China is the latest to kick off more easing with another cut in the reserve ratio. Japan just released PMI numbers that missed estimates and tomorrow will see PMI and unemployment come out of Europe. This lackluster performance could cause the central banks to have to add more stimulus, with the Eurozone’s as early as this month. With rates in the Eurozone and Japan in negative territory how much more the central banks can do will certainly become a concern. The market will have to shift its attention to the possibilities of fiscal stimulus from these regions for further growth.
Some governments are able to step in, like China, Japan, and the US. The Eurozone is a bit more complicated in the sense that there is no fiscal policy at the level that monetary policy is trying to help out the region. This is going to put most of the strain on the central bank which will try to prop up the economy on its own. This will be the place that monetary policy will be tested in its purist form, with little outside help available. Add to this the prospects of tighter border controls in response to the refugee crisis and you will see growth continue to disappoint and the ECB try and remain accommodative.
It seems that the BOJ governor is speaking again and all seems well. Kuroda believes that the 2% inflation rate is attainable with the current monetary base, but is willing to go deeper into negative territory if needed. He quoted on Tuesday's meeting in Parliament:
“We aim to raise prices through an increase in inflation expectations and a tighter gap in supply and demand under QQE,”
In order for this to be the case I would need to ask where these inflation expectations will come from and how long a time frame he is looking at for supply and demand to tighten. Sure as the ageing population starts to spend more and save less, and there are less workers producing there will be a tightening of the supply and demand relationship. Back to the current decade and you have sinking growth and inflation which is far from boosting the expectations of inflation in the near term.
BHP Billiton is in the news because of its shift into oil and how that has changed the fate of the company compared to its competitors. This has caused the company’s share price to follow oil more than the price of copper has given BHP a lower valuation than its peers. This creates an opportunity with earning due tomorrow to assess the financial condition of the company and make a longer term assessment of the company’s prospects.
The macro factors seem to be against the company at the moment but should the company look to snap up more fire-sale oil assets BHP could be a strong longer term player as oil recovers and eventually base metals. One risk to look at is the possibility of litigation from the Samarco dam accident. While a lot of reports will come out over the week because of the earnings, it would be good to take a longer term look at the numbers and make an assessment for the longer term.
The Yen has been in a range since its decline starting this month. The direction from here is a bit unclear in the near term, with an unexpected currency devaluation from China or bearish news from the US sparking another decline or positive news stemming gains. In the longer term the Yen will have to decline to keep the economy on track. Whether this happened through market forces or through intervention is where the when comes in. as the VIX remains above 20 in the US the demand for a safe haven is still very much in play. While safe haven demanders can wait out the storm in the Yen, the real economy of Japan cannot. The longer the currency stays elevated (it is up over 5% year to date) the less that major exporters will suffer in revenue from overseas. This drop in demand as well as confidence will keep wages from increasing and employees from spending. This strengthening will also add to the deflationary pressures that the country sees again from lower oil prices and a slowdown in global growth, particularly in China. This will add to the slowing growth rate by consumers delaying purchases and companies reluctant to give pay raises. The longer the BOJ waits to act the harder the turnaround of the Yen, sentiment, and economy will be.
The gold rally has gotten a lot of attention lately with many analysts citing a flight to safety, fears of a recession, etc. These are all factors that go into the decision to purchase gold but the rally as of late have more to do with lower yields than anything else. With the amount of money in debt that is currently yielding a negative rate the opportunity cost that keeps some from purchasing gold has gone positive. But in Europe negative rates were not something that occurred in the past month, likewise Japan is not imposing negative rates on the majority of their deposits either. The biggest factor that has sparked interest in gold is the change in perception that the Fed will keep bucking the trend and increasing rates. Talk of negative rates as a policy option and concerns surrounding the global economy has flattened the yield curve in the US and put the dollar into question in terms of its recent strength as well as the yields that can be derived from dollar debt. This is why we see such a strong inverse correlation between the long end of the treasury curve (yield) and gold. With inflation expectations looking dim and rates moving more negative around the world, holding an asset that may not have a return, but importantly doesn’t have a fee, looks like a safe bet at the time.
