February 2015 Global Macro Recap

After January’s big surprises, February’s news looks decidedly tepid.  The US continued to roll along at a moderate pace, helped by low energy prices from the consumption side, though threatened by the coldest February on record.  At least the “Polar Vortex” mania was slightly more moderate than last year’s “Sharknado”-style media blitz.  Europe survived the Swiss Franc floating freely as it patiently waited for Q€ to begin in March.  The Greeks managed to negotiate a four-month stay of execution in terms of dealing with their economic problems (though the current word is that an additional €30-50 billion loan package may be in the works so further bitter medicine may be delayed for a few years).  Russia’s proxy fighters in the Ukraine scored a regional victory on the battlefield and strategic victory of a cease-fire, allowing them to secure recent gains.  Score two for Putin.  Some not-negative economic news out of Europe as well as impending Q€ cheered the markets.  China offered up some additional evidence that its economy is slowing though that was not officially recognized until their annual National People’s Congress in early March.  In commodities news, the plunge in oil prices caused a massive pullback in capital spending plans, with associated cutbacks in personnel.  These negative effects have not shown palpably in GDP or similar statistics but with production to still increase over 2015, consumers and businesses should be able to enjoy low prices at the pump for much of the year. 

Treading Water:  Once again US economic news turned in mixed results though they were on the balance acceptable.  The jobs report was positive for January as over one million jobs have been created over the last three months, despite the slowdown in the energy sector.  November and December also had positive revisions and February looks good. Employment Gains 2005-2015 Another way of putting the 257,000 gain in non-farm payrolls is that the increase has been over 200,000 net positions for eleven months running.  The sector gain has stayed skewed positively, with more sectors gaining jobs than losing (see left from the WSJ).  Another positive aspect has been that the annualized growth in wages at +2.2% is the largest since August last year.  Technically, the unemployment rate moved up to 5.7% but that was due to more people looking for jobs.  With the recent cold weather, there should be some oddities in the upcoming report for February.  Existing Home sales however, put in disappointing results in January as they fell an annualized -4.9% for the month, though the average price increased +6.2%.  Housing Starts also were lower by -2.0% keeping inventory relatively limited.  Finally, the Q4 2014 GDP annualized growth was revised downward from +2.6% to +2.2%.  Lower business inventories and higher imports clipped the previous estimate. 

Does this all mean that Yellen is no longer on track to raise rates?  Personally, I feel that she weighs employment gains more than economic growth and inflation (which fell 0.7% annualized in January but was up +0.2% for the core ex-food/energy components).  The trailing twelve-month core rate is actually slightly higher than a year ago and gasoline is already off the low so these results so far support the argument that low commodity price effects will be transitory.  Therefore, I think that the first +0.25% increase will occur this year, likely this summer after the Q2 GDP numbers are known.  0.25%-0.5% target Fed Funds would be still a pitifully low rate and the impact would be felt only in Wall Street not Main Street as I believe that such low interest rates are non-binding constraints to companies deciding whether to add workers and machinery.  Besides the decent employment numbers, the Fed is likely to raise rates at least by a token amount this year due to that 2016 is an election year and thus the Fed wants 1) to appear to be non-political and 2) to have a little room to lower rates in case of an emergency.  Q1 GDP may be rocky based on the West Coast port strike and the February cold but those effects should be sorted out by Q2.  The US is still the best house on a bad block.

Imminent Q€:  The European economic block is poised to begin wholesale sovereign debt buying on March 9th, joining the US and Japan in the latest round of financial substitution for economic activity. EU Inflation 1997-2015 - Germany's GDP The ECB is concerned about the slide in January’s annualized inflation of -0.5% (see graphic at right from WSJ), though quarterly German GDP growth of +0.7% for Q4 2014 was ahead of expectations.  Unfortunately, total Eurozone 2014 Q4 GDP growth was moved only one tick higher to +0.3% for a total 2014 growth of +0.9%, less than half the US rate.  The EU is forecasting higher growth in 2015, certainly presuming a successful Q€ reaction.  The Euro itself stayed at a relatively low level versus the Dollar which should help exports.  Low oil costs generally should help the European economies apart from the UK and Norway.  However, both Italy and France were officially allowed to breach their EU budget deficit limits, again demonstrating that politics of the powerful still trumps the treaties that bind the small.  European government debt is set to grow slightly to 94.4% of GDP in 2015, demonstrating again that “austerity” is simply a political word devoid of real meaning.

