Recap 2014-11-21: Thoughts On Draghi’s Speech, PBoC cut, Weekly charts

Commentary:

On Draghi’s Speech:

So the market understood Draghi’s speech as a green light for sovereign QE. It was actually a clever speech – Draghi actually never used the word ‘sovereign,’ and in fact the only references to purchases of sovereign bonds were discussions of the Fed and BoJ QE programs. On the face of it, it will be very difficult for the Bundesbank to criticize Draghi for the speech, even though he seems to be clearly signaling that the ECB is getting closer to such a program.

The market reaction is pretty understandable – after all, the ECB is unambiguously missing its mandate by a large margin. But there are a number of nuances here. Given the commentary I read today, it seems that people are making a number of assumptions that are on shaky ground. Assumptions seem to include:

  • EU QE will be like US or Japanese QE. A major difference is simply that there is a much lower limit for the ECB’s balance sheet size. It’s not clear what that limit is, and they are probably quite far from it, but the limit nevertheless exists. One reason the BoJ program has worked as well as it has is because there is theoretically no limit for the BoJ’s balance sheet – that’s not the case for the ECB.
  • Central Bank Balance sheet increase = automatic currency depreciation. The best way to explore this assumption is via the chart below, which shows EURUSD vs the relative central bank balance sheets as a percentage of GDP. It should be clear that the relationship is weak and time varying. In addition – current currency levels already discount a surge in the ECB balance sheet. In fact, if the ECB wants to get its relative balance sheet position vs the Fed to the same level as mid 2012, they will have to increase their balance sheet to 4trn Euros – twice as much as Draghi’s target size. It is of course quite possible, if not probable that the ECB balance sheet gets to that size. What I want to point out here is that it seems to be already discounted by the price.

  • QE results will be similar across countries A very key point is that there needs to be a mechanism to convert the printed reserves into expenditures. In Japan, the government did that via large budget deficits. In the US, that was actually done by the banks – C&I loan growth was quite strong despite the fiscal contraction at the Federal level. There is no such mechanism in Europe.

With respect to the surprise PBoC cut today – we should be careful not to interpret it as much of an ease. The cut is simply following the decline in inflation over the past few quarters. Note that the REAL 1y lending rate remains at the highest level since late 2009:

Finally – a couple interesting weekly charts:

The S&P is back near the rising uptrend line stretching back to 2010 on the log chart:

And quite interestingly, WTI seems to be starting its bottoming process, with the first weekly up close (though barely) since Sept. Falling oil prices have been a major source of support for the long USD trade, especially vs the commodity currencies, so this is probably a good time to reassess.

Notable:

  • Draghi’s speech at the European Bank Congress:
  1. a channel I particularly want to focus on is the risk that a too prolonged period of low inflation becomes embedded in inflation expectations. The firm anchoring of inflation expectations is critical under any circumstances, as it ensures that temporary movements in inflation do not feed into wages and prices and hence become permanent. But it is even more critical in the circumstances we face today.
  2. This is because if inflation expectations fall, the real interest rate rises, which is the interest rate that matters most for investment decisions. And because nominal short-term rates in the euro area have already reached the effective lower bound, they cannot be adjusted downwards further to compensate for this. In other words, any de-anchoring of expectations would cause an effective monetary tightening – the exact opposite of what we want to see.
  3. Longer-term indicators are on the whole within a range that we consider consistent with price stability. Over shorter horizons, however, indicators have been declining to levels that I would deem excessively low. Survey-based measures of inflation expectations have generally been more stable, but the latest Survey of Professional Forecasters also indicates some decline – and at all horizons.
  4. there is evidence that both the various Large Scale Asset Purchase programmes of the Fed as well as the Bank of Japan’s Quantitative and Qualitative Easing programme led to a significant depreciation of their respective exchange rates, even in a situation in which long-term yields were already very low, as in Japan.
  5. through these portfolio balance effects the central bank can also expect to have a strong signalling effect. They signal that we will use all means available to us, within our mandate, to return inflation towards our objective – and without any undue delay. This in turn helps anchor inflation expectations and thereby lower real interest rates, boosting activity and inflation. This is also a channel that was operative in the US and Japan.
  6. Let me underline however that contingent on outcomes, we are committed to recalibrate the size, pace and composition of our purchases as necessary to deliver our mandate.
  7. it is essential to bring back inflation to target and without delay. Monetary policy can and will do its part to achieve this. But it is also clear that, as monetary policy works on the demand side of the economy, other policies can assist in this process – or at least not counteract it.
  8. This means that the aggregate fiscal stance of the euro area has to be consistent with our position in the cycle. And it means that this fiscal stance must be achieved in a confidence-enhancing way – that is, consistent with the fiscal governance framework – otherwise lack of confidence will undermine investment and offset the positive effects of fiscal policy on demand.
  9. we will continue to meet our responsibility – we will do what we must to raise inflation and inflation expectations as fast as possible, as our price stability mandate requires of us.
  10. If on its current trajectory our policy is not effective enough to achieve this, or further risks to the inflation outlook materialise, we would step up the pressure and broaden even more the channels through which we intervene, by altering accordingly the size, pace and composition of our purchases.