Next week the Fed minutes will be released which could shine some light on the conversations between governors about the relative strength of the US jobs markets and how they can hold up to the concerns about the global economy. Gold will remain a US Yield play so long as other safe haven bonds are charging for the right to hold them.
Another down day in the markets with gold spiking and oil down in the commodity space. Currencies are also running the usual flight to safety, with the Yen making huge gains. This seems to be due to the concerns of the Fed after Yellen testified (she will speak again today) and didn't provide a clear answer that the market liked. Her tone was more dovish and her speech did take into account global events. Perhaps the markets were looking for a more concrete decision to push back another rate hike. Whatever the outcome from today's testimony, the larger trend of central banks will continue to be a trigger for volatility as some are pushed towards more interventions as others try to refrain.
The BOJ has commented on the rise in the Yen, and that was before the surge we have seem in the past week alone. Seeing the YEN outperform as a flight to safety currency comes from the relative safety that the BOJ is not in a position to add more stimulus because of the split decision for the rate cuts in the last meeting. This paralysis is making buyers of the Yen fairly confident (at least in the near term) that the fear of a currency war will keep the BOJ on hold. I move by the central bank however, would spur a sharp weakening as a policy floor will have seemed to be put in place, most likely 5% higher than we are today.
Bloomberg Dollar index
All things being equal, a drop in the dollar index should be a boost to the price of commodities, such as oil. Showing how all things are not equal, is the drop in the dollar index as dampened rate expectations from slowing growth have investors looking of other places to put their money in line with the drop in oil prices from the slowing expectations from slowing growth. With so little working it makes sense to see certain asset classes like the Yen and gold get so much attention. But the disappointing policy language we have been seeing as of late could also surprise and spur more resolve by central bankers to take action.
Looking at the VIX over the past few years there were a handful of instances where it broke above 20, and at those times it was relatively brief. Now that we spent the first month of the year almost entirely above this ‘bearish’ level we have seen shifts in the market that are similar to times of severe crisis. Sovereigns are rallying, with some, like the German bunds, going negative out to the 5 year. Riskier bonds and stocks have been taken down by this uncertainty as well creating the question of where the overall economy is going.
This ‘new normal’ is something that will be around for some time. The markets will have to adjust to the realities of diverging policy from central banks and more lumps in data as a result. New things do get old and when uncertainty around the changes in this new environment wanes, we will see asset prices that are oversold and under sold based on the longer term trends.
These longer term trends are going to come from stability in policies around the globe, which we seen far from at this point in time. With elections, a mystery OPEC meeting which always seems to be in the works, and the UK talking about a Brexit; there is still plenty of policy concerns that makes Germany’s negative interest rate seem attractive. In the current environment a calculated loss seems the only certainty you can get.
Oil dropped overnight with Chinese manufacturing PMI coming in with another month of contraction. This makes sense from a commodities perspective where less manufacturing of goods means lower raw materials. However with Oil the process is a bit different and the correlations between the stock market and the oil market have yet to be verified.
The drop in oil can be mainly attributed to the increase in supply taking place around the world. While the EIA estimates that there was a 1.4mb/d increase in oil consumption during 2015, and expects to see that same rate in the coming years, despite talks of a slowdown in the global economy.
This is partly due to the fact that a decline in oil makes many retail consumers utilize more of it. Unlike copper, iron ore, and aluminum; the average consume doesn't go out of their way to buy more products comprised of these commodities because of the drop in price. In oil's case many people will be more likely to drive more and buy less efficient vehicles in response to the lower price at the pump. This translates to more consumption when prices are lower not, as the markets correlation seems to be eluding to, lower demand from slower growth.
High correlation to the stock market should be observed, but not looked at as a meaningful indicator without signs of declining demand. The slowing economic indicators in countries like China do not immediately mean there will be less need for oil. China National Petroleum Corp. estimates that oil consumption will rise 4.3% in 2016, only slightly lower that the 4.8% in 2015.
With growth estimates looking to mirror 2015 in most countries, oil prices will be dictated by the supply side of the equation. Will w seem the declines needed to pull down inventories or will there be a repeat of 2015 with supply growing faster than demand. That is going to be the biggest price mover of oil in 2016.