cynthiadibartolo

[cynthiadibartolo]

All are on Vacation!

Post by Chief Economist Jean Ergas

All are on vacation! – No crisis big enough  to stop this! Are we ready for the Federal Reserve minutes? – We ponder over  the dual nature of Walmart – Pound – we are at the end of the beginning –  Punch ups starting in the UK government – Not wild about crude

I-Today’s action

Now in “Lion’s den” of becalmed summer

We are now in the “Lion’s den” of a for now  becalmed summer pause, with volatility hovering at what some might feel  dangerously low levels. Investors appear to have opted for a no- tail risk  scenario reinforcing TINA. The expected absence of turmoil overrides  valuation concerns and lends further impetus to the quest – hitherto un-ended  – for yield.

Will the markets take the Federal Reserve  minutes in stride?

Whether the markets will retain their poise  following the release of the Federal Reserve minutes is a risk hovering over  the landscape. The focus shall be on discerning any overt or “hidden” hard  line stances leaning towards a rate increase. We believe that the game is  still on and that excessive complacency may not be the best guide.

Walmart’s dual nature shall be in the  spotlight

We shall also be seeing Walmart’s progress –  or lack thereof. The archetypal merchandiser now appears to have a dual  nature. It is a strong indicator of mass purchasing with its GDP connotations  and it is a metric of “cross-over” from traditional retail to on-line –  reflecting pricing power going forward.

Who shall lead the UK out of the EU?

The Brexit picture continues to be cloudy.  Disputes have arisen as to who within the government shall be entrusted with  the task of shepherding the UK into the new economic “promised land”. This  power vacuum is accompanied by doubts as to when the infrastructure shall be  in place to commence concrete negotiations.

We expect further “slippage” in sterling

Sterling is continuing to slip and we expect  that there is more to come. Economic hard data as opposed to expectations  shall start trickling through this week. We reiterate our view that this  shall be a gradual crescendo as the weight of the PB – Pre-Brexit era –  starts to fade from the numbers.

The key metric shall be the extent to which  a collapsing pound shall boost exports, limiting the impact of recession in  the domestic economy.

UK fault line on trade hardening!

UK driven  political risk is not receding. The UK still needs to show that prospective  agreements shall suffice to buffer the impact of the “sea change” limiting  the damage to the broader global economy. We are seeing a hardening of  positions with the major driver being the reluctance to cede on freedom of  movement.

UK vote did not trigger a “Lehman moment” – is this the new metric?

This was the key factor in the “Leave” campaign platform and scope for compromise is limited. The recent economic data might be seen as an argument for greater flexibility. However, the exit brigade sees itself vindicated by the fact that the vote did not trigger a “Lehman moment”.

The calls for secession now – invoking of Article 50 – are getting louder – with the underlying rationale being to emerge from the state of limbo and start preparing for the next phase.

Not wild about crude – we have heard this song before!

With regard to the oil price we are seeing further strength – albeit prices continue to hover at low level. We remain skeptical as to the success chances of a concerted move by OPEC and non-OPEC producers - a production freeze when several countries are pumping full blast and US shale is coming back to life shall have little impact.

There is increasing talk as to Venezuela being at “break point”. Oil production remains the country’s life line. A new government would seek first and foremost to keep the crude flowing.

There shall be a revival of discounting in advanced economies

We are seeing much cheer as to the – hold on tight- the slowing of the pace of producer price inflation in China – as commodities stabilize and some reductions in coal and steel production are put through. While good news we do not see this as having a material impact on pricing power for advanced economies – who we see as reverting to discounting to elicit a timid response from consumers.

II – Monetary policy  

Further signs of global growth slowing – no “locomotive” in sight

We are seeing further signs of global growth slowing across the advanced and emerging markets. There is little scope for export offset of slack domestic demand or potential for a “locomotive” impetus to what increasingly appears to be a fractioned economic picture.

Central banks acting across the whole monetary policy “value chain”.

Central bank intervention or at the minimum abstention from “doing harm” continues to be a key issue. The predominant policy continues to veer towards easing or – as in the special case of the UK – a package of measures aimed across the whole “value chain” of monetary policy.

Monetary policy still the key focus for investors

Equity markets with the earnings season tending to the close and macro data at best mixed - remain largely in the thrall of monetary policy. Whether incremental reductions in interest rates from an already low level shall succeed in reversing a cautious approach to capital spending is doubtful.

III – Political Risk

Political risk remains high at both first and second round effects

Political risk remains high at both the first and second round effect level. The UK government appears to be floundering in attempting to formulate a coherent policy for secession from European Union. We remain of the view that the “hard exit” scenario with limited access to the single market is by now the front runner.

“Main course” in UK has yet to come!

A great deal of attention has been bestowed on the market – short term consequences. We see the “main course” as yet to come as capital and investment flows are reversed or diverted. The Bank of England has announced its willingness to take further measures. In the light of the measures recently adopted this does not sound encouraging.

Complacency seems to be official doctrine in the US

As regards the “elephant in the room” – the US election -complacency appears to be the dominant mood with a Democratic victory seen as inevitable in the mode of the “The End of History”. Abstracting from who wins, we are focusing on the common thread of a resounding No! to trade liberalization.

Key shock shall not come from the US Dollar – Knock-out blow shall be restructuring of supply chains

The risks accruing from a stronger US Dollar for the emerging markets shall pale when compared to the “shock” adjustment of supply chains. We see the revision of existing or the non-conclusion of prospective agreements as cutting a swath across multiple industries.

Italy remains “soft underbelly” of the Euro Zone economy – drive slowly!

We are seeing pressure in the “soft underbelly” of the Euro Zone – Italy – starting to increase on a dual plane. The immediate catalyst has been the disappointing zero growth in the second quarter. This shall hobble the government’s chances of winning the institutional referendum in the fall and worsen the pressure on the already faltering banking system.

The danger is not an Italian debt default but the prospect of prolonged Italian economic stagnation throwing already modest single currency area growth forecasts into reverse

IV – Oil market

Economic fundamentals and politics at odds in the oil market

As regards oil we are once again hearing that a production reduction or stabilization agreement is imminent. This has provided oil prices a boost notwithstanding continuing oversupply and expectations of slowing demand growth. Economic fundamentals and political maneuvering are now at odds with each other.

We remain skeptical as to the extent that politics can trump economics and see a reduction in volatility as the first best outcome. A sustained increase in prices will still be contingent on an economic upturn – which is not around the corner.

V – Where are we headed?  

Global growth under pressure across all major regions – we are likely to see further downward revisions

We see global growth as slowing with pressure points now appearing in all major regions. A disappointing retail sales number has put paid to the idea of a consumer driven US renaissance.

We continue to see downward growth revisions as likely

Prospects for an upturn in the other major regions appear somewhat appear thin on the ground. We are continuing to see downward revisions as likely in Europe and faltering growth in the emerging markets space.  

We are hearing a considerable “barrage” about commodities entering a bull market. Prices have risen sufficiently to limit immediate systemic risk but not enough to act as a catalyst for growth.  

Central banks still lynchpin of investor focus – divorce from “real economy” proceeding apace

Central banks continue to be the center of attention. The expectation is not whether central banks shall ease further but when. The outlier – at least with regard to longer term policy- remains the US. The focus is not if the Federal Reserve shall raise rates but when – rapidly turning the next step into a “moveable feast”.  

Sovereign bond yields collapsing – where is the impetus for growth?

Outside of the US, we are seeing a steady move towards further easing and a collapse in sovereign bond yields. We are seeing little impact on the “real economy” with the principal effect on the fixed income market. The jury is still out on whether the rapid fire proliferation of negative sovereign bond yields shall unleash “animal spirits”.  

UK government continues to flounder with regard to post secession vote strategy

The UK government continues to flounder in defining a united if not “popular” front with regard to the EU exit negotiations.  In the absence of government policy the role of economic caretaker has been devolved to the Bank of England. Previously accused of partiality before the “secession” it is now being asked to clear up the mess!  

The focus is shifting from absorbing election “shock” and a step function FX rate adjustment to seeking to limit the impact of a prospective economic contraction. We reiterate our view that a conventional cyclical analysis is not applicable.

[cynthiadibartolo]

No reason to  revise global growth after US data

Post By Chief Economist Jean Ergas

1- In a  nutshell!

No reason to  revise global growth after US data

See no reason to revise global growth expectations following US jobs  data – Central banks remain key support for equity markets – will the US  Federal Reserve dare to raise interest rates? Will it knock over “The Apple  Cart”?

Political  risk remains high

Political risk remains high with the UK situation still up in the air –  We see the government as floundering with regard to economic strategy and the  “ideologues” of secession as in firm control

US veering  towards the center

The US appears to be veering towards the center – opting for political  stability over a drastic recasting of the political and economic  infrastructure. We see the Democratic party as also benefiting from an  “optics” improvement in the labor market.

Will the US  consumers keep spending?

This week we shall be seeing – among other US data – US retail sales.  Shall the strong jobs report translate into an increase in spending providing  an offset to weak capital spending? Can the US continue to present itself as  a “stand-alone” economy?

Not bullish  on oil

As regards oil, we see further weakness as the likely outcome with  scarce support for a reduction in production. Cash remains king and trumps –  no pun intended – longer term marketing strategies.

2- Today’s  action

Stock markets  focusing on “The Call of the US” – are we seeing the rise of a new “buzz  word”?

Stock markets are up this morning as Europe focuses on not the “Call of  the Wild” but on the “Call of the US”! With US employment data coming in  significantly stronger than expected hopes are high that jobs might be a  leading indicator for GDP.

In a market which loves buzz words such as Euro – dollar parity and  de-coupling, the next one might be “convergence” between employment and  growth.

Not getting excited about the raising of the  minimum wage

We remain somewhat  skeptical on this front and see this as the “mopping up” of the lower paid  workers. People who are doing some of the most back-breaking work and being  paid a pittance! We shall not join in the “rent-a-crowd” type jubilation  around the raising of the minimum wage.

It remains well below the level required to  shift these employees from accounting employment-on the books – to economic  employment” – can eat three times a day.

Germany continues to be Euro Zone Lone Ranger and support

Turning to the Euro Zone – we are seeing some good news from German industrial production – which has come in close to 1 per cent. We see this as having a two-fold significance:

Germany remains an oasis of growth in an otherwise dismal context The “pass-through” of German strength to the “Children of a lesser God” in the single currency area remains weak.

Investors not interested in Chinese flow data – but absolute level of reserves and sealed off “banking system”

Markets are taking not brilliant Chinese export and import data in their stride. The basic assumption appears to be that growth resulting from constant government mini-stimuli is irrelevant. What counts are:

FX reserves remaining at a level sufficient to stem the risk of  a devaluation That the banking system – riddled with bad loans – remain hermetically separated from the thoroughfares of international financial flows.

Focus on the US

Trump - is this the “flat tax” once again?

We now seem to be in the doldrums of summer with the Trump economic speech the highlight of the day! Whether the prospect of lower taxes – reminiscent of a “flat tax” shall be sufficient to deflect attention from the recent polemics shall be critical to maintaining the candidacy as a going concern.

The “Street” appears to be putting its money on the Democrats. Their program appears to be mutating into Sanders’ decaffeinated lite in exchange for civil peace in the economic sphere. 

Federal Reserve shall not shift from “Dating Game” to  the “Waiting Game”

The Federal Reserve knows no rest! Federal Reserve governor Powell appears to be shifting his position from lower rates for the short term to lower potential growth for the proverbial “long run”.  We are not surprised and see companies’ continued reluctance to invest as paving the way for declining productivity and wages.  

We do not see the US central bank as shifting from “The Dating Game” to the “Waiting Game” subordinating interest rate increases to a stabilization of easing in the other major economies.

Focus on the UK

We are seeing a go ahead from the City for a “hard Brexit”

With regard to the vexing issue of Brexit –we are seeing some ominous rumblings from discussions between the UK government and representatives of the financial community.  The position seems to be shifting towards “mutual access” negotiations as opposed to maintaining the status quo. This would require freedom of movement of people which would negate the major rallying call of the Leave campaign.  

On the trade front the focus seems to be steadily shifting towards bilateral agreements or unilateral tariff reductions – We are looking at a “hard Brexit”!  

Political Risk – West shall not risk action against Erdogan

As we forecast – where are the sanctions against Turkey?

On the political front we are hearing ominous rumblings from Turkey with Erdogan getting ready for a visit to Russia! Some see this as a reaction to the “Free World’s” criticism of the Turkish government’s repression following the attempted coup.

We shall be charitable!

Being charitable – one might view this as an attempt at injecting some humor into otherwise grim proceedings. Criticism has not led to any action and has remained toothless.  Where is the threat of sanctions so generously bandied about in other cases? 

Security remains the “bottom line”

We continue to see the “bottom line” as security and see an upcoming “From Russia with Love” scenario – for those old enough to remember James Bond- as a further lever used by Turkey. Merkel’s position is weakening and she will be hesitant to do anything to prejudice the agreements regarding the migrants. 

3- Global Overview

1 - Global growth and key market drivers

Can the US become a new beacon of growth or is this “capitalism in one country”?

We confirm our view that despite the stronger than expected jobs data in the US, a “holding” pattern at a low level in the Euro Zone and a “financial economy” recovery in the emerging markets global growth remains weak and shall likely weaken further.

Symbiotic relationship between markets and central banks persists

Investor hopes remain anchored in continued central bank easing. Despite the by now pan-continental descent into record low or – in many cases – negative rates growth remains minimal. As we have often said comparisons between current real interest rates and the pre-Lehman epoch are highly misleading.

It is not the cost of debt but its sheer size!

The impediment to reinvestment and expansion is not the cost of finance but the sheer volume of debt. Reducing “coupon” is irrelevant in a context of slow growth and deflation – with the former impacting cash flow and the latter leading to a “re-leveraging”.

We are not through with the UK “sea change”!

With regard to extra – cyclical factors investors continue to focus on the potential impact of the UK vote on both the EU and the global economy. We are continuing to see a steady stream of disappointing data indicating a marked slowing of the world’s 5th economy.

Bank of England takes broad array of measures

This has prompted broad based action by the Bank of England centered on a reduction in interest rates, an expansion of quantitative easing and targeted bank lending. Whether these measures shall be sufficient to ease uncertainty and rekindle consumption and investment remains doubtful.

Monetary policy has hitherto benefited the “haves” boosting the value of assets. The asset-less have not seen a significant “wealth effect” as reflected by rising wealth and income inequality in the US and UK.

US jobs data and growth are not synonymous!

The US jobs data has confirmed its iconic status as a political and not economic metric. “Full employment” and an alleged labor squeeze have not engendered a commensurate rise in wages. Hiring continues to focus on the service sector – low pay levels. This shall limit consumption’s capacity to offset continued stagnation in capital spending.

Political risk remains high – UK situation far from resolved

Political risk remains high and we see the UK situation as far from resolved. The UK – exit revolution is still in the “ideological phase” and we are seeing increasing calls for “secession now”.

The proponents of this “maximalist” vision are propounding bilateral trade agreements or trade within WTO terms. This does not bode well for a friendly separation.

Turkey not out of the critical phase  

The situation in Turkey while fading from the press remains tricky. Repression continues to increase and the Erdogan government is not remiss to use the migrant issue to force his political agenda regarding visas and deflecting EU critiques.

US – Erdogan relationship – A new Saudi Arabia?

Turkey – as during the Cold War – is a key bulwark in the defense of the “Free World” and shall not be held to exacting institutional standards. We continue to see the “bottom line” for the US as security, Turkey is mutating into a Saudi Arabia type relationship – no space for linking human rights and cooperation.

IS the US opting for the institutional status quo?

Turning to home shores we are seeing a shift towards the institutional “status quo” in the presidential campaign. Whether “more of the same” represents an optimal economic outcome, it is deemed preferable to a drastic re-drawing of political alliances carrying in its protectionism and a “hiring freeze” with regard to new trade agreements.

It shall not be “ad-hoc” life boats that shall quell the European banking crisis

The European banking crisis continues to at periodic, ever shorter intervals sow uncertainty. In Italy attempts at a private sector rescue of MPS are seen as insufficient to solve the bank’s capital issues with regard to both:

Settling the bad loans issue Re-establishing MPS as a “going concern:

Suspension of trading in banking stocks is at odds with repeated government assurances as to “move on” admonitions from the Italian government.

Crisis is multi-layered, we expect an EU TARP

We see this grasping for private sector solutions as inadequate to:

Successfully confront complex – multilayered issues Lay the framework for a re-capitalization of many European banks and “bail-in” bank lending as a substitute for fiscal policy.

Oil

Pressure on oil not over – “bulls” tempering their enthusiasm

-Excess supplies adding to volatility

We continue to see oil prices under pressure with supply increasing as disrupted production returns to the market. The likely scenario remains a further “raid” below the US Dollar 40 WTI mark and a gradual recovery. We are seeing the “bulls” moderating their enthusiasm downgrading their price target from the US Dollar 70 to the high 50’ range.

We view as a complicating factor making for volatility the inventories which remain high.  

“Dash for cash” still the dominant strategy

Supply steadiness shall also be driven by the continued need for cash of the major producers, with any decline in price setting off further lifting. We see production as still guided by short term liquidity and not by sophisticated marketing strategies.

We continue to view Saudi Arabia as reluctant to overturn the “apple cart” in the light of the heightened uncertainty driven the “Primacy of Politics”.

[cynthiadibartolo]

Markets Still Looking to Central Banks - Will They Deliver?

Post By Chief Economist Jean Ergas

In a  nutshell!

Global growth  expectations falling – markets still looking to central banks – will they  deliver? – Political risk remains high and investors starting to focus on the  US elections – We expect further volatility driven by the European banking  crisis – Stress tests far from clearing the air!  

This week we  shall be seeing more US earnings and key macro-economic data culminating in  the employment data. This shall be preceded by data on manufacturing,  services and personal income with investors focusing on whether consumer  spending and growth are diverging.

On the  foreign front, the Bank of England meeting is expected to reduce interest  rates and trigger a further fall in sterling. We see as more important  comments as to the expected consequences of the UK’s prospective “secession”.  

Global  overview  

There are no  more “locomotives”! – US economy “swapping dollars” but not creating  value  

Global growth fundamentals remain weak with both the US and the Euro  Zone posting lower growth and laying to rest any residual hopes of a  “locomotive effect”. We reiterate our view that in the US “optics”  improvements in the labor market and economic expansion have been riven  apart. Capital spending remains weak with companies hesitant to part with  their cash buffers as uncertainty increases.

We expect  little cheer from the EM space and put little faith in Chinese mini-stimulus  programs. They are not a substitute for sound economic growth.

Euro Zone  remains weak and risk of “re-leveraging” high

As concerns the single currency area growth rates have slowed sharply  and achievement of inflation targets appears distant. This increases the risk  of lower revenue growth, pressure on pricing power and the “re-leveraging” of  corporate and sovereign finances.

Structural  weaknesses which cannot be resolved via monetary policy shall be compounded  by the repercussions of the UK vote.  

Sterling is a  “special situation” – we are now entering the second stage of the decline

We continue to view sterling as a “special situation” and see the  currency as entering the second stage in its repricing. The first “step  function – shock vote” adjustment having taken place the currency decline  shall be driven by a steady drum beat of disappointing economic news. Central  bank support shall not be forthcoming and the pound shall be a “clean float”.  

Race to the bottom in European fixed income not yet over

As regards fixed income we see the “race to the bottom” in the European space as not yet over. This shall be driven by a continuing weak economic performance compounded by potential central bank efforts to “front run” potential nasty surprises out of the UK.

Investors are starting to grasp that domestic demand is driven by deflation “windfalls” and that this is not the way to sustainable growth.

Remain cautious on oil – “pumping for cash” remains dominant strategy

We remain cautious on oil and see continuing oversupply. Disruptions are not the same as policy changes. “Pumping for cash” remains the dominant strategy as Iran returns to the market and Iraq “floors” the accelerator. With the Middle East once again in the spotlight as Turkey re-enacts the 1970’s we see Saudi Arabia as reluctant to add to the tension.

We see political risk as high – extensive “second degree” risks – intersection of political and macro instability  

We continue to see political risk as high with the UK situation far from resolved, the clampdown in Turkey gathering steam and the US election outlook looking possibly closer than many had expected.

“Second degree” political risks whereby macro-shifts are closely correlated to political decisions – such as the European banking crisis - continue to sow uncertainty.

Which is worse – the Democratic left or Trump?

The key issue appears to be the choice of the lesser evil. Which is worse – the adoption of a left oriented Democratic platform or the uncertainty stemming from a Trump victory with a concomitant redrawing of the global economic trade framework?  

Focus on economic hot spots!  

1 - European banking crisis

The banking crisis is being played out on several fronts

In Europe the banking crisis is being played out on several planes, both short term and long term. A solution remains contingent on waiving EU rules and /or governments succeeding in corralling private sector support for rescue plans.

Stress tests - do they reflect full range of risks?  

In this respect we do not see the European banking stress tests as having cleared the air as to the extent of further action necessary. The stress tests did not take into account the UK’s future political and economic trajectory or the impact of negative interest rates on profitability.

We view the re-capitalization “package” for MPS as likely a “short term” gap measure for the bank and not materially impacting the outlook for the Italian or European banking segment.  

2 – Oil prices shall continue to be under pressure

We see the continued fall in oil prices as exerting further pressure on sovereign risk, increasing the pressure on marginal producers and eroding reserves. The political driver behind Saudi oil strategy is once again dominant with Saudi Arabia: Not prone to want to risk de-stabilizing a brittle global equilibrium but seizing price weakness to exert persistent pressure on Iran.