ANZ: China’s central bank announced tonight that it would cut the policy rates, effective from tomorrow morning (22 November 2014). There are two features of this surprising move:

  1. this is an asymmetric rate cut. The central bank cut the one-year lending rates by 40bps to 5.6% while cut the one-year deposit rates by 25bps to 2.75%.
  2. the PBoC allows the commercial bank to increase the ceiling of deposit rates to 1.2 times of the benchmark interest rates, from 1.1 times previously. PBoC states that this intends to accelerate the interest rate liberalisation reform.

Japan’s finance minister Taro Aso expressed alarm over the rapid decline in the yen. “The pace of the decline in the past week has been too fast.” Koichi Hamada, a key Abe advisor, defended “Abenomics” and said the country’s economic policies were working well; Hamada also called the yen slide a positive and said the economy would benefit from the yen hitting 120.

Canada CPI jumped to 2.4% YoY vs 2.1% exp and 2.0% prev. The core measure also rose to 2.3% vs 2.1% exp and prev.

Upcoming:

  • Mon: German IFO, US Markit Services PMI, BoJ Minutes, BoJ Deputy Governor Nakaso speaks
  • Tue: Canada Retail Sales, US House Prices, Consumer Confidence
  • Wed: UK 3Q GDP, US Durable Goods Orders, Us Jobless Claims, Personal Income, Core PCE, Chicago PMI, Pending Home Sales, AU 3Q Capex
  • Thu: US Holiday, German Employment, Consumer Confidence, Japan Employment, CPI, NZ Business Confidence, UK Consumer Confidence

Recap 2014-11-20

Commentary:

Interesting: http://ftalphaville.ft.com/2014/11/20/2048172/you-are-not-experienced/

Because you probably haven’t seen enough 2015 outlook pieces (just kidding) I’m working on my own version. (not kidding) Stay tuned.

Notable:

  • PMIs:
  1. EU Mfg PMI declined to 50.4 vs 50.8 exp and 50.6 prev.
  2. EU Services PMI declined to 51.3 vs 52.4 exp and 52.3 prev. German weakness was only partially offset by French strength
  3. US Markit Mfg PMI declined to 54.7 vs 56.3 3xp and 55.9 prev
  4. Philly Fed jumped to 40.8 vs 18.5 exp and 20.7 prev. This was the highest print since 1993.
  5. Japan PMI declined to 52.1 vs 52.7 expand 52.4 prev
  6. China HSBC PMI declined to 50.0 vs 50.2 expand 50.4 prev

US CPI was stable at 1.7% vs 1.6% exp, but Core CPI ticked higher to 1.8% vs 1.7% exp and prev

Existing Home Sales rose 1.5% MoM vs -0.4% exp

EU Consumer Confidence declined to -11.6 vs -10.7 exp and -11.1 prev. This was the weakest print since Februrary

Upcoming:

  • Fri: Canada CPI
  • Mon: German IFO, US Markit Services PMI, BoJ Minutes, BoJ Deputy Governor Nakaso speaks
  • Tue: Canada Retail Sales, US House Prices, Consumer Confidence
  • Wed: UK 3Q GDP, US Durable Goods Orders, Us Jobless Claims, Personal Income, Core PCE, Chicago PMI, Pending Home Sales, AU 3Q Capex
  • Thu: US Holiday, German Employment, Consumer Confidence, Japan Employment, CPI, NZ Business Confidence, UK Consumer Confidence

Recap 2014-11-19

Commentary:

None

Notable:

