BSIC MARKETS DIVISION MACRO VIEW
This week’s US data releases showed improvement in the economic sentiment: GDP and labour market confirmed our view on US Economy. The second estimate of third-quarter GDP was revised from 2.8% to 3.6%. However, we must point out that positive GDP growth increase has once again been led by a higher accumulated level of inventories. A possible explanation is that aggregate demand is not strong enough to absorb the supply level. Indeed, November data about durable goods orders was down by 2%.
The unemployment rate declined from 7.3% to 7.0% (the lowest since November 2008) against the expected level of 7.2% led by the Non-Farm payrolls data, which recorded the creation of 203k jobs in the last month, above the 180k expectation. The second is more representative of the US situation than the unemployment rate, since the latter does not take into account those people who essentially gave up searching for a job. Low participation rate (roughly 63% of the adult population) continues to remain an issue for the US labour market.
Also, ISM Manufacturing PMI (Nov) is very positive (57.3 Vs 55.0 expected);
As the Fed’s tapering is more likely to happen soon, the 10y UST rose by 12bp on the week to 2.87%.
Therefore, this week confirmed our last week’s view of the taper starting after the 18th December’s meeting. We are betting on a reduction of purchases from the FED and possibly a lowering of the unemployment threshold from 6.5% to 6%.
BSIC Market recap 30/11: https://bsic.it/2013/11/30/bsic-market-recap-301113/
Prepare for Tapering: https://bsic.it/2013/11/30/prepare-for-tapering/
Short the S&P 500.
Sell 6m T-Bill, Buy 4Y UST Sell 10Y UST
Receive 5Y, sell 5Y UST.
A bunch of data on Europe came out during this week. Looking at the whole Eurozone, the Manufacturing PMI (Purchasing Managers’ Index) moved up from October’s 51.5 to 51.6 in November, suggesting an acceleration of the recovery in the manufacturing sector. However, the situation is not as nice as it seems. Focusing indeed on the different countries, we noticed that there are significant differences among Northern countries and the periphery. In particular, data for Netherlands (56.8), Austria (54.3) and Germany (52.7) were fairly good while, on the other side, data for France (48.4), Spain (48.6) and Greece (49.2) were disappointing. These data reinforce our view (already highlighted in our previous market recap) about the strong differences existing among the European countries.
On Thursday December 6th, President Draghi kept unchanged the ECB’s rates. His speech was sufficiently clear about the future moves of the central bank: if recovery does not take off or deflation continues to scare, ECB is ready to support the Eurozone, keeping interest rates low and implementing further policies, if necessary. We strongly believe that Draghi will play more forward guidance in the future, trying to convince the markets not to increase rates. As far as new monetary policies are concerned, our view is that another round of LTRO is more likely than a negative interest rate on deposit or a quantitative easing programme.
An interesting theme that will arise in the future regards to the possible reaction of the European rates after the start of the Fed tapering. Would they increase as well as the US ones? There are two main reasons supporting this statement. Firstly, history shows that central banks’ decisions usually go towards the same direction. Therefore, the market could expect that, if the Fed starts reducing its stimulus, the ECB will probably do the same. Secondly, US and German yields, risk-free benchmarks for the two areas, have been strongly correlated during the time. Hence, a rise in the risk-free benchmark would lead to an increase in all the other rates. However, this view is not consistent with ours. First of all, the economic situations in the two blocks are too different, and an increase in the European interest rates cannot be justified with fundamentals. In addition, we think that Mr Draghi will try to persuade the market with the game of forward guidance, keeping the rates low. In conclusion, we believe that there won’t be a sharp increase in European rates after Fed tapering.
We are still very confident on our position on European financials that we have proposed in our last market re-cap. (23/11)
In addition, an interesting trade is to short EUR/USD: this can be easily justified by the increase in US interest rates after the tapering.
Government Bond :
Finally, looking at Italy, we forecast a reduction in 10-year BTP price, because of the political instability that is going to characterize the end of the year (electoral reform? anticipate elections?).
Portugal bought €6.6bn bonds maturing June 2014, October 2014 and October 2015 and sold bonds maturing October 2017 and October 2018, practically extending the maturity of its debts. This move shows that Portugal is willing to regain full access to the debt market and exit from the €78bn bailout, expiring next June and received from the IMF (International Monetary Fund) and the ECB (European Central Bank). The market response was not linear: bond yields fell, but the stock market (PSI20), mainly due to political uncertainties, plunged.
Data definitely shows that UK economy is regaining some momentum. In particular, the PMI Manufacturing of November, which gives indication about the health and the expansion of the manufacturing sector, expected to be steady at 56, was eventually up to a surprising level of 58.4. The PMI Construction was also up to 62.6, from a previous 59.4 in October and a consensus of 59.0.
BoE left all its policies unchanged. Recall that Mark Carney, BoE governor, recognized a possible housing price bubble and addressed this problem by using macro-economic tools, such as slowing the Funding for Lending Scheme down (see our previous market recap for more information on the topic).
