Tickmill Daily Market Notes

[Tickmill-News]

Will carry trade bonanza continue?
With world central banks shelving their plans to tighten credit conditions, investors were forced to hunt for yields in emerging markets, making carry trade the “top choice” in terms of risk/reward in the first quarter of 2019.

But will it continue further?

The regime of subdued volatility in the equity markets of the US and Europe should last for some time due to a number of statements and forecasts of the ECB and the Fed, which can be unambiguously interpreted in favor of keeping rates at the current level or even reducing them.

For the European Central Bank, there was a reduction in GDP and inflation forecasts for 2020 and 2021 at the last meeting, as well as a signal for a new TLTRO round, i.e. flexible and small-scale easing measures. Against this background, the talks about rate hikes would at least send a conflicting signal to the markets and make it difficult to interpret the policies of the ECB.

The Fed, in turn, announced the imminent completion of the process of reducing the balance of the assets, i.e. turning off the autopilot mode, which Powell talked about in December. The reason for this decision was also implied the inconsistency in the policy of the regulator, where the pause in the rate increase, indicated in January, was combined with the tougher nature of the decline in assets on the balance sheet. That is, the conflict signal for the markets, the Fed soon called for interpreting in favor of further bearish policy changes. In other words, the transfer of the balance of assets under “manual control” in this case served as an important confirmation that the pause in tightening the policy is not transitory.

The need for the Central Bank to make binding commitments (as it is intended to preserve the reputation and correct transmission of monetary policy decisions) in turn becomes the final step in the reasoning why large central banks have provided and will continue to provide a lot of time for the safe carry trade.

According to HSBC, the carry trade has already yielded investors about 5.5% since the beginning of 2019, due to asset returns and FX returns. At the same time, the year 2018 was marked by a negative return for the carry traders in the amount of 1.4%, apparently due to the period of the Fed interest rate increases.

BNP Paribas predicts that the short-term trend of large economies will not enter either the extreme growth zone or the strong decline zone, so the carry trade remains an attractive opportunity to earn.

But if the yield differential is high enough to attract investors to the carry trade, then the second factor of preference, i.e. risk can soon scare them away. The first in the list of risks is the US trade conflict with China and in favor of the growing chances of realizing this risk is the postponement of the deadline for negotiations until June of this year. The second is the threat of accelerating inflation or the increased credit risks of developing countries, again as a result of the slowdown in world trade.

Despite possible threats, investors gained long positions in the Mexican peso by 2.3 billion against the dollar since January 2019, the latest CFTC data showed. The net position on the ruble also rose from almost zero to 22.6K positions in the trading week ending March 15.

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

 

[Tickmill-News]

Only recession could be worse: Why the Fed’s Wednesday surprise lies between neutral to mildly bullish range.
On the eve of the FOMC decision on Wednesday, the market is contemplating two base case scenarios: soft policy comments, while preserving the possibility of 1 rate hike this year and 1 in 2020, or an even softer bias with only 1 rate hike in 2019 with a corresponding downside revision of economic forecast. At the same time, the old dot plot, which boldly indicates two increases in 2019, diverges drastically from the current Fed stance and it will probably need to be revised. The question is whether the FOMC will be able to correct the “problematic channel of communication” with the market so as not to give a signal for future recession and at the same time avoid a premature hint of a rate hike that Bill Dudley, the former head of the New York Fed and analysts Morgan Stanley discussed this week.

The federal funds market went even further in anticipation of the end of policy normalization, believing that the Fed would have to lower the rate in 2020:

Dudley, answering questions in an interview with Bloomberg, said he expects the Fed to extend the pause in providing accurate guidance to the markets due to sluggish and iffy momentum of the economy in the first quarter. According to him, this may change in the second quarter, when the conflict signals from the economic front will be replaced by more predictable dynamics and the Fed will be able to “come into play” again.

Dudley believes that only weak inflation prevents the Fed from continuing to raise rates. If a recent wage increase finds a way into the consumer inflation, which usually occurs, but with a lagging nature, then the current expected limit of normalization of the policy can be lifted.

The former Fed top manager said that the Fed will probably devote March meeting to the discussion of fine points of balance sheet runoff. Recall that at the last meeting in January, Powell unexpectedly announced that the Fed was leaning in favor of maintaining abundant reserves system to ensure the effectiveness of the transmission of monetary policy. The federal funds rate, which the Fed announces, “does not oblige” banks to borrow or lend to each other precisely at this rate. Depending on the demand and supply of money it can fluctuate in a range and its precise value is called effective funds rate (EFFR). The upper limit of the corridor of fluctuation is controlled by the rate on excess reserves (IOER), i.e. the interest that banks earn by keeping money in the FRB accounts. The lower limit of the corridor is adjusted by REPO operations. If the Fed believes that the EFFR went too low, they increase repos with banks, in effect replacing securities (assets on the balance sheet) with cash borrowed from banks. Then the supply of federal funds in the market falls and their cost, i.e. market rate rises.

So, taking into account how this mechanism works, the Fed should maintain a sufficient level of securities on the asset side (and as a result, encourage banks to maintain excess reserves in the Fed accounts) so that in case of deterioration of control over the market rate, the volume of repos can be increased on a large scale.

Here you can see how excess reserves started to rise after the Fed signaled the early end to balance-sheet decline:

In addition to the issue of policy transmission, Powell also mentioned the problem of conflicting signals, which arose when a pause in raising rates was announced and at the same time, the balance sheet continued to decline. After the signal at the last meeting that the sell-off of assets will soon be completed, the market is interested in the composition of the balance of assets that the Fed will choose. Since the bulk of the assets will fall on treasury bonds, the market will be interested in detail on their maturity structure. Obviously, the shape of the yield curve, and, consequently, inflation expectations, will depend on this.

Formally, Dudley’s views cannot in any way reflect the FOMC position, but in reality, he can safely “correct the direction” in which market expectations are formed (without threat to the Fed’s reputation) so that the market will be more or less prepared for the bullish surprise of the regulator.

Given that the federal funds rate futures are pricing the rate cut in 2020, the Fed will find it difficult to negatively surprise the market. The worse is only a warning about recession. Therefore, in my opinion, the expectations of the response in sensitive assets should be based on a neutral meeting or weakly positive surprise.

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

 

[Tickmill-News]

Yuan’s confident rally drops some clues about trade talks success
The Asian markets opened on Wednesday with a decline as a result of investors’ tendency to liquidate their long positions in Asian stocks before the period of high market turbulence. The meeting of FOMC officials is today, which should determine the fate of monetary tightening cycle in the US.

The broad MSCI index, which tracks the aggregate stock returns in the Asia-Pacific region, except Japan, fell by 0.2%. The leaders of the fall were shares of Australia and South Korea.

European stock futures have been also wary about possible surprises in the US. The concerns drove futures lower indicating that European session is also likely to spend most of the time in the red zone today.

The Japanese Nikkei index lost 0.2%, while shares of companies in mainland China have changed little, posting tepid response to the updates on trade negotiations.