3 – UK triumph of ideology over economic common sense!  

Rift between reality and investor “wish list”

As regards the UK we continue to see a rift between the political reality and the “wish list” of many investors. Market participants appear to be underestimating the “ideological” component. This posits a return to economic pragmatism and concessions in exchange for unfettered access to the EU market.

Restricting EU immigration remains key constraint

We view these expectations as misplaced and see both UK assets and currency correcting as markets start to grasp the full import of the UK’s economic and political “pivot”. Freedom of movement – politically correct expression for immigration – remains the objective constraint to which trade agreements shall be subordinated.

Limited EFTA type agreements the likely outcome – where is the “knowledge economy”?

Comments regarding future trade agreements have been guarded and do not appear to prospect a EU lite solution but a shift towards limited EFTA type agreements. These shall be centered on merchandise limiting unfettered access for service exports – the backbone of the “knowledge economy”.

See a “pincer” squeeze in the UK economy – foreign direct investors starting to balk

UK domestic data continues to point to further weakness on a broad range of fronts, leading to substantial downgrading of growth forecasts. With uncertainty still having the upper hand we see a “pincer squeeze” as the domestic economy slows and longer term investment flows from supply chain driven foreign direct investors start drying up.

4- Emerging markets

Remain cautious EM - like Brazil – myth of de-coupling exploded

Turning to the emerging markets we remain cautious seeing them – with the exception of Brazil – as put options on the US Dollar or hostage to Chinese growth and commodities. We view the “Myth of de-coupling” as having been exploded on multiple levels: EM – developed markets EM – China The possibility of “EM in one country”.

Longer term structural pressures shall weigh on EM

Abstracting from persistent slow growth in the developed economies longer term structural pressures loom. Advances in manufacturing shall shorten supply chains and continued overcapacity shall discourage capital investment. Domestic markets have proven incapable of generating sufficient demand to buffer contracting export markets.

Brazil is weathering the storm

We make an exception in the case of Brazil where looking past the political uncertainty and the many chronic structural problems continue to see attractive opportunities.

Our stance is dictated by two principal considerations:  

Brazilian institutions are holding

Political institutions are proving capable of effecting a transition of power within a democratic framework

There have been few examples of economic development where the institutional framework was “perfect”

We see a modest cyclical recovery taking hold

While structural problems abound – the principal challenge being fiscal policy, we see growth – albeit moderate – picking up next year as a – albeit moderate – cyclical recovery takes hold as excess capacity and inventories fall.

Impact of further rating downgrades shall be limited

As regards the rating “Damocles Sword” we see further downgrades as having a limited impact. The key shift from investment to non-investment grade has been absorbed by the financial markets and there has been strong demand for Brazilian debt. We do not see this as a further example of a “grasp for yield”.

A strong economic team determined to fully exploit all margins of maneuver and strong FX reserves limiting sovereign default risk are providing a powerful underpinning. We see as apt the German proverb that “the start is the half of the whole”!

Argentina – is there a positive outlook after years of autarchy?

We see Argentina – while riskier than Brazil – as offering attractive long term opportunities for the more stout hearted. Our view rests on the dual axis of:

Longer term - after 12 years of a 1960’s import substitution and hostility to foreign direct investment a transition to a more pro-business policy Short term  - an incipient Brazilian economic recovery providing a “pull” effect to the Argentine economy.

Could a possible structural shift be underway?

While considerable uncertainty remains and likely further pressures on the FX rate loom we see a possible structural shift underway. Argentina has disappointed before as regards abandoning populist strategies. However we see the chance of a greater than expected Brazilian upturn and increase in trade as providing a partial buffer.

5 – Central Banks

Shall abstain or ease monetary policy further

What of the central banks? We see central banks as still in an abstention or easing mode. The dismal US economic data which we see as persisting shall likely stay the Federal Reserve’s hand until the end of the year.

We do not see any acceleration of US growth and view the economy as mired in a low wage growth – minimal capital spending mode.

ECB challenge shifting from deflation to preventing a Euro appreciation

As regards the ECB, we view as its principal challenge shifting from avoiding a 1930’s deflationary collapse to preventing an appreciation of the single currency. A euro revaluation shall put paid to the Euro Zone’s principal competitive advantage. Whether the continuation of a negative rates policy shall be sufficient is not clear.

Continue to see Japan as a longer term issue

While investor attention has been focused on Japan we continue to assess the risk as longer term. We have not “written off” Japanese growth but with expectations minimal we view a potential shock effect for the global economy as limited.

The key issue in Japan shall not be growth but the need to “externalize” the funding of the foreign debt as negative demographics take their toll.

[cynthiadibartolo]

Do Not Confuse GDP Growth with Political Stability

Post by Chief Economist Jean Ergas

Key point -  The attempted military take-over in Turkey shall act as a reminder to not  confuse GDP growth with political stability. Westernized elites are not in  touch with the popular mood. We saw this in Iran in 1979 and we shall see it  again!  

Stock markets  breathing a sigh of relief – coup plotters in Turkey not waiting for the  Federal Reserve – This is not “Topkapi” and wild adventures in Istanbul, but  re-emerging historical tensions -  UK  situation remains complex – further pressure on the pound likely

Stock markets  breathing a sigh of relief! We do not buy the political risk – bad news is  good news story!

Stock markets are breathing a sigh of relief at failure of military  takeover in Turkey and cheering a monster tech deal between the Japan and the  UK. Some are starting to view political turmoil as a new variant on the “bad  news is good news” story. Central banks shall be further encouraged to keep  the brakes on interest rate increases so as to avoid further  de-stabilization.

The coup  plotters in Turkey were not waiting for the Federal Reserve meeting!

What do we make of this new paradigm? Not much! Politics and coups are  not marching in lockstep with monetary policy. Should the next attempt – and  there shall be one – succeed no monetary tinkering shall mute the impact. The  re-drawing of political and military alliances in one of the two riskiest  areas in the world – along with Pakistan – is not at the whim of the ECB or  the Federal Reserve.

Struggle in  Turkey is about a vision of history and of society not about the discount  rate!

The struggle that we are seeing in Turkey is a political undercurrent  stretching back to the collapse of the Ottoman Empire. With the founding of a  secular state Turkish history appeared uni-directional. This has not been the  case as political Islam has steadily gained new adepts and legitimacy.  We see this struggle as far from over.

On the  European front, we reiterate our view that the events in Turkey and the  terrorist attack in Nice shall lend further legitimacy to security over  economics.

Turkey is the  new Stalingrad – We must hold it!

The US has cautioned Erdogan as to avoiding excesses in the repression  of the coup organizers and participants. We see this intervention as stopping  there. Turkey is the new Stalingrad which must be held at all costs – we are  looking for the least bad fit and shall go with the flow.

Fortress USA  shall continue to attract foreign investment

In the US investors shall be focusing on earnings. Bank of America has  beaten estimates reinforcing the “Fortress USA” theme which we see as picking  up steam. This does not presage a US boom but plays to the safe haven versus  growth theme. US assets remain attractive both on a cash yield basis across a  broad range of risks and due to lower interconnection with ROW.

This is not 1962! EU outpunches Commonwealth!

As to the “Adventures of Brexit” the UK has boldly announced its intention to conclude trade agreements with Australia and Canada once free of the EU’s yoke. Whether this shall be sufficient to offset – in a bizarre throwback to the pre-EEC era – commerce with the EU is highly doubtful. Canada has made clear that its key objective is to conclude a free trade agreement with the EU. They know what side their bread is buttered on.

In a nutshell!

We are going to continue to see safe haven buying

Despite a slight increase in yields from systemic risk levels, we still see a shift towards safe haven fixed income – with equity allocations falling and investors opting for security over return – We continue to see the UK pound as overvalued and expect a further fall in the “cable” – The bounce last week was ephemeral and not based on economic fundamentals

UK situation far from resolved – still substantial risk in UK property sector

Investors are relieved that the UK has a government but realize that the uncertainty as to timing of the exit and post-exit framework shall drag on for some time – The UK property sector remains a source of considerable potential systemic risk, with a further property collapse knocking the UK economy flat.

Investors continuing to look to central banks

Looking beyond the UK – we see investors as relying on continued and if necessary increased central bank intervention as the principal support for equity markets. The driver shall be collapsing fixed income returns pushing investors towards stocks and the prospect of dividend yields. Allocation is now a choice between the bad and the worse.  

ECB shall they wait?

This week we shall also be hearing from the ECB in its first meeting since the UK vote. We expect that moderation shall prevail but that the ECB shall await further data on the single currency area economy prior to taking further measures.

ECB impact on real economy shall be slight

The assessment of the Euro Zone economy following June 23rd shall be key to defining expectations as to both the financial and the “real” economy. We see the ECB as easing further – triggering further buying of US assets. The impact on the Euro Zone economy shall be slight – with a likely further reduction of growth estimates.

1- The coming week!

Are we shifting from one locus of turmoil to another?

Last week some thought it was safe to start re-focusing on economic fundamentals and concentrate on earnings. The installation of a new UK government and the prospect of a “beginning of the end” scenario were seen as a positive first step. Optimism was further boosted by some better than expected US earnings and macro data.  

EM elites represent nobody but themselves

Is all this going to be put in jeopardy by the prospect of political turmoil on the EU’s borders? Have some mistaken GDP growth and other economic metrics for being synonymous with political stability? We see the “experts” as having fallen prey to a common mistake many EM analysts make – not realizing that the “westernized elites” represent nobody but themselves.

To the already existing political strains in Europe, shall now be added the- for some shocking reality - military take-overs are a distinct possibility on the EU’s borders.

2- UK situation far from resolved – best is yet to come!

We expect a hard line in the UK exit negotiations

The UK situation is far from resolved, with the benefit of the installation of a new government being offset by two risks: The calling of a general election in the short term That the new powers that be shall – as we believe – pursue a harder line than expected in the disengagement talks.

Pressure building for invoking of article 50

We see the pressure building from the EU members for the UK to “pull the trigger” and invoke article 50. This shall not be the end of the uncertainty – trade agreements have never been easy to negotiate. Even after formal conclusion there shall be a considerable amount of “tweaking”.  

The UK is not Lichtenstein!

The free movement of labor being the sticking point – we do not see much chance of an EEA type agreement. This runs contrary to the idea that there might be an agreement as with Lichtenstein! This due to the size of the population and economy is a completely spurious comparison. 

Recent terrorist attack in Nice shall push pendulum towards primacy of security

The recent terrorist attack in Nice shall push the pendulum towards ensuring domestic security as opposed to granting free movement of labor in return for trade access. In this context, we are seeing references to adopting an “omnibus” free trade agreement – falling short of the current market access.

Not surprised by pause in sterling’s bounce

With regard to the UK economy, we are not surprised by the pause in sterling’s bounce. Short term prospects for the economy in terms of traditional macro metrics are being steadily revised downwards. Capital investment is frozen and the property market is in shock – with a massive amount of transactions on hold in both the commercial and residential sectors.

See little improvement in visibility over next three months

Looking beyond the next 3 months, we see little improvement in visibility. The outlook shall continue to be clouded by the timing of the UK’s invoking article 50 and some indication as to the trade regime feasible. We see this as placing the UK economy in a “holding” pattern – with business expenditure at minimum level and foreign direct investors hesitant to move.

This is not a managed sterling depreciation

While there has been much cheering last week, the fact remains that sterling is trading at Marianna’s trench levels. Some see this as a necessary adjustment for sterling’s overvaluation. We beg to differ! A managed depreciation with the prospect of improving the trade balance within a stable framework is not the same as a crash born of a political shock.

Outlook for pound weak

We continue to view the outlook for the pound as weak both short and longer term. In the immediate uncertainty prevails and asset allocation metrics are being shifted from store of value to a return basis. Longer term, we do not share the optimism that sterling shall increase its role as a reserve currency.

Do not see central banks increasing their allocation to sterling

Central banks shall be wary of increasing their exposure to an economy which shall both likely contract and be more dependent on a devalued currency to accommodate a less welcoming trade regime. We see the shift as ideologically driven and doubt that the EM space can offset the loss of trade with the EU.

3- Italian banks source of systemic risk

Little concrete progress on the European banks

With regard to the European banking crisis there has been much talk but no concrete breakthroughs. Plans for a direct government recapitalization of the Italian banks are still deemed non-compliant with EU bank rescue rules.

Will the Italian government get the exemption?

The Italian government is seeking an exemption from using certain types of debt as first line loss buffer. Whether this shall be granted is far from certain. Whatever the outcome – we see the “banking question” as a constant.

The discussion as to a bad loans backlog is clouding the more important issue of a further addition to distressed assets as the economy continues to – at best – tread water.

As concerns the broader Euro Zone – Deutsche Bank is once again under pressure, with renewed concerns – as reflected in the sharp rise of CDS rates – as to its ultimate “stand – alone” solvency. We are now seeing the confluence of bank specific strategic missteps, regulatory pressures and linkages to the Italian banks.

4- US companies beneficiaries of US “stand alone” capacity

“Gathering storm” in Europe increases attraction of US

US markets have been the beneficiaries of increasing risk aversion with regard to the “stand alone” capacity of the other major developed economies. This has been paralleled by what some may see as “The Gathering Storm” about to break in Europe on multiple fronts.

Collapse in US consumption not yet on the cards

US economic data – while not stellar – indicates that the economy shall both continue its slow growth trajectory and that a collapse in consumption is not yet on the cards. With regard to the “financial economy” a favorable risk- return relationship across a broad spectrum of fixed income assets is also encouraging investment flows.

US attraction for investors hopefully not fatal!

We see the relative but hopefully not “fatal attraction” of the US economy continuing. Investors shall become increasingly impatient with regard to the EM argument – centered on FX spot rates –and to the European sales pitch, focused on the convergence of P/E ratios. We have yet to see why the P/E ratios should converge!

We reiterate our view that the Europe discount is amply justified by both economic prospects and the inability of the large European groups to leverage the dual benefits of currency depreciation and quasi- zero rate financing.

5- China – still a wild card?

Not convinced by Chinese data

Turning to the emerging markets we have seen better than forecast data from China. We see this data as of scant relevance. Growth continues to be driven by government spending and currency depreciation. The Chinese government has opted for stabilization via overcapacity and exports.

The incremental impact of the devaluation is steadily decreasing. We see a Chinese government that is running out of time and measures – is a repeat of 2015’s “Guns of August” scenario likely?  

6 – Commodities – are we at a turning point?

Do not see another commodity super-cycle on the horizon

As concerns commodities, we continue to see little chance – despite talk of a “bull market” – that this segment shall attract the same funds flow as during the “super cycle”. In the light of both slowing global growth and a hiatus in capital expenditure – we are hard put to see where the demand boost shall come from.

Unwinding of long positions in the oil market

We are seeing an “unwinding” of long positions in the oil market. Easing of disruptions and robust US supplies have stemmed fears of an incipient balancing of the oil market. The much touted demise of the US shale industry has yet to materialize!  

7 - Focus on Turkey

Turkish delight? – Not quite!

The political challenge

We have not seen the end of the turbulence in Turkey. This is the beginning of a rocky ride which shall force “The West” to choose between increasing democratic freedoms and secure borders. We see secure borders as trumping free speech.

More political tremors – Primacy of politics reasserts itself brutally!

We ended last week on another political tremor, with an attempt at a military take-over in Turkey. While this is nothing new – there have been repeated interventions by the army since 1945: It highlights the risks attaching to the EM space overall, there are reasons for the risk premiums. Once again the “primacy of politics” is pushed to the forefront

Turkey bulwark of the west in a “tough neighborhood”

The risks attaching to the Turkish situation are political,   economic and closely intertwined. Turkey is once again the bulwark for the “free world” as it was during the Cold War. Strategically situated astride East and West it is seen as a reliable outpost in a “tough neighborhood”.

For US and EU – bottom line is security

While after 1945 this was aimed at the Communist bloc, the focus is now on ISIS and Islamic fundamentalism. “Holding” Turkey continues to be part of the dominant strategy of the US and its allies. With the EU risking coming apart at the seams – UK secession and migrant crisis – the “bottom line” remains security.

Greek collapse bad enough but economic – Turkey potential re-drawing of post 1945 security framework  

“Losing” Turkey would be a Greek catastrophe writ large. We correctly argued last summer that the US would pull out all the stops to halt a debacle in Greece – in the case of Turkey they shall stop at nothing.

Key transit point for global oil supplies

From the economic angle – three per cent of the world’s oil supplies transit through Turkey as well as significant shipments of grain. Interruption of the oil flow – largely from Iraq – could contribute to a significant disruption in supplies.

Do not confuse swimming pool at the Hilton with “brute force” realities of power!

What lessons can we draw from these dramatic events? The key point is not that the takeover was successful or not but that it was attempted. We see too many continuing to confuse GDP and assorted economic metrics with political stability. The development of political institutions often lags growth.

Remember hanging of Menderes in 1961!

While considered a key Eurasian economy Turkey is not a country steeped in political niceties! Following a military coup in 1960 – the former prime minister, Menderes, was hung! We see a close parallel to analysis of the Middle East where foreign observers – familiar with the “westernized” elites - do not grasp the more “basic” forms of political dialogue.

Attempted takeover heaven sent opportunity for Erdogan to crack down on dissent

The tensions which have underpinned recent events on the Bosphorus have not disappeared. The takeover attempt is a heaven sent opportunity for the Erdogan government to both crack down further on dissent and wring further concessions out of the US and EU.

We have not seen the end of the turbulence in Turkey. This is the beginning of a rocky ride which shall force “The West” to choose between increasing democratic freedoms and secure borders. We see secure borders as trumping free speech.

Economic volatility up ahead - Are we heading towards a balance of payments shock?

Turkish current account deficit key weakness 

With regard to economics and global markets – the Turkish central bank shall provide the banking system with unlimited liquidity. While this shall help to avoid an internal liquidity squeeze it shall do little to resolve the key weakness of the Turkish economy - a massive current account deficit.

Will investors continue to finance short term financing gaps?

The attempted and almost successful coup has put “red alert” political risk on investor radar screens. Will Turkey be able to continue to attract sufficient short term inflows? Is the much talked of risk of a balance of payments crisis looming nearer? 

Shall foreign direct investors stay the course?

We are also concerned as to the impact on longer term foreign direct investment which has been a key factor in: providing capital investment  Lessening the link between foreign borrowing and economic growth  The Turkish crisis may put to the test those investors who confused the wealthy neighborhoods in Istanbul with a polarized country.

Are we heading towards an IMF facility?                                              

In Turkey political chaos and sudden economic collapse have been closely correlated. Should investors hesitate to cover financing gaps there are two scenarios: The central bank raises interest rates pressuring the economy  The IMF extends an emergency facility  We reiterate our view that the Turkish situation may cast a pall on the EM space. 

[cynthiadibartolo]

Safe Haven and Bond Asset Allocation Flows Continue

Post by Chief Economist Jean Ergas

In a  nutshell!

We see  continued safe haven and bond asset allocation flows – investors, despite a  recovery in equity markets are reducing equity and increasing top rated  sovereign debt – The UK pound is still far from having bottomed – We shall  see further rounds of position “unwinding”!

Investor mood  remains a movable feast, with investors continuing to attempt to understand  the ramifications of the UK referendum.

Uncertainty  continues to dominate on the political front and do not see this dissipating  any time soon. What is clear is that as concerns the economic repercussions,  we have barely started to see the consequences.  

With regards  to monetary policy, we see the central banks as still in an easing mood. We  see hopes of stimulating growth and / or fighting deflation giving way to  attempts to fend off systemic risk – with the two principal sources of same  being constraints on interbank financing and “mass of money” shifts

Today’s action!                                        

One candidate race in the UK and prospect of more  “kindness of strangers” from Japan!

Markets are up  on what now looks like a one candidate race for the prime minister post in  the UK and a resounding victory by the pro – monetary easing / QE party in  Japan. We are also still seeing some carry over from the stronger than  expected employment data last week. Many investors remain confident that the  Federal Reserve shall not do anything to block job creation - regardless of  pay levels- and – above all – shall not want to be the catalyst for turmoil.

Financial economy continues to rule the waves!

Where do we  stand on this? The key is that the financial economy continues to rule the  waves – with no discernible changes in the global growth picture. Investors  continue to focus on the reaction and not on the causes- there is reason  interest rates continue to plumb the Marianna’s trench!

We are seeing strong flows into selected government  debt triggered by massive build up in cash as a wide range of investors and  companies are confronted with a dearth of attractive projects.

UK – Devil I know scenario – distressed asset sales a  zero-sum game

With regard to  the UK –this is starting to look like “A devil I know” scenario.  The choices facing the UK are  unappetizing.  We shudder when we hear  that the problems facing the commercial property sector are contained –  shades of US sub-prime and expect that the bargain hunting of one shall prove  to be the collapse of another. Distressed asset sales are a zero-sum game.

We read with interest the UK’s Chancellor of the Exchequer’s article in the WSJ, extolling a reduction in corporate tax rates as showing the UK is open for business. Will this be enough to counter the “primacy of politics” and a “no holds barred” policy on labor mobility?

Investors continue to eye UK property sector

Investors continue to watch the UK property investment sector – with the risk of further blocking of redemptions triggering further panic. We see the property shakeout as still in its early stages and expect to see further downward “Step function” adjustments as leveraged owners of commercial and residential properties start to make for a very tight door.

Watch for second round effects!