  • Fed Minutes
  1. a number of participants noted that economic growth over the medium term might be slower than they currently expected if the foreign economic or financial situation deteriorated significantly…However, many participants saw the effects of recent developments on the domestic economy as likely to be quite limited.
  2. Survey-based measures of inflation expectations remained well anchored, but market-based measures of inflation compensation over the next five years as well as over the five-year period beginning five years ahead had declined over the intermeeting period…. many participants observed that the Committee should remain attentive to evidence of a possible downward shift in longer-term inflation expectations; some of them noted that if such an outcome occurred, it would be even more worrisome if growth faltered.
  3. Most participants judged that it would be helpful to include new language in the Committee’s forward guidance to clarify how the Committee’s decision about when to begin the policy normalization process will depend on incoming information about the economy. Some participants preferred to eliminate language in the statement indicating that the current target range for the federal funds rate would likely be maintained for a "considerable time" after the end of the asset purchase program… However, other participants thought that the "considerable time" phrase was useful in communicating the Committee’s policy intentions or that additional wording could be used to emphasize the data-dependence of the Committee’s decision process.
  4. With regard to the pace of interest rate increases after the start of policy normalization, a number of participants thought that it could soon be helpful to clarify the Committee’s likely approach… Most participants supported retaining the language in the statement indicating that the Committee anticipates that economic conditions may warrant keeping the target range for the federal funds rate below longer-run normal levels even after employment and inflation are near mandate-consistent levels.

US Housing Starts declined 2.8% MoM vs +0.8% exp

BoE Minutes:

  1. Below-target inflation was judged to be partly the consequence of a margin of spare capacity bearing down on domestic costs and prices: in the year to 2014 Q2 underlying unit labour costs had been broadly flat.
  2. Although there was little evidence that it had yet occurred, and perhaps only a rather small likelihood that it would, a prolonged period in which inflation was below the target created at least the possibility that medium-term expectations of inflation would begin to drift downwards. This had the potential to lengthen the period for which inflation itself would remain below 2%.

BoJ left policy unchanged as exp. Worth noting is that that three out of four board members who objected to the additional easing (QQE-2) on October 31 turned to favor today’s decision as they think, according to governor Kuroda, that the committee decision should not be changed in the short term as it would lose the credibility of the BoJ. (Kiuchi voted against) In the press conference, Kuroda said that ““It’s the responsibility of parliament and the government, not an issue for the central bank to be held responsible for,” He emphasized the importance of the fiscal discipline and repeated to say that the BoJ is expecting the government to establish the sustainable fiscal structure, but the 18 month delay of the tax hike, especially with strong remarks of Abe to maintain the FY2020 fiscal targets to turn the primary balance of central and local government to surplus, was not regarded as the loss of discipline.

Abe gives an interview to the Nikkei and in it he talks about how upcoming corporate tax cuts (to be enacted next fiscal year) will help drive wages higher. Starting in F15 Japan will begin lowering its corporate rate to the 20% range. Nikkei “There is no backing away from our commitment to fiscal consolidation,” Abe said. “We will keep our fiscal 2020 goal to achieve fiscal health. I am convinced that through that, there will be no loss of international trust.” “There will be yellow lights flashing on whether we can achieve our fiscal target next year” considering the need to compile an economic stimulus package, Economy Minister Akira Amari told reporters after Abe’s comments. “All I can say now is we will make our utmost efforts.”

Upcoming:

  • Wed: Japan Trade Balance, PMI, China HSBC PMI
  • Thu: EU PMI, US CPI, Jobless Claims, Markit PMI, Philly Fed, Existing Home Sales, EU Consumer Confidence
  • Fri: Canada CPI
  • Mon: German IFO, US Markit Services PMI, BoJ Minutes, BoJ Deputy Governor Nakaso speaks
  • Tue: Canada Retail Sales, US House Prices, Consumer Confidence

Recap 2014-11-18: Thoughts on the GMO Letter and the BAML FMS survey

Commentary:

It appears the secular stagnation thesis is starting to get more adherents, and that is starting to affect perceived ‘fair’ valuations for asset classes. The most recent GMO letter was good as usual, but quite important is their emphasis of the possibility that the low return environment is here to stay (i.e. where cash yields averaged 0% real) vs most of post WW2 history. (where cash yields averaged 1.25% real) They took it so seriously that they published a separate set of asset return forecasts, (labeled “Hell”) which are quite different from their previous forecasts. (which are labeled “Purgatory” below)

