Tickmill UK Daily Market Notes

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IEA’s Birol: Oil consumption forecast can be revised to the downside in the coming months
The International Energy Agency (IEA) cut forecast for oil consumption in 2019 due to flattening growth of the global economy and persisting risks from trade standoff between US and China, said Fatih Birol, the head of organization.

The agency expects consumption to fall to 1.1 million barrels per day and may deliver even gloomier revision of the projections if the global economy, and especially China, shows further weakening, Birol said.

The IEA was much more upbeat last year predicting an increase in demand by 1.5 million b/d in 2019 but updated projections contained much more pessimistic figures weighed largely by global trade risks.

«China is experiencing the slowest economic growth for the past three decades, as well as some developed economies … if the global economy figures are even worse than we expect, then in the coming months we can even revise our figures again,” said Birol in Reuters interview.

According to Birol, the demand for oil were adversely affected by the trade war between United States and China at a time when the markets have been drowning in oil due rising shale oil production in the United States.

It is expected that in 2019, US oil production will increase by 1.8 million barrels per day – less than 2.2 million barrels per day in 2018, Birol said, but “these volumes will go to the market, where demand growth is decreasing “.

According to him, the IEA is concerned about rising tensions in the Middle East, especially around the Strait of Hormuz, an extremely important shipping route connecting the Gulf oil producers with markets in Asia, Europe, North America and other countries.

 

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US and Vietnam: from “Best Friends” to Trade Rivals?
Next possible leg of the trade war may affect countries that have emerged victorious at the expense of first victims. This assumption is explained by the fact that losing the accumulated trade and economic advantage is more expensive for any economy than simply missing it out – and Trump understands this perfectly well. Already very attractive for the US president is the ability to knock out concessions from China’s small neighbour, Vietnam, which is seen as one of the main beneficiaries of the transformation of the supply chains in the trade between the US and China:

Trump just needs to make a threat, but can Vietnam avoid this or a new trade front with an East Asian country is only a matter of time?

First, it is worth remembering that in May, the US Treasury Department included Vietnam in the list of potential currency manipulators, which gives Trump a formal pretext for imposing tariffs on Vietnamese goods if the fact of deliberate devaluation is proved. This threat has already led to the introduction of 400% of the tariffs on steel imports from Vietnam, which was produced in South Korea or Taiwan. Thus, the role of the country as an “unwitting accomplice” is being blocked, also serving as a warning that the connivance of the authorities will be punished specifically with tariffs on Vietnamese goods.

And there is a reason for this. For example, there are allegations that Chinese goods are “rebranding” in Vietnam and exported to the United States under the guise of Vietnamese goods. The rise of exports from China to Vietnam and from Vietnam to the United States indicates that there may be a phenomenon that US officials call “transshipment”:

As can be seen, China’s exports of key goods to the United States have shrunk along the “short route” and have grown along the “long route” through Vietnam.

If the United States introduces 25% tariffs on imports from Vietnam, considering that the severity of misconduct is commensurate with Chinese, then according to some estimates, this could lead to a reduction in export volumes by 25% and a loss of 1% of GDP. The United States continues to be Vietnam’s main trading partner, and vice versa, the share of US exports to Vietnam, especially in terms of agricultural products, has risen sharply:

Last month, Trump stunned the Vietnamese authorities with statements that Vietnam was “the worst abuser in the trade of everybody” and “fairness in trade with Vietnam may even be less than with China.” Back in 2016, after entering the presidency, Trump made similar complaints, but the contract for Boeing purchases of several billion dollars and the trend to strengthen alliances with China’s neighbours, in the opinion of the Vietnamese authorities, have become a reliable dam protecting the country from criticism of the POTUS. But it was not there. Trump expressed discontent with the explosive growth of Vietnam’s trade surplus with the United States, which in the first five months of this year reached $21.6 billion, almost doubling compared to the same period last year.

Several sources claim that Vietnam made several promises to Washington related to trade, and Trump’s recent criticism can only accelerate their implementation. For example, the development of a law on the creation of three free economic zones, which, according to fears of local firms, could go under the control of China, was suspended indefinitely, demonstrating to Washington that the trend of rapprochement with a neighbour was interrupted. Nevertheless, Vietnam is also working on a “spare airfield”, having entered into the Trans-Pacific Agreement (from which the United States left) and signed a free trade agreement with the European Union. Together they can mitigate damage from possible US sanctions.

