Thursday, December 18, 2014

Economic Summary for the week ended 17th Dec 2014

Market movements
Last week was a very poor week for equity investors. Around the world, there were signs of slowing growth: weak data from China; multiple downgrades of global oil demand accompanied by further declines in prices; more stringent collateral requirements in China; and renewed angst over European politics. The dichotomy between the US and other countries was sharply represented this week by fund flows, with US exchange-traded funds gathering $2.5 billion of inflows, while those in Europe saw $1.6 billion of outflows. It was a particularly poor week for equity investors in Europe, led by the Greek stock exchange, as there is potential for the Syriza Party to triumph in a series of presidential elections, which start on 17th December. The Greek stock market plunged 18.6% on the week, and Greek bonds sold off. Other equity markets in Europe were also weak as the potential risk to global growth suggested by the declining oil price led to people fleeing those markets in anticipation of earnings downgrades.
In spite of a still-resilient economy, US assets are demonstrating that they’re not immune to the global slowdown. The S&P 500 traded down to a five-week low, with technology and energy leading the way down. Volatility, as measured by the VIX index, rose above the 20 threshold for the first time since October. This increase in volatility was consistent with the further widening of credit spreads, which are now at their highest level since June 2013. The sell-off in high yield has been largely driven by growing concern over energy issuers. Indeed, since the OPEC meeting at the end of November – when no cut in the quota was suggested – we’ve seen the spread on energy stocks rise by 260 basis points. The oil price is the central topic of the moment. Is it the canary in the coal mine, warning us about global growth declining, or is it actually a stimulus to global growth? It’s probably a bit of both in that we’re seeing reductions in energy intensity in a number of countries (China, in particular), but we would expect there to be some activity boost from consumers, who are now finding it cheaper to fill up at the pump. And that is the dilemma that investors find themselves in, because bond markets are rallying strongly: last week, US 10-year Treasuries touched 208, which is the lowest level in over a year, and government bond markets in Europe also rallied.
Another big event of the week was the re-election of Prime Minister Shinzo Abe in Japan; the market will now be looking for an acceleration of institutional and structural reform over the next few months. However, it must be said that investors are a bit nervous as we head into year end. A couple of important things to look out for this week: firstly, as mentioned, there will be a Greek parliamentary vote for a new president, the final round of which will be held on 30 December. If the Syriza Party should prevail, we will need answers to the following questions: will they pull out of the euro? (They’ve said that they will not.) Will they renegotiate or ignore Greece’s International Monetary Fund payments and loans? (In terms of austerity, almost certainly, yes.) And would that be a crack in the eurozone’s recovery? Our view is that while there are some extreme parties in Europe, this is an unusual case, because Greece has suffered more than most in terms of the aftermath of the crash. The decline in European assets has as much to do with the falling oil price and the time of year, but there are concerns that the Greek presidential election will set off a kind of snowball effect. The other thing that spooked people about Europe last week was the relatively small take-up of the European Central Bank (ECB)’s targeted long-term refinancing operations. Investors still hope for quantitative easing involving sovereign-bond purchases by the ECB in the first quarter of 2015. Otherwise, as we head into year-end, Wednesday will be an important day, with the Federal Open Market Committee’s last meeting of the year. All eyes will be on the language of their statements regarding, specifically, whether they remove the reference to not changing rates for a “considerable” amount of time. Also, purchasing managers’ indices across Europe will give us a sense of how flat that economy is.
There is a hangover from this party; it’s being felt in high-yield markets & leveraged-loan markets most of all
It’s important, with regards to economic policy, to look beyond the stream of economic releases and remind ourselves that this is the time of year when markets tend to trade quite thinly. The only major issue that people are having difficulty with is the decline in the oil price. We can see this if we look at stock market indices again, because much of the decline in those indices and the widening in spreads is down to the energy sector. And the question that people want to look into as we move into next year is: has there been a lot of bad lending to energy companies that will impact our capital markets and our banking ratios? The answer is: there probably has been a lot of bad lending, because the oil price has been remarkably stable at a very high level for three years, which set off an increase in global exploration and production. So there is a hangover from this party; it’s being felt in the high-yield markets and the leveraged-loans markets most of all, and in the equity markets in terms of downgrading earnings forecasts for energy companies. But there are bright spots as well: this fall in energy prices is essentially a tax cut for consumers, and as we move into the new year, we feel that investors will start to look at the positive side of the coin as well, and will almost certainly be looking to bargain-hunt in equity markets.