New difficulties in trade talks between China and the United States have become one of the reasons that deprived the stock market of a positive mood. Bloomberg said that China does not agree to some of the demands of the American side due to the lack of guarantees that the tariffs will be canceled after the deal is made. At the same time, the WSJ, referring to sources familiar with the course of the negotiations, wrote that the negotiations have reached the final stage and the end of April is the reference date of the deal. US Trade Representative Robert Lighthizer and Treasury Secretary Stephen Mnuchin plan to visit China next week to sum up the interim progress in the negotiations, the White House administration said on Tuesday.

Yuan has been decisively updating highs thanks to positive WSJ note:

Asian firms are postponing investment plans as indicated by INSEAD poll. The confidence remained at the lowest level for three years in the first quarter and contagion spread to investors who are not in a hurry to stage a rally in the stock market. Trade wars, interest rate hikes and slowdown in the Chinese economy were listed among the top risks for the companies.

The Fed is expected to leave the interest rate unchanged at today’s meeting, so the focus of market participants is shifting to the regulator’s expectations, in particular, plans to complete the asset sales program and the change in forecasts for macroeconomic indicators – GDP and inflation.

Since the beginning of this year, Jeremy Powell has persistently intertwined the phrase “patient Fed” in his comments, so that with the incoming data more and more it acquires an interpretation of the Fed’s intention to complete the normalization of monetary policy. Futures on the interest rate price in first rate cut in 2020 and based on this fact it will be difficult for Powell to disappoint the markets today.

The current volume of assets on the Fed’s balance sheet is about 4 trillion. dollars, consisting predominantly of treasury bonds and mortgage-backed debt. It is difficult to call the program of reducing assets on the balance sheet as such, since after buying assets from the pre-crisis level of $900 billion to $4.5 trillion, the Fed was able to release to the market a total of $500 billion worth securities. The need for the swelled balance sheet stems from the transition to the so-called system of abundant reserves where the major amount of excess reserves of banks are kept on the Fed’s accounts, which makes it easier to keep the market federal funds rate within a certain range. The final balance at the time of the completion of the asset sale program is projected at $3.85 trillion and the composition of the assets will primarily contain treasury securities.

The British Pound remains hostage to Brexit-related headlines.

Prime Minister Theresa May will be begging for another postponement for leaving Britain from the EU for at least another three months after the third vote on her plan failed. May’s blackmail of the Parliament is now in the simple principle of “My plan or no plan” and asking the EU to delay the process can bring the process closer to “no” plan that certainly won’t suit the Parliament. On the other hand, the head of the EU Brexit negotiation team, Michael Barnier, said that extending the time frame for discussing the plan would make sense if May’s chances of ratifying her agreement increase in the Parliament.

Oil continues to cautiously update its highs against the background of a decrease in the activity of American oil companies, as shown by data on drilling rigs from Baker Hughes and a gradual shift in market equilibrium in favor of the deficit, which the IEA recently warned in its report.

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

 

[Tickmill-News]

Small-Cap vs. Large-Cap Stock Rotation: How it can predict a slump in the US economy?
Fed Policymakers confirmed their marked shift in tone after their meeting on Wednesday, with a downward revision of inflation and GDP forecasts, as well as significant downgrade of the dot plot. Fixed-income securities rose sharply as they reached on only one increase in 2020.

Prices of US Treasury bonds posted the highest daily gain for several years as the meeting basically led to an unexpected downside revision of nominal rate and inflation outlook. At one point, bond yields fell below the effective federal funds rate.

Surprisingly, the appetite for risk assets also remains steadily high, as can be seen from the returns of the S&P500, confidently targeting the historical peak of 2900 on Thursday.

The demand for stocks and bonds reflects a diametrically opposite attitude to risk. This is due to a differing degree of certainty in future cash flows. Theoretically, it’s also due to the fact that the growth of stocks is accompanied by a decrease in the value of bonds, and vice versa. However, this is not always the case.

Since the beginning of 2019, both the stock market and bonds have risen, which raises the question of an unobservable factor breaking the correlation. Either the stock market knows something more than the fixed income market, or vice versa. The latter option is more likely, as disturbing movements in bonds are known for their predictive potential.

The yield on 10-year securities went down to 2.539% on Friday, which was last observed in January 2019 when rumors began to circulate about the end of the recovery phase and the imminent transition to recession. In particular because of the “error” in the Fed policy.

More recently there are also examples where stocks and bonds have been growing simultaneously. For example, in February 2016, the yield on 10-year Treasury bonds decreased from 2.32 to 1.36% over six months. In the same period, the stock market grew by 17%.

The boost for both stocks and bonds came largely from the Fed who announced a pause in tightening until almost the end of the year, and only then resumed rate hikes.

The current situation is very similar to one back in 2016. A study of the causes of concern back then in the fixed-income market, in particular the two leading indicators, could make it possible to understand what considerations investors in bonds are guided by today.

Firstly, it’s worth noting that in 2016 the Chinese economy failed, as can be seen from the slump of export orders for the country’s manufacturing sector. As China’s main trade partner is the United States, the fall in Chinese export orders is largely a reflection of the decline in demand for imports to the US. This is a mechanism for transmitting a fall in economic activity from a leader in production to a leader in consumption. Now, when one of the worst times in Chinese history has come for their manufacturing sector, we can expect a sluggish increase in import prices in the US (which also determines the dynamics of consumer inflation in the US). As a consequence, we can also expect a fall in compensation for inflation in US bonds. The chart below shows how closely China’s export orders and US bond yields are.

Export orders are the leading indicator that predict consumption of imported goods in the US.

It’s also prudent to mention that when trying to predict economic fluctuations, it’s useful to take our attention to stock “rotation” in the US. There is value vs. growth rotation as well as small-cap vs. large-cap rotation happening, depending on underlying economic trend. Small-cap stocks are usually more vulnerable to cyclical factors as their number prevails in cyclical sectors of the economy. For example, in sectors like retail, real estate, raw materials processing, production of some non-sophisticated goods and the restaurant and hotel industry. Such concentration in sectors is logically related to the level of their capital intensity.

If managers expect negative cyclical factors to take effect, then plans for output and investment will be adjusted accordingly. Investor expectations will also be lowered. Accordingly, the dynamics of the shares of small vs. large capitalization can be expressed by a simple ratio of the corresponding indices for example: Russell 2000 and the S&P500.

If we compare the joint dynamics of this relationship and the yield of 10-year securities, it can be seen that the flow from small companies subject to cyclicality, to large-cap companies is accompanied by a drop in bond yield. This is logical if the economy is going to slow down.

These indicators shed light on the near future of economic activity in the US, which may soon go into a slowdown phase. The question remains however: what contributes to, and for how long will the US stock market growth last?

We always want to start a conversation so, get involved and let us know your opinion!

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

 

[Tickmill-News]

Industrial Profits in China Indicates Slowing Manufacturing – Key Burden on the Economy.

The Chinese industrial sector continues to be an increasingly painful burden on the economy. Data released on Wednesday indicated that in the first two months of 2019, profits of enterprises suffered the strongest decline since 2011. The slowdown in domestic and foreign demand is fueling growth of the surplus of production capacity, a structural issue of the sector. It’s aggravated further by the transformation to the consumer growth model.

