Edge and Odds

The enemy of knowledge is not ignorance, it’s the illusion of knowledge (Stephen Hawking)

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so (Mark Twain)

Edge and Odds

Invest with smart knowledge and objective odds

NEW$ & VIEW$ (12 AUGUST 2015): Getting Very Complicated…Cautious Out There!

China lets yuan fall further, fuels fears of currency war
Stocks, yields tumble after China pushes yuan lower again
China Intervenes to Support Tumbling Yuan China intervened to prop up the yuan in the last minutes of trading, according to people familiar with the matter, in an apparent attempt to prevent an excessive fall in the currency.

The yuan had dropped nearly 2%—the maximum allowed in mainland China—to its lowest level against the dollar in four years during mainland trading, with one dollar buying about 6.45 yuan, as the People’s Bank of China followed through on its pledge to let market forces play a bigger role in determining the yuan’s value. To that end, the central bank set Wednesday’s reference rate for the yuan based on the currency’s closing level in the previous trading session. (…)

But the move led to more selling of the yuan, and a statement by the central bank earlier in the day trying to reassuring investors that there was “no economic basis” for continued yuan depreciation largely failed to stabilize the market.

The PBOC then instructed state-owned Chinese banks to sell dollars on its behalf in the last 15 minutes of Wednesday’s trading, according to the people. The result: The yuan jumped about 1% in value against the dollar in the final moments of trading, bringing it to a level where one dollar would buy 6.3870 yuan.

The PBOC then instructed state-owned Chinese banks to sell dollars on its behalf in the last 15 minutes of Wednesday’s trading, according to the people. The result: The yuan jumped about 1% in value against the dollar in the final moments of trading, bringing it to a level where one dollar would buy 6.3870 yuan.

The Chinese currency is now down 2.8% since Monday’s closing.

China Economic Data Underwhelms Once Again July industrial output figures add to growing signs of weakness in China’s economy

Value-added industrial output rose 6% in July from a year earlier, the statistics agency reported, down from a 6.8% year-over-year increase in June and below the median 6.6% forecast by economists in a Wall Street Journal survey.

Fixed-asset investment in nonrural areas rose 11.2% in the January-July period from a year earlier, weaker than the 11.4% increase posted in the January-June period, it said. Retail sales growth edged down to 10.5% in July from June’s 10.6% increase. (…)

While housing sales between January and July rose 16.8% year-over-year, compared with a 12.9% gain in the first half of 2015, commercial and residential building starts fell 16.8% in the first seven months, compared with a 15.8% decline in the first half, the statistics bureau said Wednesday. (…)

Global Stocks Fall Further on China Concerns about China’s economy rippled through global markets, sending stocks sharply lower and putting pressure on some currencies.

(…) The Stoxx Europe 600 index was down 2.0% late morning in Europe, with Germany’s exporter-heavy DAX index falling 2.1%. The declines mirrored a slide across the board in Asia, where Hong Kong’s Hang Seng Index fell 2.4%, Japan’s Nikkei 225 index dropped 1.6% and China’s Shanghai Composite Index was down 1.1%.

Metals prices and Asian currencies sank and shares in companies that rely on sales to China dropped. Haven U.S. Treasury bonds climbed.

Shares in car maker s, luxury goods firms, and mining companies—sectors highly sensitive to demand from China—were among the hardest hit.

A weaker yuan could hurt the competitiveness of firms outside China by making their goods and services relatively more expensive. Companies that sell goods in China could find revenue generated in yuan is worth less in their home currency.

Copper, aluminum and nickel prices all hit more than six-year lows, while zinc hit a near four-year low.

For the quarter ended June 30, revenue grew 28% to $3.26 billion, missing analysts estimates for $3.39 billion.

Shares of the company fell 6.2% to $72.55 in premarket trading. Through its Tuesday close, the stock has risen 14% since its initial public offering price of $68 in September, but it is far from its high of $120, reached in November.

Currency Rout Goes Global as Jen Sees Risk of 50% Loss on China Yuan’s devaluation changes the FX landscape

As bad as things are for emerging-market currencies, China is about to make them a whole lot worse.

Its devaluation of the yuan risks a new round of competitive easing that may send currencies from Brazil’s real to Indonesia’s rupiah tumbling by an average 30 percent to 50 percent in the next nine months, according to investor and former International Monetary Fund economist Stephen Jen. (…)

“The emerging-market currency weakening trend is now going global.”

