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PM Bulletin: Crude makes fresh multi-year lows
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AM Bulletin: Stocks slide as oil slumps
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January: Non Farm Payrolls Out Today
08 Jan 2016
PM Bulletin: Another blow-out payroll number
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AM Bulletin: China effect calms markets
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AM Bulletin: Equities slump after 2nd China trading halt
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AM Bulletin: Chinese equities plunge
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Week Ahead: Monday 18th – Friday 22nd January

Economic Outlook 

There were high hopes for a stock market rebound at the beginning of last week. Investors were recovering from their collective shell-shock following the worst New Year start for equity trading in living memory. The slump in Chinese stocks helped trigger the global sell-off as China’s policymakers once again struggled to bend markets to their will. Their overarching problem is to manage an orderly devaluation in the yuan without triggering a damaging flight of capital. The early signs are that they are failing.

Back during the financial crisis China quietly “pegged” its currency to the US dollar. Prior to this (from July 2005) the yuan (renminbi) was linked to a basket of currencies, as it is now. Initially the yuan/USD peg worked well. Global equity markets began to rally off their Financial Crisis lows in March 2009. The US dollar began to fall and the Dollar Index declined by around 15% over the next eight months. This suited the Chinese perfectly. Not only was their managed currency tied to the world’s reserve currency, but the latter was getting cheaper. This meant that Chinese exports remained competitively priced and in demand. The dollar did pick up over the next six months or so as the Euro zone crisis developed. However, by June 2010 it was waning again and it proceeded to hold around manageable levels for the next four years.

But then it began to rally - relentlessly. The dollar Index rose 20% from the summer of 2014 to March 2015 as the US Federal Reserve first tapered and then ended its monthly bond purchase programme. Despite a few minor pull-backs it has held on to these gains ever since. This move has proved devastating for those emerging markets who took on dollar-denominated debt at low rates in the aftermath of the financial crisis. That debt has to be paid back in dollars which have appreciated by 20% or more. The stronger dollar has also led to the ongoing sell-off in oil and other dollar-denominated commodities. As for China, the yuan has risen making exports relatively more expensive while its economy has slowed significantly.

Now Chinese policymakers have to guide their currency lower. They took the first step by quietly linking the yuan back to a basket of currencies at the end of last year. But the daily USD/CNY fix is still the most important aspect when it comes to monitoring FX moves. The trouble is that desperate as the People’s Bank of China (PBOC) is to lower the yuan, it can’t be seen as a one-way bet. This would play into the hands of short-sellers and would inevitably lead to capital flight no matter how tight exchange controls are. The issue for investors is the deflationary pressures that will wash up on US and European shores. This could prove devastating for developed economies currently drowning in debt. So it’s a tricky operation for China’s authorities, and considering their recent track record it’s one they could easily mess up.

This week’s major economic releases include:

Monday - USD Martin Luther King Day; GBP Rightmove HPI

Tuesday - CNY GDP, Industrial Production, Fixed Asset Investment, NBS Press Conference, Retail Sales; EUR German Final CPI; GBP CPI, RPI; EUR German ZEW Economic Sentiment; USD TIC Long-Term Purchases

Wednesday - GBP Employment data; USD CPI, Building Permits, Housing Starts, Crude Oil Inventories; CAD BOC Monetary Policy Report

Thursday - EUR Final CPI, ECB Minimum Bid Rate, ECB Press Conference; USD Philly Fed Manufacturing Index, Unemployment Claims

Friday - JPY Flash Manufacturing PMI; EUR French, German, Euro zone Flash Manufacturing & Services PMIs; GBP Retail Sales, Public Sector Net Borrowing; CAD CPI, Retail Sales; USD Flash Manufacturing PMI, Existing Home Sales; WEF Annual Meetings.

Equities Outlook

It was around nine months ago that many global indices were making fresh all-time highs. Then came the “summer swoon” triggered by China’s equity market turmoil and the authorities’ cack-handed efforts to control it. The lows from that sell-off were hit in late August. After that investors were once again in “risk on” mode and the major indices soared, boosted by the US Federal Reserve’s decision to delay hiking rates. But despite coming within 1% of the all-time highs made in the first half of last year there was not enough momentum for stocks to make new highs. Since then equities have struggled. Then the New Year brought fresh China-inspired concerns which coupled with the protracted sell-off in crude has led to another stock market rout.

Last week’s report focused on probable areas of overhead resistance for the major stock indices. These came in around the 17,800 area for the Dow), 2,080/2,100 for the S&P500, 6,400 for the FTSE and around 10,800/900 for the Dax. Of course, these now look like a moon-shot given the carnage inflicted on equities at the tail-end of last week. So it’s worth trying to identify if there’s any significant support levels from which a short-covering bounce, or even fresh buying, may emerge.

For the Dow, if it closes below 16,000 this week then 15,800/600 is the target and a retest of last August’s low of 15,250 looks possible. For the S&P500 1,870 is a big number. Below here we’re looking at 1,830 and then 1,810/20.

