• Weekly Bulletin: The Fed, China, oil and the yen

    Economic Outlook

    In last week’s weekly bulletin we discussed the minutes of the US Federal Reserve meeting held back in March. The release of the minutes followed on from a speech that Fed Head Janet Yellen delivered to the Economic Club of New York the previous week. Both the minutes and Mrs Yellen’s speech were interpreted as dovish. This fact is important as both appeared to Trump© a number of other speeches from regional Federal Reserve presidents calling for a rate hike at the Fed’s next meeting later this month. The “hawks” (if that is what they really were) had their wings clipped. What was particularly notable in the minutes was how much emphasis was placed on “global” financial and economic developments. Committee members repeatedly cited global risks when discussing US monetary policy. Of course, when members of the Fed refer to global risks they’re really talking about China. A reasonable interpretation of this would be that the US central bank is warning investors not to get hung up on its dual mandate of maximising employment and striving for price stability. The Fed is giving itself a “get-out” clause to hold off from hiking rates further even if its unwritten targets for unemployment and inflation are hit, or exceeded. This is interesting because an Unemployment Rate of 5% can be considered to be full employment.  Meanwhile last week US core CPI (excluding food & energy) came in at 2.2% year-on-year. Now unemployment has ticked up a touch, while inflation has ticked down. But the increase in unemployment is due to formerly discouraged workers coming back into the jobs market (which is good) and inflation (including food & energy) should rise further now thanks to the recent 40% increase in crude oil prices. Really the Fed should really be getting ready to hike again, if only it wasn’t for those pesky “global risks.” But last week Chinese first quarter GDP came in at 6.7% annualised for the first quarter. This may have been the lowest reading since the financial crisis, but it was bang in line with expectations. Also, it’s considerably better than the 1.4% growth recorded by the US in the fourth quarter of 2015. In addition, China’s Industrial Production, Fixed Asset Investment, Retail Sales and New Loans were all up from the prior month and came in better-than-expected. So if the Chinese economy has turned a corner, the Fed has just lost another excuse not to tighten. You and I may question the accuracy of China’s data, but the Fed can’t. The trouble is that if investors feel that the Fed has run out of excuses not to tighten, then equities could sell off – just as they did in the New Year following their 25 basis point hike.
    This week’s major economic releases include:
    Monday - EUR German BUBA Monthly report; USD FOMC Member Dudley Speaks Tuesday - AUD Monetary Policy Meeting Minutes; EUR German ZEW Economic Sentiment, Euro zone ZEW Economic Sentiment; USD Building Permits, Housing Starts Wednesday - JPY Trade Balance; EUR German PPI; GBP Claimant Count Change, Unemployment Rate, Average Earnings Index; USD Existing Home Sales, Crude Oil Inventories Thursday - AUD NAB Quarterly Business Confidence; GBP Retail Sales, Public Sector Net Borrowing; EUR German Constitutional Court Ruling, ECB Minimum Bid Rate, ECB Press Conference; USD Philly Fed Manufacturing Index, Unemployment Claims Friday - JPY Flash Manufacturing PMI, Tertiary Industry Activity; EUR French, German and Euro zone Flash Manufacturing and Services PMIs, ECOFIN Meetings, Eurogroup Meetings; CAD CPI, Retail Sales; USD Flash Manufacturing PMI

    Equities Outlook

    The first full “official” week of the first quarter US earnings season is now behind us. The first week is often a gentle ease-in to the rest of the season with just over 8% of S&P500 companies (earnings-weighted) reporting. The next two weeks are far more significant with the vast bulk of S&P500 companies (over 64% by earnings-weight) set to post results. Despite this, the first week is still important as it includes the top four US banks by market capitalisation: Wells Fargo (WFC), JP Morgan (JPM), Bank of America (BAC) and Citigroup (C). All four posted earnings and revenues below those for the same period last year. So did BlackRock (BLK) the world’s biggest asset manager. Despite this there was no let-up in the global stock market rally which has seen the S&P500 rally close to 15% from the first quarter low hit in mid-February. In fact, the broader US market as measured by the S&P500 is within three percent of its all-time high which was hit back in May last year. At the same time US corporate earnings have already registered two successive quarters in decline (an “earnings recession”) and this is projected to be the third. So what’s going on? Well the first observation is something we have seen so often over the last few years as the “positive” effects of all the stimulus which followed the financial crisis dwindles. That is, no matter how weak earnings and revenues are projected to be by the companies themselves, analysts will always predict something worse. As a consequence, the reported numbers would have to be appalling to fail to beat the consensus expectations. That hasn’t happened so far, but of course it still could. The second observation is that it is widely acknowledged that the financial sector has just experienced its most difficult quarter since the financial crisis. The declines in Initial Public Offerings, negative interest rates and fall in trading revenues have all contributed. But it’s not just the banks that have a “get out of jail free” card this quarter. The energy sector is projected to report the biggest earnings decline. The big question now is whether business is about to improve from here. The feeling is that it may, as the headwinds from a strong dollar and low oil prices abate. This is why investors continue to climb the “wall of worry” and pay high prices to get exposure to equities. For the time being they seem resigned to push any concerns they have about high P/E multiples to one side. But given that a low oil price and strong dollar are now fading as excuses for poor results, we should expect some upbeat forward guidance from CEOs. If that isn’t forthcoming, then there will be one less reason for paying up for stocks, particularly US ones.