Additional second round effects shall likely stem from multi-asset funds, which in a desperate dash for yield have plowed into illiquid cash generating investments.  In the UK = this includes some of the fund management groups who have shuttered their dedicated property units.  We expect some of the sovereign wealth funds - traditional investors in UK property to suffer losses.

Bargain hunters shall be very selective!

We read of a US real estate investment firm seeking bargains in the UK commercial property market following the recent turmoil. The fund shall invest UK sterling 1 billion of which 400 million equity and the rest borrowed. over the next 6 to 18 months. We see this as a classical distressed strategy presaging: The scope for further declines in the medium term Selectivity in the choice of assets – with likely second string prop

1-This week!

We are leaving behind us a week full of excitement- more to come!

We are leaving behind us a week replete with excitement as markets continue to attempt to assess the impact of the UK vote. This is taking place in a context of slowing global growth, continuing deflationary pressures and a European banking system which is floundering.

We are still at the “appetizer” stage of a long meal! UK shall play “hardball” – triumph of nation state over macro!

We reiterate our view that: 1 – We continue to see “The primacy of politics” drowning out macro data 2 – We are at the “appetizer” stage of the fallout from the UK referendum 3 – We expect any new UK administration to exit the EU and to take a hard line on immigration – limiting the scope of an accommodation on a “business as usual” basis with the EU.

US jobs data tells us little about direction of global economy  

We have seen the US employment data and view it as proving little except for more low-wage hiring, which will do little to spur consumption. With regard to monetary policy, we see the US central bank “coming up for air” and unlikely to raise rates before the end of the year.

Monetary policy shall be subordinated to the risk of financial market volatility as multiple situations unfold.

We shall be seeing US retail sales and US beige book- see US becoming a safe haven for moveable capital

With regard to data, we shall be seeing US retail sales hoping granting some insight into the robustness of the constitution of the US consumer. This shall be preceded by the beige book. We see the US economy as being a winner by default among the major advanced economies. It continues to combine growth – albeit modest – with political stability and an internally driven economic dynamic.

Bank of England meets – shall they cut rates? – Can monetary policy stop asset repricing?

Abroad, on the monetary front the Bank of England shall meet. This shall be critical to understanding the condition of the UK economy. The extent to which monetary policy can be effective against a political void and a still in its infancy repricing of grossly overvalued property assets.

UK property market – get ready for a loud, crashing sound!

The UK property market has historically been the leading indicator for a turn in the UK business cycle. We now see it as ushering in a structural shift, with lower safe haven demand from flight capital and doubts as to the shape of prospective economic relations dampening demand for London property.

Chinese GDP irrelevant – reflects government spending and dumping – divorced from market mechanisms

We shall also be seeing data on Chinese GDP. While important we view this data as bearing scarce relationship to any market based economics. The Chinese economy is being kept going by mini =-stimulus programs –with ever lower incremental effects – and by adroit currency “salami tactic” – slice by slice currency devaluation.

The dependence on the low value added export model remains the centerpiece of the economy. China’s government still appears reluctant to write off the sunk cost of capital investment and is determined to privilege revenue and FX receipts over profits.

2- Global growth

Cautious on global growth – US likely the best in a disappointing lot

We continue to be cautious on global growth and view the uncertainty stemming from the UK situation further impacting modest prospects for the Euro Zone. China’s efforts to lend impetus to its economy remain temporary and limited. In this context, the US – despite its manifold challenges- likely remains the only major economy with “stand alone” capacity.

A throwback to the “Cold War” – Europe remains “The crucible”

We continue to see Europe as “The crucible” - with political shifts likely to cause changes in economic policy. A protest against free markets and trade is underway and we expect social discontent to accelerate.

We see a structural shift in global trade

On the theme of global investment the G-20 trade ministers are sounding a cautious note- estimating that capital investment may fall 15 per cent next year. This is seen as driven by a slowing of trade. We might well add that overcapacity is still going strong, new manufacturing techniques are reducing production times and supply chains and that topping out of infrastructure investment in China will reduce exchanges. The slowing of trade growth is structural and not cyclical.

3 - Will we see a shift to micro and away from politics and macroeconomics?

Will the start of the US earnings season signal a shift towards the more mundane business of business? Last week, we saw the US stock market on the verge of scaling new heights pushed by a shift towards US assets and expectations of prudence from the US central bank.

We view earnings as important. However, we continue to see markets in the thrall of politics, currency fluctuations and oil prices.

4- Focus on the UK

UK – situation - Bottom line is security!

Is this the end of the line for the Brexit “rejectionists”?

Is this the end of the line for the “rejectionists”  who insist on a rerun of the UK – EU vote? The US president at the NATO conference has basically stated that – like it or not – the working assumption is that the EU and UK shall now start disengagement talks – and speedily too!

The concern is that uncertainty will further damage confidence in an already shaky global economy. With populist, anti – free trade and anti-immigrant on the rise a further economic weakening will spell further havoc.

For US bottom line remains security – this is the new “Cold War” – shades of Kennan and containment

We continue to see the US thrust in the direction of security policy – the bottom line remains NATO.  This assumes a major importance in the light of the UK’s large contribution to the European defense budget.

Which trade agreements are concluded between the EU and the UK  is  of secondary importance to the US. What counts – in a throwback to the Cold War – is the solidity of the European front against Russian expansionism.

We are watching sterling!

The UK remains the focal point, with sterling an accurate barometer of the UK’s political and economic fate. Since the “leave” victory, the once world’s reserve currency has collapsed close to 15 per cent. Doubts and caution are starting to prevail among the victors.

Exit difficulties for UK are becoming apparent!

The difficulty with regard to satisfactory post – exit trade and financial services agreements is becoming apparent. The establishment of bilateral agreements might take up to a decade. In the meantime foreign direct investment shall be on hold constraining growth.

A tale of two economies – Is it the best of times and the worst of times?  

We are continuing to see a marked divergence between the FTSE 100 – large global groups – and the FTSE 250 – small and mid-cap domestically focused economies. Companies with domestic sales shall be impacted by higher import prices and an economy likely to slip into recession.

5- Government debt markets signaling panic

Are we moving to global negative yields?

Government debt markets continue to benefit from – despite a temporary stabilization in equity markets – from massive safe haven buying. We are seeing one bulwark of still positive yield after another capitulate! Negative yields are creating a dual pressure:

Negative yields creating a “full court” press

1 – Limiting the bonds available for purchase by the ECB

2 – Reducing bank lending margins – increasing longer term operating concerns at the same time as the UK crisis threatens to negatively impact the single currency area.

6- Banking crisis - source of systemic risk

Counter-piece to UK crisis – banking crisis – Italy at end of its tether with the EU

The counter-piece to the UK political crisis in Europe continues to be the banking crisis. The collapse of several Italian banks has put the Italian government on a collision course with the EU with regard to bank rescue guidelines and is rapidly leading to TARP solution. This is now – following the collapse of attempts to assemble a private sector “lifeboat” – considered the only way out.

The mighty – how they have fallen! – Deutsche Bank hitting new lows!

We are also seeing continued turmoil in Germany, where Deutsche Bank’s restructuring efforts continue to flounder. The shares are hitting new lows as investors flee a sector deemed assailed on multiple fronts. Regulatory pressures shall remain a constant and the UK crisis is likely to negatively impact Euro Zone growth.

UK banks – shall we see another wave of state support?

As for the UK, the banking sectors shares have collapsed – without having fully recovered from the financial crisis. Bank stocks have fallen in excess of 20 per cent as political and longer term economic uncertainty refocus attention on exposure to the housing and overall – UK domestic economy.

UK “challenger” banks – is this a re-run of Countrywide?

We remain focused on the UK “challenger” banks which replicated the US Countrywide model – disproportionate exposure to housing and higher risk lending. One cannot exclude the UK government needing – should the collapse continue – facing the need to bail –out the once again improvident.

7- Emerging markets – are they an FX proxy?

As regard the emerging markets, we do not share the optimistic view that European asset allocations shall be partially shifted to the EM space. These economies continue to have a disproportionate correlation to global growth – which at the present juncture is in short supply.

We see the EM strategy as a bet on low interest rates and a limited strengthening of the US Dollar. The focus is on reducing debt servicing costs and not on an improvement in operating revenues.

8 – Oil and commodities – cautious outlook

US producers continue to confound all predictions

While oil prices have staged a rebound from the US Dollar 25- 26 level, we continue to see the market as oversupplied. Short term, we see a move down to the US Dollar 40 WTI level as possible. US supplies remain robust and shale production continues to confound all predictions of its early demise.  

Not wild about commodities

As for commodities, we continue to see the sector as having established a new and more constrained trading band. While one hears a great deal about a “bull market” prices are coming off a very low level. Longer term optimism is predicated on a reduction in supply and not on an increase in demand.

[cynthiadibartolo]

Markets are still coming to terms with UK events

Post by Chief Economist Jean Ergas

Markets are  still coming to terms with UK events, with the only certainty further  uncertainty. The primacy of politics remains unassailable and unpredictable –  with nationalist emotions outweighing economic rationalism.

We see  central banks as locked in a race with the populist “tsunami. People are fed  up with the “old order” and want change now! Slowing global growth shall  exacerbate inequality.

Storm craft  warnings increase as we are now fighting a two front war – UK and the Italian  banking system! Will Italy defy the EU – choice between the bad and the  worse!

1-Today’s  action!

US taking its  cue from Europe

The US looks like it shall be taking its cue from Europe, with S+P  futures pointing downwards. Europe is slowly stirring following the central  bank induced mirage last week – realizing that the UK political situation is  far from solved and the potential for a “hard line” outcome is high.

UK – it is  all about immigration!

We said from the start that the battle ground was not economics but  immigration, immigration, immigration cloaked as sovereignty. Prior to the  opening of the EU to the newly admitted countries of Eastern Europe – the EU  faceless bureaucrats were deemed an annoyance but not an existential threat.

Those who had  most to lose from quitting the EU voted to go!

The UK economy shall be facing considerable challenges and number of  vulnerable shall increase as a result of the uncertainty wrought by the  referendum. These are those who in their largest numbers voted against the EU  and the additional social protections that it afforded them.

We see this  as veering on the optimistic and should the property sector take a punch,  there could be “some unpleasantness”.

Is Standard Life the canary in the coal  mine?

Are we  already seeing the unwinding of the UK property sector?   Standard Life has blocked redemptions from its 2.9 billion pound retail fund.  The fund which invests in commercial properties has been hit by considerable  redemptions. Considering that the fund holds 13 per cent in cash, this may be  the tip of the iceberg.

Property market not yet at bottom!

Shall we be  seeing a replay of 2008 when commercial property fell by 40 per cent? In one  week, we have read of 20 per cent discounts on property – the bottom is some  ways off. The pressure on the banks shall intensify and we reiterate our  fears as to the non-bank niche lenders.

Legal and General down 7 per cent – are the insurers next?

We are also seeing pressure build on the insurers, who derive a substantial part of their income from commercial property. Already hammered by collapsing bond yields – shall we be seeing government intervention to prop them up?  

London commercial property – is it still a “store of value”?

A key consideration is that London commercial real estate was viewed by foreign institutional investors as a “store of value” – when the properties are assessed on a conventional yield basis, the results may look somewhat different.  

UK construction index at lowest level in seven years!

We also saw that the construction index prior to the vote had fallen to the lowest level in seven years – reflecting that the mere possibility of a “leave” victory was sufficient to sow panic. This was accompanied by collapsing business confidence, with most predicting a contraction in the economy. 

Sterling trading at a 31 year low to US Dollar – shall go lower

In the light of the above, it is not surprising that sterling is trading at a 31 year low. This despite the manifold protestations by the “leave” campaign that everything is just fine! Housing construction had already started to collapse before the vote – with the property builders having a better sense of the literally “facts on the ground” than Cameron.

The one blessing in disguise is that the UK is no longer on either the gold standard or part of a monetary mechanism. The entity of the recent move would have smashed through its reserves.

UK central bank reduces reserve requirements – shall have little impact on “real economy”

The Bank of England has reduced capital requirements for the banks. This is generally seen as the counsel of despair – with the aim of limiting the curtailment of credit to be expected in a downturn. We see this as having a limited impact on the real economy as uncertainty as to the future structure shall reign for some time.

Foreign investors shall be wary of political uncertainty and of a rapidly depreciating currency

Foreign direct investors while maybe not proceeding to a mass asset liquidation – which would now be at fire sale prices – shall be remiss to increase their stakes. On a more prosaic note – we may ask whether short term investors shall be willing to funnel excess cash into a rapidly depreciating currency.

Italian banks – we are starting to see the “Great Unwind”

Markets are also being impacted by the continuing drama of the Italian banks – with the EU challenging Italy’s determination to bypass new rules and stage a “state as entrepreneur” rescue. We reiterate our view that there is no easy way out. With bad debts at 17 per cent of GDP and likely to rise, Italy may simply have to go it alone.

The choice is reminiscent of TARP – between the bad and the worse. The experts have once again overestimated the willingness or ability of the private sector to seize “bargains”!

2 – What are the prospects? This week – may be exciting!

Will this week be a “return to fundamentals” or continued hope in the central banks?

This week we shall see whether the stocks markets shall succeed in maintaining their boisterous tone. Shall equity ebullience focused on large caps hinting at a new role for leading groups - safe haven assets – continue?  

Is the UK signaling a shift towards safety in size?

The gap between the FTSE 100 and the FTSE 250 is instructive – with investors looking beyond the depreciation dividend and seeking safety in geographical diversification and sustainable cash flow.

Government debt markets playing a different tune!

In contrast, the government debt markets appear to be discounting a return to the “Great Deflation” of the 1930’s – with grinding slow growth the “shape of things to come”.

All of Swiss government debt is now in negative territory and the UK 10 year has hit a record low.

We have QE yields without QE – will this boost the economy?

In the US we have succeeded in having QE yields without QE – will this support domestic capital investment and consumption? Will central banks continue to lower rates – subordinating bank solvency to avoiding a deflationary re-leveraging of company balance sheets?

We are keen to hear what the Federal Reserve shall say about the UK situation

The key data point shall be the US employment data – seen in times of “business as usual” as the principal metric. As these are anything but – we are far more interested in statements by Federal Reserve officials with regard to the prospective impact of the UK situation on the global economy.

Markets will be gearing up for earnings – but politics still in “pole position”

Markets shall be starting to gear up for earnings. However, we see these as being subordinated to political events which have not yet begun to play out. Following the UK vote, we are now in uncharted territory on both the economic and political planes. The UK vote has shattered an order deemed unshakeable as well as cherished beliefs in the implacable advance of “progress”.  

While economic policies are deemed to follow some basic paradigms politics has a well-deserved reputation for unpredictability. The result of the UK consultation highlights that “nation state” trumps global economy!

Are we at the start of the populist wave in Europe?

Will the UK vote lend steam to the populist sentiment running riot in Europe – rendering countries ungovernable as rejectionist parties make effective coalitions impossible? The recent Spanish elections have failed to produce a clear majority and the advance of the 5 star Movement in Italy does not bode well for reforms.

3-Global overview

Despite comments by Gove – “experts” not giving up! EU not NAFTA!

The UK situation continues to be the” Talk of the town” as the “experts” – much mocked by the “leave” campaign attempt to divine the future – if not necessarily – righteous path. We reiterate our view that this is not – as was often presented in the US – a re-negotiation of trade agreements.

This is the “Congress of Vienna” with open doors!

What we are seeing unfold before us is a “Congress of Vienna” with open doors. Power is rapidly moving from elected parliaments to direct democracy as the “discontented of globalization” seek to redress the excesses of a world run amok.

What can we read into the financial market bounce?

With regard to the impact of what is an extremely fluid situation – this has hitherto been viewed through the prism of traded financial assets. A collapse was followed by an equally speedy recovery of some of the lost ground – with however fixed income at odds with stocks.  

Global growth continues to be weak – central banks between a rock and a hard place

We continue to see global growth prospects as weak – as constraints on fiscal policy prevent demand management from picking up the relay baton from monetary measures. These have reached the limits of their efficacy. Central banks shall need to choose between limiting long term damage to bank balance sheets and attempting to stop the deflationary onslaught.  

Shall we see a US re-pivot to the “Old world”?

On a global political scale, the UK referendum has – together with the refugee crisis – contributed to shift the political focus to Europe. Previously the European challenge was seen as economic - the political stability is now being questioned. We expect that there shall be a re-pivot to the “Old world” with the bottom line being security.

US economy slowing but still growing

With regard to specific regions – we see the US economy as growing at a pace sufficient to avoid a recession but not fast enough to significantly lift wages and increase consumption. We put little stock in arguments pointing to “tightness” in a labor market – which is now increasingly centered on temporary employment affording little stability and no bargaining power.

Federal Reserve likely to tread cautiously

The center piece remains the Federal Reserve. We see the US central bank as unlikely to move for fear of triggering a “mass of money” shift out of the emerging markets and worsening the position of countries with substantial current account deficits. Further discussions centered on domestic metrics are now moot.

Euro Zone growth rates continue to reflect wide divergences between economies  

As regards the Euro Zone, we reiterate our view of a hitherto incipient recovery in the aggregate but with wide divergences between the key economies. Germany continues to power ahead while Italy continues to struggle and France stalls. We see the populist surge as impeding the longer term reforms necessary to power growth.  

Do not see emerging markets as “natural” beneficiaries of turmoil in the UK

Turning to the emerging markets, we do not view them as “natural” beneficiaries of the turmoil in the UK. While some see investments exiting Europe and flowing to the EM space – beyond re-balancing from very underweight positions we do not see this as likely.

The EM space in Asia continues to be subject to the centrifugal forces of Chinese growth and / or commodity demand. We are continuing to see slowing industrial production in China and do not see a second commodity super cycle on the horizon.

Emerging Europe in the eye of the storm

As concerns emerging Europe – the former socialist republics –we see them as in the eye of the storm. The exit of the UK prospectively reduces the flow of financing from the EU and a slow Euro Zone growth impacts on their role as part of the European supply chain.

Continue to see oil market as oversupplied

We remain relatively cautious on oil prices and continue to see the market as both oversupplied and subject to the impact of slowing global growth. The context shall not be helped by the economic uncertainty triggered by the UK events. 

[cynthiadibartolo]

Are we seeing the legitimization of mob rule in the UK?

Post By Chief Economist Jean Ergas

Are we seeing  the legitimization of mob rule in the UK? Rebellious elites and uneducated  ally to proclaim “Age of ignorance”!

EU tells  Cameron – “We do not want to be just friends - Get your stuff out of my  apartment”! - Fasten your seat belt – we paraphrase immortal Lenny Bruce –  non-sked global economy flies again! – Will stiff upper lip last? – Scared to  death of “Shadow Banking”!

Markets have  not yet begun to shake out, stay hedged! – Leave campaign some want to  “control” immigration – what about the others? – Not wild about EM – Last one  to leave turn off the light!

Week 2 of ARE  – After Referendum ERA!

We are entering the second week of the ARE – After Referendum Era and  the world- despite collapsing financial markets – is still spinning! Are we  being too Euro-centric? We think not! The pound – once the world’s reserve  currency – keeps falling and there continues to be havoc on the European  stock exchanges.

We expect  that we are far from out of the woods and foresee that like an earthquake the  initial damage shall be followed by collateral losses triggered by fire and  flood.

UK – total  confusion!

On the UK front the confusion appears to be total with both the  conservatives and labor in complete disarray. We see it as utterly pointless  to speculate as to which shall be the final “arrangement” the UK shall  choose. There is nobody there to negotiate and the erstwhile EU partners do  not appear to be in a conciliatory mood!

Osborne  speech unleashes further selling!

As expected the speech by Osborne – the equivalent of the US Treasury  secretary – has done little to reassure. The term “adjustment” is being used  as a euphemism for recession and – we believe – longer term, slow growth. We  are repeatedly told that the UK is only 4 per cent of global GDP.

This is a  rubbish argument – Lehman Brother counted for much less and we are still  dressing our wounds today. Commercial and financial interconnections in the  context of integrated economies count for far more.

Banking  stocks kaput!

These points have not been lost on owners of banking stocks. Barclays  and RBS had trading in their shares halted as investors make a dash for the  door! To regulation, slow global growth, low interest rates has now been  added utter uncertainty as to whether they shall be able to still access EU  markets.

Italy wants a  waiver!

In Italy, prior to “The Vote” seen as the epicenter of the banking  crisis, the government wants EU rules on direct state assistance to the  banking system waived. We are not surprised. The private sector scheme via  the Atlas backstop was already floundering and the UK vote was an excellent  opportunity to push through the request.

The message is simple. Either the EU agrees or we shall have another locus of major banking turmoil. This is not what the EU wants now.

It all started with a fight among friends!

On the political front this week shall see the beginning of EU meetings without the UK. We can well understand the anger of the other members – whose economies and people shall pay a steep price for the conservative party’s ill-fated attempt to overtake the United Kingdom Independence Party on the right.

Emotional “victory lap” Leave campaign not yet over!

Kerry is on the way to Europe to seek clarity. We wish him luck! This is a – hopefully – first and one of a kind event. What is being lost on many observers is that this event was not the result of sound economic reasoning but of a need to reaffirm sovereignty. The “victory lap” has yet to run its course – cooler heads and organization are not the order of the day!

We are seeing a continued move towards the safe havens, which we expect to accelerate. Credit risk in Europe is – finally – being repriced. Will there be profits to be made selling overpriced protection on fundamentally strong companies?

Be grateful for small mercies – center holds in Spain!