Latin America is a particular concern because of the region’s high levels of corporate debt, said Jen, who predicted the 1997 Asian crisis as a strategist at Morgan Stanley. (…)

Strategists surveyed by Bloomberg anticipate declines in 19 of the 31 leading emerging-market currencies by the middle of next year, with those from Latin America and Eastern Europe seen as the biggest losers.

Declines will be exacerbated by “a confluence of cyclical and structural factors,” according to SLJ’s Jen, who pointed out that global growth is slowing and said the record $9 trillion owed by sovereign and corporate borrowers outside the U.S. will create demands for dollars. 

Morgan Stanley cautions against being too bearish. Investors betting currencies will weaken should limit their potential losses because China will follow its devaluation with fiscal-stimulus measures to boost the economy, its strategists said Tuesday in a note. (…) (First chart from Bespoke Investment, next 2 from Ed Yardeni)

During June, the index for the 34 advanced economies that are members of the OECD fell to 100.0, the lowest reading since June 2013. Among the weakest components of the overall index is the US LEI, which fell to 99.4, the weakest since November 2011. Sorry, that doesn’t make any sense to me. Making more sense is the LEIs for the BRICs, which all remained below 100 during June.

And this chart from BloombergBriefs…

China Devaluation Path Could Worsen Dollar Drag on Growth

and this from Mohamed El-Erian:

(…) With this move, China explicitly joins other nations trying to capture economic activity outside their borders, and it is doing so as the global economy is struggling to generate sufficient growth. The decision therefore provides many signals about what ails China and the global economy, and has implications for financial markets. (…)

China’s decision leaves the U.S. as the only systemically important country willing to accept the strengthening of its currency. But what may work for individual countries cannot work for the system as a whole; and that has implications for financial markets.

The timing of China’s policy decision signals that one of the largest and most systemically important economies is no longer in a position to play its longstanding role as a locomotive of global growth. The tailwind China has provided other countries now risks becoming a headwind. (…)

Excessive dollar appreciation is one of the concerns highlighted by the Federal Reserve as a possible counterpoint to the growing list of domestic reasons to increase U.S. interest rates as early as September. (…)

…which lead to this:

Dollar Tumbles As Fed Rate Hike Suddenly Looking Very Uncertain To Goldman, Bank Of America
U.S. Steelmakers Again Ask for Tariffs on Imports Target is hot-rolled coil from Australia, Brazil, Japan, South Korea, the Netherlands, Turkey and the U.K.

(…) and warned that China’s devaluation of the yuan could have severe repercussions on their industry.

Six of the nation’s biggest steelmakers— U.S. Steel Corp., Nucor Corp., AK Steel HoldingsCorp., ArcelorMittal USA LLC, SSAB Enterprises LLC and Steel Dynamics Inc.—filed their third trade complaint of the summer, as they attempt to stem what Nucor Chief Executive John Ferriola has called a “tsunami of foreign imports.”

(…) the U.S. already has tariffs on imports of that kind of steel from China.

The problem for U.S. steelmakers is sluggish prices, which are held down by inexpensive imports. The U.S. index price for hot-rolled coil, a benchmark product, has fallen more than 20% this year to $468 per ton.

Pointing upThat is still about $100 higher than the price in Europe and $200 above that in Asia, according to steel buyers, making the U.S. a tempting market. (…)

Maybe the U.S. steel industry has a severe cost problem. What else is new?

Sputtering Worker Productivity Vexes Economy U.S. worker productivity is advancing at one of its worst rates on record, frustrating prospects for a sustained economic acceleration more than six years into the expansion.

The productivity of nonfarm business workers, or the output of goods and services per hour worked, increased at a 1.3% seasonally adjusted annual rate in the second quarter, the Labor Department said Tuesday. That gain followed two consecutive quarterly declines. From a year earlier, productivity was up just 0.3%.

Annual revisions, also released Tuesday, showed recent gains were even weaker than previously estimated. For example, labor productivity was flat in 2013. The Labor Department’s prior reading was a 0.9% improvement. Over the past five years, productivity has grown at just 0.4% annual pace—the weakest advance since the early 1980s.

The productivity figures help explain “why the labor market has tightened so much over the past five years despite what was considered at the time to be tepid GDP growth,” said Amherst Pierpont Securities economist Stephen Stanley. (…)

“We’ll need a large improvement in labor productivity from the past five years’ trend to get close to even a sustainable 2% GDP trend,” said Morgan Stanley economist Ted Wieseman. (…)

Tuesday’s report showed a gauge of compensation costs, unit labor costs, increased at a 0.5% annual rate from April through June. The measure, which is adjusted for productivity gains, was up 2.1% from a year earlier.

