European Central Bank to Expand QE, Cuts Interest Rates Further

The European Central Bank cut all its interest rates and expanded its monthly bond purchases by a third as President Mario Draghi strives to fend off the threat of euro-area deflation.

Faltering US economy leads global slowdown

(…) The developed world PMI fell to its lowest since April 2013, signalling just 0.5% annual GDP growth. Rates of expansion slowed in all four largest developed economies, with a steep slowdown in the US the most worrying, pushing the US down to stagnation and below the equivalent index for Japan. Slower growth was also seen in the UK, which is now seeing the same modest pace of expansion as the eurozone.

Markit’s US PMI series for both manufacturing and services fell sharply again in February. Bad weather was partly to blame, but weaker underlying demand meant February was the second-worst month since the global financial crisis. Although both the surveys and official data showed job creation remaining robust, and keeping further rate hikes on the table, slower economic growth may soon feed through to weaker hiring.

China to ease commercial banks’ bad debt burden via equity swaps – sources China’s central bank is preparing regulations that would allow commercial lenders to swap non-performing loans of companies for stakes in those firms, two people with direct knowledge of the new policy told Reuters.

The new rules would reduce commercial banks’ non-performing loan (NPL) ratios, and free up cash for fresh lending for investment in a new wave of infrastructure products and factory upgrades that the government hopes will rejuvenate the world’s second-largest economy.

NPLs surged to a decade-high last year as China’s economy grew at its slowest pace in a quarter of a century. Official data showed banks held more than 4 trillion yuan ($614 billion) in NPLs and “special mention” loans, or debts that could sour, at the year-end. (…)

The sources said the new regulations would get special approval from the State Council, China’s cabinet-equivalent body, thus skirting the need to revise commercial bank law, which bars banks from investing in non-financial institutions. (…)

China Inflation Fastest Since Mid-2014 as Food Prices Jump

The consumer-price index rose 2.3 percent in February from a year earlier, up from 1.8 percent in January, as food prices surged 7.3 percent. Raising question marks over the durability of that pickup, non-food prices moderated from a month earlier to a 1 percent increase and services inflation slowed.

The producer-price index fell 4.9 percent, narrowing from a 5.3 percent decrease in January, extending declines to a record 48 months. (Chart from Zerohedge)

CLSA’s Christopher Wood, author of the exquisite Greed & Fear, smartly relates China’s nominal GDP to its PPI (charted by Evercore ISI). If the relationship holds, nominal GDP growth has probably bottomed out.

Many of you may not be familiar with Chris Wood’s Greed & Fear publication. Here’s a treat from his latest piece (thanks Gary):

These forces of disintegration are already building in the case of the refugee crisis which is, fundamentally, a much more important issue than Brexit. The past week has seen Austria and nine Balkan nations unilaterally cut the flow of migrants across their borders with the result that there are now estimates of as many as 22,000 refugees trapped in Greece. One consequence is that a German effort to agree on a Eurozone-wide approach looks increasingly unlikely with the result that what in GREED & fear’s view is the Eurozone’s greatest achievement, namely the Schengen visa free area, looks under increasing threat. It is also worth noting that Hungary’s controversial ultra nationalist leader, Viktor Orban, called a referendum last week on whether the country should accept a Brussels instruction to take
refugees. The point here is that the habit of referendums can become infectious.

So the centrifugal forces are at work in the Eurozone and there are clearly other growing risks which will capture headlines in coming weeks and months, be it the likely electoral success of Germany’s increasingly overtly anti-immigrant Alternative für Deutschland (AfD) party in local “länder” elections this month or the inevitable growing focus on France’s presidential election scheduled for spring 2017. But there is, in GREED & fear’s view, one country which gets insufficient attention as a trigger for a Eurozone break-up and that is a founding member of the EU, namely Italy.