The one good piece of news is the strong showing of the PP and Rajoy in the Spanish elections. Prospects of a wide fall-out from the UK have tempered people’s penchant for embarking on radical adventures. That said the anti – EU far left has held, while the more moderate socialists have lost seats. Is this the spring being coiled for an advance next time?

1-Summary of the plot! Young, charming UK prime minister goes “A vote too far” and drives off cliff! Global economy now at mercy of 100 people arguing in London! Scary!

Does the UK’s conservative party have a talent for self-destruction?

We may well ask whether the UK government has not unwittingly engineered an “internal Suez crisis”. In 1956 the vestiges of a dying colonialism triggered the biggest UK foreign policy debacle - cementing the country’s steady political decline.

Attacking Egypt - a struggling third world country fighting neo-colonialist aggression - did not go down well in the post-war world!

Cannot believe that this debacle started with a quarrel among chums!

Last week the ineptness of a prime minister seeking to win a spat within the conservative party has unleashed a reaction which shall take years to run its course. Like the Arab Spring which was seen as heralding freedom but has engendered chaos, we see last week’s events as the prelude to massive shifts in the political and economic construct.  

New school of economic thought – makes import substitution look enlightened!

A prospective secession based on a “Biggles – Commonwealth” view of the global economy risks breaking up the world’s largest trading bloc and ushering in “The era of economic obscurantism”. 

Some are making comparisons to the UK’s exit from the EMS in 1992.

Leaving EU is not like leaving EMS!

We see the comparison as spurious for two reasons:

The UK stayed in the EU, along with Italy. The global interconnections at the economic and financial level were less developed minimizing the impact.

We see this as a defining moment for the global world economic and political order – confirming the grim view that history is not unidirectional.  

2 - Fasten your seat belt!

Expect markets to come under further pressure – this is a start and not an end!

Markets are continuing to get their arms around the “sea change” wrought by the – for some – surprising result of the UK-EU vote. We do not share the enthusiasm of some who see this as a short term re-pricing. We beg to differ and reiterate our view that we have not yet seen the whites of their eyes!

It seems to be getting “lost in translation” that we are dealing with the European Union’s second largest economy and one of the world’s major beneficiaries of foreign direct investment.

Too early to discuss future model – still in the early stabilization phase.

Discussions as to which model should be adopted – post EU exit – are senseless until there is a government in place able to open negotiations. The UK has been served a “get your stuff out of my apartment” notice! We are seeing a hardening of the tone with scarce willingness to grant “most favored nation” status without politically impossible labor mobility.

3- Central banks to the rescue?

Central banks shall provide liquidity to banks – we expect widening spreads across a wide range of assets

Stiff upper lip admirable but not sufficient!

Stiff upper lip appears to be the “word of order” for global central banks. The Bank of England informs that there is nothing to worry about as the UK banks are bursting with health. Should financing be required 250 billion pounds are ready! This does not explain why the top UK lenders collapsed more than 20 per cent!

Central banks issuing “comfort letters” – very hard to enforce!

We are seeing similar “comfort letters” of the type - issued by parent companies of subsidiaries veering on collapse – from the ECB and others. While we do not doubt their sincerity, it is a sorry reflection that eight years on and endless liquidity and capital injections, we are still fretting about the health of the banks!

4 – The UK Banking System

We are not finished with the banking system!

UK bank privatizations put on hold – will more money shall be necessary?

The UK government shall now need to postpone once again the sale of RBS and Lloyds Bank – the result of the financial crisis and the state as banker! With a UK recession on the cards and falling government revenue, where shall the money come from for a further re-capitalization?

What about the “Shadow Banking” system? - UK adopting specialized lender “Countrywide” model

But are we barking up the wrong tree? Should we not be focusing on the “shadow banking” system which has stepped into the breach for the traditional commercial banks? The non-bank lenders in the UK appear to have cloned the “Countrywide” model much beloved in the US prior to the financial crisis.

Will the Bank of England be forced to once again bail-out the irresponsible?

A massive exposure to the riskier fringes of property lending and limited funding flexibility do not bode well! We expect a bloodbath in UK property with non-diversified lenders taking it on the snout. Will the Bank of England be forced to bail them out? What shall be the political consequences?

5- “The immigrant question”

Will this turn into harassment of children of immigrants in the UK?

Starting to see backtracking from the instigators of a campaign based on ultimately appealing to fears of “The other”

Moving on to the key issue – the primacy of politics- we are seeing substantial confusion as to the future UK leadership. We are seeing backtracking from the “secessionists” with regard to some of the key promises made during the campaign.  

Some want to “control” immigration others will close the door!

The key issue is immigration which was the battle horse of the leave campaign. We are starting to see a subdivision within the “go it alone” camp between “revisionists” and “Stalinists”. The former wish to control the flow of new-comers while the latter shall not shrink from closing the doors!

We are already reading of increased hostility towards immigrants. The “Leave” campaign may have opened a Pandora’s Box which they shall find very difficult to close. This could get very ugly.

6 – Are we seeing the end of Yugoslavia?

EU stalwarts running scared!

European Union in a state of shock – Socialist French president meets with leader of National Front!

Turning abroad – we are seeing shocked reactions throughout the European Union. The fear of a spread of “referendum-itis” and direct democracy – at which the retrograde are expert – has forced the French socialist president to meet with the head of the National Front!

We are keeping a close watch on Spain – expect progress of extreme left

Today’s Spanish elections may also prove to be another “body blow” to those who believe in growing economic and political cooperation. Should the anti- everything Podemos and hard left alliance succeed in emerging as the second largest party - European investor nervousness may well ratchet higher.

Do not see a US Civil War type secession sequence in the continental EU

Will there be a spate of departures from the EU? We see this as the lesser evil due to: The relatively long term time frame The greater interdependence of the “continental” EU countries as compared to the UK.

Who shrunk the UK?

Greater danger break-up of the UK

We view as the greater short term risk a breaking up of the UK. Scotland is wasting no time in getting into the starting blocks for another go and Northern Ireland shall likely follow. The breaking up of the second EU economy shall not be seen favorably by the capital markets, raising financing costs at both the sovereign and corporate level.

What was striking is that the referendum highlighted a state not only segmented by age and education but also by geography. England voted out – while Scotland was overwhelmingly pro-EU.

7- Federal Reserve and the ECB – can they play doubles?

Is the Federal Reserve walking on eggs?

As concerns monetary policy, we reiterate our view that the Federal Reserve shall tread cautiously. This shall be driven by two major factors:

1-The fear of causing “mass of money” shifts from the emerging markets with second round effects being:

A re-leveraging of US Dollar mismatched liabilities Difficulties in attracting financial flows to cover current account deficits without needing to increase interest rates.

2-The second driver focuses on concerns that a fragile US recovery may be thrown off course by a further drop in capital spending as companies make a further dash for cash.

ECB – two strategies- short – short term and short term!

ECB shall be operating on a dual axis - monetary measures and lender of last resort

We see the European Central Bank as acting on a dual axis:

Monetary easing and bond buying to lift inflation via currency devaluation Providing liquidity to the banking system and – where necessary – foreign exchange.

We expect further turbulence in the European banking sector and see little scope for a revival of the equity markets prior to a stabilization of the financial sector.

8- Expect further weakness in EM – looking for PE ratios of 6!

Cautious on emerging markets – do not buy inflation story

We remain cautious as to the emerging markets with caution by the US central bank outweighed by the risk of slowing global growth. Some analysts are foreseeing sharp increases in inflation in some economies – for example – Brazil as the currency depreciation pushes up import prices. We do not agree and see Brazil as:

1- A “closed” economy 2- Having sharply reduced imports

The key point is that the Brazilian problem and solution are overwhelmingly internal.

Not wild about Japan

This is not about Japan!

Will we see Japan pass from stagnation to collapse? We see the Japanese economy as slow at best. While safe haven flows into the yen shall reduce export competitiveness – a strong currency has not impeded exports from accounting for close to 50 per cent of exports. Japan’s problems are structural and not solvable via either FX devaluations or short term fiscal policy.  

[cynthiadibartolo]

Is This the Turning Point in the UK-EU drama?

Post By Chief Economist Jean Ergas

1 In a  nutshell!

Have we seen  the turning point in the UK-EU drama following brutal member of UK MP?  Equities signal lower risk but investors continue to focus on top rated  sovereign debt –– Remain centered on economics but poll rooted in emotions –  IMF launches another warning!

As expected,  Federal Reserve cautious as to both US economy and international situation –  Stands by call on higher rates but does not say when! UK-poll cited as a key  factor – UK leave victory seen as de-stabilizing

Central banks  rally around and confirm contingency plans in the event of a “leave” victory  – widespread turmoil expected across asset classes and currencies – central  banks focused on maintaining interbank liquidity – Finland Minister of  Finance describes Leave victory as European Lehman moment!

2 Today’s  action

Shall common  sense triumph or are we back to the 1930’s?

Shall common sense triumph or shall we start putting up the drawbridges  all over the world – with “going it alone” the modern day equivalent of the  competitive devaluations of the 1930’s? Was the brutal murder of the UK MP  the turning point – swinging the pendulum from politics centered on  demonizing “the other”?

Despite some  relief safe haven asset bond yields still rock bottom

We are seeing some tensions easing in the fixed income markets, with  German 10 year government bonds now above the zero mark. This is paralleled  by a fall in peripheral bond yields –signaling short term relief. What is  remarkable is that rates are still near record lows.

Key macro  concerns remain firmly in place

We see the slight improvement as reflecting only one of the two pillars  spurring flight to safety instincts. Investors are focusing on the “systemic”  aspect – the macro concerns centered on growth and deflation – remain firmly  in place.

Do not count  chickens before they hatch!

This morning markets are taking the view that reason shall carry the  day forecasting a victory by the “remain” camp in the UK. The pound is  surging and stock markets are on a tear. Can we sound the all clear? We see  the following as in the short term key:

Will the  “remain” camp margin widen?

The vote has not taken place  The remain margin remains thin and within a margin of error  There is the risk of a “silent majority” emerging

This tends to  confirm our view that there is a roughly 40-45 per cent hard core anti –EU  camp and that the vote shall play out on a relatively small part of the  electorate.

“Remain” camp has not addressed fundamental fears of secessionists!

The polls turned on an event as opposed to any concrete proposals by the “remain” camp to address the fears of the disaffected. Longer term – strains within the European Union on major policy issues shall persist and the structural problems besetting the Euro Zone shall not abate.

Remain victory shall do little to attenuate desire to “split” of many others!

We will see break-up pressures regardless of who wins!

Some are saying that if the “leave” camp wins, others shall also want to leave. They shall in any case want to leave – regardless of the result of the UK poll. We are already seeing a steady rise in anti-EU populism – with Italy and France in “pole position” in this regard. 

The “unionist” camp must in addition to the populists also contend with separatism – which long quiescent is now roaring back.

UK Poll like the “Arab Spring” not an end but a beginning!

We see a “remain” victory as possibly delaying but not materially changing the push toward less austerity and greater leeway with regard to a wide swathe of regulations.  We may well see the UK poll – like the Arab Spring – whatever the result, not as an end point but as the start of even greater convulsions.

Watch the elections in Italy and Spain – populists and hard left uniting?

The first test shall be the Spanish elections on June 26th – centered on the extent to which the “hard left” and populists can succeed in shifting the political axis. In Italy the populists have seized the mayor position in the capital presaging a rough ride ahead for the Renzi government.

With a total outstanding Spain and Italy debt of Euro 3 trillion- and a Euro Zone rescue fund of Euro 500 billion effective firepower- this is food for thought.

3 Global growth and what’s next?

Sentiment regarding global growth worsening

We are revising our overall sentiment for global growth downwards. This is based primarily on a slower for longer outlook for the US economy – beset by slowing exports and cash strapped consumers - and a still struggling Euro Zone.

See little chance of relief from the emerging markets

We see little hope for relief from the emerging markets – whose prospects are on the solvency front largely hostage to fluctuations in the US Dollar – and as regards growth to China. Should the “leave” camp carry the day, we expect a continued shift towards safe haven assets limiting asset allocation shifts away from Europe.

Political risk increasing and shifting to the advanced economies

We view political risk as both increasing and shifting towards the advanced economies. The coming week the UK-EU poll shall dominate decisions. This shall be followed on June 26th by the Spanish political elections, where a strong showing of the hard left is expected.

Strong populist advance in Italy

The populist advance in Italy has materialized. This shall place considerable pressure on the Renzi government, which is struggling to put through major economic and institutional reforms.  

The attack on globalization continues and we are seeing a move away from economic and political integration. An increasing number of countries seem to be prioritizing “sovereignty” over unfettered access to foreign markets.

Rise in oil prices shall not be a trigger for major increase in global growth

We do not see the recent recovery in oil prices as acting as a catalyst for a recovery in growth. Its principal impact shall be to limit systemic risk - producer or trader insolvency. It however shall not be sufficient to make oil producers backtrack on their plans to cut capital investment.

4 Systemic risk - Brexit emergency

IMF sounds warning – is anybody listening?

IMF once again warns on UK poll – are they barking up the wrong tree?

The IMF has once again chimed in foreseeing a substantial and longer term contraction in the UK economy. This shall be due to both the lengthy “divorce” proceedings creating uncertainty and scant prospects for replicating on a “stand alone” basis the current trading agreements.

Continued leads and lags between the cash and derivatives markets

With regard to the short term outlook, we are continuing to see “leads and lags” with regard to the cash and derivatives markets. While the pound has staged a comeback in the cash market –FX options are closing in on levels last seen at the peak of the financial crisis.

This is a sobering thought when we consider that at the height of the debacle ATM were a week away from being shut down!

Concerned by the extension of risk perception from “step function” FX to solvency

We are concerned by the extension in investor attention from currency and equity risk to credit as reflected to the escalation of volumes in the CDS market. This reflects a “sea change” in risk assessment. Markets are now deeming the potential “aftershocks” as sufficient to trigger insolvencies, as well as other credit events.

“Heart of the matter” first 24 hours! 

Market participants are now rapidly realizing that the “heart of the matter” is not the long term consequences of an exit but the financial turmoil in the first 24 hours! The global financial system may need to absorb and fend off systemic risk while still struggling with the aftermath of the financial crisis.

Central banks are focusing on providing liquidity – Lessons from Lehman?

Global central banks have confirmed that they are preparing contingency plans for the “Day After”. Efforts shall be focused on ensuring sufficient liquidity to the banking system. The objective is to avoid a freeze of interbank lending, which ultimately was the key factor in the “forest fire” speed spread of the Lehman crisis.

We reiterate our view that liquidity shall not necessarily be sufficient to support asset prices and expect “step function” adjustments across all asset classes.

5 – Macro - All quiet on the US front?

No major surprises from the Federal Reserve

The Federal Reserve meeting while producing no surprises with regard to monetary policy revealed incipient doubts as to the underlying strength of the US economy. Was the labor market collapse in hiring a blip or the start of a trend?

US employment levels belie structural weakness – who is working?

We remain skeptical as to apparent enthusiasm as to employment levels when set against the low labor force participation rate and “shadow unemployment” at close to 10 per cent. There is still an apparent disconnect between alleged “full employment” and wage driven inflation.

Do not see US housing as the key to a turnaround in US growth prospects

One hears growing enthusiasm regarding the housing market. While this is positive, we do not view a recovery in housing as a prelude to a significant shift in US growth prospects. The housing market has come back from the Depression levels of the first phase of the financial crisis.

However it is still on both an absolute and relative basis still well below levels seen pre-crisis or at the height of the 1960’s boom! The US economy was one half the size and housing starts were higher!  

Federal Reserve focused on limiting de-stabilization and not on managing through the business cycle

We are also seeing a Federal Reserve increasingly focused on limiting the risk of de-stabilization as contrasted with cyclical management. While the UK-EU poll is viewed as a possible immediate proximate cause of bedlam, we discern continued fears of triggering a massive “weight of money” shift out of the emerging markets.

6- Oil is this still a macro wild card?

Oil coming off the boil! Need to separate “noise” from “signal”

With regard to the oil market, oil came off the boil last week. We see the key long term drivers as the rise in the US oil rig count, increasing concerns as to global growth and no let-up in Iranian exports. While some have focused on the easing of disruptions, we view these as contributing to short term “noise – volatility” and not impacting at the long end of the curve.

See carnage in US shale sector as largely over

We confirm our view that the worst of the carnage in the US shale sector is over for two reasons. The first is that the recent spike in prices has allowed producers to hedge forward sales. The second is that the recent travails shall prompt a re-structuring of the sector, with M+A acting as a capital provider.

Scope for concerted action in oil limited

We continue to see two factors constraining concerted action: While prices are moving higher, we consider that Saudi Arabia shall be remiss to tip the boat over at what might be a turning point for global growth prospects. Any action without Iran is likely to be ineffectual.

[cynthiadibartolo]

European markets off to a shaky start – is it all about the UK?

Post by Chief Economist Jean Ergas

Europe wobbly – bond market ominous – UK poll casts powerful pall –  expect report but no action from the US central bank – European banks shall  remain under pressure – oil, a lot of wildcards

1 - Today’s action!

European markets off to a shaky start – is it all about the UK?

European markets are once again getting out  of bed on the wrong foot with the upcoming UK-EU vote – due to its systemic  implications – being the major driver. Chinese data has confirmed that the  recent recovery is being supported by government capital investment- with  retail sales and private investment missing the mark.

What is the bond market telling us?

Sentiment is not helped by the continued  collapse in government bond yields. Investors continue to seek shelter from a  “step function” financial assets adjustment following the UK referendum and  express their view on both growth and inflation.

We expect central banks to hold their fire – banking system still  under pressure

We expect this context to prompt central  banks to continue their easing strategy. This shall lead to both a further  distortion in fixed income markets and place pressure on the banking system.  Italian banks are once again getting smashed as the difficulties of re-capitalizing  ailing banks while seeking to eliminate the link between sovereign and bank  risk are once again coming to the fore.

And yet more foreign intervention in the UK referendum!

The UK-EU poll is prompting a renewed spate  of intervention by world political and economic figures and organizations.  Following the German minister of finance that it shall not be “business as  usual” a further cheerful note has been added by the president of the EU –  Donald Tusk.

Would a UK exit ring in “The Decline of the West”?

We are now hearing that a UK exit shall not  only have wide-ranging economic consequences but potentially lead to a  Spengler type “Decline of the West” scenario. What is clear is that this  might signal the “all clear” for other countries to seek to water down or  outright leave the EU.

Keen to hear Federal Reserve’s report – US economy still going strong?  

With the UK – EU referendum turning into a  cliff-hanger, central bank meetings are getting less attention than  customary. We do not expect any moves from the Federal Reserve but shall be  focused on their report on the “Rake’s progress” of the US economy.

The Bank of England is continuing to focus on providing a buffer for a  “day after” a UK “leave” vote. Currently, many are forecasting a strong  bounce should the “remain” vote triumph. We see a bounce capped by structural  problems in the UK economy.

Shall not purport to be prophets!

Some are arguing that a close victory for the pro-EU camp shall lead to a weakening of the government’s position, highlighting the risk of political instability. We do not purport to be prophets and are focused on the potential for a “shock” impacting the global economy and not possible UK domestic squabbles.  

Is the UK poll also impacting energy?

Oil prices are also heading south. This is being driven by concerns that the US shale industry may stage a short term rapid production comeback. UK – EU concerns dealing a blow to an already fragile economic framework are also taking a toll.

We continue to see several wildcards in the oil space and reiterate our view that even a best case US Dollar 50-60 scenario shall not be sufficient to lift all boats.

2 – In a nutshell

Markets taking fright at UK polls and rush to safety in the fixed income market - UK-EU referendum gaining in importance with some polls showing “leave” winning – UK Prime Minister “very concerned”

Heading into US data intense week + Federal Reserve meeting – Oil starting to slip – will it fall further as growth concerns increase?

Fasten your seat belts!

It is now all about the UK-EU referendum. This “binary” event is now seen as the crossroads for short term financial stability and the prospective re-casting of regional and global economic and political order. We reiterate our view that – successful or not –the “leave” campaign has lent respectability to those advocating secession – and anti – EU sentiment.

We are seeing increasing desperation by the “remain” camp, with continued foreign intervention to support the status quo having seemingly little impact.

We shall hear an assessment of the US economy but do not expect action

Will the disappointing jobs data and the confluence of event risk and macro concerns last week lead the US central bank to stay its hand? While an increase rate increase is seen as unlikely attention shall be focusing on the “state of the nation” of the US economy. Do we need to get over the UK hump?

We expect a re-shifting from cyclical issues to a renewed focus on preventing that potential markets turmoil might be the catalyst for a recession or have systemic impacts.

Oil market – is this the turning point?

Oil prices have remained firm, supported by continued supply disruptions, seasonal factors and the hope that India is poised for a “step function” in fuel consumption. On the US front the debate continues to focus on determining the respective trigger points for an escalation in shale production and / or exploration.

Two major constraints for concerted action

With regard to the potential for concerted action – we see two constraints. The first is the lift-off in prices from the lows touched in the first quarter. While the second is the continued reluctance of Iran to limit production until its pre-crisis volumes are reached.

Price is now subordinated to stability – shall this lull last?

We see price levels as subordinated to price stability as the key factor for producers and investors, with the former taking a “wait and see” attitude prior to relaxing their cost cutting. The latter are drawing comfort from a perceived reduction in systemic risk.

3 - Global overview and what’s next?

Do not see global growth as having reached a turning point – recoveries subdued and bereft of long term investment

We see few signs of an improvement in global growth prospects and see political uncertainty as acting as a constraint on capital investment. The economic model shall migrate from the classical model posited on the triptych of government spending, consumption and capital investment to limited recoveries driven by “catch up” consumption and discounting.

