Markets Facing a Test of Reality vs. Liquidity

June 28, 2020 — Mitul Kotecha

Risk assets ended last week under pressure (S&P 500 fell 2.4%) as some US states including Texas and Florida began to reverse opening measures and Anthony Fauci, the infectious diseases expert, warned that some states may have to return to full “shelter in place”.  Banks were among the worst performers even as they came through the Fed’s stress tests in reasonably good shape.  The Fed did however, cap buybacks and dividend payouts for the 33 banks that underwent tests. However, the reality is that banks were hardly likely to increase dividends over the next few months, while the 8th biggest banks had already suspended buybacks.  Perhaps what spooked markets was the news of “additional stress analyses later in the year”.

It feels like equities and risk assets in general are facing a test of reality vs. liquidity. It’s hard to fight the growth in excess liquidity global (G4 central bank balance sheets minus GDP growth) which has risen to its highest rate since Sep 2009, coinciding with a solid run in global equities over that period.  Clearly forward earnings valuations have richened but while absolute valuations appear rich (S&P forward price/earnings ratio has risen to 24.16), relative valuations ie compared to low global rates, are more attractive. This hasn’t stopped the intensification of concerns that after a solid market rally over recent months, the entry of a range of speculative investors is leading to a Minsky Moment.

Investor concerns range from the fact that the rally has been narrowly based, both in terms of the types of investors (retail investors piling in, while institutional have been more restrained) and type of stocks (momentum vs. value), the approach of US Presidential elections in November and in particular whether there could be a reversal of corporate tax cuts, as well as the potential for renewed lockdowns. Add to the mix, geopolitical concerns and a certain degree of market angst is understandable. All of this is having a growing impact on the market’s psyche even as data releases show that recovery is progressing somewhat on track, as reflected for example in the New York Fed’s weekly economic index, which has continued to become less negative and the Citi Economic Surprise Index, which is around its highest on record.

China, which was first in and now looks to be first out is a case in point, with growth data showing ongoing improvement; data today was encouraging, revealing that industrial profits rose 6% y/y in May though profits in the first five months of the year still fell 19.3%, with state-owned enterprises recording the bulk of the decline.  While there are signs that Chinese activity post-Covid is beginning to level off, domestic consumption is gradually improving. This week, market activity is likely to slow ahead of the US July 4th Independence Day holiday but there will be few key data highlights that will garnet attention, including June manufacturing PMIs in China and the US (ISM), and US June non-farm payrolls.

Posted in Asia, bank rescue, Bond markets, central banks, China, coronavirus, COVID-19, Currencies, ECB, Economics, emerging markets, equity markets, Europe, eurozone, Federal Reserve, FX, Interest rates, Monetary Policy, Politics, Trade, Trump, US, US administration. Tags: , , , , , , , , , , , , , . Leave a Comment »

Tensions Take A Turn For The Worse

May 25, 2020 — Mitul Kotecha

As highlighted in my post last week markets face “Risks of a body blow” amid an intensification of tensions between the US and China.  Such tensions have worsened over recent days in the wake of the decision announced at the start of China’s National People’s Congress (NPC) to draft national security legislation for Hong Kong, which would reportedly bypass the territory’s Legislative Council.

The news prompted a slide in Hong Kong equities, demonstrations in Hong Kong and a strong reaction from the US Secretary of State. Attention will also turn to whether China’s decision will push the US administration into imposing sanctions based on the Hong Kong Human Rights and Democracy Act passed last year by Congress as well as remove the special trading status that Hong Kong enjoys with the US.

Unrelated to the above, but in line with the strengthening in non tariff measures being applied to China, the US Senate passed a bill that would effectively result in a de-listing any companies from the US stock exchange if they did not comply with US regulatory audits. In particular, Chinese company listings will be at risk given that many Chinese companies would fall into this category.  This follows hot on the heels of tougher restrictions on the sale of US technology, and the ordering of the main US federal government pension fund not to invest in Chinese equities.

Markets are right to be nervous, with tensions only likely to intensify ahead of elections, but as noted in my previous post, it seems highly unlikely that the US administration would want to tear up the “Phase 1” trade deal at this stage given the impact on domestic producers and consumers.  Instead expect more non trade measures, export controls, visa restrictions, etc, to move into place.  If the US economy/asset markets rebound more strongly, the risk of a breakdown in the trade deal will likely grow as the administration may have more confidence at that point.   Either way, the November 2020 presidential election will have a large bearing on policy towards China.

