November 2014 Global Macro Recap

  • Global Macro Recap

The trend was your friend in November, with the US Dollar triumphant against the Yen (+5.6%), Euro (+0.6%) and Sterling (+2.2%), the S&P 500 setting a new high at 2067.56 (+2.5%) and US 10-year Treasuries at very low yields (2.3%).  The inflow of currency into the US is covering the absence of Fed action (apart from the talking up of the markets).  Europe is slowly buying bank bonds and asset-backed securities, though it is uncertain if the slow pace is due to already-exuberant markets or lack of qualifying instruments.  Japan and China are more heavily engaged in QE with the Japanese Pension Fund buying foreign and domestic stocks and foreign bonds, and China propping up bank lending with guarantee schemes.  The big market-moving news was in the energy space with OPEC not cutting production in order to halt the slide in oil prices.  Saudi Araba, along with UAE and Kuwait, decided to maintain market share and resisted the calls for cutting by Mexico, Venezuela and Iran (and Russia – though Russia is not an OPEC member).  The Saudis know that the other countries will cheat if given the opportunity – they have to as their budgets are in serious deficit – and most of the cutters are on the opposing side geopolitically (Iran and Russia come to mind).  And so the Saudis changed the game, sending oil down to $66 per barrel (and to possibly beyond).  The net consequences are still uncertain, but recession for Russia, Iran, Brazil and Venezuela and an economic boost for Europe, Japan, US (net), India and China seem to be reasonable expectations over the next few months.  Deflation (at least some kinds) is good!

Hitch Your Sleigh to the Santa Rally!  Low interest rates, low commodities prices,  decent economic performance, minimal political theater from Washington DC, no polar vortex and a holiday season should make for a supportive close of the year.  Q3 GDP growth was revised upward to +3.9% from +3.5% as consumer and business spendingUS Retail Sales Rise in October 2014 drove the results.  Retail sales rose in October, especially when one excludes gasoline spending (see WSJ graph to right, based on the Departments of Commerce and of Energy statistics).  It is even possible to buy gasoline for under $3 a gallon just outside of San Francisco (of course, not in the city).   There has been a -17% decline in US national average gas prices since the beginning of the year which should lead to lower prices of almost everything – assuming that the lower costs are passed along to the retail level and not held back as corporate profits.  This deflationary pressure should be good for the average consumer.  On the other hand, lower oil and gasoline prices will hurt oil production and service companies, and in turn could cause some losses in the bond and stock markets. However, there is still so much QE money looking for a home that losses could easily be offset by buying on the dip.  There is some concern over the “Black Friday” weekend retail sales as they fell short 11% versus last year (offset somewhat by internet and “Cyber Monday” sales but with consumers knowing that more bargains are out there as they go through December, their purchases may simply be more spread out and tactical.  Too soon to tell.  Job growth is supportive with a 5.8% unemployment number and a 62.8% participation rate, a small up-trend in the number of people who are working.  Real wages are still flat, however. 

Grandma Got Run Over By A Reindeer:  If the US is enjoying a little boost, Europe is still hoping that it can find something that at least sounds positive.  Q3 GDP growth was an annualized +0.6% for the Eurozone as Germany turned in a flat performance andStaggered Post Recession Recovery in EuropeFrance’s growth was offset by Italy’s decline (not-fun fact:  Italy has not grown since 2011).  Greece did have a bounce of +1.7%, though its debt burden is still being negotiated by the IMF, ECB and EU.  Italy’s unemployment rate unexpectedly rose to 13.2% in October, setting a record.  Eurozone manufacturing is considered as slowing but very slightly positive (PMI at 50.4, the lowest in sixteen months) though Germany’s fell to a contracting level of 49.5 as German exports fell for the first time in sixteen months.  Draghi continues to hint at more ECB stimulus by expanding the new €1 trillion bond buying program to include government bonds.  So far, they have bought €18 billion of covered bonds and asset-backed securities so have fell behind market expectations.  Of course, the market has front-run them to try to flip the bonds for a quick profit (40 basis points is the estimated price differential per the Financial Times – not bad money given the €1 trillion buying target).  Buying overpriced assets does not sound like a smart plan to me but it does keep yields low.  Banks have started to charge for deposits to match the negative interest rates imposed by the ECB – Commerzbank (Germany’s second-largest bank) announced selective charges on deposits in November, joining a number of US, Swiss and UK lenders.  In other banking news, ING announced that it will pay off the remaining €1 billion that it owes to the Dutch government as the last part of the financial crisis bailout in 2009.  That leaves Royal Bank of Scotland and Bankia as the remaining large banks that still owe from the crisis – and will owe for a long time. 