We reiterate our “stand-alone” approach to assessing economic prospects for selected countries. In the absence of global growth expansion shall be subordinated to resilience.

Political risk shall be the driver from which central banks shall take their cue

With the UK-EU referendum rapidly assuming the contours of “Checkpoint Charlie” for global markets we expect central banks to postpone potentially de-stabilizing measures. Macro issues shall take second place to providing a buffer against market volatility.

Central banks standing by with fire hoses!

Several of the major central banks have confirmed that they are standing by in the event of a “Leave” victory. We see as key the distinction between providing interbank liquidity and managing currency adjustment and the disruptions in equity and fixed income markets.

Convergence between currency market and FX options incomplete

Will the central banks succeed in stabilizing equity and fixed income markets? The key event last week was the convergence between European equity markets and sterling FX options. We do not see this process as having run its course.

ECB launches corporate bond buying - scant avail for equity markets

The start of the ECB’s corporate bond buying program was not sufficient in a context of rekindled political risk to either stem a massive flight to quality in the fixed income markets or infuse optimism in the equity markets. In a potential pre-systemic situation investor asset selection is reduced to its simplest terms – move to cash or safe fixed income.

Axis shifting with demographics from young buying on credit to older generation spending investment income!

With regard to the Euro Zone – we are once again starting to hear heated criticism of the ultra-low interest rate policy. These critiques are not focused on macro-prudential banking concerns but on the decline in purchasing power.

​Low returns on savings crushing consumption – no point in low interest rates if banks do not lend and companies do not invest!

Savers and pensioners are seeing their life’s savings vanishing. Due to the lopsided demographics – “re-instating” adequate returns may be more important than fighting unemployment. It is estimated that global GDP has been reduced by more than US Dollars 1 trillion since the start of these monetary experiments.

Have we found the philosopher’s stone – German government bonds?

Are German government bonds the new gold? Investors have been scooping them up like hot cakes and seem ready for a second helping! We are seeing 10 year yields at practically zero and no “buyers strike” in contrast to autumn 2015.

German economy shall be the last to fall!

This may reflect even further reduced inflation and growth expectations - triggering a further rush for yield and risk / return distortions. A passing thought is that a UK exit may be a harbinger of a EU and subsequently Euro Zone break-up. Investors are honing in on the country deemed to survive best.

Is the US consumer still with us?  

With regard to the US we shall be seeing a considerable amount of economic data. This shall include retail sales which are expected to provide some insight into the last hope of the US economy – the domestic consumer.

Will the US consumer – despite a recent fall in consumer sentiment – pick up the slack offsetting stagnant manufacturing and flagging capital investment?

US shifting from “locomotive” to bulwark – Is the US the sentinel of the market economy?

The concept that the US has shifted its role from that of “locomotive” to bulwark against turmoil continues to gain ground. The Treasury secretary sees a US economy still plowing ahead with “robust” consumer spending and falling unemployment.

US labor market additions shall add less than their numbers to purchasing power

We shall not reiterate our criticism as to the US labor data but insist on the distinction between accounting and economic employment. What we are seeing is the mopping up of the unskilled, commanding low wages and whose re-entry into the labor market has scant impact on purchasing power.

Emerging markets benefiting from commodity stabilization – we do not see this as a game changer

As regards the emerging markets we are seeing a firming in selected markets following some stabilization in commodity prices. We do not see this as being a “game changer” – with a commodity super-cycle unlikely.

 The key challenge for several of the EM economies is shifting from managing the commodity cycle to implementing long term reductions in government spending.

[cynthiadibartolo]

Is it all about Brexit?

Post by Chief Economist Jean Ergas

UK – EU poll ever more dramatic – is this the dress rehearsal for the rest of Europe? Shall markets hold the line this week? – Tired of excuses from the Federal Reserve! – Not impressed by low interest rates!

Investors remain cautious – await Yellen speech and hedge against a UK exit from EU – US Dollar stable following fall after jobs data – Do job numbers count?

Is it all about Brexit?

So – is it all about Brexit? The UK-EU referendum long dismissed as a sop offered by Cameron to a disgruntled electorate now appears to be turning into a Pandora’s Box. A series of opinion polls places the “quitters” in the lead as the excess immigration argument trumps – no pun intended- economic arguments as to the long run benefits.

UK economy unbalanced – shall not be solved by a “remain” vote!  

We stand by our view that the UK economy remains unbalanced. A massive current account deficit and a dependence on consumption fueled by the spending of unrealized real estate gains do not bode well for the future. Whatever happens on June 23rd, the problems are structural and shall not be resolved by a relief rally in the financial markets.

Leave supports latter day Keynesians – not interested in the “long run”!

For what it counts in their reasoning, we see the leave partisans as being latter – day Keynesians, echoing the great economist’s admonishment, “in the long run we are all dead”! We are seeing a groundswell in the UK that regardless of the ultimate result shall be a warning to Europe and the world’s elites.

It is often said that the Spanish Civil War from 1936 to 1939 was the dress rehearsal for the Second World War.

Will the June 23rd vote be the summons for a re-drawing of the European political system?

Old enough to remember speech by Enoch Powell “rivers of blood” speech!

A poll by the highly respected “Observer” places the exit camp in the lead 43 per cent versus 41 per cent as the “separatists” wage their extremely effective battle centered on immigration. Are we seeing echoes of Enoch Powell’s controversial speech in the UK in 1968 warning of “Rivers of blood” should immigration not be scaled back?

UK poll shoot-out between “winners” and “losers” of globalization

The key point remains that the poll is rapidly becoming a confrontation between globalization’s “winners” – the highly paid and / or owners of “capital” and the “losers” – those who have not had the good fortune of inventing a “killer app” and who do not believe in the great statistical fallacy – averages.

We are seeing a shoot-out between capital accretion fed by global capital flows and the last cavalry charge of the mass of the unskilled.

Is this “Tales from the Vienna Woods”? Beware of the de-classed European middle classes!

We are seeing a race against time between the speed at which the ECB can engineer a stronger cyclical recovery and the mounting frustration of a large part of the electorates, who are starting to fear being de-classed. Are we seeing the prescient play “Tales from the Vienna Woods” which foresaw the rise of Nazism?

Populist tsunami makes landfall in author’s hometown!

The populist “tsunami” has now made landfall in the author of these lines hometown – Rome – The Eternal City. Years of mismanagement and corruption appear to be catapulting a candidate of the 5 star Movement into the mayor’s seat.

Is this the end of “transformist” politics in Europe?

The movement is anti-Euro and opposed to the austerity measures imposed on the country. A victory in the second round ballot will create serious difficulties for the Prime Minister Renzi- whose left wing government is attempting to put through a right wing program. We may be seeing the end of “transformist” politics in Europe.

Populist movement echoes non-aligned of 1950’s and 1960’s? What shall be their Aswan Dam?

Like the non-aligned movement in the 1950’s and 1960’s gave a voice to the countries recently free of the colonial yoke, today’s populists are appealing the downtrodden at home! A nirvana down the road shall do little to assuage the pain of those who cannot afford to go for the private option in health care and education.

Focus on the US

Will equity markets continue to hold the line this week? Does the job number count?

Will markets continue to hold the line this week after a strong show of resilience following the “shock” jobs number last week? Are markets taking the view that employment and economic growth are now completely divorced? Low wages reduce incremental purchasing power and pricing power is increasingly weighted towards capital – technology intensive sectors? We may believe in miracles but not in “flukes”!

Or are they hoping that this was a “fluke” – a term which we consider has no place in rational discourse among sentient beings! We find it hard to accept that “The number” can be solely placed squarely on the shoulders of the Verizon strike or that the job market is so “tight” that there is nobody left to hire? Common sense and decency preclude any further comment. Are we seeing cracks in the Federal Reserve’s “united front”?

“Hot off the press” we are seeing a glimmer of a crack in the Federal Reserve hitherto “US economy full steam ahead” united front. While the head of the Cleveland Federal Reserve continues to see an “American Graffiti” US economy – central bank governor Lael Brainard rightly sees the data as a warning shot. Can the “Great Displaced” survive fifteen rounds?

We stand by our basic view that the US labor market has mutated from that of an advanced economy to more closely approaching the duality common in emerging markets. In one corner the highly skilled able to wring a living wage from employers.

Strongly recommend Arthur Lewis’s essay on “unlimited supplies of labor” – is this a plantation economy?

In the other, ever more numerous – “The Great Displaced” casualties of outsourcing and technology struggling to make ends meet. We refer readers to Arthur Lewis’s excellent essay on unlimited supplies of labor to understand why wage increases are scant and unevenly distributed.

We may well ask – are we mutating into a plantation economy for those not endowed with extraordinary skills? Can this trend be reversed or shall the social compact be ripped into shreds? Focus on interest rates heading for bottom of Marianna’s trench!

Do not see positive impact to “real economy” from ever lower interest rates With regard to the fixed income markets, the jobs data has led to a further fall in US and safe haven yields abroad. Speculation is rife that the German 10 year bund might fall into negative territory.

Low interest rates shall not trigger a boom in capital investment

While this shall force investors further out on both the credit risk and maturity curve, we continue to see little impact on the “real economy” which has hitherto shown scant reaction to the appeal of low financing costs.

The “discount rate” for investment assessment is composed of both the cost of financing and a risk premium. We shall need to see a decrease in the European risk premium for a recovery in capital spending.

1 - Key issues - In a nutshell!

UK-EU poll seen as key “event risk” – focus now shifting to hedging short term turmoil – Federal Reserve meeting downgraded following disappointing jobs data – Oil stabilizing  - will it hold at these levels?

Fasten your seat belts!

We see political risk in the form of the UK – EU referendum as being the focal point for investors - with the key objective to build a buffer against potential market turmoil. Longer term concerns linked to global growth are being subordinated to avoiding losses in the event of a “leave” outcome.

Continued dissonance between the Federal Reserve and Wall Street?

We see the upcoming Federal Reserve meeting as having been relegated to second place following the disappointing jobs data. This is seen – whether rightly or wrongly – as limiting the chances of rate increases. This appears to reflect the basic dissonance between financial markets and the central bank – with the latter increasingly focused on US internal dynamics.

Oil market remains oversupplied – are supply disruptions permanent?

Oil prices have continued to hover around the US Dollar 48- 49 mark deemed sufficient to ward off short term systemic risk, while still insufficient to reverse a decline in profitability. We are continuing to see prices supported by disruptions and seasonal factors – while the market remains oversupplied.

2 - Overview and the coming weeks!

Markets shall continue to be driven by political risk and central banks

We are leaving behind us another action packed week with investors reflecting on the OPEC conference, the ECB meeting and the US jobs data. With the Federal Reserve meeting and the UK – EU poll up ahead, we see little reason to see an attenuation of tensions and expect market participants to keep their “finger on the trigger”!

OPEC meeting as expected – “natural re-balancing” the way forward!

The OPEC meeting – as expected – did not signal any change in the Saudi Arabia laissez – faire policy. The market is seen as re-balancing by natural means limiting the need for external intervention. Oil is now deemed by market participants to be at a level still pressuring marginal producers but as having recovered from the depths which might have triggered a systemic event.

ECB holds to trusted adage – When in doubt abstain!

The ECB meeting confirmed the adage - when in doubt abstain! The single currency area central bank has opted to await the outcome of the measures adopted while remaining to intervene further if necessary. The need to attenuate systemic risk in the form of a persistence of deflationary pressures – as opposed to “re-entering” the economic cycle – remains the key priority.

Markets are awaiting the launch of the ECB program of corporate bond purchases. We see this as having little impact on the “real economy” with capital investment decisions remaining largely independent of interest rates.  

Will the Federal Reserve opt for the “long view” or shall they see jobs data as trend?

The US jobs data was a powerful wake-up call with regard to the prospects for the US economy for domestic investors and for foreign investors, the direction of US monetary policy. Shall the US Federal Reserve reverse course and refrain from raising rates or shall they take the “long view”? We expect to learn more on June 6th from a speech by the head of the Federal Reserve.

UK–EU poll bellwether consultation on economic and political integration – increasing concerns as to power of concerted EU political action without UK

The UK-EU poll on June 23rd remains the key short term political event seen as a potential watershed longer term for the EU, Euro Zone and moves towards global economic and political integration.

We are seeing concerns shifting from the economic to the security sphere – can the EU stand up to Putin without the UK?

3 Global survey

US markets stabilize at upper end of trading range – Europe remains pressured by macro data and slowing global economy – China still in pre-transition economic mode – Brazil internal factors dominate – Commodities in “short cycle” within longer cycle of lower prices

Global growth

Global growth is once again a key topic. Disappointing data out of the US and Europe is tempering expectations of either an economic acceleration or a recovery in earnings. We see central banks at the end of their tether and see “organic” domestic demand as the key determinant of expansion moving forward.

US stocks surprisingly resilient – is this a head fake?

US stocks have proven remarkably resilient despite disappointing data across a broad spectrum of metrics. We see the key as being weakness across both manufacturing and services. This is limiting expectations as to the potential for the domestic economy - centered on services - to offset weakness in the export heavy manufacturing segment.

Is the “tightening” labor market argument still valid?

The “optimist” case continues to rest on US internal dynamics – with the US marching to a different beat. A key support has been the conviction that a “tightening” labor market shall boost both employment and wages. Whether these assumptions shall hold in the context of an increasingly dual labor market appears doubtful.

ECB remains principal economic arbiter – major challenge stopping deflation

With regard to the “Old World” the ECB – in the absence of structural reforms – remains the principal economic arbiter. The focus remains on reversing deflationary pressures, with prices falling despite an increase in oil and commodity prices. Growth is being driven by a recovery in domestic consumption with consumers cashing a “one off” deflation dividend.

[cynthiadibartolo]

Investor focus on US data

Post by Chief Economist Jean Ergas

1 - Today’s action

Europe continues to play waiting  game- Euro Zone still in deflation – Are we in the 1930’s? Inflationist camp  living in a by-gone world – Following events in France - Are we on the verge  of another 1968? OPEC conference – not expecting major changes

Equity markets in Europe marking  time – US investors alert on their perch!

Equity  markets in Europe are marking time while waiting for the trio of a US data  avalanche this week, the OPECE conference and the ECB meeting. US investors  shall be alert on their perch for the personal income, consumption and  savings data. With manufacturing doing a dead man’s shuffle - the customer is  king!

ECB needs to get cracking on  deflation – is this the 1930’s?

The  ECB shall have its work cut out this week, with Euro Zone consumer inflation  staging a dramatic advance to – 0.1 per cent. Consumer prices are continuing  to fall – albeit at a slower pace. This is causing havoc with regard to  capital structures – goodbye Modigliani – Miller and leading to a  re-leveraging of the economy.

Interest rates at levels not seen  since publication of “The origin of the species”!

Notwithstanding  massive monetary injections and easing of interest rates not seen from before  the publication of “The origin of the species” – prices refuse to budge. As  we have often mentioned, in the Euro Zone, we are in the post-industrial era  – with energy price increases having a more limited impact.

Those expecting inflation harking  back to a by-gone world!

The  “inflationist” camp is harking back to the global economy, pre WTO – internet  and China. The world has changed – along with unlimited supplies of labor  globalization has brought unheard of economies of scale and – if all else  fails – state financed overcapacity.

We shall not get inflation from  services – too much price transparency

Some  are looking to the service sector for a price boost – internal “organic”  inflation. We see the potential here as limited for two reasons: wages are  going nowhere and there is scant pricing power in highly transparent  commodity product domestic markets.

Who cares what Euro Zone inflation  is – 2 per cent is a rounding error!

Whether  Euro Zone inflation is 1 per cent – ½ per cent or 2 per cent is utterly  irrelevant. European companies compensated for a lack of structural  efficiency by riding the inflation wage and raising prices – in a form of  “pricing power for the utterly incompetent”. This is no longer possible.

Following events in France with  grim fascination – echoes of my youth!

We are following the events unfolding in France with something akin to grim fascination. The French government’s attempts to reform the labor system are once again floundering with key industrial constituencies on strike. Some see in this a slowing of the – albeit- timid recovery.

Little to laugh about – Is this another May 1968?

We see something more serious. A victory by the strikers, who want Soviet job-security within an allegedly market economy would sound the death-knell of real reforms in the Euro Zone. Looking farther out along the curve, these may be the storm warnings for a new cohesion by labor. Should the students join in, we may be looking at another 1968!

OPEC conference – do not see major changes!

We do not see any major changes on the horizon. Iran is still playing the Lone Ranger and price support remains contingent on attacks in the Nigerian Delta and fires in Canada. Expected increases in demand are largely dependent – excluding seasonal factors – on India being the new China.

The oil producers are taking a page from the China commodities story. We believe that visibility is low and we are flying on sight.

2 - Where are we headed?

Political risk increasing

G-7 meets but scant scope for agreement on concrete measures –austerity to the “bitter end” – Japan warns of “Eve of Destruction”- need for pro-active fiscal policy – UK and Germany say No!

Political risk increasing and expected to be “swing factor” for US monetary policy decisions – UK mood appears to be veering towards not leaving EU – will this sentiment persist? Austria does not elect anti-EU president but close victory lends boost to populists – Oil continues to firm but has difficulty staying above US Dollars 50

Investor focus on US data

Advanced economy markets move higher – US dollar rises, lending boost to export focused Euro Zone – Pound stronger on polls indicating UK to stay in EU  

Investor focus now on US internal data

With the ebbing of earnings season investor focus now looking inward – US domestic data seen as key for monetary policy – US economy increasingly seen on a “stand alone” basis – Will US consumers finally start pulling their weight? US data seen as sufficiently positive to move for central bank

Expect to see increasing divergence between US and other central banks

US central bank head confirms at end of week favorable outlook for US economy – most indicators flashing all clear – expect to move in coming months – We are seeing broader cohesion at Federal Reserve – ECB shall be meeting next week – still contending with deflationary pressures.

3 - Global survey

Advanced economy stock markets recover some brio!

Advanced economy equity markets have continued to firm, with  the US near its all-time high – as concerns over political risk, commodity prices and the resilience of the US economy commence to dissipate. Expectations at the macro level remain muted with an acceptance of lower prospective growth rates and the need to “manage decline” or at best the “new normal”.

The fundamental issues remain unresolved with investors increasingly accepting of temporary solutions centered on engineering short term cyclical upswings. Political “wiggle” room to push through structural reforms is seen as limited.

We are shifting towards “capitalism in one country”

In the light of continuing slowing global growth we are seeing a shift to “capitalism in one country” with expansion centered on the US consumer. This is highlighted by investors reacting disproportionately to consumer domestic demand data as opposed to manufacturing or even domestic capital spending.

UK and US – special relationship also extending to economic model

We are seeing increasing similarities between the US and the UK growth model. Both are characterized by a sharp fall in capital spending offset by consumer demand boosted by low interest rates and housing revaluations.

These are structurally weak recoveries – with the fall in capital investment reducing productivity growth and future wage increases.

Central banks – more hope than reality?

Central banks are still seen as the ultimate bulwark notwithstanding increased skepticism as to:

The efficacy of their measures hitherto Further possible initiatives

Need to balance attempts at low grade cyclical boost with bank solvency

Growth remains slow across the advanced economies.  A further lowering of interest rates might provide a short term “shot in the arm” to selected economies. However, this would once again place bank lending margins under pressure limiting scope for re-capitalization via retained earnings.

UK – EU referendum remains key political risk event – shall this trigger a “Congress of Vienna”?

The UK – EU referendum remains the key political risk event with the need to completely recast the European chessboard - in a manner reminiscent of the Congress of Vienna in 1815. While opinion polls indicating a resounding victory of the “remain” campaign are boosting sterling and UK stocks the business world is less sanguine about the outcome.

Currency risk hedging costs are rising rapidly as option volatility hits new records. This is leading market participants to seek to hedge their long sterling exposure via cash and derivative long Swiss Franc positions.

Watch for hit to asset prices if UK leaves EU

While this – despite the basis risk- may reduce transaction exposure, we see the major short term impact of an exit as a butchery of UK asset prices. The UK economy is now largely supported by safe haven money flows into property, seen as mitigating slowing exports and continued pressure on financial institutions.

Emerging markets caught in dual squeeze – balance sheet impacted by stronger US Dollar and revenue by slowing Chinese growth

Emerging markets have given up a substantial part of their gains as the likelihood of US interest rates rising increases and slowing global growth impacts both finished goods exports and supply chains. A stronger US Dollar shall also make repayment of US Dollar denominated debt more expensive further eroding already falling margins.

Investors accepting short cycle fiscal boost as best current outcome for China

While China remains the principal alter- ego to the US with regards to acting as a growth catalyst, we see investors accepting a short cycle stimulus boost and a holding pattern as the current best outcome. The key issues of economic reform – cleaning up of the banking bad debts and reduction of overcapacity are unlikely to be tackled in the short term.

Brazil will need to contend with transition to new political structure

We continue to see Brazil, where the context is dominated by attempts to consolidate political change as the first step to getting at “The heart of the matter” - fiscal reform – as an exception. The key for the Brazilian government shall be to prevent the real from “front running” prospective political change.  

Euro Zone – ECB still the major focus in midst of persistent deflationary pressures

As regards the Euro Zone continued deflationary pressures are steering investor attention once again towards the ECB and monetary policy. We do not see the upcoming ECB meeting as indicating a shift in strategy. The single area central bank continues to need to lift prices while not further jeopardizing a precarious banking equilibrium.