Proportion of Negative Positive Yielding BondsLow financing costs continue to help sovereigns control their deficit finances – Ireland issued €4 billion in thirty-year debt at 2.08% yield (lower than US yields!) in February, for example.  Last month both Germany and Finland issued five-year debt at negative yields (-0.086% and -0.017% respectively), setting a new level for issuance of negative debt at such a long tenor.  Denmark, the Netherlands and Austria have five-year debt that trades at negative yields but have yet to issue five-year debt at those negative rates.  Switzerland also has borrowed in February at record low ten-year rates, paying only 0.011% for the privilege.  The proportion of negative interest rate bonds for the main Eurozone countries can be seen in the FT graphic to the left.  When the ECB starts buying bonds on March 9th under the new program, we shall see how smoothly the system will work – will investors that have bought bonds hoping to flip them to the ECB be able to lock in easy profits (sold to the greater fool, as it were)?  Check back next month to see if Q€ mania keeps its hold!

Debt Owed by Greece coming due by 2017Greece’s new government came into their debt negotiations with the weakest of hands – they needed €5 billion by the end of February, they need to repay/rollover €29 billion (€6.5 billion to the IMF which really cannot be put off, €6 billion to the ECB which Draghi will have to figure out since the ECB is not supposed to buy Greek debt as part of Q€, €1 billion to individual European central banks and €18 billion short-term treasury notes) in 2015 (see maturity schedule above ), and they will run a modest budget deficit €338 million per their December budget… which the ruling Syriza party will tear up if they follow through on their plans to end fiscal restraint.  Hence when the dust settled at the end of February, Greece received €5 billion from the ECB as emergency loans and a four-month extension to negotiate a reform package that at least optically has Greece able to repay its massive debts.  The problem is that such talks are already considering a €30 to €50 billion package of additional loans, increasing Greece’s debts, not writing them off.  Of course, faltering countries like Spain and the other PIIGS are wondering where their free money is too!  Meanwhile, the privatization of government assets has fallen well below the amounts promised at the original bailout with only €1 billion raised of the €50 billion agreed upon.  Also, tax revenue is an estimated 22% lower than expected since the election due to people not paying taxes and hoping for forgiveness from the new government.  We do not expect any real progress to be made in March or April for that matter – as long as Greece comes up with a list of credible reforms in the near future.  People are slowly being forced to make decisions that they do not want to have to make, but are not over the cliff yet.

Ukraine’s back is not to wall yet either, though it took some body blows in February as France and Germany negotiated a cease fire agreement with Russia on the current battlefront… lines that Russia pushed in its favor after the agreement was signed.  However, the grand appeasers of Hollande and Merkel were not going to make a fuss over a little thing like lines in the sand.  On the other hand, the IMF reset its line of credit to Ukraine, adding €17.5 billion to the €4.5 billion already lent.  Whether it will be used for guns or butter is the next question.  For now all is quiet on the eastern front and Russia is distracted by its economic privations (including a collapse of the Crimean economy, a credit rating cut by Moody’s to junk (Ba1), and the tapping of half ($52.3 billion) of the government’s “rainy-day” fund to cover the budget deficit) and the assassination of an anti-Putin politician, one of the last from the reform years of the 1990’s.  It was reported that Yeltsin’s considered Boris Nemtsov to be his successor, but he chose Putin instead.  Such a potential alternative reality, a “what-might-have-been” is sobering.  

Asian Stimulus Fever:  The National People’s Congress got underway in early March and Premier Li, as is customary, set the GDP growth goal for 2015 at “around 7%.”  Obviously the goal will be met but it is a decline from last year’s +7.4% GDP, which was the slowest growth since 1990.  The headwinds are equally apparent – exports fell -3.3% in January while imports fell 19.9%, significantly worse than the Reuters’ forecast.  February PMIs are holding flat – neither showing expansion nor contraction.  Chinese New Year holidays around February 18th may be distorting the numbers but that should have been included in the expectations. Chinese Home Prices Jan 2011-Jan 2015 There is the concern of genuine deflation as producer prices fell -3.4% in January from a year ago while consumer prices moved up only +0.8% over the same period.  The Bloomberg graph on the left underscores the deflationary pressure from overbuilding.  In reaction, China’s central bank cut interest rates for the second time in three months, surprising the markets with sooner-than-expected timing.  With big infrastructure projects planned, such as the second Beijing international airport to the city’s south, big construction projects are also being looked at as the solution.  Of course, the ghost cities that dot China make one wonder about the value of such spending.

Not much news from Japan – low January inflation (thanks to falling oil prices), low January employment (though higher from 3.2% to 3.4%), decent January industrial production (+4.0%) but lower real household consumption of -0.3%.  2014 GDP growth was +0.0% so hopefully better luck in 2015.  The deficits are still record, Q¥ is still underway and the population is still aging.  Expect more monetary stimulus and more lackluster results.