The compensation figure matches with other measures of pay in showing some modest firming this year. Average hourly earnings, which isn’t adjusted for productivity, grew 2.1% from a year earlier in July. (…)

The article says that the recent productivity gains were well below the long-term average of 2.2% per year since the end of World War II. But that misses the fact that average U.S. productivity growth has been 1.4% since 1975 as this chart from RBC Capital illustrates. Meanwhile, other industrialized countries have seen their productivity slow even more.image

Meanwhile, in the USA, mortgage apps for purchase are rolling over again…(Chart from CalculatedRisk)

Oil Demand Growing at Fastest Pace in Five Years, Says IEA Demand for oil is increasing at its fastest pace in five years, boosted by an oil-price drop below $50 a barrel, a top energy watchdog said.

(…) In its closely watched monthly report, the IEA said global oil demand would grow by 1.6 million barrels a day this year, an upward revision of 200,000 barrels a day from its previous forecast, and would keep rising by 1.4 million barrels a day next year. The organization—which advises industrialized nations on energy—said consumers were responding to lower oil prices while macroeconomic prospects were better than expected.

“Oil’s plunge below $50 barrels a day from triple digits a year ago has seen demand react more swiftly than supply,” the IEA said. “Against this backdrop, many participants in the oil industry have adopted a new mantra – ‘lower for longer’.”

The news comes after OPEC also upgraded its oil consumption views for 2015 in a report Tuesday. Global oil demand is expected to grow by 1.38 million barrels a day this year, some 90,000 barrels a day more than it previously expected, the oil producers’ cartel said. (…)

Supply outside OPEC is expected to decelerate but it has yet to fall. Non-OPEC production growth is expected to slow from a 2014 record of 2.4 million barrels a day to 1.1 million barrels a day this year, the IEA said. But it will only start declining—by 200,000 barrels a day—in 2016. Most of the drop will come from Russia as U.S. production will continue rising—by about 190,000 barrels a day—next year, the agency also said. (…)

Canadian oil sands crude halves in price Prices drop 50% in six weeks to $23 a barrel

This week, Western Canada Select, a marker for heavy, diluted bitumen from Alberta’s oil sands region, fell to $23. It was less than half the price of Brent, the global oil benchmark listed in London.

A combination of steadily rising production, pipeline constraints and a surprise outage at a US refinery explain the 50 per cent fall in Canadian oil since July 1. (…)

The discount of Western Canada Select to US benchmark West Texas Intermediate crude this week widened to nearly $20 a barrel, the most in a year, according to Bloomberg data. Canada is the largest foreign crude supplier to the US. (Chart from FT)

NEW$ & VIEW$ (11 AUGUST 2015): Hmmm…

Confused smile If, yesterday, like Evercore ISI’s Ed Hyman, you thought that the picture was getting “very complicated” with things such as “Fed tightening, China, PR default, S&P earnings, Brazil, Russia, the Middle East, and a Greek relapse”, you must be feeling pretty dizzy today:

Devalued Yuan Rattles Markets China’s central bank devalued its tightly controlled currency, causing its biggest one-day loss in two decades, as the world’s second-largest economy continues to sputter.

(…) The devaluation Tuesday was the most significant downward adjustment to the yuan since 1994, when as part of a break from Communist state planning, Beijing let the currency fall by one-third.

China sets a midpoint for the value of the yuan against the U.S. dollar. In daily trading, the yuan is allowed to move 2% above or below that midpoint, which is called the daily fixing. But the central bank sometimes ignores the daily moves, at times setting the fixing so that the yuan is stronger against the dollar a day after the market has indicated it should be weaker.

With Tuesday’s move, the fixing will now be based on how the yuan closes in the previous trading session. As a result, the yuan’s fixing was weakened by 1.9% Tuesday from the previous day, leaving it at 6.2298 to the U.S. dollar, compared with 6.1162 on Monday. The yuan dropped as much as 1.99% from its previous close to 6.3360 against the dollar in Shanghai and fell as much as 2.3% in Hong Kong in early trading.

The engineered fall in the yuan is likely to cause political ripples around the world. In particular it may reignite criticism of China’s tight control over the yuan’s exchange rate within the U.S. Congress and some American businesses, which have long said the currency was already too weak and set at a rate that allowed Chinese exporters to sell their goods artificially cheap on world markets.

