Bedrock’s Newsletter for Friday 20th of April, 2018
19 April 2018

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 Friday, 20th of April 2018

It is Friday again, after an unusual week- Nothing unusual happened! Trump didn’t tweet, no scary words from anyone- quite the contrary, we now know that the North Korean threat is being managed/massaged away. But there were real airstrikes in Syria by a new, mini-coalition of the UK, France and the USA. Further evidence that the power of the word is greater than the sword! Talk of wars rattled our markets, real shooting? we get the quiet and stability… Yes, the VIX is down to 16.24 down from 26 just one month back, when everybody was shouting and tweeting at everybody but no-one was shooting…

China’s economy grew 6.8% in the first quarter of 2018, the country’s statistics bureau reported on Tuesday. That topped a consensus estimate of 6.7% year-on-year growth for the quarter, marking the third-straight quarter of 6.8% growth for the world’s second-largest economy. China’s economy grew 6.9% in 2017, beating the official target of around 6.5% in part due to a synchronized global recovery. We think that this growth rate is amazing and is the motor of the global economic rebound! This said, we want to bring your attention to some linguistic pitfalls which can cause mistakes- China has an economy which is growing in leaps and bounds at almost 7% per annum and yet, you read the headlines which state “Chinese economy is slowing down…”. Be careful: An economy that is growing at 6.8% isn’t slowing down! It is growing really, really fast! Yes, 6.8% is less that the 6.9% rate of growth we saw for all of 2017. However, the economy isn’t slowing, it is the rate of growth which has slowed! In actual dollars and cents, the increase in GDP is more this quarter than it was last year… 5% of $2’000 is more than 8% of 1’000 😊

China has become so big, we can no longer expect it to be able to grow as fast as it was doing. Don’t fret even if you see the data wilting away to the 5% rate, just imagine how you’d react to US data showing a 5% GDP growth in America! The International Monetary Fund on Tuesday said it expects the global economy to expand 3.9% this year and next, a forecast that is unchanged from January estimates. That’s the good news for markets. The bad news is that there was something much more important in the IMF report this quarter: caveats about risks related to protectionism and global conflict. Given that these risks have become more acute during the period since the last set of IMF growth forecasts were released in January, and that the IMF’s latest estimate remained largely unchanged, it’s safe to say that these risks have not been priced into the growth outlook and only partially priced into financial markets. This means that the growth outlook, commodity prices and equity markets are all at risk of dropping if U.S.-China trade relations do not see a significant thawing in the near term. Of course, the IMF is not the only entity to blissfully forecast without incorporating significant (and rising) macroeconomic risks associated with the unpleasantries of the trans-Pacific tariffs being lobbed about. The Federal Reserve’s forecasts for growth and policy rates that were released on March 21 didn’t incorporate trade risks. To its credit, the IMF acknowledged that the “shift toward inward-looking policies that harm international trade” as well as “a worsening of geopolitical tensions and strife” are critical factors. Nevertheless, by leaving these as essentially footnotes, it means that the upside potential for the growth outlook is already largely priced in, while downside risks that are only acknowledged could prove to be significant. This is an especially glaring asymmetric risk and problem, since the importance of trade for recent economic growth was stressed by the IMF. As such, it should be clear just how important trade is, when considering the potential risks at play. The risk of faster inflation has kept the dollar from repeating its precipitous drop in 2017. But with other central banks looking to tighten monetary policy, the greenback is unlikely to strengthen back to levels seen in late 2016. It is not the dollar that faces the greatest upside risks from inflation. Rather, it is interest rates and bond yields.

Technical analysis of the US bond market by Citi shows that the 2-year yield has now broken to new trend highs; 5-year yield will close above 2.732% and 10-year yields would have an outside month on a close over 2.935%. All suggesting that we may be on the cusp of another topside move. The “historical rule of thumb” is that where 2-year yields go…the Fed will eventually follow. The last major fixed income bear market was 1946-1981 (35 years) from around 2% to above 15%. The last major bull market was 1981-2016 (35 years) from above 15% to below 2%. Are we there yet?

Maybe, there is also the ancillary matter of oil prices- Even if Oil peaks, as Citi expects, around $70 per barrel for WTI and enters into a range, the base effect is likely to have an impact on inflation for some time to come. the magnitude of the recovery from a supply shock has been much less than that of a collapse in demand. Given a more robust global economy and this lower price, it should not create the “economic drag” that we saw in 2011-2013 when it ranged between $75-115 (mid $95).

