Down in Flames

The nation that built the Great Wall
Has lately begun to blackball
Its best and its brightest
For even the slightest
Concerns, causing prices to fall

Last night it was TenCent’s new games
Which suffered some unfounded claims
Concerns have now grown
They’ll need to atone
So their stock price went down in flames

The hits keep coming from China where last night, once again we were witness to a government sanctioned hit on a large private company, in this case Tencent.  In fact, Tencent is was the largest company in China by market cap but has since fallen to number two, after an article in an official paper, Xinhua News Agency’s “The Economic Information Daily” wrote about online gaming and how it has become “spiritual opium” for young people there.  While the government did not actually impose any restrictions, the warning shot’s meaning was abundantly clear.  Tencent’s stock fell 6.5% and Asian equity markets overall fell (Nikkei -0.5%, Hang Seng -0.2%, Shanghai -0.5%) as investors continue to fret over President Xi’s almost nightly attacks on what had been considered some of the greatest success stories in the country.  Apparently, that has been the problem; when companies are considered a greater success than the government (read communist party) they cease to serve their purpose.  It seems that capitalism with Chinese characteristics is undergoing some changes.

There is, perhaps, another lesson that we can learn from the ongoing purge of private sector success in China, that it has far less impact on global risk opinion than the activities in other geographies, namely the US.  While China has grown to the second largest economy in the world and is widely tipped to become the largest in the next decade or two, its capital markets remain significantly smaller on the world stage than those elsewhere.  So, when idiotic idiosyncratic situations arise like we have seen lately, with ideological attacks on successful companies, investors may reduce risk in China, but not necessarily everywhere else.  This is evident this morning where we see gains throughout Europe (DAX +0.15%, CAC +0.9%, FTE 100 +0.4%) as well as in the US futures markets (DOW and SPX +0.4%, NASDAQ +0.2%).  Despite last night’s poor performance in Asia, risk remains in vogue elsewhere in the world.

Away from the ongoing theatrics in China, last night we also heard from the RBA, who not only left policy on hold, as universally expected, but explained that they remain on track to begin tapering their QE purchases, down from A$ 5 billion/week to $A 4 billion/week, come September, despite the recent Covid lockdowns in response to the spread of the delta variant.  They see enough positive news and incipient credit demand to believe that tapering remains the proper course of action.  While there were no expectations of a policy change currently, many pundits were expecting the lockdowns to force a delay in tapering and the result was a nice little rally in the Aussie dollar, rising 0.5% overnight.

But, as we have just entered August, the month where vacations are prominent and government activity slows to a crawl, there were few other interesting tidbits overnight.  At this point, markets are looking ahead to Thursday’s BOE meeting, where there is some thought that tapering will be on the agenda, as well as Friday’s NFP report.  One final story that is gaining interest is the US financing situation with the debt ceiling back in place as of last Saturday.  Congress is on its summer recess, and Treasury Secretary Yellen has been forced to adjust certain cash outlays in order to continue to honor the government’s debt obligations.  As it stands right now, Treasury cannot issue new debt, although it can roll over existing debt.  However, that will not be enough to pay the bills come October.  There is no reason to believe this will come to a messy conclusion, but stranger things have happened.

As to the rest of the markets, bonds are under a bit of pressure today with Treasury yields rising 1.5bps, and similar size moves throughout Europe.  Of course, this is in the wake of yesterday’s powerful bond rally where yields fell 5bps after ISM data once again missed estimates.  In fact, we continue to see a pattern of good data that fails to match forecasts which is a strong indication that we have seen the peak in economic growth, and it is all downhill from here.  Trend GDP growth prior to Covid was in the 1.5%-1.7% range, and I fear we will soon be right back at those levels with the unhappy consequence of higher inflation alongside.  It is an outcome of this nature that will put the most stress on the Fed as the policy prescriptions for weak growth and high inflation are opposite in nature.  And it is this reason that allowing inflation to run hot on the transitory story is likely to come back to haunt every member of the FOMC.

Commodity markets today are offering less clarity in their risk signals as while oil prices are higher, (WTI +0.5%), we are seeing weakness throughout the rest of the space with precious metals (Au -0.2%), base metals (Cu -0.85%, Al -0.5%) and agriculturals (Soybeans -0.7%, Corn -0.9%, Wheat -0.5%) all under pressure today.

Finally, the dollar is falling versus virtually all its main counterparts today, with the entire G10 space firmer and the bulk of the EMG bloc as well.  NOK (+0.75%) leads the G10 group as oil’s rally bolsters the currency along with general dollar weakness.  Otherwise, NZD (+0.6%) and AUD (+0.5%) have benefitted from the RBA’s relative hawkishness.  The rest of the bloc is also higher, but by much lesser amounts.  I do want to give a shout out to JPY (+0.1% today, +2.3% in the past month) as it seems to be performing well despite the risk preferences being displayed in the market.  something unusual seems to be happening in Japan, and I have not yet been able to determine the underlying causes.  However, I also must note that last night, exactly zero 10-year JGB’s traded in the market, despite a JGB auction.  If you were wondering what a dysfunctional market looked like, JGB’s are exhibit A.  The BOJ owns 50% of the outstanding issuance, and the idea that there is a true market price of interest rates is laughable.