Thus, the chances of introducing trade tariffs against Vietnam will directly depend on:

1. Dynamics of transshipment operations, where Vietnam serves as a gasket between China’s exporters and US importers. The lack of repression and conniving routes – loopholes is likely to provoke a new wave of criticism from Trump.
2. Vietnam surplus with the United States. The main item of US exports to Vietnam is agricultural products (4 billion dollars in 2018). If purchases will grow at a faster pace, it can be assumed that countries have agreed on something.
3. Cooperation in the military sphere. In terms of concrete numbers, this should be increased purchases of American weapons and equipment. This should be a more reliable signal of preference for cooperation with the United States to balancing between the interests of superpowers (i.e. US and China and probably Russia).

 

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Reserve Currency Status as a Factor for Medium-term Dollar Decline
The status of reserve currency should be necessarily supported by an economic power of the issuing country as it makes possible for the currency to assume key functions of money – a means of payment and store of value (protection of purchasing power). Within one country, the money is empowered with these functions via monopolisation of the money supply by single body (state) as well as enforcement of their use, covered in the notion of “legal tender”. If we talk about world economy where different currencies exist and no enforcement can be carried out, other natural mechanisms are instead at work, namely:

• The dominant share of the country’s GDP in world output and product diversity. The more goods or services you can buy for a reserve currency, and the wider their range, the greater the chance that this currency will become a transnational means of payment. All previous economies, which currencies held the status of reserve, met this criterion, but, oddly enough, only temporarily:

• Low and stable price level growth. Low inflation provides a better protection of purchasing power relative to other currencies, which makes savings in it more attractive;
• Efficient capital markets, which provides a quick and cheap transformation of savings into investments.

From the standpoint of inflation, there are no wide inflation gaps between world powers, like persistently high inflation in US Dollar and low in the Euro what makes Euro more attractive & puts pressure on dollar as reserve currency, as the inflation slackening became global issue. Same with capital markets, US still rocks. But if we talk about economic growth, technological advancement and competition, the dollar losing the role as global means of payment is becoming an increasingly relevant topic for discussion. The July note of Morgan Stanley’s investment strategy, entitled “Exorbitant dollar privileges are coming to an end?” was dedicated precisely to the factor of reserve status in the mid-term outlook of the dollar.

The brief conclusion is that MS analysts have lost faith in the dollar, believing that it will soon lose the status of reserve currency (which will cause its decline in the medium term) due to structural changes and cyclical impediments. After one hundred years of dollar domination, investors have accumulated significant positions in dollars, but feel quite comfortable with this overweight. Diversification makes sense if investors put more weight on Asian currencies and EM, however, to keep it safe, the underlying assets may remain the same, but investment instruments will be denominated in other currencies, which will balance out the FX proportions.

This is the current and recommended currency composition of MS client portfolios:

The bank’s analysts point out that the accelerated growth rate of China’s GDP at purchasing power parity, as well as the improving balance between low and high value added sectors, create the necessary basis for increasing the share of the yuan in world calculations once the country takes more decisive steps to liberalise the monetary regime:

Source: IMF, J.P. Morgan Private Bank Economics

Source: Bloomberg, J.P. Morgan Private Bank Economics

Over 70 years, China’s GDP has more than quadrupled to 20%, compared with 25% of the United States. The growth of other Southeast economies, such as India, means that the number of transactions in a currency other than the dollar will grow, reducing the relative share of the dollar in the total volume of global transactions. Between 2015 and 2030, the growth of middle-class consumption is estimated at 30 trillion dollars and only 1 trillion dollars will be spent by the middle class of Western economies.

The latest data on central bank reserves show that the share of dollar reserves in the assets of the Central Bank has steadily decreased since 2008:

Source: Exante

However, while the share of global transactions involving the dollar is at a very high level – 85%, the US share in global GDP is only 25%. Strengthening the US position in the oil market suggests that payments for primary products – energy will also be carried out in dollars, which is a strong counter argument to the arguments of JP Morgan, predicting quite swift changes.

What are your thoughts about future dollar dominance? Have your say in the comments section below.

 

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ECB Increases Focus on the Side-effects of NIRP, Warranting new Depths in Negative Rates
ECB’s statement and Draghi’s remarks at the press conference on Thursday set the stage for exploring new bottoms of NIRP, QE and other mitigation measures. But not surprisingly, they did not justify the wildest expectations of euro bears.