They also estimated the impact of the drop in the discount rate on the present fair value of various asset classes:

Note that using GMO’s assumption of a 4.5% risk premium for equities, ‘fair normalized PE’ on US equities would be ~22. That’s been my estimate for ‘fair PE’ for a couple years now, so it’s gratifying to see other managers coming around to that view. Note also that GMO recommended a ‘shorter duration way’ to take equity risk. I’d note that this is exactly what I recommended a year ago, via my S&P call purchase recommendation. Having said that, I still have some quibbles with the GMO projections – but mainly on the international and EM side. In particular, I think a lot of the assumptions regarding the relationship of corporate profits and equity valuation vs economy-wide aggregates do not apply in many countries. But that’s a topic for another day.

Separately, the BAML Fund Manager Survey for November was published today. Some highlights:

The consensus is that oil is cheap:

Cash balances remain high:

But the long Japanese equities trade is the most popular since April of 2006:

And real estate globally seems to be unusually popular as well:

The European FMS also had a couple interesting charts. ECB QE is expected by almost half of the respondents in 1Q next year:

Finally, I thought this post is very good:

http://ftalphaville.ft.com/2014/11/17/2045622/japans-debt-problem-in-perspective/

Notable:

  • Draghi: "other unconventional measures might entail the purchase of a variety of assets, one of which is government bonds". In this context, Mr Draghi also said that "the ECB has not been created to ensure that governments actually do the right things … we have a mandate".
  • The minutes of the November RBA notes the China property slowdown poses one of the key risks to the Australian economy. The RBA Board Minutes predate the more detailed Statement on Monetary Policy and there is no major change in views.
  • UK CPI improved to 1.4% YoY vs 1.2% exp and prev. The Core measure was stable at 1.5% vs 1.6% exp
  • German ZEW jumped to 11.5 vs 0.5 exp and -3.6 prev
  • US Core PPI rose to 1.8% YoY vs 1.5% exp and 1.6% prev
  • NAHB Survey improved to 58 vs 55 exp and 54 prev

Upcoming:

  • Wed: BoE Minutes, US Housing Starts, Fed Minutes, Japan Trade Balance, PMI, China HSBC PMI
  • Thu: EU PMI, US CPI, Jobless Claims, Markit PMI, Philly Fed, Existing Home Sales, EU Consumer Confidence
  • Fri: Canada CPI
  • Mon: German IFO, US Markit Services PMI, BoJ Minutes, BoJ Deputy Governor Nakaso speaks
  • Tue: Canada Retail Sales, US House Prices, Consumer Confidence

Recap 2014-11-17

Commentary:

Interesting chart from JPM:

Notable:

  • Japan GDP dropped -1.6% QoQ SAAR, vs +2.2% exp. The GDP Deflator ticked up to 2.1% vs 1.9% exp. Despite that, nominal GDP declined -0.8% QoQ, vs +0.4% exp and -0.2% prev. In other words, nominal GDP declined more than when the tax hike hit!
  • US Empire Mfg improved to 10.16 vs 12.0 exp and 6.17 prev
  • Canada Existing Home Sales rose 0.7% MoM vs -1.4% prev
  • UK House Prices declined -1.7% MoM vs +2.6% prev
  • Decade-long negotiations have been completed on a Free Trade Agreement between Australia and China. A Declaration of Intent was signed, and final docs will be signed in 2015. 85% of all Australian exports will enter China tariff-free initially, expanding to 93% within four years and 95% on full implementation. 95% of Chinese goods imported to Australia will be tariff free after four years.
  • G20 seems to have focused on downside risks to the global growth, capped by David Cameron’s comment that “red warning lights are flashing on the dashboard of the global economy.” The Bank of England Governor, Mark Carney, and chief economist, Andy Haldane, indicated they are focused on downside risks to inflation. In an interview with The Australian newspaper, given while attending the G20 meeting in Brisbane, Carney said “we’ve got huge disinflationary forces coming from our trade partners, particularly in Europe, and commodity prices have gone down quite sharply”. Meanwhile, Haldane said in a speech published on Sunday that he’s watching developments “like a dove”.
  • JPM on US HY and Oil: The rapid fall in oil prices is raising some risk in the US HY market. 18.5% of the US high yield market is energy, and we believe that if producers do not cut capex, a sustained $75/bbl price for WTI could lead to a cumulative default rate through 2017 of as much as 12%. Assuming capex is cut and assets are sold, that cumulative default rate would likely be closer to 8%. In a $65/bbl scenario, the cumulative default rate could reach 40%. Our oil analysts expect WTI to average $77/bbl in 2015, then moving higher to average $80/bbl over the longer term. Our HY energy analyst thinks this scenario is already amply in the price, given HY energy company yield curves have flattened and are now inverted in many cases, i.e. front end bonds yield more than long end bonds.