    Commodity/ FX Outlook


    Unfortunately this report will go to press (or pixel if you prefer) before we hear the outcome of the oil producers’ meeting in Doha on Sunday. Arguably, news of this meeting has been the biggest driver of oil prices over the last two months. Brent and WTI have rallied around 36% and 41% respectively since the production freeze plan was made public in mid-February. While the pull-back in the US dollar has also helped to lift crude, it cannot take too much of the credit. After all, the Dollar Index is only down between 2-3% over the same timeframe. Last week I was wondering if the conclusion of Sunday’s meeting could remove a vital support for oil prices. This was on the rather cynical view that even if all attendees (bear in mind producers who won’t even take part) managed to agree to freeze output at January’s levels, there was no chance that all would follow through on their promises. Additionally, let’s not forget that numerous oil analysts have said that producers need to cut supply to make significant inroads into the record crude inventories currently stacked up around the globe – a production freeze would be of little significance. But last week the International Energy Agency (IEA) released its latest report on the oil market. While it calculated that the impact of an output freeze deal "will be limited" it noted that supply/demand rebalancing was already taking place. The IEA said that falling US production and a drop in output from other non-OPEC producers would help the oil market "move close to balance" in the latter half of 2016. It further estimated that world surplus would diminish to 200K barrels a day. Earlier this year the surplus was estimated to be anything between 1.5 and 2 million barrels per day. The IEA made it clear that there would still be a production surplus throughout 2016, which means, of course, that unless demand growth were to miraculously turn higher, global inventories will continue to rise. Nevertheless, the projected decline in the surplus is positive for the oil price. But ironically a pick-up in prices brings its own problems as mothballed production comes back on line. In addition US shale producers will take advantage of higher forward prices to hedge future supply. In essence, we shouldn’t expect the oil price to revisit the $100 per barrel levels seen in the summer of 2014. As a guess, $50-60 would seem nearer the mark – assuming we don’t experience a downturn in global growth.

    Gold/ Silver

    Gold turned sharply lower in the latter part of last week. On Tuesday it briefly poked its head above $1,260 an ounce to hit its best level for a month. The push higher corresponded to the Dollar Index falling below 94.00 and recording its lowest intra-day level since the China-inspired stock market turmoil back in August last year. It looked as if gold was getting ready for a run up to $1,280 – its next staging post on its way towards the $1,300 milestone and a fresh twelve month high. However, the dollar’s decline came to a screeching halt midweek. The Dollar Index bounced off support around 94.00 while the EURUSD ran into resistance around 1.1425/50. The Dollar Index tacked on around 1.5% from its low last week while gold lost over 2% in the same period. Gold bust below support at $1,240 and $1,220 looks like the next downside target. A break below here could open up the possibility of a decline to $1,200 or even $1,180 per ounce. However, this is predicated on the dollar continuing its rally. So far support for the EURUSD is holding around 1.1260 – the 61.8% Fibonacci Retracement of the August-December 2015 sell-off. It is worth noting that silver held up well last week, despite the gold sell-off and the dollar’s rally. On Wednesday it achieved its best intra-day high since the end of October last year. It has struggled a bit since then but has managed to hold above $16 on a closing basis so far. Part of the reason for silver’s relative outperformance of gold probably has to do with the gold/silver ratio. This had been hovering above 80 for a few weeks – levels last seen at the end of 2008 during the financial crisis. This means that one ounce of gold will buy you around 80 ounces of silver. This is historically high with the average over the last 100 years coming in around 50. Last week the ratio dropped back below 77 as silver held up as gold retreated. If the ratio is now set to trend downwards, this would mean that silver should outperform gold. However, that could just mean that both metals head lower with gold falling faster than silver. But the current negative interest environment should be good for both precious metals. Zero and negative interest rates reduce the opportunity costs of holding gold. There’s less of an issue in owning gold that doesn’t pay interest if, say, bonds don’t either. But if investor risk appetite grows then both metals will be in less demand as “safe havens”.


    In the early part of last week the US dollar was continuing to weaken against most of the majors. The EURUSD hit its highest level in close to six months, while the USDJPY fell to its lowest level since October 2014. However, there was a sudden turnaround midweek as the dollar bounced. This may be a countertrend rally or the begining of a more protracted move. The greenback strengthened sharply from the summer of 2014 through the first quarter of 2015. But despite some sharp moves either way, there was no discernible trend for the dollar for the rest of last year. However, that seemed to change in early December after the European Central Bank (ECB) disappointed the markets by providing less fresh monetary stimulus than expected. Since then the dollar has weakened appreciably, despite additional stimulus from both the ECB and Bank of Japan (BOJ). The reason for the dollar’s latest move has been the Fed’s backpedalling away from its December prediction of 100 basis-points worth of rate hikes over the course of this year. The market expectation is currently for a 0.50% total rate hike – at best (worst). But last week began with a near-panic in FX-land thanks to the rally in the Japanese yen. This is one of the side effects of a weakening dollar – whether deliberately engineered or not. A stronger yen is very bad news for Japan as its economy continues to battle with tepid growth and low inflation. It is particularly worrying as Japan’s policymakers have taken unprecedented fiscal and monetary measures to weaken the currency. There is a feeling that Japanese policymakers have run out effective tools to provide further monetary stimulus. Japan has a history of currency intervention. However, this activism has waned over the years. In fact the last unilateral intervention was back in October 2011, but not only was the impact short-lived, but the USDJPY was below 80 prior to the intervention. This time round the consensus view from analysts is that no intervention will take place above 100 although some banking models put fair value for the USDJPY at around 97.00. This suggests that the yen would have some way to rise before it could be considered as overvalued. Last week the Japanese yen finally managed to pull back from recent highs, offering Japanese policymakers some relief. But the currency is not out of the danger zone. This became apparent when the USDJPY suddenly reversed direction yet again and fell sharply on Friday. The yen’s rally may have been linked to a sell-off in crude ahead of Sunday’s Doha production freeze meeting. However, if it continues this week and makes fresh multi-year lows, it could have worrying implications for risk assets in general.
    *Prices are accurate at time of writing

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