The sharp reduction in profits could ensure some deferred negative consequences like an increase in unemployment rate, rising number of defaults on the bond market and cuts in capital investment plans. This should lead to the fall in optimism of households and firms, which makes it more difficult for monetary and fiscal stimulus to impact aggregate output. In addition, the target GDP growth rate of 6.0-6.5% that was set for 2019 is likely to remain, on paper, as the decline continues despite government support measures.

As reported by the Bureau of National Statistics on Wednesday, enterprises’ profits fell by 14% YoY to 708.01 billion yuan in January-February – significantly exceeding the moderately negative outlook of -1.9%. Although the assessment was formed specifically over a two-month period in order to smooth out the distortions associated with the celebration of the Lunar New Year, the attempt to “softly manipulate” the data could not hide the impact on industrial activity.

It should be noted that profit changes are indeed subject to seasonality and sharp decreases in the first months of the year:

The numbers look even more daunting if we look under the hood of the report. Firstly, deflation hit key industrial components such as carmakers, oil refineries, steel and petrochemical industries. Secondly, the fall in profits also consisted of a slowdown in sales and the accumulation of unsold goods. The leaders in terms of decline were: the oil refining industry and smelting non-ferrous metals and steel, where profits decreased by 37.1 billion and 31.7 billion yuan, respectively.

The average margin of the manufacturing sector in China does not exceed 5 percent. At the same time, because of the state support of some sectors, the variation in the indicator is quite high and many firms suffer losses. The government will probably have to continue to reduce the VAT burden in order to maintain the profitability of enterprises. China’s largest steel mill, Jiangsu Shagang, reported that profits in the first quarter of this year could fall by 68.6 percent in annual terms. Sales of Chinese cars also switched into reverse, falling by 13.8% in February compared with last year, declining for the eighth consecutive month.

The variation of profits by type of firm ownership in favor of less damage to private enterprises may indicate some effectiveness of credit stimulus to the private sector:

Earlier this month, Beijing announced a 3% reduction in VAT for the manufacturing sector but, if it allows firms to keep afloat for some time, it’s unlikely that it will be able to move companies from “austerity” mode, which is what leads to a reduction of hiring and investments. According to some estimates, stabilization in the manufacturing sector will come no earlier than in the second half of 2019.

Foreign investors also lost faith in the revival of the manufacturing sector in China. On Monday they liquidated their positions in China’s mainland stocks by 10.8 billion yuan, which was the largest decline since opening access through Hong Kong in 2016.

ShCOMP fell by 2%. It is worth noting that, historically, the exit of non-residents from stocks preceded an even greater fall in the stock market.

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

 

[Maikeisha Cuyler]

So, the NFP is important away from the Unemployment rate?

An analysis in favour of a weak NFP:
for weaknesses in the US economy.
After the Fed characterized the growth of economic activity in the US as “strong” at a meeting on Wednesday, it is unlikely that any economic report will surprise the market, even if it beats the forecasts. Therefore, today’s report does not hold much hope, the general Fed tightening course comparing to other Central Banks is now a sufficient driver of growth for the dollar. But do not assume that a negative deviation in the report will also pass unnoticed.

The case below is in favor of the second option.

As was indicated by the ADP report released on Wednesday, the US economy is likely to have maintained a high rate of hiring in July. The growth of jobs according to an unofficial estimate amounted to 219K jobs, which exceeded the forecast of 186K. The indicator of employment from the ISM changed insignificantly in July compared to the previous value of 56.5 points. Values above 50 signal that the economy is in a state of recovery.

High consumer optimism in July (127.1 points) indirectly indicates a possible improvement in pay and a rise in vacancies, since consumers usually closely associate their well-being in the future with rising incomes and the ability to change jobs.

As for unemployment in the US, in July we see the following change of unemployment benefits:

“Fresh” unemployment (initial applications):

Note: the blue line is the actual reading, the purple line is the forecast.

In July, the rate of initial unemployment claims was below projections throughout the month. This suggests that the pace of transition from the category of employed to the unemployed declined faster than expected, which is undoubtedly good for economy. This could indicate one of two things – either the working conditions are good, and wages are sufficiently high which could mean that people are less willing to leave the jobs, or the forcedly stay at work, which is certainly unlikely. In the second scenario, the rate of layoffs is also growing, so if the economic situation worsens, the indicator of initial claims will grow more rapidly.

That is, according to the initial claims report, July proved to be very successful for the labor market.

Now let’s take a look at the “old” unemployment (continued claims):

Throughout July, the indicator exceeded the estimate. It turns out that finding a new job or starting to work was harder for unemployed than expected. Given that some economic reports such as ISM Employment or PMI indicators warned of a growing labor market deficit, a weak indicator of continued claims indicates a “disconnect” in supply and demand-side qualifications. That is, employers, for example, make demand for workers of high qualification, and the labor supply is mainly represented by low-skilled labor force (a common scenario happens). However, what is interesting here is that a structural problem could hinder the growth of wages.

As you probably already know, inflow into the labor force (population 16-64 years) is about 100K per month in the US (supply increment). We add to this number the part of labor force who turned into unemployed and claimed for unemployment benefits for the first time. It turns out that in order not to widen the deficit in the labor market, the remaining new jobs, roughly speaking, should be covered, by a reduction in the previously unemployed (continued claims). We do not take into account the slight fluctuations in the level of participation in the labor force.

Let’s take a look at the change of continued claims for the last three months:

In May – the indicator decreased and was mainly below the forecasts, that month BLS released reports on the growth of employment in almost all sectors. In June, the indicator was also better than expected, with a continued decline, BLS reports a reduction of 21K jobs in the retail sector. In July, we see that the indicator is worse than the forecasts, so we can assume that the Labor Department will indicate a reduction in activity or lack of expansion in several sectors. The forecast for pay and the increase in jobs are respectively moderate.

References to the reports of the Ministry of Labor:

For May: https://www.bls.gov/ces/highlights052018.pdf

For June: https://www.bls.gov/web/empsit/ceshighlights.pdf

Sector reports will be useful to study in the context of Trump tariffs, for example, slowing employment growth or layoffs in industries that have already been affected by tariffs (for example, steel). It is possible to single out the following sectors, which use steel intensively:

1. 
   
   
   • Construction
   • Transport and mechanical engineering
   • Infrastructure for Energy
   • Packaging
   • Household appliances

For June, in all sectors as a whole, we see job growth.

The impact of tariffs has not yet been traced in terms of employment. But as the accommodation is gradual, the reduction in the use of labor cannot follow immediately, and we will explore July for the reaction of firms to tariffs in terms of hiring. Along with the Fed’s bullish position, it is also worth recalling the statements by Powell that “small US firms already feel the tariffs. This is not visible in the aggregated data, but signs of economic discomfort will show up gradually. ”

Today, I’ve presented the case in favor of a weak NFP, which could hinder the growth of the dollar. In general, everything seems to be working out alright for the US economy, and there seems to be no reason for worries, but “smart money” is probably already in search of the first signs of weakness, isn’t it?

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

 

[Tickmill-News]

Is the ECB regretting the end of QE?

After the ECB completed its asset buying program in December, the economy barely showed signs of self-sustained growth, with trade wars seemingly choking growth substantially.