Central banks now acting like sovereign states! – Now both EU and UK seen as losers in case UK exits!

If further proof was needed that central banks are the new “third estate”, the UK EU referendum has dissipated this doubt. The ECB has started to weigh in with its own set of warnings as to the consequences of an exit. We are seeing a marked shift in thinking from the inception of the crisis, when the UK’s loss was seen as the rest of the EU’s gain.

Oil price is being supported by disruptions and hopes of long run increased demand – will this be sufficient?

As concerns oil sentiment has been lifted by in the short term, continued disruptions in Canada and Nigeria, a falling rig count in the US and increased demand prospects from the emerging markets. Prices are still well below the peaks reached in 2014 and un-economical for many producers.

We continue to see any new equilibrium at a substantially lower level which shall reduce systemic risk but still act as a brake on capital investment. These prices are interesting entry points for both hedging and ramping up production.

[cynthiadibartolo]

US rates shall rise

Post by Chief Economist Jean Ergas

Markets lower  – we wait for US economic data – Euro Zone slowly advancing, better than  reversing! Iran shall go it alone – oil market remains shaky. US rates shall  rise – do not ignore the Federal Reserve- does it matter?

European  markets easing – will the US follow?

European markets are easing this morning as investors continue to  digest the prospect of a rate increase by the Federal Reserve, a fall in oil  prices and PMI data confirming that not all is well in Euro Land. We are  seeing also the knock-on impact of US monetary policy on the emerging markets  space which is a key market for European companies.

Iran shall continue to play the Lone Ranger!

As concerns the fall in oil prices Iran’s resolve to go it alone is  taking its toll on the new found enthusiasm. We might also add that in the  event that prices do not rise, this might trigger the sale of vast amounts of  crude oil held offshore at a loss. Carry is negative with the trade not being  playing the futures curve but selling into a stronger spot market. 

Euro Zone composite PMI – nothing to write home about! 

The Euro Zone PMI composite is down overall but is improving for France and  Germany. We see this as confirming a single currency area that is posting a  slow advance but is showing some signs of stabilization.

We have  reached equilibrium – have we reached the end of the night? 

An apparent equilibrium has been reached with however unemployment  still high, country risk disparities massive and the link between sovereign  risk and banking risk still firmly in place. 

Political  risk seems to have mutated from combating and seeking to stem the risk of  further insolvencies to keeping the EU together – regardless of the UK exit  referendum. 

More blood  curdling warnings about Brexit – will asteroid hit? 

With regard to event risk the UK exit from EU “asteroid”, polls are  showing a firming of the “remain” camp. More blood curdling warnings have  been issued with the latest from the UK Treasury foreseeing the loss of ½  million jobs and – the ultimate terror- a fall in housing prices. 

The UK  government appears to have backed itself into a corner. It has created a vast  asset bubble and a mass market wealth effect while allowing a referendum  which could put paid to it in minutes.     

US futures are slightly lower with  investors hearing further rumblings from the seers of the Federal Reserve.  Strong labor markets and prospectively higher inflation are cited as the  drivers to move into second gear.

Federal Reserve Bank of Boston – US Land of a thousand rate increases?

In this context, we are accompanied by the soothing words of the head of the Federal Reserve Bank of Boston. The outlook for the US economy remains positive, with data expected to be supportive of an interest rate increase in the short term. Growth targets are basically not below ½ per cent and inflation is seen rising.

We are clearly in the camp of the “existentialists” who say the only data point that counts is this one.

Are you working? Not – are you eating?

We are not surprised to see that the assessment of the labor market is posited on a “brute” measure of unemployment – without distinguishing between accounting unemployment and economic unemployment. It is now estimated that almost two thirds of Americans could not find US Dollars 1000 in an emergency. Some recovery! 

Election not an obstacle to raising rates – UK referendum counts only if more financial market turmoil? Economist expectations are now over 50 per cent for a rate rise in either June or July. 

With regard to the event risk factors which some see as halting the march of progress, the Boston Federal Reserve has little time! Election years have not proven an impediment in the past and shall not be one now. Neither shall the UK – EU referendum – unless there is considerable financial turmoil before the vote. 

Shall market risk supplant event risk?

Foreign entanglements shall count if systemic. The US central bank is not the “growth” manager for the global economy. Paradoxically stronger showings in the polls regarding the UK referendum may tilt the Federal Reserve towards a more aggressive stance. Market risk shall supplant event risk. 

We have lowered our targets! Euro Zone still there!

As regards Greece – the parliament has agreed to further draconian measures aimed at both speeding up the asset stripping of the economy and generate a primary budget surplus of 3 ½ per cent. These measures shall hopefully be sufficient to unblock the financing needed to make debt payments in July. 

Almost one year on the Greek banks are open and the Euro Zone has not broken up. And now to keep the EU idea alive!

In a nutshell!

Political risk increasing

Key words – political risk increasing and likely to form bedrock for short term monetary policy decisions – G-7 recognizes slowing global growth but no concrete solutions – oil steady but WTI does not break 50, is this the key resistance level? 

Federal Reserve minutes spark reaction

Federal Reserve minutes released sparking concerns of summer rate rise – Advanced economy stock markets hold ground, EM currencies and assets start to reel – Is this the end of the EM rally? Brazil marching to a different beat, economic situation worse than expected 

Stock market volatility increasing

Stock market volatility has increased with release of the Federal Reserve minutes adding interest rate concerns to scant earnings cheer. Selected “spot” US economic data shows some improvement but year on year data remains weak. Will the Federal Reserve act on today or use time series analysis? 

Attention shifting back to macro data

With the ebbing of the earnings season attention is shifting away from corporate results to macro-economic data. Data continues to indicate a slowing global economy and central banks getting desperate as to how to engineer a turn-around.

Central bank positioning unvaried

We see the relative positioning of the major central banks on monetary policy as unvaried. The US is the only major developed economy making noises about raising rates, while Euro Zone struggling with deflation and growth downgrades.

No risk of Brexit but massive hedging underway

Brexit polls are now leaning more firmly towards the “remain” camp. While this is giving sterling a lift corporates are hedging their long pound exposures and asset managers are both reducing their pound bond allocation and hedging inflation risk by shifting sterling fixed income to index linked bonds.

Investors apparently accepting temporary outcome in China as “permanent” solution

We are seeing slightly less concern about China with investors apparently content to accept that the best outcome is continued short term government intervention. The chances of a state ordained reduction of overcapacity remain slim. 

Global overview

This week yet further key US data – is the US economy still growing?

As the earnings season draws to an end the focus shall revert to the US economy with the Federal Reserve watching for any confirmation of positive trends. Data shall include durable goods, international trade and the second estimate of first quarter growth.

We remain cautious on the US economy and continue to see growth constrained by cash strapped consumers internally and slowing exports growth.  

UK referendum and pound – is this the turning point? 

UK sterling has posted a strong performance on the back of more favorable polls showing reduced probabilities of a “Leave” vote. We the issue as two-fold. The first is the short term “shock” potential of a “leave” victory – with a step function adjustment in currency and selected asset markets.

British economy unbalanced and shall remain so even if “remain” camp carries the day

The second is what we view as the structural weaknesses of the UK economy – which both pre-date the EU referendum and shall not be resolved by a maintaining of the status quo. We see the key short term factor and risk to investors as the volatility stemming from the run-up to the vote.

Euro Zone continues to fight with deflation and growth downgrades

With regard to the Euro Zone, the single currency area continues to contend with deflation and growth downgrades. Accommodative monetary policy has not been able to increase domestic demand, restoring pricing power to local companies, or to cause a currency depreciation sufficient to generate imported inflation. 

Little faith in ECB corporate bond buying program

The ECB shall soon start to aggressively purchase Euro corporate debt. We see the effects as remaining contained to the “lucky few” able to access the fixed income markets and not reducing financing costs for those who need money the most – the small and mid-size firms representing the bulk of the economy.

Key European focus - multiple political storms!  

The key variable remains the political arena, with several crises impacting simultaneously. While the UK referendum is “top of the pops” there is a time demarcation point – June 23rd. We see the other crises – rise of populism, migrants and the Greek conundrum as ongoing.

We see a “remain vote” in the UK as stemming a financial rout but not stopping the spread of autonomy movements in the EU. Economic and political integration is likely to stall, with the EU reverting to its origins as a free trade area with benefits.

Emerging markets marching in lockstep with Federal Reserve

As concerns the emerging markets we are seeing the lock-step correlation between US central bank policy and currency rates - financial asset values confirmed. The Chinese “locomotive” is both slowing and changing focus, reducing the scope for revenue growth and causing a shift towards containing the cost of excess leverage compounded by FX mismatching.  

Oil prices firming but still below US Dollars 50

Oil prices have continued to firm although they seem to have hit a resistance level below US Dollars 50. Abstracting from the US Dollar effect common across the commodity spectrum, we see this as reflecting that the recent price increases are being driven by disruptions and not tangible evidence of a longer term non seasonal rise in demand.

Tenacity of US shale producers surprises bullies! The tenacity of the US shale producers continues to limit the “elimination pricing” strategy pursued by Saudi Arabia. This is due to technological innovation reducing the break-even point and “volatility windows” allowing for hedging of future production. Production remains out of line with the pressure exercised by Saudi Arabia’s elimination pricing strategy.  

Iran keeps socking it to rest of OPEC!

The oil market – never a dull moment! Iran has reiterated that it shall not freeze oil output before the OPEC meeting and shall wait until it has reached its pre-crisis output. With sanctions largely removed, Iran continues to confound the skeptics – who saw a lack of investment as limiting the speed of the bounce-back. 

There shall be blood in the oil market! 

Exports are up 40 per cent and the country expects to hit its pre-crisis production level in the second ½ of 2016. Unless demand increases dramatically or disruptions become permanent, there shall be blood in the oil market! 

Get over it – super-cycle kaput!

Our view on non-oil commodities remains unchanged. We see the present phase as a short cycle of price recovery within a longer cycle of price stabilization following the end of the super – cycle. While mining and commodity trader shares have posted a considerable gain, they are still well below their super-cycle peaks. Glencore management’s timing of their IPO was brilliant! 

Political Risk

Increasing and not yet factored into investment values 

We see global political risk as both increasing and possibly not yet factored into asset valuations. The UK referendum, whichever way it goes represents a watershed. This shall be the first time since 1975 that an EU government allows a vote to decide whether to stay in the EU.

EU separatism – A Damocles sword!

We see this as a “Damocles Sword” hanging over the uneasy alliance and ready to be used to extract further concessions. A combination of slow growth and the migrant crisis – obliging all EU members to take in some refugees – is sowing discontent and stoking populist rebellion.

Austria – a powerful wakeup call?

The focus has hitherto been on the “New Europe” – Eastern European countries that joined starting in 2004. However, the presidential election in Austria has been a powerful wake-up call.

The possibility that one of the EU’s most prosperous members may have a president from the far right of the political spectrum would be unprecedented.

Migrant agreement starting to fray 

With regard to the migrant crisis, the agreement reached between Turkey and the EU is starting to fray at the edges. At the same time the migrant flow from Africa towards Italy has once again picked up steam!

US stock market not UK sterling! 

As concerns the US – the presidential campaign is now veering towards the conventions. Some see the US markets trading increasingly like sterling – political volatility trumping economic data. We see these parallels as misplaced.

The UK stepping out of the EU shall be a far greater shock to the global economy than the US not increasing its push for new trade alliances. A UK exit vote has a definite time point and is not subject to re-negotiation. 

Commonalities between US candidates

We continue to see commonalities between the two leading US contenders. Both shall revert to spending freely and resorting to over or covert protectionism to secure their political base. There shall be attempts to push back the clock of history.

China was not a bigger Korea!

In the 1950’s the rallying cry of the conservatives was “Who lost China”? Today it shall be to find a scapegoat for not recognizing the difference between China and the other emerging markets. China was not a larger Korea but had the potential to both complement and compete with the advanced economies.

[cynthiadibartolo]

US economy – all dressed up and nowhere to go?

Post by Chief Economist Jean Ergas

US  economy – all dressed up and nowhere to go? US and Europe is this the parting  of the ways or “noise”? Chinese economy – straight out of central casting –  as the famous Jazz song said “can’t get started”. UK exit concerns rising –  hard core of exit fans resists! Central bank independence – is this a bad  joke?

Markets  gearing up for US data - better surprise on upside than stuck in a rut!

Markets shall be gearing up for a lot of US  macro-data. We still see signs of growth as preferable to a collapse. While  expansion may engender concerns of an earlier than expected rise in interest  rates, a stumbling economy shall be viewed as the death knell for corporate  profits.

With investors banking on an end to the  earnings recession and deliverance from the second best solution of multiple  expansion - there is a lot at stake!

Today’s action!

You go your way – I shall go mine!

Are  we seeing a parting of the ways, with Europe slipping and the US hanging in  there? Europe has confirmed its susceptibility to “Foreign affairs” by  hesitating following the latest data from China. A rise in the oil price  triggered by more disruptions has failed to lift spirits as investors look  beyond the Nigerian delta and focus on the global macro picture.

China – pull up your socks!

With  regard to the data from the world’s second economy, this is a case of not  good enough, with lower than forecast data across a broad array of metrics.  We see this as a classic case of decreasing returns on government stimulus  measures. There is a limit to which you can prop up an economy whose clients  are  “working to rule”, like the UK trade unions in the 1970’s.

Where is the  substance in the recent Chinese recovery?

The Chinese  mini-recovery is being fueled by speculation on the back of loose monetary  policy and continued overproduction. As we have often noted – deflation is  less about oil than about competing with countries where the social  break-even is considered more important than conventional accounting.

The Chinese  economy while not kaput is generating low incremental returns on state  largesse – with more lending simply adding to a mountain of bad debts!

Kindness of strangers – for some!

Notwithstanding  commodity stocks are rising on hopes of yet further stimulus. This generosity  shall be selective, with the commodity producers getting a slight lift, while  those whose strategy is based on ever faster rising standards of living shall  not get seconds!

 Japan – be careful on the downside!

This week we shall also be seeing Japanese GDP data, with many hoping that the world’s third largest economy is not in recession. The key point is that while expectations for Japanese growth are low – a protracted recession is seen as a catalyst for more aggressive monetary policy and competitive devaluation.

With the EM story on hold, attention is shifting to the advanced economies as growth generators.

EU industrialists say no to Leave!

In the Euro Zone attention is now shifting to event risk as the UK – EU exit referendum looms larger. We are seeing polls which show 46 per cent wanting to stay, 43 per cent opting to leave and the rest undecided. We are now seeing the pressure build with grim opinions from leading EU industrialists.

We are getting to the heart of the matter – economic exposure

We see this as getting to the heart of the matter, future investment flows and economic exposure, as opposed to hedging transaction long sterling exposure. A loss on “cable” is a one off. A slowing of inward bound money into an economy with a massive current account deficit is somewhat more serious.

EU shot in the arm for UK economy – was tottering on verge of collapse

The UK economy which for years suffered from very low productivity and declining living standards has benefited enormously from massive EU capital inflows. This was driven by both the supply of equity capital from abroad reducing pressure on the capital markets and creating a wealth effect via absurd property prices.

Wait to buy that house in London!

One is in any case pleased to see that our view on the precarious state of the UK economy is shared by others. Parallels with the UK in the early 1990’s are becoming increasingly common - an overheated housing market positioning the country for a housing crash and recession.

Euro Zone government bond yields mispriced – we agree! Some should be paying 10 per cent!

On the broader EU front, we are reading that the EU peripheral sovereign debt yields do not adequately reflect the UK exit risk. We agree, but would add that this is only a minor part of the picture. The key point is that the yields ex- Brexit do not reflect the parlous state of economies which despite low interest rates and a weaker Euro simply cannot get started.

We view the statements by the rating agencies as to the impact of a UK exit on the remaining EU economies as well placed but missing the essence. Abstracting from a possible UK exit, we are heading towards an EU de-caffeinated lite.

Central bank independence – is this a joke in poor taste?

The UK economy – will there be a recession?

The polemic continues to rage in the UK following statements by the head of the Bank of England that a UK exit from the EU would not only unleash the divine punishment but also a recession! This is raising questions as to the independence of the central banks.

Independence of central banks irrelevant when economic system is at stake

We consider this discussion to have been made utterly irrelevant by the financial crisis, when the focus shifted from cyclical management of the economy to saving capitalism for the capitalists. Independence ceases when the economic system risks tipping over – bringing in its wake democracy.  

Right or wrong – it is hard to see any sentient being arguing that zero interest rates as anything but the primacy of politics over longer term sound policy.

Watch out for punches coming out of left field!

Japan – be careful on the downside!

This week we shall also be seeing Japanese GDP data, with many hoping that the world’s third largest economy is clambering out of recession. The key point is that while expectations for Japanese growth are low – a protracted recession is seen as a catalyst for more aggressive monetary policy and competitive devaluation.

With the EM story on hold, attention is shifting to the advanced economies as growth generators.

Are we on the brink of the “Age of muscle flexing”?

Will VW usher in a new era of investor activism in Europe?

We read with interest that the Norwegian state pension fund, the world’s largest intends to take part in a class action law suit against VW. This is due to the losses on its holding in VW stocks following the breaking of the emissions scandal.

Norway state pension fund owns almost 2 per cent of VW – shall we see the “weight of money” in action?

What is more interesting than the law suit is that the pension fund owns 1.64 per cent of VW’s common stock. Is this the beginning of a new era in activist type investing in Europe? If so what shall be the consequences for corporate balance sheets and prudent reserving?

In a nutshell!

Stock markets have been struggling to maintain their footing. Stronger than expected US retail sales and a firming of oil prices  have not been sufficient to offset further intimations of a slowing in global growth.

Major global groups are increasingly seen as leading indicators for the world economy. In this context, disappointing earnings have not helped to dispel a mood of caution.

Monetary policy remains accommodating – with the US the only central bank discussing further rate increases. The divergence trade is intact, with other major central banks still firmly set on stopping deflation in its tracks. We see the upcoming Brexit referendum as inducing prudence.  

Oil prices have firmed. This is due to a combination of “Short end” of the curve disruptions and longer term expectations – or better put, hopes – of a substantial increase in demand from the emerging markets.

With regard to the China risk, we see the focus shifting from industrial data to the monitoring of the build-up in commodity and oil stocks. Is this hoarding prior to a repeat of “The Guns of August”?

This week further key US data – is there a “Fifth Column” within the Federal Reserve?

This week we shall be seeing further key US data, which shall include CPI, industrial production and key manufacturing data. The FOMC minutes shall be published – fueling another round of speculation as to the existence of a “Fifth Column” ready to raise rates. How close are we to the tipping point?

Expect more pressure on the pound and Euro

As the UK – EU referendum rolls closer, we are likely to see further volatility with regard to both the pound and the Euro. The single currency has shifted from being a safe haven from the cross-channel turmoil to being the “fellow traveler” of the UK’s fortunes.

Still about repaying debt!

What is the closing gap in US bond yields telling us?

We are silent witnesses to the closing of the gap between two year and ten year US government bonds to the lowest level since December 2007. Does this indicate low long term growth and / or a secular decrease in inflation expectations?

Absolute amount of debt the critical issue

Abstracting from the oft cited slowing of the emerging markets, we see as the key long term economic “deadweight” the still very high debt levels – across sovereigns, companies and consumers. Any excess cash shall be used to pay down this “burden of the ages”!

Two per cent inflation does not cut it!

With regard to inflation, a return to an inflation target of two per cent shall prove insufficient to restore pricing power across a wide breadth of business sectors. We are seeing negative demographics in the advanced economies and an intractable overcapacity in China.

Political risk building!

Earnings and macro data ceding way to political risk

Earnings and macro data shall however be superseded by the “Gathering Storm” of political events. The UK referendum, initially seen as a secondary, domestic matter has mutated into an international issue! Foreign governments and international organizations have not been remiss to threaten the apocalypse should the leave contingent win!

Will Spanish elections set the pace for European populism and shift to extremes?

With regard to the Euro Zone a general election in Spain on June 26th is seen as a bellwether for the growing populist discontent. The forging of an alliance between the euro and debt rejectionist Podemos party and the communist left is seen as threatening the traditional Socialist – PP binary option.

US campaign getting moving into goal zone – We see commonalities between the parties

Needless to say, the US presidential election – although the candidates have not officially been chosen- has spawned a wide range of forecasts as to future economic policy. We are starting to discern two commonalities.

Do not expect balanced budgets!

The first is that fiscal conservatism is unlikely, with the Democrats reluctant to cut entitlement programs and the Republicans ready to expand deficit spending.

A Farewell to Free Trade!

The second is a shared aversion to “business as usual” with regard to free trade agreements. We can expect a slowing in the pace of trade liberalization. The promise of “long run” equilibrium is not deemed a satisfactory offset to the loss of well-paid positions.

Turkey – EU relations rapidly souring

The honeymoon between Turkey and the EU are once again souring. Turkey is threatening to flood the EU with refugees if no progress is made on both vise free travel for Turkish citizens within the EU, as well as on the disbursement of funds for the migrant camps. This is what Gaddafi used to threaten Italy with!

General overview – The long run

Macro-economic data continues to disappoint – lagging realization that it counts!

Macro-economic data has continued to be disappointing, with already modest growth forecasts revised downwards. With a considerable lag time investors are starting to discern the limits of monetary policy and re-focusing on the “real economy”.

Are we seeing 1990’s Japan writ large?

Deflationary pressures remain constant despite a firming of oil prices and massive monetary stimulus. The impression that we are on the threshold of a liquidity trap – Japan in the 1990’s writ large – is rapidly gaining in credibility.

