Monday, August 25, 2014

Market reaction to weakening fundamentals in Germany

The German business climate index tracked by the Ifo Institute declined more than expected this month, making it the 4th drop in a row.
The Guardian: - German business sentiment dropped for a fourth straight month in August as concerns about the Ukraine crisis and the effect of sanctions against Russia swept through corporate boardrooms in Europe's largest economy.

The Munich-based Ifo thinktank's business climate index, based on a monthly survey of about 7,000 companies, fell to 106.3 from 108, below the Reuters consensus forecast of 107.
A large part of the decline was of course due to the Ukraine crisis, but that was not the only cause of Germany's deteriorating private sector growth. Slowing exports to the rest of the euro area nations due to weaker demand as well as persistent economic headwinds in China (see discussion) have contributed as well.



This means that Germany is unlikely to support any further sanctions on Russia and will make a concerted effort to stabilize the situation (in spite of any pressure from the US).

The market reaction was swift, with the 10-year Bund yield hitting another record low.



Investors also piled into the three-year government notes, sending those yields into negative territory for the first time since 2012. The German government is now getting paid to hold your euros for three years.



In fact the nominal yield curve is in the negative territory all the way through the three-year point and showing signs of inversion - with the 1-year yield higher than the 3-year.



The euro dropped below 1.32, with rising expectations of diverging monetary policies between the US and the Eurozone. This was fueled in part by the Jackson Hole conference where Janet Yellen's speech was not as dovish as some had expected. The currency weakness will deliver some much needed relief for the euro area by helping the exporters and by providing some support to import prices. Currency weakness is one way to arrest deflationary pressures – the Japanese way.




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Sunday, August 24, 2014

Watching for signs of economic deterioration in Brazil

Staying with the South America theme, we are seeing signs of economic troubles in Brazil. To be sure, the nation is still an economic powerhouse – the 7th largest economy in the world. Yet the end of the China-driven commodity supercycle has created significant headwinds for Brazil's economic growth.



Here are some key indicators economists are watching for signs of further deterioration:

1. In recent months industrial production has been declining at the fastest rate since 2009.



2. The labor markets remain under pressure, resulting in declines in consumer confidence.

Source: Reuters

3. While the consolidated public sector accounts (including state-owned enterprises) remain in the black, the surplus levels continue to shrink. Fiscal deterioration remains a major risk.

Source: Credit Suisse

4. Even though the nation's banking system has been relatively sound, credit extended by banks to the housing sector has exploded in over the last 5 years. If the economy stumbles, this could become an issue.

h/t @cigolo

With economists now projecting Brazil's GDP growth of just 0.79% for 2014 and the national elections approaching, the central bank is injecting new liquidity into the banking system. As usual, central bankers are asked to solve what amounts to structural problems - which they try to address with the only tools they have.
FT: - Brazil has made its second multibillion-dollar injection into the banking system in less than a month as the government struggles to boost the economy ahead of hotly contested presidential elections.

The central bank on Wednesday eased rules on reserve requirements, freeing up about R$10bn ($4.5bn) for new lending. Just over three weeks ago, it injected R$45bn into the economy by easing compulsory deposit rules and changing the risk calculation of some loans.
While the nation faces a number of economic headwinds, the near-term risk for Brazil stems from the US monetary policy. If rates in the US rise faster than expected, we may revisit the volatility of 2013 (and early this year), as taper fears and capital outflows had sent the Brazilian currency and debt sharply lower (the 10-yr yield reached 13.5%).


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Friday, August 22, 2014

Argentine peso hits record lows on increased uncertainty

Argentina is showing signs of stress, as the official exchange rate has the US dollar now quoted 8.4 pesos - a new record.

Chart shows USD appreciating against ARS (source: Investing.com)

The "parallel" exchange rate also hit a record, with the dollar quoted at 14 pesos - a 67% premium to the official rate. Note that before the first devaluation in 2002 (see this NY Times story) it was one peso to the dollar.