Inflation expectations, measured through forward swaps, collapsed, while Thursday CPI data (1.3% vs. 1.5% of the forecast) fueled concerns that things are spiraling quickly out of the ECB’s control:

It’s unclear to some, as to why the ECB decided to taper off purchases, at a time when core gauges of economic health were dire:

Inflation on industrial goods collapsed in the Q4 2018, not taking into account fuel’s downtrend that has been running since the end of 2015 (green line).

In order to search for positive points recovery, one could investigate German production figures, the powerhouse of EU. However, we’re still confronted with an unpleasant surprise:

Production of passenger cars in Germany is falling at an alarming rate, with figures similar to those seen in the 2008 crisis. At the same time, the barrier to sales was not only a slowdown in demand in Asia, but also a decline in domestic sales.

Pessimism grew in corporate expectations, and they have steadily declined until today:

It remains a mystery to some, as to why the ECB decided to stop supporting the economy. Although there is an assumption: a structural imbalance in terms of growth prospects for the economies of the periphery and the core. “Narrowing” the growth gap was done through credit easing. Therefore, if weak economies lose nothing, then stronger economies like Germany prefer to have some monetary tools reserved to impact the output in the event of a recession.

We always welcome other opinions, so why not share! Do you think that ECB made a mistake by ending their QE programme?

In other news, Asian stocks rose on Friday. The main surge of optimism came from the Chinese stock market, thanks to reports of a breakthrough in the US-China trade negotiations. The global bond rally seems to have run out of steam before the end of the week, marked by a strong flight from risk.

The Shanghai Composite Index jumped 3.2%, after receiving an essential dose of confidence. Growth could potentially extend next week, after White House officials stated that China had taken the first step in resolving key bargaining differences, namely, determining the conditions for a fair playing field in getting long-term technological leadership.

On Friday, Mnuchin said that a working dinner with Chinese colleagues turned out to be very “productive”, increasing the hope that further statements on the progress of the negotiations would balance the news background, already badly damaged by the statements from the ECB and the Fed.

The robust position of US indices primarily speaks of the favorable reaction of investors to the signal of support from the Fed. The stock market does not share the concerns of the bond market, which is reflected in the simultaneous growth of both, generating a conflicting signal in assessing the prospects for economic recovery. Since the beginning of the year, SPX has soared by 12.3%, posting the best realized return since 2009.

The yield on 10-year Treasury bonds rose to 2.402% on Friday, after dropping to a 15-month low of 2.352% on Thursday as the Fed began to cut plans for policy tightening. The negative spread between the yield on 10-year and 3-month bonds, observed at the end of last week, demonstrates the expectations that, even in a three-month investment horizon, even deeper Fed concessions may occur.

Sadly for the Fed, the fourth-quarter US GDP was revised from 2.6% to 2.2%, consumer spending to 2.5%, and the price level of goods (excluding imports) rose by 1.7%. This adds to concerns about inflation, which is losing momentum because of a deterioration in foreign trade (i.e. a component of imports in inflation).

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

 

[Tickmill-News]

Mnuchin sounds upbeat ahead of new round of trade talks, helps traders to boost risky bets
US Treasury Secretary Stephen Mnuchin sounded upbeat on Friday saying that he had a “productive working dinner” in Beijing on the eve of another round of talks aimed at resolution of the trade dispute between the two largest economies in the world.

Mnuchin and US Trade Representative Robert Lighthizer arrived in Beijing to meet their Chinese peers for the first time after the parties failed to talk at the Trump-Xi summit in Argentina.

“We had a very productive working dinner last night, and we are waiting for today’s meeting,” Mnuchin said before the meeting with Vice Premier of the State Council of the People’s Republic of China Liu He, who is due to visit Washington next week to continue the talks.

Mnuchin did not go into details, and it is not clear who attended the dinner on Thursday.

Last year, Trump imposed tariffs on Chinese products worth $250 billion in an attempt to force China to open economy to the rest of the world and level playing field for Chinese and foreign companies on the domestic market.

White House economic adviser Larry Kudlow said that the United States could lift some duties if parties strike a deal, but would keep some of the tariffs in order to make sure that China remains committed to the agreements.

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

 

[Tickmill-News]

Should we dismiss February retail sales data again? What about other reports?
After some dire January retail sales figures following the US Government Shutdown, February’s data was expected to recoup some of the emotional balance of investors. However, despite the market writing off some of the issues associated with the shutdown in January, February’s data did not bring back much harmony.

Sales in the retail sector declined for the second month in a row, according to preliminary estimates. Despite the fall in the broad index being less dramatic (-0.2% against the forecast of 0.2%), the change in the core index (-0.6%) has seriously jeopardized the path to target inflation. Two months of decline in retail sales, coupled with mediocre demand for durable goods and falling residential investment, spells bad news for the US economy, where about 70% of GDP is consumption. But, let’s not rush to judge without taking a look at the revisions…

Sales in the control group, which some economists view as a clearer “imprint” of consumer spending on retail goods, also fell by 0.2%. Indicating that the US is missing its growth target. A positive point, however, was the revision of sales in the control group to 1.7% in January. This gauge attempts to provide the best estimate of volatile discretionary purchases, which are highly dependent on behavioral factors. Factors include the perception of future income and well-being, which come after the necessary purchases. Actually, in contrast to the base indicator, where fuel and car parts spending are excluded, construction materials and food products are also not included in the control group indicator.

The upward revision of the rest of retail sales estimates suggest that, it’s too early to wait for a correct estimate of consumer spending in the first few months of 2019. In 2013, the shutdown of the government (shorter than the last) also affected data collection and processing and created huge discrepancies between the preliminary and revised readings, which were resolved only after three months.

According to the current data in annual terms, broad retail sales index grew by only 2.2%. It should be noted that in the summer of 2018, the YoY growth rate was about 6.8%. By the end of last year however, it went off the growth path quickly due to seasonal factors, which normally tend to boost consumer spending. In December, retail sales found a bottom at 1.6% growth, which was the lowest reading since January 2014.

Retail sales declined in 7 of 13 categories, with the least spent within households on building materials and garden tools, with the corresponding figure falling by 4.4%. Purchases of electronics and household goods decreased by 1.3%, which was the worst change since May 2017.

The dollar index rose, probably ignoring retail sales for February, as the estimates continue to remain unreliable. The indices of manufacturing activity from Markit and ISM differed in assessments of the state of the sector, which resulted in polar changes in broad indices. The final estimate from Markit fell by 0.1 points to 52.4, with the figure from ISM jumping to 54.3 points.

According to Markit’s calculations, the main contribution to the decline in the index was made by the weakening of consumer demand, with some delay affecting production volumes. In this case, the next in the cyclical chain is the labour market, which should recede from the highs with the subsequent upward correction of unemployment from ultra-low levels. The leading export orders indicator barely increased according to Markit calculations. It is noteworthy that ISM made the opposite conclusions and pointed to the growth of orders and production volumes. Distortions in statistics are likely to be the cause of strong discrepancies in the estimates.