As recently as April, other central bankers were speaking confidently that China wouldn’t devalue. This puts pressure on them to follow suit. China’s currency move also could pose a challenge for the U.S. Federal Reserve. The Fed is preparing to raise U.S. interest rates later this year. One source of concern for the Fed this year has been a strong U.S. dollar, which is squeezing exports and helping to hold U.S. inflation below the Fed’s 2% target. China’s move puts more upward pressure on the dollar, which could be exacerbated further when the Fed actually raises rates. (…)

This is a big deal. Described as a “market reform” move by the PBoC, this move de facto allows the market to set trends, at least if the PBoC is serious when it says this will enhance “the market-orientation and benchmark status” of the renminbi. From the FT:

Previously, the PBoC would set the currency wherever it liked. Now it will give markets a voice: the daily fix will “refer to the closing rate of the interbank foreign exchange market on the previous day”. (…)

The renminbi had been under pressure to weaken for months because of capital outflows but the PBoC restrained any depreciation by setting the fix higher and selling forex reserves. Today’s one-off depreciation eases some of that pressure.

(…) But we will not know if China is truly letting the market have a say in the currency’s value until we have seen it move in a direction that would not be supportive to its own goals.

The Chinese currency has a soft peg to the US dollar, which has surged this year and contributed to the decline in Chinese exports. A weaker renminbi could support the economy, so Beijing could simply be allowing the currency to slide and use the talk of “market reform” as political cover; otherwise it would be controversial for the currency to be devalued. (…)

Investors have been pushing for the renminbi to weaken and if they are allowed to determine where the fix is, it is possible the currency could depreciate quickly. (…)

Punch The reality is that China’s economy is weakening more than what Beijing thinks is safe from a social and political standpoint. China’s exports have been crushed by global sluggishness AND global devaluations while domestic demand is not accelerating enough to support manufacturing. The collapse in the equity market has been seen as a further threat to social peace (confidence and support of the party). The way officials handled that revealed Beijing’s nervousness.

Now they cleverly enter the devaluation game, adding fuel to the global deflationary trends just when all central banks are trying to restart inflation.

Ghost Back in 1987, when the world realized that world central bankers were getting into a free for all, equities also devalued.

Asia faces round of currency wars

(…) “The more market is allowed to play a part in China, the more sensitive Asian currencies will be to moves there,” said Mitul Kotecha, head of Asia currency and rates strategy at Barclays. “In the past both China’s equity and forex markets have had only a limited impact.” (…)

From Macquarie Securities:

In the past, one major problem with the yuan exchange rate setting was too much emphasis on its stability against the U.S. dollar while neglecting [trends in] other currencies. In the past 12 months, the yuan appreciated by 23% against the euro and 17% against the yen. As a result, so far this year, China’s exports to the EU and Japan are down 4% and 11% year on year. Today’s change should mitigate the problem.

NFIB: Small-Business Optimism Rebounds in July Small-business owners’ confidence about their economic situation rebounded modestly in July, according to a report released Tuesday.

After a sharp and unexpected decline in June, The National Federation of Independent Business’s small-business optimism index rose 1.3 points, to 95.4, in July.

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Seven of the 10 subindexes increased in July.

Expectations for better business conditions, plans to add inventories and plans to create jobs were among the biggest contributors to the uptick. Those expecting better conditions over the next six months rose five percentage points, though the subindex was still in negative territory, and the subindex reflecting plans to build inventories rose four percentage points to the flat line.

The job-creation subindex rose three percentage points, to 12%. The report said job-market indicators “held their respectable historic solid positions,” though it added that “there were no signs of a second half ‘liftoff’ that many are forecasting.” (…)

From the report:

  • Earnings trends continued to deteriorate, posting a 2 point decline after a 10 point drop in June, falling to a negative 19 percent. Far more owners reporting profits lower quarter to quarter than higher.
  • Reports of increased labor compensation rose 2 points to a net 23 percent of all owners (seasonally adjusted), still shy of the high of 25 percent for this year. Labor costs will continue to put pressure on the bottom line.
  • Seasonally adjusted, the net percent of owners raising selling prices was 5 percent, unchanged. There are no signs of inflation bubbling up on Main Street, should be good news, but maybe not for the Fed.

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OPEC Pumps at Three-Year High Despite Oversupply The Organization of the Petroleum Exporting Countries said the group’s production rose to its highest level in over three years, despite global oversupply that has helped send prices tumbling.

In its monthly oil market report, the 12-nation cartel of some of the world’s biggest oil producers said its members pumped 31.51 million barrels a day in July—its highest level since May 2012, representing an increase of 101,000 barrels a day, compared with the previous month. That is 1.5 million barrels a day above the group’s stated output ceiling of 30 million barrels a day, which OPEC endorsed at its last gathering in June in Vienna.