In the meantime, government borrowing rates in Europe are at all-time lows – Germany’s 10-year Bunds at 0.71% yield and the French are below 1% too.  The all-time low list includes such questionable players as Spain, Italy, Ireland, Austria, Belgium and Sweden – as well as their neighbors in Eastern Europe:  Poland, Hungary and the Czech Republic.  Germany’s 5-year bonds were recently issued at a 0.12% yield – almost negative!  And yet the radical left still wishes to repudiate government debt as unaffordable:  Podemos (basically the Spanish Communist party) is leading in their polls and states that the country’s debt burden is “unsustainable and needs to be reduced [could be in a number of ways including lowering interest payments, rescheduling, haircuts, etc.].” 

The European Union’s President, Jean-Claude Juncker, took the reins from Draghi by announcing a new stimulus plan – basically the EU and European Investment Bank would pledge €26 billion of guarantees and €5 billion of capital as the basis for a European infrastructure investment fund that would try to raise €280 billion of private money.  Of course with borrowing costs so low already, why does the private capital need a guarantee in addition to go ahead with possible projects?  The projects contemplated must be really terrible!  At any rate, the plan cannot get underway until mid-2015 as it requires EU legislation.  At least the EU pushed back on France’s bogus budget and moved a step closer to fining the country for not staying in line with EU guidelines.  It will be interesting to see what happens, with EU credibility (such as it is) is at stake. 

With winter, the war in Ukraine has gone pretty cold – Russian troops have re-entered Eastern Ukraine and there is sporadic fighting.  The battle has shifted to the Ruble, which the graph to the left shows spectacularly (a decline of 15% in November and about 40% since the beginning of the year).  So who cares?  Average Russians fighting 9.1% annual inflation rates, Russian banks which have $192 billion (10% of GDP) in foreign liabilities, any Russian who borrows as the one-week government interest rate is now 9.5%, and anyone associated with the now-canceled “South Stream” natural gasChina buys Russia's Natural Gaspipeline that was to connect Russia and Western Europe via Bulgaria and Serbia (and thus circumventing Ukraine).  Maybe there will be a re-route through Turkey, but I suspect that Putin needed the billions in order to meet his commitments to China.  Readers will recall the recent agreements for Russia to export oil and gas to China via a new set of pipelines.  In early November, a framework was agreed upon to almost double the natural gas portion from 38 billion cubic feet per year to 68 billion.  Apparently Putin is looking East not West to secure Russia’s economic future.  We shall see how the Chinese take advantage of that cheaper energy. 

Japan Quarterly Change in GDPBakemono (化け物) Among Us:  These mischievous and often malevolent shape shifting creatures from Japanese folklore walk among us in the form of central bankers and politicians – promising growth but with uncertain results.  Japan, the country that arguably has been engaged in QE the longest and greatest in size (at least relative to GDP – twice as much as in the US or Europe), slipped into recession in Q3 2014 by falling -1.9% (after being revised downward from -1.6%) instead of growing +2.2% as forecasted.  After a fall of -7.3% in Q2 (revised down from the first estimate of -7.1%), the expected pain from the increase of the sales tax in April has hit home.  With the second increase due in October 2015 (from 8% to 10%), Prime Minister Abe decided that his political future would be more secure by postponing the upcoming increase for another eighteen months (to April 2017) and calling for elections in December 2014 to maintain his office for up to four more years (he has served two years already in his current term).  With real base wages stagnant or falling, Abe is facing a do-or-die situation with his attempts to use monetary policy and deficit spending to try to get the Japanese economy going.  Of course, the deficit will be made all the worse without the sale tax revenue coming in.  However, with the collapse of the Yen, Japan has an opportunity to take manufacturing and export market share away from its Asian neighbors (particularly Korea, Taiwan and China) and Germany (assuming no reciprocal reaction).  Quite directly, I do not see anything right now that will halt the Yen’s slide in the near future.  With all these challenges, Moody’s downgraded Japan one notch from Aa3 to A1 (the same level as Israel and the Czech Republic), joining Fitch (who?) who first lowered Japan in 2012 in a similar manner (AA- to A+).

China decided that it was time to start lowering its interest rates to try to stimulate economic activity with a reduction of the benchmark lending rate by -0.4% and deposit rate by -0.25%, perhaps partially in response to a ramp in money market rates that had two-month interbank lending rates hit 6%, the highest since February.  Overall credit growth through the first ten months of 2014 is running about $207 billion behind last year’s pace, though money supply (M2) is still running about 12% higher than last year. Bad loans are on the rise in ChinaWith this money sloshing around, one would not be surprised that a Chinese state planning agency report estimates that $6.8 trillion has been wasted on “ghost cities” and non-producing industries since 2009.  China’s October industrial production slid to +7.7% while the market expected a total of +8%. In the most recent Purchasing Managers Index, the number fell to 50.3, down 0.4 from last month and signifying that there is minimal industrial expansion.  China real estate sales fell 3% in October, but investment grew at 12% as property developers cut prices for the seventh month running.  With nonperforming loans in China steadily increasing (see graph), more is being done to prevent a panic.  In looking at ICBC, China’s largest bank (and in the world by assets), non-performing loans moved up 9.0%, more than the improvement in net income of 7.7%.  Perhaps to try to add some stability to the banking sector, there is an impending nationwide deposit insurance plan for January for accounts up to RMB500,000 ($81,400) which is expected to cover 98% of deposits.  In another form of insurance, China announced that it completed the first state of its strategic petroleum reserve of about 91 million barrels, lower than analyst estimates.  Undoubtedly China is using the current low oil prices to improve its reserves!