Debt repayment remains key objective

High debt levels are precluding further borrowing and forcing companies and consumers to employ cash flow to repay their liabilities. While gearing has been reduced worldwide sovereign, corporate and consumer debt remains very high.

Focus on emerging markets

Remain cautious on emerging markets – where is the structural change?

We remain cautious on the emerging markets space. The stabilization of the US Dollar lessening the balance sheet impact of currency debt mismatching shall not be sufficient to engineer a “Sea Change”. Investors are starting to distinguish between “one off” political shifts – see in this regard the Brazilian “earthquake” and the fall in the real.

China – economic drivers have not changed

With regard to China, the economy continues to slow, with domestic demand apparently not sufficient to take up the slack from contracting export markets. While the service economy is growing, the major economic lever remains low value added export manufacturing. Some are seeing stockpiling of oil and commodities as a buffer for a prospective devaluation.

Brazil – are we at the turning point?

With the approval of the impeachment process and the passing of the presidency to Temer, the first scene of the first act of the Brazilian drama is over. Markets are now starting to grasp that the tough part has just begun, with a global cyclical upswing likely to have a limited impact. The “heart of the matter” is not commodity prices but the enemy within – public spending.

Whether any government shall be able to reverse rights enshrined during the transition from a military government to democracy remains the key challenge.

Euro Zone – we remain cautious!

Euro Zone – “Age of Re-Leveraging” looms closer

We are not surprised by a downward revision to Euro Zone growth in the first quarter. Adjustments within a very low band reflect “noise” and not signal. In our view inflation data is the key factor. With deflationary pressures resistant to negative interest rates, massive liquidity injections and firming oil prices, we see the “Age of re-leveraging” on the horizon.

European banking problem not over – cannot break umbilical cord between sovereign and banking risk

Together with the lack of inflation, we see the banking crisis as not over. Pressures on the Italian banking system are not abating. The government is now seen as the permanent back-up to the “coalition of the un-willing” of the private banks. One may well wonder whether the Euro Zone economy is strong enough for a severing of the link between banking risk and sovereign risk.

Focus on US

US economy – Federal Reserve sees lift off – are they right?

As regards the US economy – a better than expected result in retail sales and consumer sentiment have not been sufficient to mitigate investor concerns. The US economy is seen as stuck in first gear, with prospects based on hopes of a marked and diffuse rise in wages.

Cash shall be used to pay debts!

Whether this shall be sufficient for the US to look inward mitigating the impact of slowing global markets remains highly uncertain. Wages are lifting off selectively and from a low level. We continue to see the majority of spare cash flow as being used to pay down debt.

Focus on oil and commodities

Can oil prices rely on India? Is India to oil what China was to iron ore?

As concerns oil we have seen a firming of prices based on IEA projections of increased demand from the emerging markets – in particular, India – reducing the persistent excess in supply. This represents a long end of the curve factor as opposed to a short end squeeze driven by supply disruptions.

Saudi Arabia shall not wage battle on two fronts

We remain cautious on oil. With Iran coming on stream faster than expected and the Saudis not likely to change course. A government can only act in one sphere successfully at the same time – the Saudi priority now is generational change not a reversal of energy policy.  

Commodities coming off the boil – is there life after the super-cycle?

Commodities have continued to come off the boil, with the China – largely speculative – driven spike, starting to ebb. The focus is now shifting from commodity prices to the extent to which the industry leaders can regain profitability in the absence of a new “super cycle”.

Need to look at commodity prices on a “normalized” long run basis

This is based on efficiency gains – lifting current margins – and a slashing of capital spending limiting future supply and equilibrium prices. We see a return to super-cycle conditions as difficult and argue for a “normalized” steady state pre-China boom metric for determining long run prices.  

[cynthiadibartolo]

Macro Impact of Saudi Arabia Changes

Post by Chief Economist Jean Ergas

Markets  moving up on oil disruptions. Investors ponder meaning of Chinese data – is  it all just about the currency? Will Saudi Arabia change its tactics in the  oil market – “natural re-balancing” is still the dominant strategy. UK – EU  referendum gets down to the wire – Stay camp pulls out last refuges of the  desperate – housing prices and lessons of World War 2!

Today’s  action

European markets are moving up this morning on stronger than forecast  factory orders in Germany and oil supported by disruption in Canada. Euro  Zone investor confidence is also perking up – with many hoping that a floor  has now been put in with regard to both energy prices and systemic risk.

Whether it  shall be smoother sailing through to the UK- EU referendum is however still  open to considerable doubt.

Chinese  exports - is this about the currency?

Chinese  exports have risen. This however is seen as reflecting more the recent fall  in the currency than a strong recovery in demand. We see this as confirming  that the economic model remains unchanged - with low value added  manufacturing exports facilitated by government credit and a weaker currency  as the major bulwark.

Where is the  “cross-over” point for the yuan?

This has also  led to an increase in FX reserves – again reflecting the currency  depreciation versus the Euro and Yen. Will this strengthening continue when  the currency depreciation shall pass the trigger point, where capital  outflows outweigh export inflows?

Historic  changes in Saudi Arabia? Iran remains key target!

What are we  to make of the changes at the top in Saudi Arabia? We see our view of the  “natural re-balancing” strategy confirmed. Saudi Arabia shall continue to  pursue its elimination pricing strategy. The principal target shall be Iran,  which it sees as a “dual” enemy:  As the leader of the Shiite wave in  the Middle East, and as an upcoming commercial competitor, hitherto confounding  all sceptics with regard to the recovery in production. 

Global  economy long term energy changes

The Saudi  Arabian policy is centered on reducing dependence on oil in anticipation of a  post – oil era. We are pleased to see that our view of a global economy which  may be both less energy intensive and / or focused on other energy sources is  starting to be widely shared.

We do not exclude further pressure on prices

We do not exclude further pressure on prices. Declarations by the new Saudi Arabian oil minister confirm the intention to be a reliable supplier - do not expect a massive cartel squeeze any time soon!

The ultimate UK economic threat- housing prices shall fall!

The Brexit debate continues to call forth the views of all and sundry. The latest to pitch in is the UK Chancellor who has affirmed that an exit would reduce UK housing prices. In the UK where housing equity is not – to cite Vince Lombardi – not everything but the only thing – is strong stuff indeed!

As if the housing “bazooka” were not sufficient, the British PM has appealed to the need for the EU as a bulwark against war. With the polls almost tied, this is grim warning indeed.

General overview

In a nutshell!

Stock markets have been attempting to stabilize – with downward pressures limited by a firmer oil price and by what some see as selectively marginally improved Chinese data. Markets are supported by the overall consideration that notwithstanding slowing growth, we are in the presence of “managed decline” as opposed to a burgeoning systemic crisis.

With regard to political risk, Europe remains the key focus. Fears as to a cessation of economic and political integration remain firmly at the forefront. The UK – EU referendum next month is seen as a possible catalyst for “contagion” – both political and economic, while the Greek crisis has awoken from its slumbers!

With regard to oil, prices have firmed driven by medium term forecasts of a supply squeeze wrought by continuing slashing of capital investment. Longer term structural factors appear to be supported by shorter term production disruptions.

Notwithstanding supply excesses persist, Iran continues to confound the skeptics and the US shale sector keeps lowering it break-even level.

This week – fall-out from the jobs report – will this sway US monetary policy?

This week, we shall be contending with the fall-out from the C- US jobs report. The principal focus shall be on the consequences for US monetary policy – with some optimists seeing the slight increase in wages as partially offsetting the lower job creation.

Whether this shall be sufficient to convince the US central bank to plow “full steam ahead” remains doubtful.

Have slowing jobs growth and a broke US population impacted retail sales?

We shall also be seeing if the slowing US jobs growth has impacted the “Silent majority” of the US economy – consumption. Shall retail sales once again disappoint, reflecting lower consumer confidence and rising gas prices?

While manufacturing is expanding, the pace of expansion remains insufficient to act as a trigger for faster growth.

Brazil in the “hot seat” – is this Dilma’s swan song?  

Turning to the foreign arena, Brazil shall be in the “hot seat” with the vote on the impeachment of the president. We see the president’s possible departure as a start of a longer process, with uncertainty remaining a constant. Any incoming government shall need to tackle structural problems centered primarily on the fiscal situation.

With the deficit to GDP ratio hovering at 10 per cent and 90 per cent of government spending non-discretionary, the immediate margin for maneuver is limited.

UK referendum tensions continue – polls have been wrong before!

The UK remains a key focus – with the UK – EU referendum looming and the polls still indicating a tight contest. While “received wisdom” still sees a “leave” outcome as unlikely – the polls have been wrong before! See in this regard the majority the conservatives won at the last general election – with the polls foreseeing the necessity of forming a coalition government. Has the UK vote conferred legitimacy to foreign intervention in the internal politics of sovereign countries?

We are seeing repeated interventions by foreign leaders in the UK-EU “dispute”. Under other circumstances, these interventions would have been considered interference in the internal affairs of a sovereign state. Regardless of the outcome, has Brexit led to the breaking of one of the cardinal precepts of diplomacy?

Will the Bank of England act on rates – is it the UK–EU vote or the slowing global economy?

Closely intertwined with the UK – EU poll, the Bank of England’s meeting shall be closely watched. Will a series of disappointing economic indicators  - which some see as reflecting increasing nervousness as regards “decision day” – lead the UK central bank to consider lowering interest rates?

Euro Zone – deflation an intractable issue – economic growth driven by “catch-up” buying  

With regard to the Euro Zone, the economy continues its gradual advance, with however inflation an apparently intractable problem. Several institutions have again lowered their growth estimates – with the customary references to the need for structural reforms. Growth continues to be powered by “catch up” domestic demand, fueled by massive price cutting.

European banking – this is not the end of it!

Last week, banking stocks continued to wobble. The sector was not helped by declarations by the governor of the Italian central bank – following the BPV debacle – that government intervention to support ailing institutions was justified and would continue.

Major plank in ECB’s plan about to unravel – link between banking and sovereign risk

We see this as threatening to unravel a major plank of the ECB platform – the severing of the link between the banking sector and sovereign risk. This “mésalliance” was one of the catalysts for the Euro Zone crisis in 2012 – which almost spelled the end of the single currency experiment. Shall this again be the proximate cause of further turmoil?

Emerging markets – demarcation between markets and economies remains  

With regard to the emerging markets, the demarcation between markets and economies remains firmly entrenched. We have seen a recovery in financial markets, which however has not been matched by any significant changes in fundamentals.

EM financial assets – are they a proxy for spot FX rates?

Financial assets have mutated into proxies for FX spot rates. The weaker US Dollar has reduced the local currency value of foreign currency debt – a key consideration for entities with mismatched liability FX positions.

These imbalances are one of the legacies of “The Age of Quantitative Easing” – which led to US Dollar devaluation, low US Dollar interest rates and triggered a desperate search for higher yields.

The central issue is not the spot FX rate - Where is the local currency cash flow?

We do not see the central issue as short term fluctuations in spot rates. The longer term risks to solvency are posed by the triptych of slowing global growth, advances in manufacturing shortening supply chains and the growing threat of protectionism.

Major threat political populism – free trade root of all evil

As we have often commented, the major threat is now political populism which sees in free trade the root of all evil. The reaction to badly managed globalization – which has together with technology – wrought destruction among the middle classes of the developed economies – shall not be short lived.

Oil prices supported by a motley band of factors – does this hang together?

Turning to the oil price – markets have been supported by a motley array of factors, ranging from disruptions to investors discerning the endless “turning point” in the US shale sector.

US shale production has now following massive pressure retroceded to the level of 2014.

With technological advance and firmer prices supporting debt and equity values, are we seeing decreasing returns from the Saudi “elimination pricing” strategy”

Commodities – short cycle within the longer cycle

Commodities have taken a tumble following a strong run, with the Chinese government intervening to quell speculation in iron ore speculation. We remain skeptical as to another commodity boom but are focused on discerning the short cycle fluctuations within the longer cycle.

Chinese commodity boom a result of political authoritarianism and infrastructure as a leading indicator

There is no discernible next candidate for an infrastructure boom along Chinese lines. The commodity squeeze was the result of centralized planning and no need for a broader political consensus, conditions not present in any other EM candidates.

Longer term – we shall see the impact of technology on the creation of the global middle class

In addition, we expect that technology and incipient protectionism shall hamper the emergence and further advance of manufacturing in the new economies. This shall with regard to foreign suppliers constrain the demand for repeat use commodities and also slow the growth of the middle class.    

[cynthiadibartolo]

Brexit Looms

Post by Chief Economist Jean Ergas

Europe taking baby steps – backwards or forwards? Oil coming under pressure, key weapon volatility not price cutting - Brexit, this is getting serious! US manufacturing to the rescue and does unemployment data mean anything?

European markets cautious – pullback in Asia – Italian banks under pressure

European markets are mixed with the stronger Euro restraining investor enthusiasm and the Italian banking crisis dragging down the local index. We are seeing a sharp pullback in Asia following a “wait and see” stance by the Japanese central bank. This has propelled the yen higher and reduced hopes of a rapid improvement in the Japanese economy.

Energy fundamentals in “pole position”

On the energy front fundamentals are once again in “pole position”. This is driven by a strong increase in Iraqi production despite civil disorder and estimates that OPEC and Russia are still busily “pumping for cash”. Iran continues to confound the scoffers with a 300000 barrels a day increase, adding further pressure to the export markets.

Big stick not price cutting but capacity to stoke volatility

What is clear is that the solution to oversupply shall not be from agreed production cuts. It shall be driven by the threat of relentless price cutting stoking market volatility, making incremental investment risky. Prices may have recovered but the market remains “unregulated”.  

The IEA warns that we may have too much of a good thing. Should capital investment not rebound by 2017, less capacity may result in a “squeeze” pushing prices sharply higher and blocking economic recovery. We continue to see a bumpy ride for energy prices with the US shale oil sector capable of surprises!

Euro Zone manufacturing continues its gradual advance

The Euro Zone manufacturing sector growth continues – albeit at less than the annual pace of the pre-crisis years. While Germany, Spain and Italy are picking up, French manufacturing is contracting. With exports under pressure and capital investment low, the key issue is whether Euro Zone domestic consumer driven growth has peaked.

The Longest Day in the currency markets – June 23rd 2016?

Brexit is “getting real” The Bank of England is getting ready to both provide the London banks with liquidity and FX for a “Brexit day” scenario. What needs to be borne in mind is that the result shall not be known on June 23rd but likely the next morning. Whatever the outcome - a sharp spike in volatility is on the cards.

Sterling could fall 15 -20 per cent – are we ready?

The “Day after” scenario continues to tax the best minds! One of the top City of London economists - now on the monetary policy committee of the Bank of England - sees the pound falling 15 – 20 per cent should the UK vote to go it alone.

Exit risk not yet priced in – will there be any dust left to settle?

According to this well regarded expert, the market has not yet appropriately priced in the exit risk. The UK central bank will however not act immediately on the interest rate front but wait for “The dust to settle”. Will there be any dust left? One of the most recent polls shows the quitters in the lead!

While concerned as to the market disruption potential of a Leave victory, we see the UK economy as unbalanced with consumption reasonably resilient but capital investment and exports squeezed.

US unemployment shall rule the roost! Is it relevant? The US week shall culminate in the release of the politically critical employment data on May 6th. We view analysis drawn from these data points using the metrics of the pre-technology and pre-China era as misleading. The relationship between employment and prosperity is now non-linear, with considerable downside but little upside.

A sharp rise in unemployment and the resulting “optics” can crush consumer sentiment. For many, though, gains from employment remain minimal.

Major US data today manufacturing – Weaker US Dollar shall not resolve all problems

Today the major US data shall focus on the manufacturing sector – punching well above its weight with regard to exports, pricing power and corporate profits. We are not holding our breath and d do not see a weaker US Dollar as a panacea for slow growth.   Not convinced by baby steps progress in China

We are seeing a modest expansion in China with regard to both manufacturing and services. This may attenuate fears as to a “sudden stop”. However the improvement comes at the expense of a further build up in loans to insolvent companies and continued overcapacity.

We are already seeing this in the steel sector, where frenzied activity in iron ore speculation is pushing up steel prices. This is the tail wagging the dog!

Investors need to face the fact that the Chinese recovery is not self-sustaining. The longer the day of reckoning is postponed, the more blood there shall be in the streets.

Summary

Stock markets hesitate with technology, disappointing economic data and doubts as to central bank munificence dampening investor optimism.

Continue firming of oil prices and selected commodities reduces allays systemic risk concerns and lends a boost to producers.

Brexit concerns - notwithstanding forecasts of a NO vote – persist, with increasing fears as to a re-casting of Europe and international relations.    

This week we shall be contending with the fall-out from the technology sell-off and markets evaluation of central bank strategies. Investors shall focus on key US economic data culminating in the politically critical employment data on May 6th.  Will the Federal Reserve view a further fall in unemployment as sufficient justification to “bare its teeth”?

In depth review  

A good week for destroyers of idols – cherished myths bite the dust!

We are leaving behind us a week which has seen the destruction of several cherished ideas. Technology is no longer seen as invincible, the Bank of Japan has paused in its easing and the US may suffer – if we keep going at this pace – the ultimate ignominy of growing slower than the Euro Zone.

In the midst of these paradigm shifts - oil has continued to firm providing support to stability hopes. We see this as a precarious situation - with market equilibrium at the whim of Saudi Arabia.  

US central bank opts to play from backfield – focus once again veers towards cyclical considerations

In this context, the Federal Reserve has opted for caution while downplaying global risks – with the focus shifting to cyclical as opposed to systemic concerns. Some observers see the absence of further shocks from China and a rebound in emerging markets as allaying financial stability concerns and clearing the way for rate increases this year.

Apple impact macro- economic - does this reflect a slowing of the global economy?

The US market was dominated by disappointing results from several colossi of the technology sector, with the one-two punch from Apple. Results well below forecasts with regard to both profits and sales have re-kindled speculation as to whether this is a micro – product issue or a reflection of a generalized macro slowdown.

Carl Icahn adds to general joviality!

Apple’s travails were in addition the focus of comments by Carl Icahn – who sees considerable “freedom to do business” risk in Apple’s China based strategy. We see the issue not as freedom to do business but as a slowing of Chinese growth and of the pace of addition of new recruits to the middle class.

No time to be a hero!

The Federal Reserve has decided that this is no time to be a hero and placed both rate increases and aggressive talk on hold. In a rare moment of tangency with reality, the US central bank has admitted that economic growth has slowed, while making fewer references to the global context.

Are we waiting for Godot?

US economic data has confirmed this assessment. Notwithstanding income gains, consumers remain reluctant to spend - preferring to increase savings and / or reduce debts. With manufacturing and export powered growth in abeyance, an increase in consumer spending remains the bedrock for a sustained future expansion.

US exports disproportionately large part of pricing power

Much has been said as to the “closed” nature of the US economy – with only 12 per cent of GDP dependent on foreign trade. This is seen as a buffer to global volatility. This does not take into account that high value exports / manufacturing represent a disproportionately large part of pricing power and corporate profitability.

Inflationary pressures remain in absolute terms muted. This reflects both the continued “full court press” on consumer cash flow with massive overcapacity resulting in depressed import prices.

Wage growth remains meagre – structural shift in labor market and steady advance of technology

Wage growth remains scant, a function of both the migration to low paying service jobs and an apparently “unlimited supply of labor” reminiscent of an early stage developing economy. We also see an “undertow” of technological advance placing further pressure on both job creation and wage negotiation power.

ECB asks for an extension for the final!  

With regard to the Euro Zone, while growth is slowly picking up – driven by “catch – up” consumer demand – prices are falling, leading to a re-leveraging of sovereign, corporate and personal debt. In a note of agreement with the Bank of Japan, the head of the ECB has asked for an “extension” to see the impact of the measures adopted.

What we see as not clearly defined is what shall constitute success. Whether an increase in inflation and nominal rates shall be synonymous with growth is not clear.

Choice between easing bank re-capitalization and short term boost to the economy

An increase in interest rates shall lift banking net interest margins – facilitating recapitalization via retained earnings. However, ensuing higher borrowing costs and risk spreads shall act as a constraint on growth.

Using a “rough and ready” time continuum – there are close parallels between today’s ECB and the Federal Reserve in 2010 – 2011.

Restructuring of the banking system – with the aim of separating banking and sovereign risk – and an overall decrease in systemic risk remain the key objectives.

European Equities buffeted by rising Euro – will this prompt further short term action by the ECB?

As concerns the European equity markets, stock prices are being buffeted by the rising Euro – stemming from the Federal Reserve’s docile stance – disappointing earnings and setbacks in the banking sector. Reflecting Europe’s greater dependence on exports, inaction by the Bank of Japan and concerns as to greater independence of central banks from governments has cast a damper on prospects.

Italian banking sector – is this the shape of the future?

As regards the credit sector, the Italian bank rescue fund Atlas will need to step in as underwriter and likely buyer of the shares issued in the Banca Popolare di Vicenza IPO. Instead of reducing the linkages between banking risk and sovereign risk as envisaged by the ECB, it shall increase it.  

European car emissions scandal shall increase uncertainty

We have also considerable pressure on exporters, with the EM focused car sector buffeted by slowing growth, the stronger Euro and the continuing car emissions scandal. We see the uncertainty as to the final cost of any settlement casting a pall on VW and other car makers.

What future for the “New Europe”?

Brexit anxieties as the “Day of Reckoning” looms are having second round effects with regard to the “New Europe”. These countries success has long been predicated on an expansion of and closer economic integration within the European Union.