In many respects, Italy has been the key loser of the EU project in macroeconomic terms because it adopted the euro in 1999 at too high a level of the lira. This
can be demonstrated best in the sheer lack of growth in the Italian economy since the euro was launched at the beginning of 1999. In particular Italy, which had a strong manufacturing sector at the outset of the euro and is still Europe’s second biggest manufacturing power after Germany, appears to have been the key loser relative to Germany. Thus, Italy real GDP has risen by only an annualised 0.3% since 1999, compared with an annualised 1.3% growth for the Eurozone (see Figure 8). While Italian exports have risen by an annualised 3.8% since 1999, compared with an annualised 5.4% growth in German exports over the same period (see
Figure 9).

This has not perhaps got the attention it should have and, as is the case of Japan, has been partly absorbed by a very high national savings rate which means the government debt is, as with Japan, primarily funded domestically. Italy’s gross national savings rate was 18.3% of GDP in 2015 (see Figure 10). Still human distress can be seen in the very high youthful unemployment rate of 39.3% (see Figure 11) as well as the sheer lack of income growth. Wages and salaries per employee rose by only 0.8%YoY in January, down from 1.3%YoY in December (see Figure 12).

But what is perhaps most interesting about Italy is that Italian Prime Minister Matteo Renzi has since late last year become increasingly critical of Berlin and Brussels in their approach to the Eurozone. This is noteworthy since Renzi has some credibility as a reformer in the Italian context having since he took office in February 2014 reformed the labour market for new jobs in terms of the ability to hire and fire, a process which has created 328,000 jobs in the past 18 months (see Figure 13).

The issue that is most driving Renzi’s criticism is Berlin’s and Brussels’ opposition to taxpayer financing of bad banks and the insistence under the Eurozone’s new so-called “Bank Recovery and Resolution Directive (BRRD) that shareholders and junior creditors must be bailed in to absorb losses before state funds can be used to fund a bank bailout.

While laudable in theory, the practical problem in Italy is that there is a real NPL problem while Italian banks have already sold a lot of “junior” bonds to their depositors with one elderly bond holder in one failed bank having already committed suicide late last year. GREED & fear hears that NPLs account for about 18% of total loans or about 20% of GDP (see Figure 14). It is also the case that 46% of Italian household bond portfolios are made up of bank bonds, according to the Bank of Italy (see Figure 15).

Against such a backdrop, it is perhaps not surprising that Renzi has becoming increasingly vociferous in his criticism of Berlin and Brussels. It is also the case that, while “bail-ins” make sense in principle, the Italians can point to double standards since Italy only bailed out four banks with only €4bn of government money during the 2008 financial crisis whereas the Germans did a lot more bailing out in terms of their own Landesbanken. Thus, some €646bn was spent or set aside by the government to rescue German banks between 2008 and 2012.

So GREED & fear would advise investors to keep an eye on Italy; though it may take more market stresses to force Frau Merkel to “bend” as was also the case in the Greek Crisis. That said, it may also help to concentrate minds in Berlin if some of Germany’s own larger banks come under renewed market pressure as has been the case recently. It is also the case that Renzi is mounting a growing campaign for more fiscal easing in the Eurozone in a process which is also likely being encouraged by America in terms of its call for current account surplus countries, such as Germany, to engage in fiscal stimulus. (…) this is likely to be a focus of the G7 meeting in Japan scheduled for May. In this respect, Renzi again has a point in the sense that there has been a cumulative fiscal deficit since 2008 in the US of 60% whereas in the Eurozone the comparative figure is only 30% (see Figure 16).

The point is simply that it has become dangerous to ignore Europe completely amidst the seemingly all-consuming focus on Fed policy, oil and China.

More and More People are Renting. Thank the Suburbs Renting is spreading more into the single-family homes of the American suburbs, according to a new report.

(…) Nearly 22 million more people were renting in metropolitan areas around the U.S. in 2014 than in 2006 and much of that increase was driven by the growth in suburban renters, according to a new report from New York University’s Furman Center, which studies real-estate and urban policy, and Capital One.

While the renter population in major cities increased by nine million people during that eight-year period, in the surrounding suburban areas it increased by 12 million people. (…)

The median rent in principal cities, adjusted for inflation, grew 5% from 2006 to 2014, compared with 2% for the surrounding suburbs.

In some metro areas the difference was even starker. In Washington, D.C., the median rent in the city, adjusted for inflation, grew by 27% from 2006 to 2014, while in the suburbs it grew by 8%. In New York, the median rent in the city grew by 15%, compared with 4% in the suburbs.