So these are the levels, what about the fundamentals? Are there any similarities between now and September when equities staged a storming bounce-back? Well, another US earnings season has just begun and there’s always a chance that corporate results could come in above (beaten down) expectations. But this time round the Fed has just hike rates whereas last quarter they gave the market a boost by holding back. This time round the expectation is that oil will fall further towards $20. Last quarter it was above $40 and rallying. This quarter there are worrying signs from the high-yield bond market. Three months ago these were contained. This quarter there are fears of unruly yuan devaluation. Last quarter the Chinese authorities seemed to have regained control over their stock market and currency. So there has definitely been deterioration in the financial outlook which is weighing on sentiment. If we were back in the pre-financial crash days there would be every reason to be very nervous indeed. But things have changed. Investors now expect central banks to intervene at the first sign of trouble, effectively preventing markets from doing what they’re supposed to do. It’s this expectation which could avert a disorderly melt-down. The danger is that it takes more and more intervention to produce a significant effect. This time round it may not work.


Commodity/ FX Outlook

Oil

Earlier on Friday the WTI and Brent oil contracts crashed through the $30 barrier within minutes of each other. Both contracts had broken below this level before, but not at the same time and, in the case of Brent, not in a main trading session. The break triggered a flood of stop-loss selling which sent oil even lower. The prospect of Iranian output hitting the already over-supplied markets was blamed for the move. But investors have known about the removal of sanctions for months. It seems rather far-fetched to imagine that market participants have only now woken up to the prospect of an additional 500,000 to 1 million barrels per day hitting an already oversupplied market. In fact, it is relatively straightforward to get a good estimate of supply and how it changes over time. What is more difficult to estimate is demand. It’s worth considering that lower energy prices are a symptom not just of oversupply, but also of falling demand.

To my mind the trigger was the sell-off in Asian Pacific markets. There are fears that Chinese economic growth is slowing more sharply than previously thought. As China is the second-largest consumer of oil after the US, this has obvious implications for crude prices. In a cycle that feeds on itself, lower prices mean more pain for the energy and energy services sector which has taken on mountains of debt over the past five years or so. There are growing fears of mass bankruptcies for US shale oil producers. Of course, every dollar fall in crude means getting a dollar closer to the market bottom. So now the question is where that floor may be? Will Goldman’s call in September for $20 per barrel be wide of the mark, or is $10 now looking possible?


Gold/silver

Last week was another frustrating one for precious metals bulls. Every significant advance was met with a barrage of selling and neither metal seemed capable of making any serious headway. In fact, on Thursday silver came within just a few cents of breaking below the intra-day multi-year low of $13.65 hit in mid-December. It was completely out of favour with investors as equity markets rallied along with the dollar. Silver wasn’t helped by the move in base metals. Copper continues to lead a decline driven in no small part by concerns over the state of China’s economy. More than any stock market sell-off, this has to do with suggestions that the Middle Kingdom’s year-on-year GDP growth may be below 3% rather than the 6.9% quoted by China’s policymakers.

But Friday afternoon saw a sharp reversal in the price action of both metals. This was as much a function of a sell-off in the US dollar as anything else. The dollar slumped as a succession of US data releases pointed to underlying economic weakness. In the light of this, analysts renewed their pondering on last week’s speech from Federal Reserve Bank of St. Louis President James Bullard. He said that he didn’t expect much appreciation in the US dollar in the coming year, and that’s hardly surprising when one considers Friday’s data releases (more below).


Forex

On Friday the US dollar was definitely on the back-foot. This followed the release of a clump of disappointing US data releases which stood in stark contrast to the previous week’s stellar Non-Farm Payroll numbers. Core Retail Sales fell 0.1% in December against an expected rise of 0.2%. This was a truly dismal reading for the Christmas period. Meanwhile, November’s release was revised down to +0.3% from +0.4%. Producer Prices also declined from the previous month. But worse was to come: the Empire State Manufacturing index slumped to -19.4 on expectations of a 4.1 decline – yet another stark indication of the decline taking place within the manufacturing sector. Capacity Utilisation and Industrial Production were also disappointing although there was a modest pick-up in Consumer Sentiment.

In contrast to the sharp moves in equity and commodity markets, the main EURUSD currency pair has been notably restrained. That’s not to say that there hasn’t been some significant movement in FX since Christmas. The British pound continues to slide against both the US dollar and the euro. This is not just on expectations of a delay in monetary tightening from the Bank of England. The selling pressure on sterling has intensified as investors prepare for the UK’s EU referendum which looks likely to come this year. Polls have the two sides neck and neck. Meanwhile the Aussie dollar has been in freefall as the Chinese stock market unravels and fears intensify over the state of China’s economy.

Disclaimer:
Spread Co is an execution only service provider. The material on this page is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by Spread Co Ltd or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

 

Posted by David Morrison

Tagged: Bulletin Weekly

Category: Weekly Bulletin


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