Overnight interest rate swaps gave a 50% chance of a rate cut yesterday, but the ECB opted to put off active operations until September. Exploring new depths of negative rates is associated with a rise in imbalances, marginal costs, side effects and possibly unknown surprises, so the ECB needs time to “cover its back” with a thought-out package of measures, rather than acting straightforwardly by cutting rates.

The key side effect is of course greatly reduced profitability of the banking sector. Although banks’ ROE rose from 3% in 2016 to 6% in 2018, profitability is below the long-term cost of capital, estimated by banks at about 8-10%. There were costs of immediate rate cut like further pressure of the yield curve and banks’ net interest margin and they are likely exceeding the costs of “delay” of rate cuts till September. Otherwise, the ECB would follow the Fed’s path, which is expected to preemptively cut the rate by 0.25% next week. The same conclusion can be drawn from the stock index of the banking sector STOXX 600, which, in case of ECB tepid attitude to banks profitability issues, is ready to retest the multi-year bottom:

The package to ease pressure on the banking sector is likely to include a progressive deposit rate (tiering), a new QE package, which can “strengthen” the assets of banks holding bonds on their balance sheets. Exempting a portion of bank reserves from the ECB “deposit tax” may be needed for those countries where costs of maintaining excess reserves are quite high relative to net profits, such as in the case of Germany:

According to the ECB, rates will remain at current levels or below at least until the second half of 2020. “A considerable mass of inflation expectations is moving towards lower inflation”, Draghi said at a press conference. “We don’t like it, so we are determined to act.” Discussions about deposit tiering, which the ECB brings up to the public knowledge indicate that the rates can go much lower, since the only thing holding back the Central Bank in this way are side effects.

As a result, the market prices in a rate cut by 10 basis points in September and almost 25 basis points at the end of next year:

“Diverse” package of easing measures, which Draghi promoted to our attention, gives rise to a very wide rumors in the market about the extent of the bearish surprise in September. Even in the absence of weak economic and sentiments data, considerable moral effort will be required to rely on the rise of the euro. If, of course, the Fed won’t surprise us next week, cutting rate by 50 basis points and urge to prepare for the worst, which is unlikely.

 

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High-tech shares drive growth on the Chinese stock market
Major stock indices in China rose on Friday, posting weekly gains thanks to the high-tech firms’ rally, while investors welcomed the potential progress in US-China trade negotiations. Shares of most companies in the new technology platform, STAR Market, fell on Friday in a take-profit move, posting significant gains in the first week of trading.

CSI 300 blue chip index rose 0.2% to 3.858.57 points as the Shanghai Composite Shanghai Stock Exchange Index also advanced by 0.2%, to 2.944.54 points. For the week, CSI300 scored 1.3%, while SSEC climbed 0.7%. Investors remain focused on the development of Sino-US trade negotiations.

The White House announced on Wednesday, that High-ranking US officials will visit China on Tuesday, July 30, for talks “aimed at improving trade relations between the US and China,”. Tech stocks led the weekly increase. IT-index CSI rose by 5%, while the index, which tracks the main telecommunications companies, gained 3%.

 

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Preview of the Fed Meeting: Hard Data vs. Soft Data Puzzle for the Fed
In the last two or three FOMC meetings, it was increasingly harder for the officials to communicate their decisions properly to the markets. Teetering market expectations fed by conflicting economic and sentiment signals have been especially vulnerable to Fed’s communication mistakes. Recall Fed’s Williams speech about possible response to recessions which market took as a clear guide for a rate cut by 50 basis points. Thankfully, Fed’s spokesman was quick to issue disproof which averted disaster.

The economy and expectations (especially corporate sentiments) are sending conflicting signals, pulling the blanket of monetary policy to each other what makes it difficult for the Fed to be consistent, predictable and adhere to the line of its own medium-term forecasts. It is unknown from where the next shock will appear, which may either prolong the expansion or drive the economy into crisis.

Based on the premise of “data dependence” in determining the policy course, as Powell recalled at the previous meeting, the data for the last month can shed light about possible Fed decision this week. In the following table I compiled recent soft and hard data (statistical data and surveys), two multidirectional vectors which puzzle the Fed:

The big surprise, what complicates matters for the Fed is the acceleration of GDP, retail sales and jobs growth in July. The tax cuts were supposed to run out of steam in 1Q – 2Q of 2019, moreover, the trade war should have quickly depleted this driver of growth. Over the past three months, there has been some improvement in orders for durable goods and capital goods while sales of existing houses have also stabilized.