Furthermore, on Thursday, Chancellor of the Exchequer George Osborne delivered his Autumn Statement 2013). He reported the historically largest upward revision to an official forecast: the miserable results announced in March have been swapped away by positive economic data. In particular, he underlined a much greater optimism about unemployment (with the threshold of 7.0% potentially broken in 2015), a projected public surplus of £2.2bn to be reached in 2018 and considerable growth rates for the current and following years (1.4% for 2013 and 1.8% for 2014). Useful Charts
UK economy is still unbalanced, but is indeed the most resilient. Furthermore, we look at these data with confidence. Hence, we are bullish on FTSE100.
We still believe in the position we set-up last time
This week brought negative news for Japanese markets as the positive US economic data and the consequent fear of tapering caused a drop in the Nikkei 225 by 2.40% during the week.
However the Monetary base Y/Y exceeded the consensus (52.5% vs 47.5%) and in October inflation was at 1.1%, the highest since 2008. Moreover, house prices and salaries are increasing as well. In particular, the increase in wages is noteworthy, since it’s the first time in a long time they rise. We believe that these are clear signs that the aggressive monetary policy is showing early results as confirmed by the pair USD/JPY at the six-month high of 102,40.
BOJ Governor Kuroda didn’t exclude further policies to reach the 2% inflation target by 2015. Given this situation, we are keen on going long in the export-sensitive Nikkei 225 as we believe it will further benefit from the dovish monetary policy and the weak yen.
It is true that in May, Japanese stocks greatly suffered after Bernanke’s announcement of tapering. Yet, we are convinced that a great deal of this reaction is psychological and not represented in the fundamentals of the impact of tapering on Japanese economy. In May, there was a spike in the volatility premium, while today, the tapering has become a ‘known unknown’. That is why we think that today the psychological impact is far lower than it was in May, and we do not assess a market overreaction as a likely outcome.
Trade Idea: Long Japanese exporters, short Germany Exporters, currency hedged
Given that the Fed will most probably taper, a good idea for Forex this week is to look at the emerging markets and think at what is going to happen. The Dollar would most definitely strengthen and developing economies may suffer if their exposure to the USA is too big. We believe that those that will rise are the ones with a current account surplus, while those with a strong deficit will suffer strongly as a result of market volatility following the end of Q.E. That is why we would suggest going short on EM with CA deficits and long on EM with CA surpluses.
A couple of weeks ago we were short on USDIND (Currently trading at 61.435). We still are, with a horizon that spans a good couple of months. But looking at India’s Current Account, one could say this year was quite red. It is indeed improving: the deficit narrowed from $21.8 billion in the second quarter to $5.2 billion in the third. Still, this is not enough. India’s still fragile, the move in the currency will depend on the capital inflows: tapering will alter the inflows that right now stand at 9 billion Dollars (for what concerns US), 7 % of the total. And considering that the US are India’s biggest market for exports (12.7 %), India will surely be affected by tapering if it were to happen next week. But we’re not looking at enormous falls, a move back to 65 IND is imaginable, before the dust settles, things go back to normal, and the Rupee begins its climb once again.
Taiwan’s economy has observed strong growth in the past years: real growth GDP has averaged 8% in the past three decades. It has managed to reduce the dependence on agriculture bringing it down to 3 % and boosting its electronics and tech productivity. Taiwan’s trade balance is relatively less exposed to the US than India’s one. The exports account for 10.3 % of the total, and only 9.5% of the Taiwanese imports come from the US. The foreign direct investments at home are $64.2 billion as compared to India’s $47 billion. In case of tapering Taiwan would experience a greater degree of capital inflows and an appreciation in the New Taiwan Dollar.
For what concerns Brazil, we believe that long USD/BRL is very good place to be. In fact, brazil economy seems to be instable and, more importantly, highly dependent from foreign investments. After 7.5% growth in 2010, the GDP slowed to a little +0.9% in 2012, while the inflation rose up to 5.8%. Furthermore, current account was heavily negative(-3.7% of the GDP vs -2.8% in 2011) registering for the first time in the new millennium a trade deficit. Finally, a bad public finance situation and a tight monetary policy (interest rates at 10%) to try to reduce inflation worsen the situation. We believe that in case of a December tapering the level of foreign investment will reduce and the economic outlook for the country would be even worse. therefore USD/BRL will be very volatile and it represents a very good profit opportunity.
A country that we believe will benefit from the probable asset-purchasing slowdown will be the Philippines. The national economy, in fact, relies on the exports of different products, that include petroleum and chemical products as well as lumber, clothing and electronics. It is predicted to expand 6% in 2013 and 5.5% in 2014. The country’s strong growth prospects, robust external accounts, and improving fiscal condition earned it its first ever investment grade credit rating in March 2013, followed by another upgrade in May 2013. With stronger economic reforms, the Philippines can see sustained growth of above 6 percent in the medium-term. Boosting a strong current account surplus of 2.5 billion in Q2, we believe the economy to be strong but unlike the other developing countries we’ve analyzed, tapering in this case could depreciate its currency, further benefiting the Philippines export-sensitive economy. Therefore it represents an optimal investment opportunity: long on the Philippines Stock Index and short Peso against the Dollar.