Many suburban homeowners also lost their homes during the foreclosure crisis and often ended up renting single-family homes nearby. In 2014, 37% of renters in the largest metro areas lived in single-family homes, compared with 32% in 2006.

Overall, a higher proportion of urban residents still rent than suburban residents. Nearly half of residents of central cities in rent compared with 29% of residents of the surrounding suburbs. (…)

Natural gas misses out on energy rebound Price in freefall across previously distinct regional markets

In east Asia, gas prices assessed by Platts have declined 35 per cent since the start of 2016 to $4.40 per million British thermal units — the lowest level on record at this time of winter. In the UK, the gas price is close to $4, down by a fifth.

And in the US, the gas benchmark has plunged below $2 and is easily this year’s worst performer in the Bloomberg Commodity Index.

What is striking is that gas has fizzled across time zones. Regional markets for the fuel were once separate, reflecting the difficulty of shipping gas across oceans. As recently as two years ago, Platts’ Japan Korea Marker price was $20, UK gas was $10 and the US was about $5.

“The interconnectedness between markets is clearly growing,” says James Henderson of the Oxford Institute for Energy Studies.

It is growing because of the construction of liquefied natural gas (LNG) plants, which chill and condense gas so it can be shipped on tankers overseas. (…)

Global gas liquefaction capacity will reach 274.3m tonnes this year, up 30m tonnes from two years ago, according to PIRA Energy Group. It is scheduled to increase by another 65m tonnes between 2016 and 2018.

Companies decided to add this capacity when gas prices were far higher. But they are now launching ships into unexpectedly weak demand.

A string of mild winters have depressed use of gas as a heating fuel from Tokyo to New York. Across the northern hemisphere, onshore temperatures from November 2015 to January 2016 were 1.7°C above average — the biggest anomaly on record for the three-month period, according to the US National Oceanic and Atmospheric Administration. The US Energy Department forecasts domestic stocks will end winter 40 per cent higher than average — a surplus Cheniere’s plant alone cannot drain.

Demand is soft for other reasons, too. The restart of nuclear plants after Japan’s 2011 Fukushima disaster has undercut its need for gas-fired power. China’s LNG imports contracted for the first time ever last year, according to Bank of America Merrill Lynch. (…)

Japan has contracted far more LNG than it needs until the end of the decade, says Tony Regan of Platts. He says utilities have had to turn themselves into traders in order to resell some long-term supplies. (…)

“My view is at least till the middle 2020s, a large amount of LNG will wander around the world seeking its final consumer,” Yuji Kakimi, Jera’s president, told the IHS CERAWeek conference in Houston last month. “This will happen in an already weakened market situation . . . Arbitrage among Europe, North America and Asia will also be more commonplace.”

In Asia and parts of Europe, customers’ long-term gas contracts are mainly pegged to the price of crude oil. After oil collapsed in 2014, gas prices in these markets also fell. If oil’s rebound to $40 a barrel should stick, it would take about a quarter-year for this to feed into contracted LNG prices and a season to hit European gas prices, says Ira Joseph, PIRA’s head of gas and power.

With Asian demand so soft, more LNG cargoes are likely to reach Europe, though they face tough competition from Russia’s state gas giant Gazprom. (…)

THE ENERGY WINDFALL

charted by CalculatedRisk:

Sharp Swings Intensify Worries About Bond Markets Whipsaw trading this week in Japanese government bonds is raising concerns that debt markets are vulnerable to a shock if global central banks wrong-foot expectations they will soon expand stimulus.

(…) Traders said the sharp moves were only the latest sign of the increasing volatility that has racked once placid government-bond markets in recent years, reflecting both the plunge of market interest rates in a period of soft global growth and low inflation and a series of structural changes that many analysts say are not completely understood.

Among those changes are the retreat of large commercial banks from the bond markets and the rise of central banks as bond purchasers. As a result of those shifts, traders said, liquidity has declined, meaning it takes longer to make a given trade, while more investors are crowding into various bets, at times amplifying shocks when sentiment does reverse—or even sometimes when it doesn’t. (…)

Analysts also point to a decline in market depth. Depth reflects investors’ capacity to place multiple buy or sell orders at once and have them filled quickly, an important aspect of liquidity.