In Iraq, OPEC said output rose by 46,700 barrels a day in July and broke a record at 4.07 million barrels a day. In Saudi Arabia, the other main driver in OPEC’s production growth, crude output rose by 39,200 barrels a day, to 10.35 million barrels a day, amid strong domestic demand in the summer season. Angola also increased its production by 39,700 barrels a day, to 1.78 million barrels a day.

U.S. production, meanwhile, has proved stubbornly resilient. OPEC said Tuesday that U.S. production fell by 260,000 barrels a day in May, but the group said it still sees it rising this year by nearly a million barrels a day and another 320,000 barrels a day in 2016.

“U.S. production remains near the highest level in four decades, although the commodity price is telling the U.S. shale sector to shrink,” the group said. The higher output is largely due to increased cost efficiencies, lower taxes and existing projects coming on stream, OPEC said. The group said that, for example, in the prolific North Dakota, many projects can still be profitable at $24 to $41 a barrel.

OPEC said global oil demand is expected to grow by 1.38 million barrels a day this year, some 90,000 barrels a day more than it previously expected. Despite that higher demand, OPEC said oversupply stood at 2.87 million barrels a day in the second quarter.

Russia’s Economic Contraction Deepens

Gross domestic product shrank by 4.6% in the second quarter compared with a year earlier, after falling by 2.2% in the first three months of the year, preliminary data from the Federal Statistics Service showed Monday.

From the FT:

With oil prices back down to $50 a barrel for Brent crude, a falling gas price and its share of the European energy market declining, the Russian economy is in real trouble. The situation is dangerous because the problems cannot easily be corrected. The risk is that the economic problems could lead to political instability both within Russia and around its borders. (…)

Most of Vladimir Putin’s 15-year reign (as president and as prime minister) has coincided with strong energy prices and growing production of oil and gas. The resulting revenue has enabled the Kremlin to keep most people happy – businessmen, the military, the middle class of Moscow and St Petersburg and even most of the wider population. But the sun never shines for ever. Too little has been done to prepare for the current downturn. The Russian economy has not been diversified and although there is a reserve fund that can provide some cushion against the fall in revenue the amounts involved are small and will soon run out if current prices persist.

As reported in the FT last week, Gazprom is set to produce less gas this year than at any time since the fall of the Soviet Union.” The company’s market share is falling and according to analysts at Sberbank its revenue, year on year, is expected to drop by almost 30 per cent this year.”

Gas-to-gas competition fed by the increased flows of liquified gas (LNG) has broken the traditional link between gas and oil prices and is changing the structure of a market the Russians had taken for granted. After years of cozy interdependence with the European utilities, the company’s trading activities are under sustained attack by the competition authorities in Brussels.

The oil story is no better. Russia exports about 6m barrels a day (mbd) but each one is now worth only 40 per cent of the revenue achieved two years ago. After a small surge in the spring, the world oil price has now fallen back to $50 a barrel. (…)

At the same time, fears about the future of the Russian economy are encouraging a dramatic outflow of capital. Many of those who have done well in the last decade fear that in hard times Mr Putin could expropriate assets in order to keep things going. According to some estimates, the exodus of capital since the latest phase of the Ukrainian crisis began in November 2013 could amount to $300bn by the end of this year. Some physical assets cannot be moved but cash and wealth in other forms certainly can. No one is doing more for London estate agents at the moment than Vladimir Putin.

The situation is dangerous because the options for the Russian government are so limited. The oil and gas markets are being shaped by forces that neither Mr Putin nor anyone else can control. The downward cycle could take years to play out. The dispute over Ukraine is an obstacle that could be removed but even a complete and amicable settlement there would not restore Gazprom’s market share in western Europe. The deals to sell gas from east Siberia to China and others make sense but will not make money for another decade.

The real risk is that economic discontent will force either the existing Russian government or its replacement into a harder political stance. As the maps in Barnes’s book show Russia has spent most of its history in conflict with one neighbour or another. War, as on numerous past occasions, could provide a nationalistic distraction from the grim economic realities. In many ways, the last 25 years in Russia have been a period of relative stability. But there is no guarantee that that situation will last. Mr Putin will remember all too well that one of the major reasons for the fall of the Soviet Union at the end of the 1980s was the collapse in energy prices. If anything, Russia is weaker now than it was then. Indeed, as Dominic Lieven says in a brilliant introduction to Barnes’s book: “Russia is now weaker than it has been at almost any time in the last 300 years.