As to emerging markets, we are seeing strength throughout all three regional blocs led by ZAR (+0.8%), HUF (+0.7%) and PHP (+0.6%), with the story in all places the sharp decline in US rates leading to investors seeking additional carry.  While BRL is not yet open, it rallied 0.7% yesterday as the market is beginning to believe the central bank may hike rates by 100 bps tomorrow, a shockingly large move in the current environment, but one that is being driven by rapidly rising inflation in the country.

Data today brings Factory Orders (exp 1.0%) and Vehicle Sales (15.25M), neither of which is likely to distract us from Friday’s payroll report.  We also hear from one Fed speaker, governor Bowman, who appears to be slightly dovish, but has not make public her opinions on the tapering question as of yet.

Yesterday saw modest dollar strength despite lower interest rates.  Today that strength is being unwound, but net, we are not really going anywhere.  And that seems to be the best bet, not much direction overall, but continued choppy trading.

Good luck and stay safe

Bred On Champagne

In Davos, the global elite
Are gathering midst their conceit
That they know what’s best
For all of the rest
Though this year they’re feeling some heat

As growth ‘round the world starts to wane
This group, which was bred on champagne
Is starting to find
Their sway has declined
And people treat them with disdain

This is Davos week, when the World Economic Forum meets in Switzerland to discuss global issues regarding trade, finance, economics and social trends. Historically, this had been a critical stopping point for those trying to get their message across, notably politicians from around the world, as well as corporate leaders and celebrities. But this year, it has lost some of its luster. Not only are key politicians missing (the entire US entourage, PM May, President Xi, President Macron, AMLO from Mexico and others), but the broad-based rejection of globalist policies that have led to a significant increase in populism around the world has reduced the impact and influence of the attendees. Of course, this hasn’t prevented those who are attending from declaring their certitude of the future, it just puts a more jaundiced eye on the matter. As to the market impact of this soiree, the lack of keynote addresses by policymakers of note has resulted in quite a reduction of influence. But that doesn’t mean we won’t see more headlines, it just doesn’t seem like it will matter that much.

Inflation forecasts
In Japan have been reduced
Again. Is this news?

The BOJ met last night and left policy settings unchanged, as universally expected. This means that the BOJ is still purchasing assets at a rate of ¥80 trillion per year (ostensibly) and interest rates remain at -0.10%. Their problem is that despite the fact that they have been doing this for more than 6 years, as well as purchasing corporate bonds and equity ETF’s, they are actually getting worse results. Last night they downgraded their growth and inflation forecasts to 0.9% for both GDP and CPI as they continuously fail in their attempts to stoke price increases.

While the Fed has already begun normalizing policy and the ECB is trying to move in that direction (although I think they missed the boat on that), the BOJ is making no pretenses about the fact that QE is a fact of life for the foreseeable future. Policy failure at the central bank level has become the norm, not the exception, and the BOJ is Exhibit A. As such, the yen is very likely to see its value remain beholden to the market’s overall risk appetite. If we continue to see sessions like yesterday, where equities and commodities suffer while Treasuries are bid, you can be pretty sure the yen will strengthen. While this morning the currency is actually weaker by 0.3%, that seems more like a position adjustment rather than a commentary on risk. In fact, if equities continue to suffer, look for the yen to regain its lost ground and then some.

As to Brexit, the pound is trading back above 1.30 this morning for the first time since the first week of November, which was arguably more about the US elections than the UK. But the market is becoming increasingly convinced that a hard Brexit is off the table, and that some type of deal will get done, maybe not by March, but then after a several month delay. If this is your belief, then the pound clearly has further to rally, as the market remains net short, but my only advice is to be very careful as policy mistakes are well within the remit of all government organizations, not just central banks.

Beyond those stories, there has been no movement on the trade talks, although Larry Kudlow did highlight that some type of verification would be needed before anything is agreed. US data yesterday showed a much weaker than expected housing market with Existing Home Sales falling 10.0% since last year to just 4.99M in December. The Fed is silent as they prepare for next week’s meeting and the ECB is silent as they prepare for tomorrow’s meeting. In other words, it is not that exciting. Equity futures are pointing modestly higher, about 0.25%, although that is after a >1% decline in all markets yesterday. Treasury yields are higher by 2bps and oil prices are modestly higher (0.7%) after a sharper decline yesterday. Overall, the market remains unexciting and I expect that until we see a resolution of one of the key issues, notably trade or Brexit, things are likely to remain quiet. That said, it does appear that there are ample underlying concerns to warrant a fully hedged position for risk managers.

Good luck