Upcoming:

  • Mon: RBA Minutes
  • Tue: UK CPI, German ZEW, US PPI, NAHB Survey
  • Wed: BoE Minutes, US Housing Starts, Fed Minutes, Japan Trade Balance, PMI, China HSBC PMI
  • Thu: EU PMI, US CPI, Jobless Claims, Markit PMI, Philly Fed, Existing Home Sales, EU Consumer Confidence
  • Fri: Canada CPI

Recap 2014-11-14

Commentary:

None

Notable:

  • EU GDP rose 0.2% QoQ vs 0.1% exp. France figures were notably better than expected.
  • US Retail Sales were strong, with headline rising 0.3% and the control group rising 0.5%, both a bit better than expected.
  • UMichigan Confidence improved to 89.4 vs 87.5 exp and 86.9 prev
  • China M2 dropped to 12.6% YoY vs 12.9% exp and prev
  • Abe looks set to delay the consumption tax hike. In an attempt to weaken Abe’s stance in front of snap elections, the DPJ party said they agree to the policy on shelving taxes. Nikkei: Abe reportedly told a senior government official that he was "basically moving toward putting off" raising the tax from 8% to 10% and would decide as soon as the start of next week… The prime minister is reportedly ready to dissolve the lower house as early as Wednesday, setting in motion a general election next month… the Ministry of Finance has recommended delaying only a decision on the move. But this proposal looks unlikely to be taken up. Abe will meet soon with Finance Minister Taro Aso to explain his thinking on the issue. Since an open-ended delay would stoke concerns about Japan’s commitment to righting its public finances, the Abe government would seek to specify a new date for raising the tax. It would also seek to remove a clause that makes the increase contingent on prevailing economic conditions. Waiting a year and a half would push the tax hike to April, when the government and most businesses start their fiscal year, thus minimizing the administrative burden that the rate increase will entail

Upcoming:

  • Mon: JapanGDP, UK House Prices, US Empire Mfg, Canada Existing Home Sales, RBA Minutes
  • Tue: UK CPI, German ZEW, US PPI, NAHB Survey
  • Wed: BoE Minutes, US Housing Starts, Fed Minutes, Japan Trade Balance, PMI, China HSBC PMI
  • Thu: EU PMI, US CPI, Jobless Claims, Markit PMI, Philly Fed, Existing Home Sales, EU Consumer Confidence
  • Fri: Canada CPI

Recap 2014-11-13

Commentary:

This interesting article also describes investment fads, and the reduction in market trends over time as the speed of communication quickened:

http://www.washingtonpost.com/news/storyline/wp/2014/11/11/the-mathematician-who-proved-why-hipsters-all-look-alike/

Notable:

  • Dudley: “It still is premature to begin to raise interest rates–there remains slack in the labor market and the inflation rate is still too low”. “If all goes well, I anticipate that we will begin to raise short-term rates sometime next year”. “Given the still high level of long-term unemployment, there could be a significant benefit to allowing the economy to run ‘slightly hot’ for a while in order to get these people employed again.”
  • US Jobless Claims ticked up to 290k vs 280k exp
  • China Retail Sales was roughly stable at 11.5% YoY vs 11.6% exp and prev
  • China IP slowed to 7.7% YoY vs 8.0% exp and prev
  • France CPI ticked up to 0.5% vs 0.4% exp and prev
  • Oil DoE Inventories showed a

Upcoming:

  • Fri: EU GDP, CPI, US Retail Sales, UMichigan Confidence, Fed/ECB event
  • Mon: JapanGDP, UK House Prices, US Empire Mfg, Canada Existing Home Sales, RBA Minutes
  • Tue: UK CPI, German ZEW, US PPI, NAHB Survey
  • Wed: BoE Minutes, US Housing Starts, Japan Trade Balance, PMI, China HSBC PMI