Source: Dolar Blue

As discussed earlier (see post), this peso decline should not be a surprise. The latest development in the default saga however is Argentina's recent attempt to pay the "non-holdout" bondholders by allowing them to convert to local bonds.
NY Times: - The government moved on Wednesday to push legislation through its Congress that would give foreign investors in the country’s debt the ability to swap their defaulted bonds for new ones subject to local law, thus skirting a United States court order that has blocked its ability to make bond payments.
But it seems quite unlikely that these investors will want to convert, leaving this matter unresolved.
NY Times: - But the draft of the legislation, which was first announced on national television late Tuesday by Cristina Fernández de Kirchner, Argentina’s president, has raised more questions than answers among investors who are looking for a solution to the country’s debt predicament.
The uncertainty, combined with deteriorating economic fundamentals is sending depositors and investors out of the country, pressuring the peso. Foreign reserves are likely to dwindle materially by the end of the year as a result, further exacerbating the crisis.
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Tuesday, August 19, 2014

Deutsche Bank: Ignoring food price pressures could be a mistake

Economists and central bankers tend to be less focused on what consumers pay at the grocery store because food and energy prices have historically been more volatile - remember, it's just "noise". However what they can't ignore is how shoppers view inflation - i.e. inflation expectations. And food prices have a significant impact on households' views on future inflation.
Deutsche Bank: - ... food prices factor significantly into households’ perceptions of overall price pressures. This is illustrated in the following figure, which shows year-ahead inflation expectations from the University of Michigan Survey of Consumer Sentiment versus CPI food. In fact, it is worth noting that CPI food demonstrates a higher degree of correlation with one-year price expectations than either the headline or core metrics — and it similarly surpasses energy, core goods, core services and shelter. ...  while forecasters are focusing on service-sector inflation in general and shelter inflation more specifically, they should be careful to not ignore mounting food price pressures, because this category could provide important insight toward the evolution of inflation expectations. If food price inflation accelerates, as we project, the stability of inflation expectations could degrade - and this would be a vexing development for monetary policymakers.
Source: Deutsche Bank
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A look behind the headline housing starts report for the United States

As discussed in yesterday's post on residential construction, today's report on US housing starts indeed showed significant improvements.

Investing.com

However, this is only part of the story. The number of housing starts for single-family units remains to a large extent range-bound (see chart). A great deal of the new housing growth instead is coming from multi-family construction (see chart). And that's driven by the rapidly rising demand for rental housing in the US, as shortages become more pronounced (see post). Rental vacancies are now at the lowest level in 17 years and falling.



This demand is also visible in the latest report on inflation, which came out today as well. Rent expenses are now growing considerably faster than the CPI as well as US wages - a dangerous trend.

Rent inflation vs. Core CPI

The trend of rental units dominating housing starts growth is likely to continue as homeownership rates decline. Adequate supply of new multifamily housing will be critical in years to come.


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Monday, August 18, 2014

Signs of improvement in residential construction

Despite tepid wage growth in the US and Dodd-Frank-driven headwinds for mortgage lending (see post), two signs point to moderate improvements in residential construction.

1. The homebuilder optimism index recovered more than forecast.



2. Lumber futures have risen materially from their lows in June.

Sep lumber futures contract (barchart.com)

At this point it is difficult to say whether this construction improvement relates to new home purchases or new rental units. Given the looming rental market shortage in the US (see post), we are certainly going to see more apartments built in the near-term.

And while nobody expects a major boom in construction employment across the country, there is definitely room for improvement.

US construction jobs

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Sunday, August 17, 2014

10-year JGB yields near 0.5%

The 10-yr government bond yield in Japan is now around 0.5%, following an almost linear decline that started in 2006. The only way to rationalize buying 10-yr JGBs at 0.5% is believing that Japan will have a deflationary environment over the next decade and/or the central bank will absorb (or even monetize) the bulk of new issue bonds.



Moreover, these record low yields will do some serious damage to the Government Pension Investment Fund, which invests two thirds of its assets into local bonds. A significant portion of the population will tap the pension fund in the next 10 years. There will also be pain for Japan’s insurance industry that now faces a nasty asset/liability mismatch.

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Further signs of China's slowing property markets

China's official housing index now shows home price appreciation slowing faster than some had anticipated.

Source: Investing.com

Other indicators are also pointing to weakness in China's housing markets. For example the number of cities with falling prices has spiked sharply.

Source: Scotiabank

Furthermore, the steel rebar futures in Shanghai - an important real-time indicator of construction demand - remain under pressure.

Jan steel rebar futures in Shanghai (barchart.com)

Related to the trends in residential housing, China's commercial floor space and the number of commercial buildings sold has declined materially recently (based on official reports).

Source: National Bureau of Statistics

There is no question that Beijing has the wherewithal and the will to support the housing market should things unravel faster than the government likes. Nevertheless, given how pervasive property markets are in the nation's overall economy, concerns among global investors are rising with respect to China's housing slowdown.
Scotiabank: - On the theory that where there’s smoke there's fire (and it’s not just because I’m BBQing), weak company financing and concerns surrounding potential defaults in the shadow banking sector coupled with — and likely driven by — further evidence of falling property prices will only amplify the concerns.


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