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

 

[Tickmill-News]

Volatility preference” as a Reason for Bitcoin Growth
Considering the risk-return preference of the traditional investor, the goal of maximizing expected return should be accompanied by the goal of minimizing risk. The volatility of asset return serves as the proxy of risk and, since it has an exogenous nature (consequence of market shocks, i.e. news), it’s essential to have an intuitive understanding of the link between volatility and risk.The most generally accepted idea is that the volatility of return tends to react asymmetrically to “bad” and “good” news. After the release of bad news, the volatility of returns often increases exponentially and lasts longer than with the release of positive news.
In the stock market, this pattern is entrenched in the saying “the market goes up the stairs but goes down in the elevator”. If we take a stock as an example of an asset, the explanation of this pattern may look like this:

1. The market experiences a negative shock.
2. The Stock price falls.
3. Market capitalization of the stock decreases and the share of bonds increases in the capital structure. Capital structure is defined as shares + bonds.
4. Consequently, the risk of holding those shares increases.
5. Thus, if the increase in volatility is associated with ‘bad news’ it’s a reasonable assumption that traditional investors may avoid the stock.

The first models investigating the clustering of volatility such as ARCH and GARCH revealed this drawback, which led to the creation of improved models like EGARCH. EGARCH allows the inclusion of an asymmetrical response to differing shocks, showing that it models the behavior of volatility much more effectively.

For some traders however, increased volatility may be preferred as opposed to being undesirable. For example, when using some simple option strategies such as straddle, increased volatility could positively affect profitability. Due to this, its only logical that some traders may be attracted towards non-traditional asset classes, including cryptocurrencies.

The recent capitulation of world central banks attempting to normalise monetary policy (declaring a pause of indefinite length) was probably one of the reasons for the synchronized inflow into the cryptocurrency market. Just this Tuesday saw a surge in popularity to the tune of $100 million, through Coinbase, Kraken and Bitstamp.

Some analysts believe that the policy of world central banks have the potential to rescue the cryptocurrency market from oblivion for a while, i.e. will become the main medium-term driver of cryptocurrency appeal.

One advantage that cryptocurrencies have in the ideological war between fiat and digital currencies, is due to the relative failure of Central Banks policy. For example, the concomitant renewal of the authorities’ interest in the blockchain, or the willingness to make concessions in their legal use, remains at just curious speculation.

If we consider volatility as a stationary process (returning to the long-term average) we can apply it to the price movement of BTC. The volatility of BTC returns were almost at historical minimum in March, before a sudden a surge of activity came along – as highlighted in the graph below.

The behavior of volatility in response to positive market shocks in non-traditional assets should now be different from the behavior of volatility in the traditional securities. This is firstly because the cryptocurrency market threw off its main speculative burden. Secondly, the standard methods of fundamental valuation of assets are inapplicable here. After all, what makes BTC a security? Thirdly, traders’ preferences are completely different here. Consequently, there are no reasons for the rejection of volatility similar to the example explained earlier in this article.

The fundamental reason for growth is still unclear. However, the coordinated movement of prices on three major exchanges, where purchases of 7,000 BTC on each exchange in one hour, suggests that this was the realisation of a pre-conceived plan. It is also curious that the daily trading volume of Tether was around the same volume as in BTC:

Obviously, the market growth was led by the BTC/USDT pair. It is also worth mentioning that Tether updated their main page, stating that each coin is backed with traditional currency, cash equivalents and other company assets.

Strong market movement was accompanied by many traders hitting their SL, trend following within crypto and the expiration of a large amount of put options on the Deribit. On Tuesday the trading volume on the digital derivatives stock exchange jumped to $40 million! This clearly indicates how important it is when analysing market sentiment, to not underestimate the impact of the derivatives market on the underlying asset.

We’re always looking to carry on the conversation, so get in touch and let us know what you think about the appeal of Bitcoin volatility!

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

 

[Tickmill-News]

German GDP growth revised lower unexpectedly… Is the ECB under pressure?
European stocks are sneaking up into the familiar terrain of last August, when there was a peak of healthy optimism about the European economy. Unfortunately, the current rally has nothing to do with underlying economic stability, relying entirely on signals from the ECB to fight the slowdown. The transition from signals to straight-forward action may be occurring sooner rather than later. Especially after the worrying news that the leading economic institutions of Germany, a symbol of economic prosperity in the Eurozone, updated their GDP growth forecasts for 2019 by slashing projections almost twice.

A month ago, Germany was on the brink of a technical recession, barely avoiding negative GDP growth for two consecutive quarters:

However, “rising from the ashes” became a pipedream for the largest economy of the block, especially after several German think tanks cut their growth forecast from 1.9% to 0.8%, Reuters reported. What’s most concerning is that this data is also used as an input in the calculation of the government macroeconomic estimates. Leading to far-reaching consequences like renewed pressure on the ECB and the adjustments of fiscal policy. In January, the government believed that output would rise by a modest 1.0% in 2019.

A negative jump in expectations demonstrates the sheer scale of the slowdown in Germany. Previously under pressure, not only because of a slowdown in Chinese demand for imports (mainly cars), but also due to the thinning of financial and economic ties with Britain, as well as with the reversal of US free-trade policy.

In February, the economic situation in Germany issued several wake-up calls:

Car sales have also been extremely disappointing, with dramatic drops in production shown below:

When analysed separately, the index of economic surprises, as published by Citi, gives the impression that the Eurozone economy has passed the bottom. Over the past three months, positive news has been outweighed on the economic front. However, the stance of the ECB and the latest inflation data suggest that it may be prudent to look for optimism elsewhere.

Germany’s strong dependence on trade with China, suggests that the economic rebound should follow the revival of production strength in China. Production PMI in China, which unexpectedly entered the expansion zone (above 50 points) had a positive impact on expectations but, a single report is not enough to conclude that there is emerging growth momentum. This kind of assumption should be priced immediately in the markets.

Risk Warning: Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

 

[Tickmill-News]

Lagging” ADP calculation could underestimate actual jobs growth
Non-farm Payrolls probably rebounded in March, making up for a murky February reading. Back in February the reading hit a 17-month low, with only 20K jobs added. Usually the start of spring supports activity in construction while manufacturing PMIs signaled about continuing revival in production sector.

The pace of construction spending accelerated in first two months of 2019 – by 2.5% in January and by 1.0% in February. The positive NFP report should shift the balance of arguments in favor of a transitory slowdown in the economy, which the Fed still has faith in. This will certainly underpin hopes that the US Central Bank won’t step into the ECB shoes as US policymakers attempt to maintain neutral tone of the comments. In doing so, the Fed would basically be acknowledging that the ECB’s early tightening was a mistake.

However, the US jobs market is unlikely to repeat the feat of last year. Coming at the height of fiscal stimulus, while firms face increasingly strained labor shortages and tightened credit conditions that constrain capital spending.

The rise in jobs is expected at 180K in March, while unemployment probably nudged higher, to 3.8%. These number are the median estimate of experts polled by Reuters. Some attention should be paid to the revised February reading, which should additionally smooth concerns over the slack in the labor market.

It is likely that the economy has moved to a lower gear because of the damping effect of the tax reform, which apparently could not ensure much desired “self-sustained” growth. The decline in trade due to the rivalry of Beijing and Washington for technological leadership, as well as a slowdown in foreign demand, stoked concerns that longest streak of economic expansion may be soon brought to the close.