China can also not risk a major flare up in tensions at this stage given the pressure on its economy even as it has largely opened up post the Covid-19 lockdown measures.  The magnitude of the growth shock was on show last Friday, with the NPC dropping its growth target from its work report for the first time.  This was a prudent move given that growth this year is subject to much more uncertainty than usual in the wake of the Covid-19 shock, but it also suggests that Chinese authorities do not want to commit to the type of stimulus enacted in 2008, which resulted in a sharp build up in leverage in the economy.  GDP growth fell by 6.8% y/y in Q1 and is likely to come in at best around half of last year’s 6.1 rate.

As such, the risks to markets has moved from the virus (though second round infections remains a key risk to markets) to geopolitical.   Nor have economic risks have dissipated.  A cursory glance at data globally makes this obvious.  Markets have tried to look past the data, but risks remain high that growth recovery will be far more prolonged than is being currently priced in.  At some point, maybe soon, it will be hard to keep looking past the data, when what is in view is not pleasant at all.

 

 

Posted in Asia, China, coronavirus, COVID-19, Economics, emerging markets, equity markets, Federal Reserve, Monetary Policy, Trade, Trump, US, US administration. Tags: , , , , , , . Leave a Comment »

Fed, ECB, BoJ In Focus This Week

April 26, 2020 — Mitul Kotecha

Three major central banks meet to decide on monetary policy this week, but after massive and unprecedented actions over past weeks, there is likely to be little new in terms of additional policy measures announced by the US Federal Reserve (Fed), European Central Bank (ECB) and Bank of Japan (BoJ) in the days ahead.  Key data this week include US Q1 GDP, the April US ISM manufacturing survey and China’s April purchasing manager’s index (PMI).

The Fed has thrown everything but the kitchen sink at Covid-19 to combat the severe economic and market impact emanating from the virus.  This included aggressive rate cuts, unlimited asset purchases (Treasuries, MBS), purchases of commercial paper, loans to small businesses, easing rules for banks and provision of US dollar swap lines with other central banks to help ease global USD demand pressures.  Aside from some fine tuning, there may not be much else the Fed will do at its meeting on Wednesday. Meanwhile the US ISM survey (Fri) is likely to post a sharp decline (consensus 37.0).

Markets have reacted well to the measures announced and implemented so far, but as noted there is a growing disconnect between the rally in equity markets over recent weeks and rapidly worsening economic data.  US Q1 GDP data (Wed) this week will likely reveal some of the damage, with a 4% q/q annualised fall in GDP forecast by the consensus. Q2 GDP will be even weaker however, as most of the weakness in activity will have taken place in April and will have likely continued into May and June.

The ECB continues to face pressure to do more as Eurozone activity continues to plunge.  So far the main thrust of the ECB’s measures are EUR 750bn of bond purchases and loosening of restrictions on such purchases.  However, sovereign spreads, especially in the periphery (especially Italy) are under pressure and the ECB may need to act again soon though perhaps not as early as the meeting this Thursday.  The ECB will also likely shift the onus of further easing to fiscal, especially the proposed “recovery fund”, which continues to fuel major divisions between European countries.

Last but not least the BoJ meeting on Monday will probably be the most active in terms of new measures, but on balance they will probably do little to move markets.   At the last meeting the BoJ significantly increased the amount of ETFs they would purchase, which to some extent has helped the Nikkei 225 rally over recent weeks.  At this meeting the BoJ is unlikely to alter its negative interest rate policy, but is likely to remove its JPY 80 trillion cap on JGB purchases and announce an increase in corporate bond purchases along with other measures to ease credit.

On the data front China’s official manufacturing PMI is likely to remain around or just above the expansionary threshold of 50 as much of China’s supply side of the economy opens up.  However, the ability to retain expansion at a time when global demand and therefore China’s export markets are collapsing, will prove difficult.  China’s authorities appear to be increasingly realising this and have stepped up support both on the fiscal (via special bond issuance) and monetary side (targeted cuts in various rates), but so far the scale of easing has been limited and Q1 growth was especially weak.