Tuesday, December 16, 2014

Economic Summary for the week ended 10th Dec 2014

Market movements
As we move toward the end of 2014, the themes that we expect to drive markets in the coming year are really starting to take shape. Foremost among them is the divergence of monetary policy. To that end, the past week has seen two major events that we believe will set the scene for 2015. So far, the divergence theme has been dominated by the easing camp, with action in Asia and talk in Europe. The latest instalment of the European quantitative easing (QE) debate came in the form of the December meeting of the governing council of the European Central Bank (ECB). Expectations for more easing in Europe has risen sharply over the past month, and the collapse in oil prices has, once again, raised the fear of deflation in the Eurozone. In fact, yet more disappointing data has driven the inflation swaps market to price headline inflation dropping below zero for the first time ever in the first quarter of 2015. The hope for more action has been exacerbated, both by the rise in rhetoric from ECB members and by the actions of other central banks. In this regard, the recent easing by both the Bank of Japan (BoJ) and the People’s Bank of China (PBOC) have piled increasing pressure on the ECB to do more.
In line with our expectations, ECB President Mario Draghi stopped short of announcing any new policy tools. However, it was clear from the tone of the Q&A that sovereign QE in Europe remains very much in the cards. With a nod to one of the conditions he laid out last month – i.e. that if existing measures prove too little, they may have to do more – Mr Draghi said that the current policies will be reviewed in early 2015. This, for the first time, helped set a timetable to review the policies, and, if deemed necessary, to move to the next stage of monetary easing. The first sign for that condition will be the announcement of the take-up of the second-tier of targeted long-term refinancing operations (TLTRO) on 11 December. Also notable was the clear message that legal hurdles are surmountable. In fact, according to Mr Draghi, the only illegality is allowing the ECB to move away from its inflation and growth mandate – a clear shot across the bowels of the QE doubters. Market reaction to the announcement (or lack of an announcement) was to price out some of the more exuberant price action of recent weeks, in both peripheral bonds and European equities, on Thursday afternoon. However, the disappointment didn’t last long, with markets bouncing back sharply on Friday – helped by some positive press on the chances for QE in 2015 – most notably in Germany.
On the other side of the Atlantic, the divergence theme has been particularly quiet. In fact, US Treasury yields have been held low, driven by the widening gap in yield with core Europe and the expanding search for income around the world. Behind the scenes, though, the drivers of the tightening camp are starting to pick up. This was confirmed by the latest non-farm payrolls data, which showed the strongest positive surprise since January 2012, coming in at 321,000 versus a survey estimate of 230,000. With October revised upward as well, and hourly earnings beating expectations, it was a strong report all around. Coming on top of the increase in the recent employment cost index – the Federal Reserve (Fed)’s favoured measure of income – the pressure for rising wages is clearly growing. And this is key: the missing link of wages and incomes in the US looks to be appearing fast. As we move into 2015, it is difficult to see the Fed not moving to a more hawkish stance as it prepares for what we believe will be a first hike in the Fed’s funds rate by the middle of next year. That step could come as early as this month, when the Fed may adjust the language regarding timing in a Federal Open Markets Committee meeting.
The strong growth data was taken positively by equity markets, with the S&P 500 creeping up to end on yet another weekly high – its seventh in a row – and the Dow Jones fast approaching 18,000. So far, the good news of an improving labour market is outweighing the bad news of what it might mean for the Fed’s easing stance once they start the hike. This is no small measure, due to the baton change of central-bank QE from the Fed to the BoJ, and possibly the ECB, next year. Even bond markets were relatively sanguine: the 7 basis-point (bps) rise in 10-year yields on Friday took them to 2.31%, still below where they were before September’s Fed meeting.
The winners continued to be Japan & China
While the main news came from Europe and the US, for markets, the winners continued to be Japan and China. Both sustained their positive recent momentum, with A shares up another 9% and the Nikkei up over 2.5% to close at a seven-year high. Rising volumes in A-share markets are encouraging hopes that domestic investors may finally be buying back into their own equity market. The strength of the US dollar also continues to provide strong support to Japan, with the dollar-yen exchange hitting 121.5 on Friday. For emerging markets, the dollar strength remains a significant headwind: broad emerging-market indices were down just shy of 2%. The combination of ongoing European QE hopes and the spectre of the Fed has pushed the euro-dollar exchange below 123, which will continue to help both exporters and Germany. After months of disappointment, tentative signs of a cyclical improvement in the Eurozone economy are appearing, with factory orders in Germany rising strongly. Note that autos helped drive the pick-up in these orders; this is a sector we think should benefit as we move into next year.