Daily Note – 600 million farmers?

chinese-children-2 Summary:

The morning after the night before

United States: Big jump in Initial Claims but seasonality is blamed

China: PBOC steps in with further liquidity injections     

Japan: Little of note to the last BOJ meeting of the year

Euro zone: S&P cuts EU supranational long-term rating to AA+ from AAA. Euro fx heading lower


Good morning from a chilly Dublin where for the first time ever, while dropping the kids off to school early, I saw cops out in the early morning breathalysing commuters. Given the state of a few punters last night in the centre of the city, I wonder were the cops on a success bonus. If they were, it’ll be a good Christmas in the some Garda houses next week.

Overnight, there was worrying news from China about liquidity, however the bigger problem is the persistent upward moves in Chinese bond yields, particularly in a country with such fragile banks.

Regarding China, the most interesting conversation I have had on the topic in recent years was with Jon Huntsman the former US Ambassador to China and a man who if the Republican Party weren’t intent on self-destruction, should have been a credible candidate for the GOP in last year’s election. Who knows, he may run again if the recent budget deal shows that the civil war within the Republican Party is abating.

He revealed how in a conversation with the Chinese Premier, Wen Jiabao, Mr Wen succinctly summed up the challenge for the Politburo from the migration of farmers and the impact of technology on farming.

He said calmly:

‘Our problem is we have 800 million farmers and we only need 200 million”

I always keep that in the back of my head, when thinking about China’s path over the coming years. Perspective is everything and sometimes we can lose it by focussing too much on daily, monthly or in the case of China, even annual data. So when we are thinking about the Middle Kingdom it’s worth bearing this population dilemma in mind because it impacts on everything from foreign exchange policy, interest rate policy, fiscal policy and of course all political manoeuvring.

And these migrating farmers know exactly what is going on, they know exactly where their money is going and they know exactly what it is doing as I found out on a recent visit to China

We will discuss developments in China a bit later, but let’s kick off this morning with the US.

United States: The day after the night before

It wasn’t surprising yesterday that financial markets took a breath to digest what the Federal Reserve did on Wednesday night.

In the 48 hours post the announcement of “tiny tapering”, three themes have emerged. The first is fixed income weakness concentrated in the 5yr to 10 yr section of the curve. The second is USD strength particularly against the Euro. And the third is  stock market resilience.

While I very much expected the first two, the last one (stock market resilience) has taken me by surprise in the light of already stretched valuations and near term data which shows that the recovery in the past few weeks at least, is still relatively fragile. This underlying doubt is exactly what had Bernanke re-iterating that policy would remain accommodative for some time to come, despite the tiny taper.

We are seeing that strangest of things, a market rising happily which is also experiencing large withdrawals, suggesting a lack of fundamental confidence in these valuations being sustained.

Last night, Lipper indicated that investors in U.S.-based funds pulled $13.3 billion out of equity funds in the latest week (the week ended December 18), marking the biggest outflows from the funds since September 2011.

Seasonally softer jobs data

Table 20th

Taken together, yesterday’s releases show an economy where more people are claiming benefits than expected, less houses are selling than expected and where they are selling, they are selling for lower prices. In addition, manufacturing data, is weaker than had previously been thought.

Yet the market isn’t too worried!

Initial Claims for the week of December 14th rose 10K to 379K from an upwardly revised 369K in the prior week. This is the highest claims level since late March.

Last week’s claims were originally reported at 368K. The consensus call was for claims to fall to 335K.

In recent weeks, the Department of Labour has noted that volatility surrounding the holidays is not unusual and that the seasonal adjustment process is difficult this time of year. I think that this week’s jobless claims should be viewed in that context and not as an indication of a sudden deterioration in the labour market.

The December Philadelphia Fed General Business Activity Index rose to a reading of +7 from +6.5 in October. The Philly Fed index indicates that manufacturing activity continued to improve modestly but again less robustly than people were expecting.

November existing home sales declined 4.3% to a 4.9 million units  and are being flogged a little cheaper. The median price slipped 0,6% in November to $196,300 from $197.500.The median home price has now fallen for five consecutive months after rising for five consecutive months. House prices are still up 9.4% YoY.

In general, the housing sector has lost some momentum since the rise in rates earlier in the year. I believe that deep-seated factors like income, household formation rates and population will keep housing moving forward, albeit at a slower trajectory.

The November Index of Leading Economic Indicators rose 0.8%. The data release is a tad stronger than expected. Overall, the data reflects an economy that continues to grow but isn’t totally out of the woods yet.