Will their ambition to be “The China” of the EU developed economies be vinified? Is the point moot, with robots and technological progress eroding the competitive advantage from low wage labor?

Oil prices continue to rebound – risk assets benefit

With regard to oil, prices have continued to rebound notwithstanding the debacle in Qatar, reducing default risk attaching to energy linked assets and sovereign risk of the marginal producers. This has mitigated systemic risk concerns and shifted investor focus back to macro and earnings.

Still betting on a hasty retreat by US shale oil producers

The argument for oil price stabilization, seen as a first step to price increases, rests on expectations of a drastic curtailment of US shale oil production. The focus is now on “natural rebalancing” as opposed to production cuts by major producers.

Watch out for US cash break-even at US Dollars 40!

This rebalancing may take longer than expected. With many US shale producers achieving cash break even at US Dollars 40, current price levels may act as inducement to both “hang in there” and hedge future production.

Marginal producers still focused on maximizing short term cash flow

The oil market remains oversupplied with prices supported in part by production disruptions – which are temporary. In the absence of agreement to production cuts, producers remain free to pump as much as they deem necessary to maximize short term cash flow.

The price increases reflect expectations and not any concerted move to reduce production.  

As concerns emerging markets, we are seeing a bounce in financial assets which is disproportionate to any change in basic economic fundamentals. A weakening of the US Dollar may reduce pressure with regard to the value of FX corporate debt liabilities. However, it has yet to limit economic exposure stemming from the uncertainties of the Chinese economy.

Political risk focused on UK EU vote on June 23rd

We see political risk as still centered on the Brexit vote – which is rapidly turning into an acceptable forum for intervention by foreign governments and supranational entities. These pleas are centered on a dual axis.

Will trade carry the day?

Should the UK leave it would take 10- 15 years to renegotiate trade agreements. It might also jeopardize the negotiation and impact of the US – EU free trade agreement currently being negotiated.

Are we about to see the start of “The age of disintegration”?

Rather more worrying, a British “Farewell to the EU” is seen as ushering in “The Age of Disintegration” as concerns the European experiment. The impact is seen as ranging from a re-negotiation of existing ties within the EU to outright secession, with a lengthy prospective list of renegades.

Mounting populist rage fueled by the need to find a scapegoat for the shock economic adjustments wrought by globalization and security concerns may result in the “Great closing”.

[cynthiadibartolo]

More Provisioning Anticipated for Autos

Post by Chief Economist Jean Ergas

Markets hesitant – car sector in reverse – We will see more  provisioning! Central banks return to the fore – Federal Reserve shall be the  final arbiter – not surprised at Austrian  elections, tolerance is not the sign of the  times.

Market in a hesitant mood – eyes on the central banks

Markets are in a hesitant mood as investors  re-appraise the oil situation, with the market still in oversupply. We are  also seeing caution ahead of both economic data and central bank meetings,  with the spotlight shifting from the European Central Bank to the Federal  Reserve and the Bank of Japan.

Car sector weighing on markets

We are seeing the European markets slightly  weaker, with the car companies – buffeted by the emissions scandal – ceding  ground. This is in addition to cyclical concerns regarding global and in  particular, emerging markets growth. The auto sector has often the spark for  a wide range of industries and the linchpin of the second stage of the  development process.

Emissions scandal contemporary version of environmental and asbestos  crisis

VW has drastically increased the cost  estimate from US Dollars 7 billion to US Dollars 16 -17 billion. We are not  surprised and see the issue as remaining a Damocles sword over the sector.  This shall be the auto industries version of environmental and asbestos – a  source of massive uncertainty as to both final settlement, which shall remain  elusive, and cash pay-outs.

We are still at the appetizer of what promises to be a long and heavy  meal. The auto sector is seen as still oversupplied. Will this panoply of  scandals be the trigger for further consolidation and or divestitures?

Federal Reserve – still the “keeper of the keys”

As concerns the central banks, the major  focus shall be the US Federal Reserve – seen as the global pace setter and  “keeper of the keys” of the global financial sector. We expect more Pollyanna  cheerleading about the US economy and a reiteration of caution in the face of  external risks.

With the Chinese economy, seen as the last hope, posting timid signs  of recovery, the US central bank may strike a more optimistic note.

Euro Zone – shall prices finally start rising?

Turning to the Euro Zone, we shall be seeing  inflation and GDP data this week. We are not holding our breath and expect a  muted performance on both fronts. The fall in German business confidence is  indicative of the duality in the Euro Zone’s largest economy. Strength in the  domestic economy is seen as not sufficient to offset pressure on exports -  the lifeblood of the economy and segment with the greatest pricing power.

Shall the relationship to the EU enable the Trans-Atlantic Free Trade agreement?

We are not surprised to see Obama and Merkel championing the Trans-Atlantic free trade initiative between the EU and the US. The US president is of the view that “time is not on our side” – this is an excellent use of understatement. With the walking wounded of globalization not interested in the “long run” – when we shall all be dead, this deal shall be a hard sell.

The trend towards disaggregation is alive and well in the developed economies and free trade is now widely seen as the root of all evil.

Austria – shall not be the last of the surprises?

We are not surprised to see the first round victory of the far right in Austria, which campaigned on a security and anti-everybody platform. This is not the last “surprise” we shall see. A toxic combination of globalization without buffers and the refugee – migrant crisis shall be profoundly de-stabilizing.

Global overview

Stock markets advance despite mixed US earnings and collapse of oil negotiations – ECB continues to sound cautionary note on Euro Zone but remains confident of progress – oil rebounds on hopes of re-balancing -  UK referendum looms nearer and Panama tax scandal risks forcing a re-casting of the rules.

Markets driven by macro-monetary factors and US earnings – Shall we see the oil market re-balancing?

We are leaving behind us a week with investors focused on the dual planes of macro - monetary news and US earnings – seen as the principal bellwether for the global economy. Oil prices have rebounded, boosted by hopes of a re-balancing and closer cooperation among the OPEC countries.

We remain cautious and see a rough ride ahead with markets still closely correlated to energy.

US stocks stumble to the finish line!

Last week, US stocks finished flat following early declines driven by weaker than expected earnings and continued concerns out of Europe. Weakness in the technology sector seems to have had scant impact on the prevailing belief that the “kindness of strangers” in the form of central bank generosity is likely to continue and that the worst is over in the oil market.

Next week Federal Reserve meeting and US GDP – Is the economy stuck in “park”?

Next week attention shall be centered on the Federal Reserve meeting and on the US GDP data. While a rate increase is not expected, the focus shall be on the central bank’s assessment of the US economy and its evaluation of global risks.

Low expectations of the US economy – paralleling earnings

We are not expecting much from the march of the US economy – where modest expectations parallel the minimal targets set for earnings. However, should the US economy have contracted we foresee market weakness.

Equity markets continue to hold – buoyed by hopes of central bank intervention and stabilization of commodities and oil  

Global equity markets have continued to inch forward on hopes of continued central bank munificence in both the US and abroad. This is abetted by the special circumstances of the Bank of England, reluctant to move ahead of the EU referendum.

Central banks choose pre-China deflation measures over banking margins

Central banks seem to have jettisoned concerns as to collateral damage to net interest margins. Bank profitability has been subordinated to once again seeking to engineer demand via liquidity transfers to the banks, hitherto with scant results.

Central banks shall – except for US – be moderate – TINA – There is no alternative!

With regard to the central banks, we tend to agree that – barring a sudden upsurge of inflation in the US – the moderation shall continue. Japan is mooted as considering yet further forays into negative rates, apparently unconcerned as to the impact on its banking system. The ECB is still in an easing mode, seen as the key lever as compared to extending bond buying.

Will the Japanese central bank lower rates further?

We are seeing increased pressure on the yen as disappointing Japanese economic data is seen as bringing further monetary easing forward. These shall be implemented via the dual axis of both increased bond buying and lower central bank negative rates.  

Readiness to lower rates further into negative territory shall whittle away at any residual qualms among other central banks.

Commodities higher but fundamentals remain weak

Hopes for a stabilization of commodity markets – on the basis of slightly stronger data out of China – are also contributing to the more positive sentiment. The increases are being pushed by a combination of short term re-stocking and hopes of the impact of capacity reductions working their way through to prices.

Both oil and non-oil commodities remain well below their peaks, with marginal producers struggling to stay in the game. Oil remains the wild card – get ready for a rocky ride

In our view, the oil market remains the wild card, linked to politics and not to easily discernible economic metrics. Since the collapse of the Doha meeting, prices have been boosted by hopes of a “natural re-balancing”. We see two possible impediments in this scenario:

Shall shale production rebound?

The principal boost is still expected to come from a reduction in US shale oil production. However – due to the industry’s ability to rapidly ramp up production – can dampen any increase.

Saudi Arabia, Russia and Iran – a powerful mix!

The Damocles sword of Saudi Arabia and Russia willing and capable of ramping up production combined with the Iranian risk is not to be underestimated. Iran has been able to steadily increase production despite alleged limitations of existing infrastructure.

Current oil prices shall not banish risk of defaults

We are seeing increased investment in high yield energy bonds as investors becoming optimistic that the worst is over with regard to the downside in oil prices. This, while limiting defaults, shall not reduce the pressure on the higher cost both state and non-state producers.

We remain cautious on US growth – manufacturing sector slowing and consumers still cautious

We continue to be cautious with regard to US growth prospects. Manufacturing and exports continue to be impacted by global slowing. In this respect the fall in the Euro Zone composite indices is significant, as US goods are used as components for goods to be shipped by European companies to the emerging markets. There is a greater pass-through than is commonly assumed.

Parting of the ways between US labor force and wages

While jobless claims are at very low levels, we are continuing to see “the parting of the ways” between the labor market and the real economy. Job retention and falling unemployment are doing little to boost consumer enthusiasm. While much is being made of de-leveraging, it remains at historically high levels.  

US labor market two tiered – similar to an emerging market

Analysts continuing to postpone the hallowed day when falling unemployment shall translate into higher wages. We stand by our view that we are in a two tier US labor market. The top tier is capable of demanding higher wages while the bottom tier, the vast majority of the labor force, remains bereft of negotiating power.

China improvement is fueled by stimulus–can monetary policy replace migration up the value chain?

With regard to China, we confirm our view that the recent improvement is being fueled by credit expansion detached from any consideration of solvency. This shall further fuel risks in the banking system. The Chinese model remains predicated on low value added exports at a time when wage increases should be forcing a migration up the value chain.

What if they open the capital account?

We are hearing a lot about the “saving grace” of the Chinese economy being the closed capital account, restricting outward investment flows by retail investors. This pushes savings into the stock market and property, causing bubbles in both.

Should the capital account be opened, the outflows are seen as decimating Chinese FX reserves and smashing domestic asset values.

Euro Zone economic policy now synonymous with the ECB

With regard to the Euro Zone, economic policy has been relegated to monetary tinkering and therefore entrusted to the ECB. The single currency area central bank has reiterated the willingness to take all measures necessary to see off deflationary pressures. It has however, toned down expectations with regard to the purchase of corporate bonds.

We see this as a “dummy variable” with regard to the real economy and inflation. A further reduction of fixed income borrowing costs for top rated borrowers – already replete with cash – shall do little to boost capital investment.  

US administration not remiss to intervene in Brexit debate

On the political front, the major focus of attention remains the upcoming UK referendum on membership in the European Union. In what might be setting a precedent for future administrations as regards the internal affairs of another country, the US president expressed strong and unequivocal views on the critical vote.

Discussion now shifting to trade – are we moving towards isolationism?

The focus was placed on the economic consequences of a “leave” decision centered on international trade. In the immediate, the UK shall have to renegotiate all existing agreement, risking a massive interruption in foreign trade. Longer term, the incipient disaggregation of the world’s largest trading bloc shall reduce trade further hampering any recovery.

The US is focused on ratifying the Transpacific Partnership in an increasingly anti free trade environment while attempting to inch along the Trans-Atlantic agreement with the EU. The UK leaving the EU shall cast a pall on multilateral agreements.

Panama tax scandal now being tackled at supra-national level

The Panama tax scandal has triggered agreement among the IMF, World Bank, UN and OECD for cooperation against abuse of tax havens. This is paralleled by the EU countries reaching an understanding to exchange information and draw up lists of dubious localities.

We see these measures as forcing companies to review discrepancies between flows of goods and financial flows, as well as the risk of recapture of hitherto sheltered cash. This may impact capital investment plans and profitability estimates.

[cynthiadibartolo]

Macro Fallout From Qatar Disagreement

Post by Chief Economist Jean Ergas

Stock markets holding the line – will this last? Global growth forecasts keep being revised downwards – US not brilliant. Not surprised at lack of agreement in Qatar - Saudi Arabia can tough it out! Europe – can the EU disintegrate? ECB shall hint at further easing and “total war”

Equity markets broadly holding the line – combination of micro and macro data

Last week markets broadly held the line on a combination of micro and macro data. We reiterate our view that the gap between “risk assets” and economic data is still firmly in place and do not see a slight attenuation of systemic risk as justifying current valuations.

Monetary policy set – with the exception of the US – on further rate reductions

With regard to monetary policy several major central banks have reiterated their willingness to implement further monetary easing. This shall extend to negative interest rates, with the danger to bank solvency seen as attenuated by pricing power – imperfect competition – in the banking sector.

Market imperfections are in the eye of the beholder and see this as a declaration of hostilities by the central banks.

No deal in Doha – No surprise

Not surprisingly the Qatar conference has ended without an agreement. The stumbling block was the role or rather non-participation of Iran, which is now viewed as the swing factor. Whether this shall force participants from OPEC to focus on a solution in June or unleash a free for all, cannot be determined.

We may well see an increase in financial markets volatility

What is likely is that we shall be seeing an increase in oil and financial markets volatility. Oil prices are down below the US Dollar 40 benchmark and may give more ground as hopes of disruptions providing a long term support fade.

Impact may be slow motion!

Should this be the case, we may see a wider impact when the European and US markets on a wide swathe of assets, currencies and sovereign risks. The reaction has hitherto been moderate, with the US futures down ¼ per cent.

The lack of an agreement, even when expectations had been scaled down, removes one of the key planks for an attempted stabilization of financial markets.

Focus shall now shift to the US shale industry

The supply side focus shall now shift to the US shale industry, whose reaction will be key. Should hopes for a partial agreement in June as to a freeze or a production cut materialize, this could encourage the shale producers to “hang in there”.

Lack of enforcement mechanism flaw in a potential agreement

The critical flaw in any agreement shall be the lack of a formal enforcement mechanism. We see this as prejudicing the success of any “handshake” understandings reached and consider that the Doha conference was more about optics than substance. The heavy lifting shall be postponed to thee OPEC conference in June.

Oil price stabilization is seen as the key swing factor

Investor hopes rest increasingly on a rise or stabilization in the oil price as reducing pressure for large scale asset liquidation by sovereign wealth funds. This is seen as reducing volatility and improving market liquidity.

The dominant strategy has changed from seeking to spot asset under-valuation to having a “comfort zone” of being able to exit.  

US growth – if any - modest – optimists placing their hopes on US GDP “transition” from manufacturing to consumption  

Weakening US economic growth – if any – and persistent deflationary pressures globally are shifting focus from finding a locomotive to “capitalism in one country”. With regard to the domestic US market, optimists are pinning their hopes on a short term transition from manufacturing to consumption.

Which is the right metric for Chinese growth – top down or bottom–up?

While systemic concerns may be slightly reduced by Chinese top down data – 6.7 per cent growth - a bottom up analysis backs into 4 – 4 ½ per cent maximum. Stimulus measures are now mired in diminishing returns.

Chinese government policy has accepted the trade-off between spurts of economic recovery and further wreckage in the banking system.

Political risk shows no sign of abating

Political risk shows no signs of abating, with the Brexit debate rapidly fusing with the Panama tax scandal. We see massive shifts in corporate strategy on the horizon, with a significant impact on the global economy.

Greek cauldron about to boil over!

The Greek cauldron is once again about to boil over. Demands for debt reduction as a pre-requisite for continued IMF participation are once again on the table. Are we about to revisit the crisis levels of last year?

Refugee crisis reaching tipping point

With regard to the migrants – refugee crisis there are increasing reports of violence in the camps in Greece. Will the EU countries abide by their resolution to – if necessary – forcibly repatriate the migrants to Turkey, under the spotlight of the international media?

The boat is full- shades oft the 1930’s

We expect there to be harrowing scenes when the transfers to Turkey get underway. Will the EU countries have the stomach to countenance these measures and use maximum force? Global extensive media coverage may cast events in a very unfavorable light for the western democracies.  

Focus on the US

US bank earnings cast recesssion as a lesser threat with China data taking the edge off systemic concerns

We are leaving behind us a week when the first intimations of US earnings buoyed investors and possibly dissipated their worst fears as to the economy sliding into recession. On the global macro front concerns were allayed by trade and GDP data from China indicating less risk of a hard landing and systemic risk.

This was deemed sufficient to offset disappointing US macro data, including retail data, industrial production and inflation.

Markets weathering disappointing US data on both the consumer and the industrial front

These factors were deemed sufficient to partially offset a string of disappointing US specific data, hinting at a broad weakness on a broad front. Retail data highlighted the continued reluctance of US consumers to open their wallets – with the majority still intent on reducing their leverage.

Rise in oil price insufficient to stoke inflation at either core or non-core level

The above cheerless numbers were accompanied by disappointing inflation data – even when assesed on a “core” basis. The rise in the oil price and second round effects on goods and services, has been offset by the continued whittling away of corporate pricing power.  

US economy at risk of missing its “appointment with history” as regards hand over from manufacturing to consumption

We see the US economy at risk of missing its “appointment with history” as regards our domestic version of transition – consumption stepping into the breach for manufacturing which remains weak. In the US we are seeing the last act of the auto “catch up” buying and fallign consumer confidence discouraging buying of big ticket items.  

Manufacturing exports not a strict function of the US Dollar

While much has been made of the relative strengthening of the US Dollar, we see manufacturing as reflecting the slowing of the global economy. Were it the FX, the US lost sales would be picked up by Germany – this has not been the case. This is not an issue of the reapportioning of capital investment but of its absolute decline.  

This slippage is already prompting substantial downgrades to first quarter US GDP, with the expansion foreseen by the more optimistic members of the Federal Reserve backloaded.

Focus on oil

Qatar oil conference disapppoints – was seen as a put option on the oil price – we are once again seeing buying of high yield energy debt

Markets were also buoyed by continued hopes that the upcoming Qatar oil conference might at a bare minimum create a floor under oil prices. This was seen as reducing a broad slew of cyclical, systemic and sector specific risks. This is reflected in strong buying of energy high yield debt in the US, including distressed. Was this pre-mature?

Widening split between producers focused on immediate cash flow and those pursuing a longer term marketing strategy

We reiterate our view that we are seeing a fundamental rift based on the relative financial resilience between the sovereign producers.  The longer low prices persist the greater shall be the negotiating power of the stronger players. Saudi Arabia’s declarations that current prices are sufficient to cover social programs, seen as ensuring social cohesion, are critical.

Focus on the Panama tax shelters  

Brexit referedum and Panama tax haven scandal increasingly intertwined

With the June 23rd UK – EU referendum approaching, concerns over the consequences of a UK exit from the EU have increased. These concerns have been further fueled by the Panama tax scandal and the use by the UK Prime minister of these vehicles. The discussion is now more and more resembling a latter day morality play centered on ethics as opposed to legality.  

This shall lend a powerful boost to the EU separatists – will the EU turn into an “Old World” version of the Transpacific Partnership?

We view the immediate political impact of this controversy as two-fold; Contributing to shifting UK opinion towards opting to leave the European Union; Providing grist to the mill of “separatist” sentiment in the other EU countries

Risk of tax recapture clawbacks risks causing havoc with corporate investment plans – where does tax planning stop and tax avoidance begin?

With regard to longer term macro consequences, the Panama polemic shall likely create massive uncertainty among global companies as to reputational risk attaching to the use of tax planning – tax avoidance strategies.

What share of aggregate global corporate cash flow is at risk?

This may determine substantial changes in investment strategy as the availability of hitherto “sheltered” cash resources is re-assessed. While in the short term increasing government tax revenue and assisting in re-balancing deficits this shall not be conducive to boosting capital investment.

Tax planning a key pillar of corporate strategy with regard to supply chains, cash management and pricing power. Will we see a massive shift?

The focus has hitherto been on prominent personalities. However the key impact shall be to force a massive re-appraisal by multinational groups of the tax strategies which have hitherto underpinned their internal and external financial structure.     

Focus on Europe

Euro Zone – waiting for the ECB and PMI data

With regard to the Euro Zone, this week’s ECB meeting shall likely weave the familiar refrain of downside risks and willing ness to wage “total war”.  PMI data at the end of the week are expected to show a gradual improvement in both manufacturing and services. The improvement is expected to be driven from a fall in unemployment and low interest rates boosting consumption.

No oil deal complicates ECB efforts to rekindle inflation 

However we see the failure of the Qatar meeting as removing one of the key supports to the ECB’s desperate attempts to boost inflation. The uncertainty generated by the lack of success of the Qatar meeting may impact capital goods exports, critical to several Euro Zone economies.  

Pricing power weakening – is it all about generating cash?  US shale oil model extended to industry

We see the Euro Zone economy as continuing its slow advance. It is however still brittle and on the corporate side predicated on extensive discounting. Weakening pricing power and lower margins might temper the enthusiasm of the banks to extend credit. With regard to bad loans, the EU banks have not yet begun to fight!