Posted in Bank of Japan, central banks, China, coronavirus, COVID-19, Currencies, Economics, Economy, Europe, eurozone, Federal Reserve, Fiscal/Budget, Interest rates, Italy, Japan, Monetary Policy, US, US administration. Tags: , , , , , , , . Leave a Comment »

Bonds Under Pressure, UK Parliament Rejects Election Again

September 10, 2019 — Mitul Kotecha

Market sentiment remains positive as hopes of a US-China trade deal continue to provide a floor under risk sentiment amid hopes that the escalation in tariffs can be reversed.  Weak Chinese trade data over the weekend has largely been ignored and instead markets have focused on further stimulus unleashed by China in the wake of the cut in its banks’ reserve ratios, which freed up around USD 126bn in liquidity to help shore up growth.  Expectations that the European Central Bank (ECB) will this week provide another monetary boost by lowering its deposit rates and embarking on a fresh wave of quantitative easing, are also helping to support risk sentiment though a lot is already in the price in terms of ECB expectations.

One of the casualties of the turn in sentiment has been bonds, with yields rising in G10 bond markets.  For example US 10 year yields have risen by around 18 basis points since their low a week ago.   The US dollar has also come under pressure, losing ground in particular to emerging market currencies over the past week.  Safe haven currencies such as the Japanese yen (JPY) and Swiss franc (CHF) have fared even worse.   As I noted last week I think the bounce in risk appetite will be short-lived, but how long is short?  Clearly markets anticipate positive developments in US-China trade talks, and it seems unlikely that risk appetite will deteriorate ahead of talks, at least until there is some clarity on the discussions.  Of course a tweet here or there could derail markets, but that is hard to predict.

Sterling (GBP) has been another currency that has benefited from USD weakness, but also from growing expectations that the UK will not crash out of the EU without a deal.  Developments overnight have done little to provide much clarity, however.  UK Prime Minister Boris Johnson failed in his bid for an early election on October 15, with MPs voting 293 in favour of an election against 46 opposed;  Johnson required two-thirds or 434 MPs to support the motion.  Johnson is now effectively a hostage in his own government unable to hold an election and legally unable to leave without a deal.  Parliament has been suspended until October 14, with Johnson stating that he will not delay Brexit any further, reiterating that he is prepared to leave the EU without an agreement if necessary.

This would effectively ignore legislation passed into law earlier blocking a no-deal Brexit forcing the PM to seek a delay until 31 Jan 2020. Separately parliament passed a motion by 311 to 302 to compel Downing Street to release various documents related to no-deal Brexit planning, but officials are so far resisting their release.  A lack of progress in talks with Irish PM Varadkar in Dublin on Monday highlights the challenges ahead.  GBP has rallied following firmer than expected Gross Domestic Product data (GDP) yesterday and growing hopes that the UK will be prevented from crashing out of the EU at the end of October, but could the currency could be derailed if there is still no progress towards a deal as the deadline approaches.

 

Posted in Bond markets, Brexit, China, Currencies, ECB, Economics, Economy, emerging markets, equity markets, Europe, eurozone, FX, Interest rates, Japan, Monetary Policy, Trade, Trump, UK, US, US administration. Tags: , , , , , , , , , , . Leave a Comment »

China Stimulus Paying Off

April 17, 2019 — Mitul Kotecha

For anyone doubting whether China’s monetary and fiscal stimulus measures are having any impact, the recent slate of March data releases should allay such concerns.  While a soft base early in the year may explain some of the bounce in March there is little doubt that China’s growth engine is beginning to rev again.

China data released today was firmer than expected almost across the board.  Notably industrial production rose 8.5% y/y (consensus 5.9%), retail sales were up 8.7% y/y (consensus 8.4%) and last, but not least, GDP rose 6.4%, slightly above the market (consensus. 6.3%).

This data follows on from last week’s firm monetary aggregates (March new loans, M2, aggregate financing) and manufacturing PMIs, all of which suggest that not only is stimulus beginning to work, but it could be working better than expected.   The turnaround in indicators in March has been particularly stark and has managed to overcome the softness in data in Jan/Feb.

The data is likely to bode well for risk assets generally, giving a further boost to equities, while likely keeping CNH/CNY supported.  Chinese equities are already up around 36% this year (CSI 300) and today’s data provides further fuel.  In contrast, a Chinese asset that may not like the data is bonds, with yields moving higher in the wake of the release.

Indeed with credit growth likely to pick up further this year and nominal GDP declining, China’s credit to GDP ratio is on the up again, and deleveraging is effectively over.  This does not bode well for bonds even with inflows related to bond index inclusion.

For the rest of the world’s economies, it will come as a relief that China’s economy is bottoming out, but it is important to note that China’s stimulus is largely domestically focussed.  The global impact will be far smaller than previous stimulus periods, suggesting that investors outside China shouldn’t get their hopes up.

Posted in Asian currencies, China, Economics, emerging markets, equity markets. Tags: , , , . Leave a Comment »
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