PBOC steps in with further liquidity injections to little effect. China stocks down hard.

Chinese banks are in poor shape as you would expect following such a surge in lending over the past five years. This is causing periodic liquidity events in the money market as jitters of the credit worthiness of various banks, force up rates. In short, it’s not that I don’t trust the Chinese banks but the Chinese banks don’t trust the Chinese banks.

Last night, the PBOC injected 200bn Yuan via their short term liquidity operation as fears rose over another such cash squeeze like the one they had in June.

Announcing via their micro blog, the People’s Bank  it said it “stands ready to offer liquidity support to banks when they need it”. Well of course it would, it’s a flipping central bank after all – that’s what it does.

In the market, traders were getting increasingly concerned about the underlying strength of various banks which are scrambling for cash at the end of the day to square their positions.

This end of day cash grab is becoming far too regular for comfort.

Despite this injection, the 7-day repo rate roses 50 bps to 7.56%, highest since June 24. This move pushed all other yields higher.

Have a look at the chart and make up your own mind.


China 1

China stocks have struggled this year in the face of rising bond yields.

China’s main index was down 2% overnight which has it nearly 10% YTD. I would expect global markets to focus more on China’s monetary/banking conundrum in coming weeks and as a result, I remain cautious on China stocks until the situation is resolved.

In the back of my head, Huntsman’s story via Wen Jaibao, keeps recurring.

Japan: Little of note to the last BOJ meeting of the year

As anticipated this morning the BOJ press conference was a low key affair. Here are the main take aways from BOJ’s head Kuroda press conference

  • Fed’s taper start reflects steady US recovery
  • Correction in excessive yen strength has been positive for Japan’s economy
  • No change to view that Japan heading steadily to 2% inflation target, despite fluctuations from sales tax hike
  • BOJ’s exiting two loan schemes have played key roles and the bank is undecided still on extending deadlines
  • BOJ monetary policy not aimed at FX markets
  • Consumer inflation to slightly exceed 1% by year-end 2013
  • Doesn’t expect April sales tax hike to cause big problems
  • Will carefully watch impact of Fed policy on markets and global/Japanese economies
  • Expects exports and capex to gradually rise ahead as global economy recovers
  • Doesn’t expect big change in pace of monthly JGB purchases from next fiscal year

I continue to expect the USD/YEN to move higher in 2014 but given the move in recent weeks, I am looking for a pull back to add to my position.

Euro zone: S&P cuts EU supranational long-term rating to AA+ from AAA

In the early hours of the morning, S&P cuts EU supranational long-term rating to AA+ from AAA which can’t be a surprise as country after country sees growth falter, prices fall and debt level rise.

EURUSD took a quick dip to 1.3626 but stabilised.

S&P have had a long-term negative outlook for the EU since Jan 2012.

The Eurozone is still in crisis, which is masked by the success of Draghi’s OMT promises. However, the strains are emerging in the banking sector. We will come back to the European banks next week because next year’s stress tests are likely to result in a more than a few bankruptcies. After all, a stress test without bankruptcy is like Catholicism without hell.

I think the Euro could move lower over Christmas. Have a look at the chart below. The market is long Euro and without any natural Euro positive flow in the coming couple of weeks, we could see a move lower.

Euro 2


The Irish economy posted strong GDP numbers yesterday, following better than expected news on the jobs front in the past few weeks. This is great news for those of us living on this little island in the Atlantic.

Many have questioned why the economy could be doing better than expected and what are the reasons. I have always maintained that there is pent up demand in Ireland as a result of the spike in the savings ratio in the past few years. Ireland is experiencing a classic “balance sheet recession” and if things change, these savings can be spent quickly.

I outline my thoughts about the saving ratio and Irish domestic demand here:

However, what has triggered the good news of the Irish economy?

Why it’s the rapid turnabout in our biggest trading partner, the UK, of course!

For years, the Irish and British economies have moved in tandem, which is what trading partners do. Ireland and Britain do €1 billion worth of trade with each other every week.

Look at the chart below

Irl uk GDP

Despite the obvious closeness of both economies, few in Ireland have suggested that our better data of late might be related to the UK.

In Ireland there is an economic and financial blackspot called the the UK; it is by far our biggest trading partner and yet the Irish political class is so obsessed with “Europe” that the UK economy is rarely mentioned in the reams of reports about Brussels, Germany and France.

But if you really want to see the close ties between Ireland and Britan look no further than the queues of mothers at Dublin airport this weekend waiting for their emigrant children to come home for Christmas from, you guessed it, London!



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