In the first quarter it is expected that the economy will grow by 1.4% – 2.1% in annual terms. The fourth quarter GDP was revised from 2.6% to 2.2% due to a sharp decline in retail sales, which is one of the main components of consumption. In turn accounting for almost 70% of the aggregate demand.

The ADP report released on Thursday, estimated job growth in March at 129K, somewhat limiting optimism about today’s report. On the other hand, the ADP calculation model includes data from past months, as well as information about jobs coming not directly from companies. So, the February slowdown could have affected the March indicator. Econometric studies show that the official data was lower than the ADP when temperatures in the first two months were below seasonal norms. However, with improved weather, the Ministry of Labour often exceeded their estimate the ADP reading. It is difficult to accept the assumption that the ADP data for March caught a real weakness of the labor market, especially in light of more than encouraging figures on the initial jobless claims for March:

The chart shows that in February, the increase in jobs (by 20K) was also accompanied by the persistent rise of jobless claims data, beyond initial estimates. Unemployment claims were in a downward trend in March, helping markets to price in positive reading of the NFP.

 

[Tickmill-News]

Side effects of negative rates as a primary short-term concern for the ECB
After just one month, the ECB made a seemingly significant retreat in credit tightening policy, calling off the rate hike and announcing the extension of the TLTRO program. With fresh signals of a slowdown in the economy and a jittery bond market, is there a requirement of new decisive actions from the Central Bank?

The ECB meeting on Wednesday is expected to become a kind of information bridge, with which the ECB will prepare the markets for new easing measures or measures combatting the side effects of the soft policy, to be announced at subsequent meetings. The composition of the policymakers voting on policy decisions is expected to be incomplete, as some of them will attend the spring IMF summit in Washington.

It’s difficult to believe that the economic and market challenges faced by the Central Bank are of a transient nature. As China gradually discovers excess production capacities due to lower global and domestic demand, in turn undermining medium-term Eurozone’s export outlook. Market rates (expressed through the yield of German government bonds) collapsed to the lowest level for two and a half years, resembling behavior seen in 2016, when recession fears were high. The ECB, even with a “dovish” wait-and-see attitude, potentially risks being overly optimistic and losing sustainable growth trajectory again.

Accordingly, with the need to keep interest rates low for a longer time, some analysts believe that the ECB should focus on side effects of the policy, primarily profits of the banking system. Comments on TLTRO and rates tiering from the ECB, could serve as confirmation of such intentions. In addition to the added value of the measures to reduce banking costs from negative interest rate policy, the ECB seems to conclude that the “symptomatic treatment” is the smartest step they forward. In other words, no major changes in monetary policy are expected in the near future.

Recent statements by policymakers, as well as the last meeting’s minutes concerning the introduction of rates tiering on excess reserves, suggest that Draghi may divulge more information this Wednesday. If the head of the ECB confirms that cashback for banks is on its way into the policy decision, it could have a negative effect on the euro. Since it will mean extending the era of low interest rates for an even longer period.

However, not all officials see the need for supporting the banks. The head of Danish Central Bank, Klaas Knot, commented that he has not yet got the evidence that negative rates harm lending in the real economy. ECB Vice President, Guindos, recommended banks work on their lending policies to figure out solutions for the shrinking interest margin.

As for TLTRO, the market will be interested in the size of interest rate and allowed use of funds. The minutes of the March meeting did not provide the necessary details about this step, except those that have been common knowledge since the last meeting: loans have a two-year maturity and they will be issued on quarterly basis from September 2019 to March 2021. The updates about TLTRO could cause a lively reaction in the shares of the banking sector with the impact on the common currency limited, as bank support is already known information.

Positive information that could allow the ECB to take a more pronounced neutral stance are: an increase in manufacturing activity in China this March, as well as a spring revival in the services sector in the Eurozone (accounting for almost 70% of GDP). The seasonal boost in consumer spending, associated with Easter, may have a deferred effect on inflation this year, as the celebration is scheduled for April 21 (compared to April 1 in 2018). This fact should also be taken into account when digesting the latest Eurozone inflation reading, according to which consumer prices, excluding volatile goods, rose by only 1% in annual terms.

Risk Warning: Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

 

[Tickmill-News]

ECB acclimatizes to decision-making in perpetual gloom
Whichever perspective the ECB chooses to evaluate the EU economy with, the resulting estimates lie in the range of “negative” to “neutral”, virtually ruling out a bullish surprise at today’s meeting.

• Trump opened a new front in the trade war, this time attacking Europe for its unfair Airbus subsidies.
• The Italian government had to say goodbye to hopes for economic growth this year as shown by government forecasts.
• The British Parliament is stuck in growing dissent, leaving the Brexit denouement as uncertain as it was after the referendum in 2016.
• In addition, the IMF once again cut global growth forecasts on Tuesday, which as a result increases the risks of external demand for export-dependent EU economies.

Like last time, the ECB is likely to characterize the risks as skewed to the downside. It will no longer work as though it’s giving a fresh wake-up call. Instead mentioning the reasons that will provide more information about the dynamic assessment of some ongoing processes in the economy, as well as abroad. This may shed some light on what the ECB thinks about changes in corporate expectations, or the trend for decline in trade with its main partners, i.e. China and the United States. A welcomed communication from the ECB would be the evaluation of the tariff threat from the US (for example, “external risks increased”), as the regulator can’t implement policy decisions while isolating foreign trade.

Shifts in policy are not expected at today’s meeting, as officials are mulling over the program for offering new loans to the banking sector (TLTRO) and are seeking ways to protect the profit of the banking sector. Nevertheless, warnings about the risks to growth and inflation may take on gloomier tone. The economy is facing increasing difficulties and complacency would be an unreasonably bold step. In order to prepare the markets for possible easing measures, the communication policy must also be built correctly, especially in light of the clear bearish bias of both TLTRO and compensation to banks on their interest on for excess reserves.

Although US tariffs still remain a distant threat, their emergence should definitely reflect on corporate sentiment, which could potentially delay economic recovery. The Eurozone is one of the weak points in the global economy, in part due to Italy, which is in recession and Germany unsuccessfully trying to reinvigorate activity in the manufacturing sector:

Source: Bloomberg

The IMF cut its forecast for global economic growth from 3.5% to 3.3%, as shown in updated data released on Tuesday. A decline in the first half of the year is expected to change to a pickup in the second.

The head of the ECB, Draghi, will need to somehow respond to growing rumors about the intention of the Central Bank to support profits of the banking sector. The measure could work as a “progressive taxation” of excess reserves, which commercial banks park in the ECB. Negative rates force commercial banks to pay the ECB for the reserves. Reimbursement of these costs could help banks, in the situation of shrinking net interest income, which creates an incentive for excessive risk taking:

Source: Bloomberg

Draghi may refrain from commenting, in the light of statements by Klaas Knot, the head of the Danish Central Bank, who urged his colleagues to abandon the discussion of this measure due to difficulties in its implementation.