Is $60 The New $100?  For Saudi Arabia and friends, it seems like it for a few months or so at least.  To underscore Saudi Arabia’s importance in OPEC, they produce about ten of every thirty million OPEC barrels per day, with current allies Kuwait and UAE about another five million.  Everyone else (Iraq, Iran, Venezuela, Nigeria, etc.) desperately needs to pump as much as they can to keep their economies at least halfway functioning.  They are trapped by their own dependency on oil revenue.  While certainly one impact will be to seriously impair US shale oil investment (energy capital expenditures account for about 1/3rd the US total), the impact may be much higher on Brazil’s deepwater oil fields and Canada’s oil sands – both have higher lift costs than US shale.  From the end of October, new oil and gas well permits fell by almost 40% in the US, an immediate reaction.  Many properties will have to maintain drilling based on the terms of their contracts, so not sure as to the net effect, but since permitting leads to capital expenditure, one can see the scaling back already in play.  A country that is already seeing the impact is Nigeria.  Nigeria no longer exports to the US and has found that it needs to devalue its currency and raise interest rates in order to try to maintain its low foreign currency reserves, depleted by corruption and wasteful spending in good times (as in only a few years ago!).  In other knock-on effects, lower energy prices are lowering the rate of inflation, hurting the central bank effort to cause inflation.  On the positive side, a number of countries are lowering their energy subsidies, thus helping their budgets – India and Malaysia are two.  Indonesia saved $8 billion by lowering subsidies by 30% in November alone.  Truck and SUV sales in the US picked up as lower gas prices allowed Americans to return to gas-guzzling ways – sales of Cadillac Escalades were up 91.5% versus November 2013.  Conversely, Tesla has to be worried.  Perhaps the most surprising impact of low oil prices is the coming to an agreement between the Shia-led government of Iraq and its Kurdish region on exporting Kurdish crude though Iraq pipelines in exchange for a revenue split.  This deal has been floundering for years but fighting ISIL and the need for petrodollars has sharpened the focus of their politicians.  Now if only Libya can come to a similar truce.

Goldbugs are forlorn now that the Swiss voted down a proposal to hold 20% percentage of central bank reserves in gold, to prohibit further gold sales and repatriate Swiss-owned gold to Switzerland.  While gold seems to have stabilized around $1,200 per ounce, this is the latest blow to those hoping that their shiny metal will get a boost.  They need not fear though as international QE (Japan, Europe, etc.) should keep some kind of support under it.  While the numbers are not in yet, it seems that the large US crop in grains will be limited by a lack of transportation – grains are being crowded out by oil railcars.  Another reason for more pipelines!  While some of the grain will not be harvested, most of it will be and stored on the farm until needed.  No need to panic. Transportation Costs affecting grainsSugar on the other hand has surprised in terms of a fall in production recently in Brazil although the amount milled to-date is only a little behind last year.  There is a weather threat from El Nino, but the dryness that condition brings to Brazil will give Thailand an opportunity to expand production.  In industrial metals, the banks that owned warehouses (Goldman Sachs, JP Morgan, and others) were the subject to a US Senate investigation that came to a head with their trading strategies causing artificial shortages of metals for delivery.  The “merry-go-round” trade was the shipping in-and-out of metal to and from a co-conspiring third party that would clog up the delivery facilities, forcing shipping premiums to increase and extended the amount of time rent was charged to other firms who were innocent in the scheme.  Bank traders would also know when such “shortages” were to occur and thus place bets on the market reaction to these faux shortages.  There does not appear to be any civil or criminal charges though the Federal Reserve is considering putting out rules that would limit this kind of behavior.  Advantage:  Goldman Sachs.  Finally, in African news, Ethiopia is looking to offer its first sovereign bond ever with the final size and pricing expected in December (up to $1 billion and at a 6-7% yield for ten-year paper).  Kenya is looking to add to its $2 billion offering from earlier this year as well.  This comes at a time when the World Bank has significantly lowered its estimated impact of Ebola from the $30 billion worst-case scenario to a $3-4 billion range, so between QE money and a better news story, there should be plenty of demand for these debts.  Good luck!

All the best this holiday season and into 2015!


David Burkart, CFA
Coloma Capital Futures®, LLC
Special contributor to aiSource 

Additional information sources:  Bloomberg, Financial Times, New York Times, South Bay Research, Wall Street Journal and Zerohedge. 

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