European parliament”

Whatever the heck that means, is beyond me. But it is clear that the EU is trying to push for a supranational solution, while the Germans, knowing that “supranational” is code for “Germany will pay”, are digging their heels in.

The market doesn’t seem that focused on it but the EZ bank stress tests and the surrounding issues around the bank resolution fund, I believe  remain a significant concern.

Eurozone: German IFO number comes in marginally better than expectations

Table 1 27 Jan

The important gauge of the Germany economy, the IFO sentiment number, came out this morning. It was marginally better than expected. We also note on the macro side of things, the German government is considering raising its 2014 growth forecast to 1.8%.

Germany remains the best of the EZ economies. Any slowdown in China will affect German exports more than others.

Week ahead: A packed week of economic data highlighted by US Federal Reserve meeting and EZ inflation data

Table 2 27 Jan

The Fed meeting on Wednesday is the highlight of a packed week. With a number of push pull factors affecting market sentiment we are expecting a volatile week. But I think now that the Fed is on a $10 billion “taper” auto pilot for the time being.

Portfolio: Close to adding to our US 5 Year note trade

We were unlucky on Friday not to pick up the second half of our US 5 Year note investment at 1.49%. We may get in this week. Otherwise the Euro reached resistance at 1.3740 on Friday and came back.

Portfolio 27 Jan

Download a PDF version of the note here:

_Global Macro 360 Daily Note_The Next Move





The statements, opinions and analyses presented in the articles, newsletters, and other materials appearing on this website are provided as general information and for educational purposes. Opinions, estimates and probabilities expressed herein constitute the judgment of the author as of the date indicated and are subject to change without notice. Nothing contained in this website is intended to be, nor shall it be construed as, investment advice, nor is it to be relied upon in making any investment or other decision. Prior to making any investment decision, you are advised to consult with your broker, investment advisor or other appropriate tax or financial professional to determine the suitability of any investment. David McWilliams shall not be responsible or have any liability for investment decisions based upon, or the results obtained from, the information provided.

Categories: Daily Note