The disorderly withdrawal of Britain from the European Union remains one of the main threats to economic growth, weighing heavily on corporate and consumer sentiments. This is understood by all 27 countries of the bloc, however, there is still no consensus on the mechanics of the exit. Today the leaders of European Union will meet again to discuss possible solutions, which should satisfy both sides, as well as UK political forces.

Risk Warning: Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

 

[Tickmill-News]

No trace of “trade truce” in Chinese exports data
The growth of Chinese exports in March offset decline in the first two months thanks to a combination of political, seasonal and economic factors. However, this recipe was useless to support imports, which is led by a prolonged decline in domestic consumption due to a fall in consumer confidence in China.

Exports in RMB increased by 21.3% YoY against 6.3%, effectively putting an end to anxiety after consistent decline by 1.4% and 16.6% in the first two months. The share of exports in China’s GDP has been steadily declining from a peak of 36.05% in 2006 to 19.75% in 2019. However, as can be seen, the composition of GDP remains highly vulnerable to fluctuations in foreign demand. For comparison, in the United States, the share of exports is about 12% of GDP.

The rebound of exports into positive territory reinforces the conviction that the slowdown in the first two months was a fall in trade after the “tariff rush” in 3Q and 4Q of 2018, the Lunar New Year celebration, as well as the gradual effect of the Central Bank and the government’s measures to maintain economic activity and their postponed impact behavioral benchmarks such as corporate confidence. The Chinese Central Bank urged that economic indicators be viewed not as separate readings, but in a trend, in order to get a correct idea of the causes of individual episodes of a short-term recession. As you can see, such a call was not unreasonable, although it was difficult not to succumb to the temptation to add disastrous exports on an already existing series of negative readings from China and rest of the world.

It is important to note that the progress in trade negotiations has stimulated exports from a completely non-obvious side – the strengthening of trade relations with the second largest trading partner – the EU. This can be perceived as a compensatory effect of US pressure on its main trading partners, who had no choice but to unite. During the period January-March 2019, imports from the United States fell by 28.3% in China, while exports fell by 3.7%, despite the fact that in December Trump and Xi concluded “non-aggression pact” for three months and for those three months the trade teams were busy talking up the expectations, declaring “fruitful “and “constructive” talks progress. It is difficult to consider such a decline in trade the result of a truce. However, in trade with the EU over the same period, China exported 14.4% more than during the same period last year, while imports grew by 7.3%:

The yield on 10-year Chinese government bonds rose on a positive report to 3.32%, the highest level for this year. Bond futures declined for the first time in three days. All this suggests that traders are pricing in increase in risk appetite and the effect of monetary easing measures.

Given the export price inflation, which probably remained at elevated levels after a 6.2% increase in February, real export growth in March could turn out to be more moderate. In addition, the rebound after the Lunar New Year will have to go into stabilization, so the effect of data on market expectations will be very limited.

 

[Tickmill-News]

What the new Brexit delay means for UK manufacturers?
Capital spending and exports, the engines that drive the growth of British economy, entered lower gear due to weakening foreign demand and dragging uncertainty of Brexit. In these conditions, the economy begins to rely more and more on the main driver – consumption, which in turn depends on wage growth and consumer optimism – the channels through which shocks of aggregate demand enter the economy.

The fifth largest economy in the world expanded by only 1.4% in 2018, which was the worst performance in 6 years and data for the first quarter of 2019 show that the trend for slowdown will stay in place. “A sense of urgency” left British politicians with a Brexit postponement until the end of October, which will likely resume tedious process of “dragging the rope” between politicians. Lack of clarity about the access to EU single market in future drags on capital spending of UK firms.

Consumer spending grew last year at the lowest rate since 2012. Part of the slump came from Pound devaluation after the referendum, which boost price growth and put pressure on wages, hitting purchasing power of households’ incomes in Britain.

As inflation was suppressed and wages rose, the negative gap between these two variables favoured consumption thus boosting consumer confidence which supported household spending. Consumer spending and the government purchases made the biggest contribution to the growth of aggregate demand in 2018, while the capital expenditures and net exports slowed the rise:

Normally, when expansion relies on household consumption, with muted action form other growth factors, it’s easy for the economy to lose momentum or to see how it changes sign: consumers are the last in turn to get and adjust to market signals, the only question is how soon this will happen. According to the head of the Bank of England Mark Carney, if the burden of expanding the economy lies on the shoulders of the consumer, we should start to “watch the clock.”

British firms have postponed plans to expand production since the announcement of the referendum in 2016. Now a negative outlook on investments is confirmed with a significant increase in inventories, as the companies are unlikely to expand without selling off the surplus. On the other hand, it can be preparations for a favourable Brexit outcome, in which companies will have access to a single market and will be able to support good level of sales. However, British firms will have to reduce production if Brexit drags on, in this case, a short-term surge in production activity observed now should be perceived as a “lull before a thunderstorm.”

The Bank of England for some time insisted on the need for a gradual increase in interest rates along with the emergence of certainty about leaving the UK from the EU. However, the fresh postponement is likely to force the Central Bank to repeat the mantra about patience again, especially in light of the deteriorating PMI from IHS / Markit, which to some extent well predicted monetary decisions:

This, in turn, means negative Pound outlook as a result of BoE monetary decisions since the odds of its consistent disappointment become higher.

 

[Tickmill-News]

Chinese Economy’s “Good News” May Be Bad News for Stocks
The source of genuine fundamental improvements in the Chinese economy can only come from the manufacturing sector… At least this is the opinion of Chinese investors who bought stocks and ditched fixed-income securities during the last episode of rising manufacturing PMI:

Let me remind you that on March 29, the markets were updated with the closely-tracked China manufacturing PMI, which unexpectedly jumped into positive territory (above 50 points), markedly outstripping the estimate. In one of my previous articles, we explored that the magnitude of the PMI rebound is of less importance than the variation of rise, depending on the size of firms. The greatest increase in activity was observed in small enterprises most vulnerable to demand shocks and credit conditions:

This is a very promising shift in terms of the outlook for corporate optimism as its more volatile and sensitive to economic changes in small firms.

It’s also important that two key sub-indexes shifted to recovery: production volumes and new orders (a leading indicator).

The government linked the positive changes in production with the success of the targeted credit measures for enterprises that bolstered consumption and investment. Well, the episode of liquidity injection into the economy, to the tune of 4.6 trillion Yuan in January is not quite a targeted measure. However, in February the PBOC tried to move monetary aggregates back to normal, but yet again returned to expansion in March:

Given the size and position of the Chinese economy in the world, it’s easy to understand what’s now driving the global appetite for risky assets. Reliance stems from the PBOC’s assistance, with its sheer scale obviously supporting domestic production data.

The growth of divergence in the economic surprises of US and China is probably the direct result of the difference in the magnitude of monetary easing. More precisely, the Fed kind of took a break concerning this:

Data released on Wednesday indicated that the impulse in PMI developed in broad macroeconomic variables. Industrial production and retail sales exceeded expectations, while the government’s target variable – GDP, rose by 6.4% in the first quarter, compared with a forecast of 6.3%. At first sight, the forecast looks good, however it’s possible that the “impatient” PBOC is just waiting for the first signs of improvement in order to tighten control of the monetary supply.

