Daily Note – Waiting for the Messiah


Weakness in China along with the broader emerging market complex weigh on global risk

US: Economic data takes a back seat to geo political concerns

EZ: Troika want a pre-agreement with Greece before returning

Portfolio: Weaker bond yields pressure our Euro and US 5 Year Note positions

Good morning

Maybe I should have stayed in the investment banking game. I see this morning that despite $20 billion in fines for quasi-criminal behaviour and the huge loss on its trading account triggered by a trader in London whose bets were so big he was nicknamed “The London Whale”, the board of JP Morgan has agreed to give the CEO Jamie Dimon a massive pay rise!

Apart from the huge money, one of the aspects of the business which has changed since my time on emerging markets teams at both UBS and BNP, is the fact that now the emerging markets can call the tune. In the old days, the emerging markets largely took their tone from the US; now, as we saw overnight, the opposite can be the case.

The entire market is, in my opinion, rightly spooked about what is going on deep inside the entrails of the Chinese banking system. The upshot of years and years of easy lending is rarely sustained economic growth but much more likely, massive bubbles in certain favoured sectors which when they burst, tend to lead to defaults which can domino throughout fragile financial systems as the chief bottle washer of the aforementioned JP Morgan knows only too well.

Is China a massive Lehman waiting to happen, which would have the same impact on the rest of Asia as Lehman had on the western financial system? We don’t know, nobody does, but it’s certainly worth worrying about.

Chinese ChartElsewhere in emerging markets, Argentina’s currency slumped yesterday by 18% as the central bank stopped propping it up. Argentina is going through a transition of power from the Kirchner regime, to something else. The Kirchners inherited a country which had very little national debt (after its massive default in 2001), a hyper competitive currency (after the massive devaluation), a significant trade and current account surplus and more significantly, as the world’s largest producer of soya, they had a cash crop which could have fed half of China (which they almost did). All they had to do was keep inflation low, keep monetary policy more or less sensible and eschew the temptation to run a massive budget deficit – but they couldn’t.

Now Argentina will hit the buffers again, but it will also have the opportunity to start again and this time, things might turn out if not quite totally different, at least marginally so.

They could start by winning the World Cup in Brazil in June. Odds on that? Odds on Messi at last delivering for his country?

Weakness in China along with the broader emerging market complex weigh on global risk

The market correlations we have been talking about in recent days came to the fore yesterday. US stocks finished well down on the day because of the worries about a Lehman event in China.

This “risk off” event pushed the US 10 Year yield back below the key 2.80%. This lower yield move had a knock on effect,weakening the USD particularly against the Yen but also the Euro.

On Wednesday we warned you about the positive correlation between “risk on” and strong USD, and yesterday we saw it in action. Sentiment will need to improve today or this could be the beginning of a more sustained correction in risk. Fear may well elbow out greed in the days ahead.

Driving yesterday’s panic were concerns about China. After the poor HSBC manufacturing data, markets were on edge for further bad news out of China. But Chinese manufacturing doesn’t concern me immediately, banking does.

Nervousness about Chinese banks and what sort of “crud” is hidden deep in their over-leveraged balance sheets was not helped mid-morning yesterday when Premier Li was quoted on state radio suggesting China was facing a “severe” economic situation and calling for closer monitoring of the economic situation.

It’s an ugly day in the broader emerging markets with severe signs of strain everywhere.

  • Argentina’s peso is down 18.% in the worst daily fall since 2002 after the central bank gave up intervening to preserve reserves. Merval, the main stock market index (an outperformer in 2013), is down 14%.
  • Ukrainian protesters and the government have agreed to talks but the country is on the verge of martial law (See my piece on risks in 2014.)
  • Turkey’s lira hit an all-time low, falling 1.7% after the central bank made an unscheduled intervention. Shares were down 4.2%
  • The South African rand broke 11, to a five-year low as mining workers began a strike demanding a doubling in pay

None of these stories are new. Problems in Ukraine and Turkey have received plenty of coverage in recent weeks. But in markets there sometimes comes a tipping point. The China story above was this tipping point.