Surveys of company managers, on the contrary, indicate a fall in optimism in the outlook for demand and investments. So far, these fears “miraculously” haven’t translated into the employment figures, which is growing at relatively robust pace. The growth of layoffs and the slowdown in creating new jobs usually follow in response to declining sales but based on the current state of employment this is clearly not the case. However, Powell has previously stressed that employment, while remaining an important factor in macroeconomic stability, is pushed to the background in terms of forecasting ability. Prolonged decline in unemployment and the weak inflation response in wages and consumer prices show that any obvious connection between them has been lost. Since the pursuit of inflation targets remains the primary task for the Fed, soft monetary policy can now occur simultaneously with the strengthening of the labor market.

By cutting the rate, the Fed will also have to get rid of the stigma of “Trump’s puppet”, since the possible easing of credit conditions will follow precisely Trump’s numerous reproaches that the Fed is holding rates too high.

Important point of the July meeting is the absence of updates on the dot plot, i.e. signal about the long-term plans of the officials. This speaks in favour of dry wordings a la “act as appropriate”, since Powell will have to explain only the “statement” in which officials usually interpret past changes.

Another factor restraining ability to ease policy – inflated stock market which recently renewed historical peaks. It is likely that Powell will again add the phrase about a slightly “stretched valuations”, which also rules out “big rate cut” scenario without obvious recession risks.

There are two days left before the meeting, however futures continue to price high chance of easing by 50 bp. – at 23%. With such expectations the rate cut by 25 bp and reiteration of “patient” stance with scant explanations should be a bullish surprise, what is my current baseline scenario. In this case, we should expect a positive dollar response to the meeting.

 

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BoJ Takes Pause in opening New Season of “Cheap Money”, Complicating Decision for the Fed
Bank of Japan left the amount of monetary stimulus unchanged at the meeting on Tuesday, however, it signaled its readiness to cut rates and ramp up bond purchases significantly if the risks associated with global growth materialize in the domestic economy.

The bank’s decision carries little, if any surprise for the Yen as BoJ has been least successful in forecasting and pushing inflation to the target among its peers and the baseline case for its actions is unlimited assistance to the economy.

But with ECB hitting pause button once more before opening the “new season” of cheap money increases the likelihood that the Fed will take only a modest step towards easing, by only 25 basis points. However, the chance for aggressive rate cut by 50 bp continued to increase, reaching 27.1% on Tuesday. There is a growing conviction among investors that retail sales, GDP, employment and other “lagging” indicators should now worry the Fed less than a drop in corporate optimism and a squeeze of investment. Aggressive rate cut should be the necessary shock that can outweigh caution and distrust, fueled by trading tensions.

Years of low interest rates have eroded the margins of the banking sector in Japan, which brings the Japanese Central Bank to the limit of using non-traditional instruments, apart from inflation being immune to rapid expansion of money supply. For the Central Bank, it is also important to “preserve the ammunition” in the absence of Yen appreciation, which also paves the way for less dovish wordings. If the Fed’s decision causes a strengthening of the yen, the Bank of Japan may expand the horizon of policy guarantees (aka forward guidance) or allow the yields of 10-year bonds to move in a wider range, as was done earlier.

BoJ’s policy stance in July hardly differs from June, but a new line appeared in the statement, which says that the Central Bank is ready to increase stimulus without any hesitation, if the chances that the inflationary momentum is lost, will grow. This is actually rephrasing of the notorious “whatever it takes” wording of Draghi we heard in 2013. But Yen has so far developed resilience to the dovish stunts of the BoJ.

The Japanese yen strengthened against the dollar by a quarter percent due to increased demand for safe assets, as well as return of Japanese investors “home” before the extremely uncertain outcome of tomorrow’s Fed meeting. Together with the yen, gold and the Swiss franc rose by 0.61% and 0.16%, respectively.