Further to this, the first signs of a U-turn in monetary policy are already in full view. For example:

• The widely expected decline in RRR in April was not realized.
• The PBOC did not conduct open market operations for 18 days in a row.
• The new medium-term lending facility decreased in size. As a result, overnight repo rates soared to a maximum of 4 years, indicating growing liquidity deficit.

It’s clear that, with the transition of the People’s Bank of China to a more offensive stance, the stock market will again be under pressure. Additionally, if the growth of Chinese economy again turns out to be not “self-sustained”, then new economic shocks overlapping the tightening policy may hit the asset prices much more painfully.

 

[Tickmill-News]

US Retail sales join Chinese data to hint about early stage of global recovery
US retail sales unexpectedly recovered in March at the fastest rate in a year and a half, offsetting a gloomy February with the fall by 1.7%. As the March data shows, the structure of aggregate consumption saw exceedingly favourable shift, namely, consumers spent more on car purchases. This rebound could point to the improvement in household expectations regarding the size and stability of future income, but still with only one observation such a conjecture remains a shallow speculation. Although car sales tend to be volatile by nature and thus considered unreliable, the positive monthly change in March comes right in time to support the assumption about rebound of economic activity in the second quarter.

However, in January, car sales pulled consumption down, apparently due to seasonal exhaustion after New Year’s spending.

Broad retail sales indicator rose by 1.6% in March compared with February. Core sales also rose adding 1%.

From the interesting details of retail sales report, it can be noted that all four of the largest items of consumer spending posted an increase compared with the same month last year and February:

• Cars and spare parts – + 3.8%
• Food and drinks – + 1.0%
• Restaurants – + 0.8%
• Online purchases – +1.2% and +11.6% compared with March 2018.

Positive data further attracted buyers to the dollar, after the US currency went into the lead against the main opponents during the London session on Thursday:

Unemployment in the US is likely to continue to test historical lows in April, as shown by unemployment benefits data. The number of initial claims for benefits has dropped to its lowest level in 50 years (192K) and it is completely unclear how this fails to translate into the consumer inflation.

Large downward risks to the American economy, hovered in the air, are fading from view. Given that the data from China indicated fast recovery, the trading theme of the next week should be “the search for yield”.

 

[Tickmill-News]

Why is backwardation possible in the futures market?
In one of my recent articles about the oil market, I stated that the withdrawal of waivers for consumers of Iranian oil could lead to a compensating effect on the part of the US supply, which the latest API report on commercial reserves in the US seemed to reflect. In the weekly report dated April 23, the API estimated the growth of reserves at 6.9M barrels with a forecast of -3.9M barrels, which naturally forced buyers to moderate their appetite. It also called for review of the medium-term consequences of White House “harsh” decision against Iran, which may have muted impact on the world supply considering rivalry between US producers OPEC and Russia.

The growth of US stockpiles occurs against the background of “ugly” futures price curve for US manufacturers where contracts for more distanced delivery are cheaper than contracts for the near term (state of backwardation). In this state of the market, it seems that it would be more profitable for American producers not to accumulate reserves, but to sell oil on the spot market, which should lead to a decrease in reserves and, accordingly, their ability to influence futures prices.

Within the framework of non-arbitrage theory of pricing, with deterministic rate and not counting storage costs, futures price is simply an expression of the opportunity cost of holding money (that is, a reflection of lost profit between investing now and in the future):



Where F and S are futures and spot prices for a good at time t, r is a continuously compounded interest rate. The question naturally arises about the possibility of F < S, i.e. backwardation, because then the interest rate r must be negative, which looks impossible.

This, at first glance, contradiction is resolved through an analysis of the state of current vs. future reserves of the good. In the context of contango, when stocks are now higher than in the future, the owner of the goods has a low incentive to sell the goods now, i.e. expects price to rise in the future. In this case, F> S. However, in the case of low stocks now, and expectations of their increase in the future (lower price in the future), i.e. in the state of backwardation, the so-called convenience yieldarises – an implicit yield, which I would call the “opportunity cost of selling a scarce commodity”. It should also be noted that if during contango the deficit in the future can be filled through the increased sale of futures contracts, in case of backwardation, you can’t borrow supplies from the future using derivatives. Accordingly, the futures price formula is correct with additional term:

Where c is convenience yield, which can be expressed as an advantage in the form of maintaining current customer satisfaction (since the amount of the is scarce on the market!), ensuring uninterrupted supply, or expecting for an increase in demand for the good on the spot market, etc.

The IEA’s announcement on Tuesday effectively downgraded the value of retiring Iran from the competitive market, stating that world reserves are adequate to demand, and spare global oil production capacity is currently sufficient (to counteract the supply shocks).

Most of the new supply comes from the United States, where crude oil production increased by 2 million barrels from 2018 to 12 million barrels, making the US the largest oil producer, leaving Russia and Saudi Arabia behind. The IEA predicts that in 2019, oil supplies from the United States will increase by 1.6 million barrels.

One sign that US is gradually taking over OPEC’s share was recent delivery of the first tanker to Indonesia, a major Asian oil consumer which was a traditional OPEC customer.

 

[Tickmill-News]

South Korea: World Growth Must Wait!
One of the brightest stars in terms of global growth unexpectedly faded, with South Korean GDP falling by 0.3% in Q1. Posting its worst performance in almost a decade:

The economy grew by 1.0% in Q4, 2018 alongside an expected a rebound of 0.3% in the subsequent quarter. Hopes were dashed however due to weak foreign demand for South Korean exports and diminishing domestic consumption. Retail sales declined sharply in February due to the early celebration of the Lunar New Year. Apart from the seasonal factor however, there was also a structural weakening when compared to the average value for January-February with the same period last year.

When assessing the implications for the global economy, it should be noted that the country exported fewer semiconductor elements, refined petroleum products and passenger cars. Exports declined in February and fell short of forecasts in March, indicating a continuing trend towards weakening external demand during these two months. Sources of weak foreign demand arose from the largest trading partners, such as China, USA, Hong Kong and Japan, which is all well documented in their domestic data. Channels of transmission foreign demand slack into domestic consumption were capacity utilization, which contracted in March, deterring from expansion on business investments, as well as an increase in the ratio of inventories-to-shipments of the exporters.

Source: Korean Development Institute

Industrial production in February fell by 1.4% MoM, the service sector showed zero growth. In the medium-term trend, assessing the change in indicators in annual terms, the situation also looks alarming. Waning momentum in manufacturing and mining arose became especially distinct in early 2019 while the services sector has been stagnating for a long time.

Shares of companies producing semiconductor elements, amid the decline in exports, raise doubts about the rationality of valuation, as the price is rising while EPS falls:

The South Korean government has pledged to increase fiscal momentum with an additional package of spending of $5.9 billion, in addition to the record budget set for 2019. According to their calculations, this will lead to additional GDP growth of 0.1% and creation of 73,000 jobs. With the failure of the first quarter, the government’s targets for 2.6% to 2.7% GDP growth are beginning to look excessively ambitious, unless, of course, a miracle occurs in export activity.

The country, with a high share of economic and implicit political power belonging to industrial conglomerates called Chaebol, ranks 11th in terms of the size of the economy and has been growing at one of the highest rates after the Great Depression.