Crude is the Prime Mover:  All eyes are still on crude oil, wondering when the critical commodity will calm down and recover.  However, some quick stats: 

  • US crude oil inventory has grown for eight weeks in a row by over 60 million barrels, to a level about 20% more than last year
  • Baker Hughes data shows that oil rigs count stands at 986 rigs at the end of February, a drop of 623 (or -39%) from an all-time high in mid-October 2014 (1609 oil rigs).
  • And a graphic from RBN Energy that sums up the efficiencies seen in EOG’s Eagle Ford shale oil operations:

Energy - Drill Time-Wells Per Year

NB:  IP:  Initial Production

Simply put, the US is producing more with less – and will most likely continue to do so in 2015 and 2016.  As we pointed out a few months ago, we are producing more natural gas with less than half the rigs at the peak, so we are not surprised it is happening with crude oil.  One important difference between the two is that crude is readily transported all over the world via ship while natural gas transportation is limited and costly over water.  If oil produced in North America can be limited to North American usage, then prices can stay lower for longer.  Certainly that is one of the side effects of Obama’s veto of the Keystone XL pipeline – Canadian crude is more likely to end up in the US.  Technically, the veto was over legislation forcing Obama to approve the pipeline sooner rather than later, not over the pipeline itself.  In theory, he could approve the pipeline after its “final” State Department review, but that may be long in coming – perhaps not while he is in office.  Certainly three major railcar crashes and fires in the last few weeks are not helping the idea that shipping by rail is a great alternative to pipelines. 

In other energy news, February was the coldest month on record for the continental US, pushing up heating oil prices, but with natural gas production strong and pipelinesUS Vehicle Sales 2012-2014in place to deliver to key markets, natural gas prices have stayed in a tight range, unlike last year.  US Unleaded gasoline prices moved up over 16% in February as the cold weather and refinery strikes affecting 20% of output hampered refinery operations.  Of course the low gasoline prices has spurred an uptrend in purchases of less fuel-efficient vehicles showing that Americans still love their SUVs (see graphic on right from the WSJ.com).  And while rig count may be getting low, private equity firms (Blackstone, etc.) are raising multiple billion dollar investment funds to buy out failing players and get them back to work at lower costs of capital.  Thank you QE (and Q€ and Q¥!). 

The international oil scene has Mexico’s Pemex cutting capital expenditure by $4 billion (about 15%) and the national oil company is expected to miss their 2.4 million barrel per day goal.  That will likely put a hole in Mexican government revenues, though hopefully not as much as Angola.  Angola’s budgeted revenues for 2015 are down $14 billion (25%) with the collapse of crude oil.  At 98% of export earnings (above half to China), 67% of government revenues and 44% of GDP, the country is as dependent on oil as any Middle East kingdom – and the corruption there is rampant as approximately one-third of its 24 million people live on the equivalent of $1 per day.  At least Libya is still trying to export crude oil despite its civil war – production has increased from 150,000 barrels per day to about 400,000 (though still below the 1.5 million or so from the peak) and some of it actually was exported in mid-February (600,000 barrels via tanker).

In agricultural news, Chinese stockpiles of grains, sugar and cotton are also limiting price increases in these crops in the face of stronger production and exports from North and South America.  Cotton for example – China holds 60% of the world’s cotton stocks, partially left over from trade wars with India a few years ago.  Chinese farmers responded to shortages with high production, leading to our favorite picture of the farmer with his living room filled with cotton – a soft bed for sure.  But now with US farmers announcing their planting intentions, the early signs are for more acreage for cotton than expected (though 12% less than last year).  Also, acreage indications are for less land for soy and corn though perhaps more for wheat.  Of course, final plantings and yields will finally determine crop size but with the water table soaked by snow, the first signs are for another year of decent North American crops.  Brazil and Argentina are still in the throes of their harvest, which is behind last year but moving forward.  A trucking strike threatened to disrupt some of the Brazilian harvest, but that appears to be under control now.  Their record crops will make it to market – if for no other reason than their governments need the revenue!  Coffee production too appears secure in Brazil as rains appeared in time to cause Volcafe to raise its quarterly report on supply to 49.5million bags for Brazil, almost at the high end of the estimates.  Make mine an Americano.

Finally, the CME announced that most of the futures trading pits in Chicago and New York will close by July 2nd due to a lack of volume done on the floor.  Only the S&P 500 futures and the options pits will remain.  Needless-to-say, this was not popular with the locals, but with the going public of the exchanges over ten years ago and the unstoppable rise of electronic trading, it was sadly inevitable.

Best of investing!

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

March 10, 2015

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