 

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Trump Wasn’t Lying When he said that “China needs the deal more than me”
It seems that Trump wasn’t lying when he said that “China needs the deal more than me.” This time the distress signal came from the industrial sector in China, where profits declined at the fastest pace in eight months in October, what also didn’t live up to expectations of the seasonal autumn “bump”:

Industrial profits fell 9.9% year on year, data showed on Wednesday. It was only worse in January-February of this year, when profits naturally fall due to the celebration of the Lunar New Year. In September, profit also turned out to be negative – -5.3%.
The “poisonous mix” for firms was deflation of production prices and rising borrowing costs, despite the efforts of the PBOC. This suggests that external demand for final goods fell, which affected the demand of these enterprises and also for intermediate goods, i.e. for raw materials. Credit impulses of the Central Bank, as a result, cannot get through “bottlenecks”, for example, increased risks of default on firms’ debts, which leads to a tightening of credit ratings. The “traditional channel” of shadow lending (that is, bypassing banks) cannot come to the rescue because of the government crackdown.
The production price index, which changes precede the changes in corporate profit, fell to the lowest level for three years in October. This was also reflected in the manufacturing PMI, where the downtrend has been going on for six months. The subcomponent of export orders has been declining for 17 consecutive months.

Last Tuesday, the NBK played in the big league and lowered the medium-term financing rate, for the first time in several years, since a consistent 7-fold decrease in the reserve ratio has little effect in terms of economy support.
Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 72% and 71% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

 

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Gold – Does History Repeat Itself?
Gold price has extended buying momentum on Tuesday, developing the takeoff from $1,500 seen on Monday. I guess the explanation for the move lies primarily in the following chart:

As you might expect, I’m talking about inflation expectations in the United States. I also raised this topic in my yesterday post. Since last Friday, average expected inflation over the next five years has jumped from 0.86% to 1.23%. It is well known that gold and the inflation factor in pricing of the dollar are inversely related, which is based on the simple idea that an asset that loses its purchasing power should become cheaper in relation to the asset that retains it.

The latest jump in gold can be explained by the following factors:

• Fundamentally determined weak prospects and an increased expected variance of returns on risky assets;
• Rising concerns of inflation outbreak in the United States thanks to “unlimited” asset purchases by the Fed, which also expanded the range of securities to include corporate and municipal bonds and is now basically in “whatever it takes” mode;
• Basic supply/demand change: expectations an increase in the money supply in the economy contributed to the currency weakness against other majors (including gold) which outweighed demand driven by “flight into cash” motive;

If you look at how gold behaved during and after the previous crisis, there are some parallels that we can draw:

At that time, there were debates whether QE would lead to an acceleration in price growth or not, i.e. at the beginning of QE, there were expectations of this, which was priced in accordingly in the price of gold. I emphasize that QE’s novelty as a policy measure at that time was a volume of guaranteed bond purchases (the Fed achieves its interest rate targets by the same open market operations – treasury purchases that change supply of bank reserves). The novelty of the current measures, in my opinion, is in their volume again, which has potential to lead to similar gold response.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.

High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 73% and 70% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

 

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Narrowing Range in Oil Could Suggest Sweeping Move on the Cards
Stock market euphoria, which is also expressed by a global dollar dump, does not resonate with crude oil: WTI trades in a narrowing range around the $23 mark, remaining unimpressed by the dollar weakness and rebound in risk assets:

Such a pattern usually precedes a strong move and there are some reasons to expect the market to lose its temper. Government actions around the world are increasingly saying that countries are making bets on the experience of Wuhan in suppression of the outbreak – organizing home quarantine for at least two weeks. This is accompanied by serious short-term economic losses, including a drop in demand for fuel and a decrease in manufacturing and production activity because of forced decreased labor supply. This week the second most populated country in the world and the largest oil consumer, India, announced a 21-day full quarantine, which is likely to force experts to revise consumption forecast even more to the downside.

Data on Thursday showed that the number of initial unemployment claims in the US rose to a significant 3.3M. The response of the stock market showed that the downside surprise was quickly absorbed. The number of confirmed cases worldwide increased by 13.43% on Thursday compared with the previous day after several days of consistent decrease in the growth rate:

The head of the IEA Fatih Birol said that global oil demand is now “in a free fall”, and the glut is deepening due to the price war between Russia and Saudi Arabia. According to him, 3 billion people are locked down, as a result, oil demand may fall by 20 million barrels per day (almost 20%). Goldman gave similar depressing figures for March and April (10.5M b/d and 18.7M b/d) and it is clear that bigger and longer lockdowns should shave off more near-term consumption demand. That’s why “updated” EIA forecasts offer even gloomier view. In the near-term prices may be supported by the decision of the US government to restart economy earlier as Trump promised. Rumors about the move should be kept on the radar.

Oil trader Vitol Group expects that demand drop will accelerate over the next three months and will not fully recover this year.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.

High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 73% and 70% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.