And then there is the shape of the yield curve to consider- To Citigroup Inc., the chances are slim that the U.S. enters a recession anytime soon. Officials at the Federal Reserve feel the same way. Yet both camps agree that an inverted Treasuries yield curve would be an ominous sign for growth. And with the latest bout of flattening, the reality of sub-zero spreads may soon collide with an otherwise sanguine outlook on the economy. The yield curve from 5 to 30 years flattened Wednesday to as little as 29 basis points, the narrowest spread since 2007. From 2 to 10 years, the gap touched 41 basis points, also the smallest in more than a decade. For extending to 10 years from 7, investors pick up a mere 4.3 basis points, less than a quarter of what they got a year ago. If the barrage of Fedspeak this week is any indication, the persistent flattening is creating a dilemma for officials, who appear intent on gradually tightening policy. St. Louis Fed President James Bullard was the latest to weigh in, saying that central bankers need to debate the yield curve right now, and that it could invert within six months. Fed Chairman Jerome Powell said “there are good questions about what a flat yield curve or inverted yield curve does to intermediation.” Though he added: “I don’t think that recession probabilities are particularly high right now.” And then, the economy is in good shape now and appears to have some staying power, Goldman Sachs CEO Lloyd Blankfein told CNBC on Wednesday. Despite worries that the 9-year-old bull market in stocks is coming to an end, the banking chief said there are lots of reasons for optimism.

As our old nemesis, the US Dollar is starting to listen to the reason of “carry” and the DXY index closes-in on 90 again, we see bitcoin also adapting to our thinking- Now at $8’300, we read Morgan Stanley “We estimate the break-even point for big mining pools should be US$8,600, even if we assume a very low electricity cost (US$0.03 kW/h),” Equity Analyst Charlie Chan and his team said in a Thursday note. How to value Bitcoin and its Crypto brethren? the easiest way to understand the efflorescence of theories and valuations being bandied about is to opt for a simple, overarching one: the greater fool theory. It says that one fool buys in the hope that there’s an ever-bigger sucker willing to pay more. The problem is that we don’t breed fools geometrically…

A fool thinks himself to be wise, but a wise man knows himself to be a fool. William Shakespeare

 

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Market Weekly Highlights

Currencies & Commodities

  • The greenback trades steady this week amid further signs of trade tensions easing and a rebound in risk from the latest military escalation in Syria. The Dollar Index DXY is now at 89.31 .
  • The USD lost some ground against the Euro since the beginning of the week showing1.2378 pushing towards the highest levels of 1.2555 reached back in February. Same for the CHF which stands at 0.9678.
  • The Pound is trading unchanged this week at 1.4227 after reaching 1.4375 on Tuesday moving beyond levels reached in January. The Japanese Yen is flat for the week at 107.34 but still stronger for the year against the USD.
  • After the recent comments and several Russian sanctions, the Ruble tumbled reaching 65 against the USD last Wednesday. However it has now retraced some of the losses and stands at 60.90.
  • The Brazilian Real, which opened the year at 3.3080, had reached almost 3.12 in January against the USD and has moved lower since, now at 3.3995, amid lower apetite for emerging market currencies sparked by trade-war bombast, goepolitacl risks and inflation global comeback.
  • The Crypto Currencies which went through an important correction during January, dropping about 60%, are seeing some kind of a rebound, with Bitcoin moving from 6’000 back to almost 8’200 to the USD.
  • Crude oil WTI trades higher for the week to $69.00 per barrel fuelled by the Syrian events; while Brent is trading at about $74.47 .

 

Fixed Income

  • 10Y U.S. Treasuries which had traded in a range during the last quarter of 2017 with yields from 2.30% to 2.40% have seen yields reaching 2.9537% during the first quarter of 2018 and are now a bit lower at 2.91% but higher for the week.
  • The Japanese 10 year JGB yield opened the year 2018 at 0.053% reached 0.10% in early February and now stands at 0.040%, continuing to offer a POSITIVE yield.
  • In Europe, the German Bund yield nearly doubled at one point this year jumping from 0.40% to 0.80%, but then came back down at around 0.49% to currently trade at 0.59%, 14 bps higher than where it closed 2017. Same for the French 10Y Yield which had crossed the 1% during February and is now back to 0.82%.
  • In Peripheral Europe Italian 10Y yields are now just above 1.775% trading 9 bps lower than where it started the year so far, whilst the Spanish 10Y yields trades some 54 bps lower than Italy at 1.28% down from where it started the year at 1.61%.

 

Equities

  • Markets in the US have turned positive again for the Year 2018 with the exception of DJIA which is still down by 0.08%; NASDAQ is up + 4.89% and SP500 +0.86%; having corrected from the strong rebound back in February but still higher for the week. The DJIA is at 24’498, the SP500 at just above 2’696 while Nasdaq is trading some points above 7’240.
  • In Europe markets are showing negative returns for the year so far with Eurostoxx50 down -0.50%, DAX at –2.68% , FTSE 100 at -5.98% and Swiss Market SMI at -6.45%. Italy and France are the only markets up for the year respectively at +8.65% and +1.24%.
  • In Asia, the Nikkei trades lower by -2.52% for the year while Hang Seng is up +2.64% together with Bovespa which is trading at a strong +12.19%.

 

Highlighted items are interesting data points for the week. Source: Bloomberg (18/04/2018)

 

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