The total Treasury market depth now sits about 25% below its longer-term average, according to a report released in January by J.P. Morgan Chase & Co. The market depth for the 10-year Treasury note tends to decline $37 million for each 0.01 percentage-point increase in the intraday trading range of the yield between 7:30 a.m. and 5 p.m. Eastern time, according to J.P. Morgan. Two years ago, it was a $25 million decrease.

Market depth has become more “fleeting’’ and it “disappears rapidly when investors most need access to liquidity,’’ according to J.P. Morgan.

While yields remain low, prices high and trading generally orderly, portfolio managers said the wide swings in Japan have rippled through other markets. A $20 billion sale of 10-year U.S. Treasury notes Wednesday attracted the weakest demand since August 2015. The yield on the benchmark 10-year Treasury was 1.892% Wednesday, compared with 1.832% Tuesday and 1.902% Monday. (…)

Violent moves in government bond markets were rare before the 2008 crisis. But the Treasury “flash crash” in October 2014, when the 10-year yield plunged in a short span without any specific trigger before quickly recovering, has sent investors and policy makers scrambling to reassess the risks of markets whose ebb and flow quickly spill over into currencies, riskier bonds and stocks.

(…)  The Fed held $2.46 trillion U.S. Treasury debt as of last week, about 19% of the $13.2 trillion market. (…)

“The price discovery function of markets has been largely eliminated” by central banks’ bond-buying programs, he said.

Hedge funds and money managers have been piling into government bonds, betting that the central banks’ purchases would continue to boost bond prices. Such wagers have strengthened the correlation among the major government bond markets, which means any big move in one market would spread into others.

Tighter regulations have reduced big banks’ capacity and willingness to help connect buyers and sellers. Banks also cut back funding in the securities repurchase market, or repos, for their clients such as hedge funds, limiting their ability to fill the gap even if rising volatility breeds trading opportunities.

On the other hand, more daily trades in the bond market are conducted via high-frequency trading firms and algorithmic trading programs.

Money managers are more willing to obtain newly issued bonds in their portfolio and are willing to accept slightly lower yields than they could get by buying those deemed off the run, or less popular. (…)

Powerful Pair: Protectionism and the Presidency White House wields outsize clout to direct nation’s path on trade

(…) Protectionist actions are on the rise globally, according to a tally compiled by Global Trade Alert, a watchdog group, led by India and Russia. Britons will soon vote on whether to leave the European Union. In short, a protectionist president would suit the temper of the times.

(…) in 1934, Congress decided to forgo “the business of tariff logrolling,” as trade historian Doug Irwin writes, and delegated most authority over tariff negotiations to the president.

This division of power has insulated the world trading system from Congress’s parochial tendencies. By the same token, it puts the world more at the mercy of presidents whose latitude over trade has steadily expanded.

Presidential appointees at the Commerce Department adjudicate complaints that foreign imports are being illegally sold at below cost, below home-country price or subsidized. They almost always find in favor of the domestic industry. Whether those findings actually merit penalties is up to the independent International Trade Commission, whose members are nominated by the president and confirmed by Congress.

While the candidates haven’t delved into the details of trade enforcement, a president has enormous leverage through several broader powerful tools, such as Section 301 of the Trade Act of 1974, which authorizes the president to take “all appropriate and feasible steps” against any “unjustifiable or unreasonable” discrimination against U.S. exports, and Section 201, under which he can seek to protect industry from surging imports.

Mr. Trump has promised to brand China a “currency manipulator.” The relevant legislation specifies no penalty—only consultations with the alleged manipulator. Mr. Trump says that would “bring China to the bargaining table” or “face tough countervailing duties.” There’s precedent for such tactics. Four months after Mr. Nixon imposed his import surcharge, the rest of the world agreed to devalue the dollar. In the 1980s, Ronald Reagan forced Japan to accept voluntary restraints on automobile exports. (…)

FYI:

Big Banks Paid $110 Billion in Mortgage-Related Fines.