United States: Economic data takes a back seat to geo-political concerns

Table 1 24 Jan

While economic data was not the focus for the market yesterday, it’s important to stick to the process and review what data came out.

The preliminary Markit PMI for January ticked down to 53.7 (vs. consensus 55.0) from 55.0 in December. By component, new orders declined (-0.4 pt to 54.1), output fell (-3.9 pt to 53.4), and employment ticked down (-0.6pt to 53.2). We have found the Markit PMI to be of some use in predicting ISM manufacturing in the past. However, this preliminary report stands in contrast to stronger readings from the Empire and Philly Fed surveys already released for the month. That said, we go back to our note of a few weeks back on the “fragile and delicate child”. When people are worried, anything spooks them.

Initial claims for jobless benefits stood at 326k in the week ended January 18 (vs. consensus 330k) – roughly unchanged. The Labour Department noted no special factors affecting last week’s claims. The 4 week average 331.5k vs 335k.

United Kingdom: Carney scraps forward guidance target – FT

Maybe all that altitude at Davos has gone to the heads of the FT but they’ve just published an article saying:

Mark Carney, governor of the Bank of England, has ditched his monetary policy guidance based on unemployment less that six months after it was established, saying the British economy is “in a different place” to that of last summer.

They cite comments at Davos and conclude that the BOE will drop the 7% unemployment forward guidance altogether. In a Daily Mailesque leap, the FT have over-egged this one I fear. Here’s what we know he actually said.

Carney said he saw no immediate need for a rate increase

  • Carney spoke with the BBC, repeating the line from the MPC minutes that UK growth is ‘coming off a low base’
  • He maintained that the MPC will look at the overall conditions in the labour market

Only 30% of polled economists see the UK hiking rates this year with the vast majority going for Q2 2015. Two thirds say the BOE won’t adjust the unemployment threshold of 7%. They expect the rate to fall to 7% in the next few months. (At 7.1% currently they’re not exactly pushing the boat out with that call.)

The market is moving ahead of the boffins, pricing in a 70% chance of a rate hike in December.

Have a look at yesterday’s note, the Return of Niaru for background on the UK.

Eurozone: Better PMI & Current Account gives the Euro a bid

Table 2 24 Jan

The Euro area Composite PMI rose from 52.1 to 53.2 in January, above the consensus expectation (Cons: 52.5), implying that industrial Europe is seeing a slightly brighter future as evidenced by order books.  The country breakdown showed improvements in both French and German manufacturing.  The service sector in Germany disappointed.

The split between manufacturing and services is something that came up again and again in the survey. The new orders component within the manufacturing survey rose 1.2pt and the ‘order-to-stocks’ ratio increased slightly more – rising to its highest level since May 2011.

Within services, ‘business expectations’ remained broadly unchanged while ‘incoming new businesses’ edged lower on the month.

There is nothing in yesterday’s data to suggest outside of Germany there is much of anything to get excited about.

Eurozone: Troika want a pre-agreement with Greece before returning

We had some leaked headlines on MNI about the deteriorating situation between the Troika and Greece.

  • The Troika does not want lengthy negotiations with government
  • The Euro group is likely to state that Greece must comply with the Troika

Could we be seeing patience wearing thin yet again with Greece? The Troika won’t be happy that the financial gap (between what the Greeks say their banks need and what people actually think their banks need)is growing and the fact that Greece has rowed back on some wage cut promises. Even with the “open-wallet” policy of the EU towards Greece, there still may come a point when someone says enough is enough.

Portfolio: Weaker bond yields pressure our Euro and US 5 Year Note positions

The Euro rallied hard yesterday towards the key resistance level around 1.37. We remain medium term bearish on the Euro but given the correlations we have been talking about, and the broader “risk off” environment, there is scope for it to move higher as US bond yields remain under pressure. A lot will depend on today’s weekly close.

We are happier with the US 5 Year note position. We will add to our position at 1.49 if we get there in coming days.

Table 3 24 Jan

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