China’s GDP rose by a better than expected +7.5% in Q2 Y/Y and was welcomed by markets. The improvement reflects the stimulus programme undertaken by the government and the sharp rise in lending, once again, as a result of government policy. The government’s actions suggests that they will continue with their stimulus programme/increased lending if the economy weakens. However, the associated increase in credit will just add to China’s problems in the future.

Whilst just 1 months number, the much higher than expected UK June CPI reading increases the chance of the Bank of England (BoE) raising rates this year, which clearly will be positive for Sterling. The minutes of the next few meetings will reveal whether some members vote for an earlier rate hike, which I expect will be the case.

The US and to a lesser extent the EU, have increased sanctions on Russia as a result of the situation in the Ukraine. The US imposed sanctions against 4 of Russia’s major companies, which will limit their access to financing from the international capital markets, other than short term financing. Mrs Merkel has been pressing the EU to ratchet up sanctions, even though it will hurt German businesses. The downing of a commercial aircraft just increases the possibility of a further ratcheting up of sanctions. A speedy solution to this problem does not look likely. Clearly, European markets are the most affected, with the German DAX vulnerable.

The Israeli incursion into Gaza also increases the geopolitical risks, as does the continuing conflict in Iraq and Syria. However, whilst potentially serious problems, equity markets have not reacted noticeably to the increase in tensions though, unsurprisingly, bond yields declined, with the US 10 year down to 2.48%. Unless the various crises escalate, it looks as if equity markets will continue to drift higher. Results of US companies during the current earnings season have been positive, which also helps to support markets.

The Euro has continued to weaken, though I expect that it has further to go. I wouldn’t be surprised if the Euro declines to below US$1.30 over the next few months. Sterling should also benefit.

US
Mrs Yellen was somewhat more positive about the US economy, though expressed disappointment about the housing sector. She warned of potential bubbles in some markets such as leveraged loans and lower-quality debt, though generally did not believe that markets were overvalued. A FED report, accompanying her statement, expressed concerns that valuation metrics were “substantially stretched” in respect of smaller companies and the social media and biotechnology sectors. She did not give any indication as to when the FED would raise interest rates.

Interestingly, the NAHB home builders sentiment index rose to 53 in July, from 49 in June, finally moving into positive territory. However, June housing starts came in at an annualised rate of 893k, lower than the 1.02mn expected and the downwardly revised rate of 985k the previous month. Construction plunged in the South, where starts declined by nearly 30%. The other regions were all positive. Building permits came in at 963k, lower than the 1.035mn expected and the upwardly revised rate of 1.005mn in May. The housing data in the South was particularly bad and runs counter to recent evidence of an improvement in the sector, which suggests it could be a rogue number.

US retail sales rose by +0.2% in June M/M, lower than the upwardly revised +0.5% increase in May and the forecast for a rise of +0.6%. Excluding autos, petrol and building materials, sales rose by +0.6%, the most since March. The main reason for the lower than expected headline number was due to a reduction in auto sales.

June producer prices increased by +0.4% M/M (+1.9% Y/Y), higher than the rise of +0.2% expected and as compared with the -0.2% decline in May. The higher cost of fuel, which should reverse this month, resulted in the larger than expected increase. Core prices (ex food and fuel) rose by +0.2% (+1.8% Y/Y), in line with forecasts.

US industrial production rose by +0.2% in June, lower than the revised rise of +0.5% in May and the estimate for a rise of +0.3%. However, production rose by an annualised rate of +5.5% in Q2, the highest since Q3 2010.

Foreign investors are buying US bonds once again. TIC data reveals that foreign investors bought a net US$34.6bn of US Treasuries in May, which represented virtually the total net monthly inflow of capital into the US of US$35.5bn. US investors were still net purchasers of foreign securities, though the amount (US$15.2bn) was the lowest in the last 3 months.

Weekly jobless claims declined to 302k, lower than the forecast of 310k and the prior week’s 305k. The less volatile 4 week moving average declined to 309k, the lowest since June 2007 and down from 312k the previous week.

The Philly Fed manufacturing survey was particularly positive. The index of current activity rose to 23.9 this month, up from 17.8 in June and the forecast of 15.5. The new orders and shipment components rose materially, suggesting that the improvement should continue.

Europe
The German July investor confidence index (the ZEW index) declined for the 7th consecutive month. The current conditions component declined to 61.8, from 67.7 in June. The expectations component fell to 27.1, from 29.8 in June, below the forecast for a decline to 28.2. Slower growth in Q2, combined with increased geopolitical risks, were cited as the reasons for the larger than expected decline.

UK inflation (CPI) rose to +1.9% Y/Y in June, up from +1.5% in May and the forecast of +1.6%. The higher than expected level of inflation, especially if maintained, will put pressure on the BoE to increase rates sooner than it would like, quite possibly as early as Q4 this year.

UK June retail sales declined by -0.8% according to the British Retail Consortium, well below the rise of +0.7% expected and the rise of +0.5% in May. However, discounting by supermarkets, in particular, could have impacted the numbers.

UK unemployment fell to its lowest level in over 5 years. As expected, the unemployment rate declined to 6.5% in the 3 months to May. However, wage growth slowed to +0.3% in the 3 months to May, down from +0.8% in April. More recent surveys suggest that pay should start rising above inflation in coming months.

Japan
As expected, the Bank of Japan (BoJ) kept its asset purchase programme the same at Yen 60 tr to Yen 70 tr per year. The governor, Mr Kuroda, stated that CPI, ex fresh food, would rise to +1.9% in the year beginning 1st April 2015. He added, that prices should rise in the 2nd half of the year. The BoJ reduced its economic forecast for the current fiscal year to +1.0%, from +1.1% previously, thought kept its forecasts for the subsequent 2 years unchanged at +1.9% and +2.1% respectively . He added that the lower than expected exports was due to weakness in the ASEAN economies.

The Japanese government raised its economic outlook for the 1st time in 6 months, on the basis that the impact of the sales tax hike was fading and that consumption should increase in coming months. With wage growth below inflation, the government’s forecast seems optimistic.

China
The total amount of financing rose to Yuan 1.97tr (US$318bn) in June, well above the estimate of Yuan 1.425 tr and the Yuan 1.4 tr in May. M2 money supply rose by +14.7% Y/Y, the highest rate since last August. The authorities have been encouraging financial institutions to lend to stem the slowdown of the economy. The increase in lending, combined with a stimulus programme, with spending accelerated into the 1st half of the year, is helping for the present. However, to increase the amount of credit in an economy which is already materially overleveraged is particularly dangerous. The government in Beijing is also putting pressure on the provinces to increase spending/stimulus. A number of these provinces have already incurred high levels of debt. Bloomberg reports that China’s aggregate financing rose to 206.3% of GDP in Q2 this year, up from 202.1% in Q1.

Chinese GDP rose by +7.5% in Q2 Y/Y, slightly higher than the +7.4% expected and the +7.4% in Q1. Industrial production increased by +9.2% Y/Y, above the forecast for a rise of +9.0% and the +8.8% in May. Retail sales increased by +12.4% Y/Y, marginally lower than the forecast of +12.5%. Fixed asset investment, excluding rural households, rose by +17.3% in the 1st half of the year Y/Y. It is clear that government policies, including a stimulus programme, combined with increasing the amount of credit, has helped to avoid a material slowdown of the economy. The question is whether this is sustainable without further stimulus. Furthermore, Chinese data is unreliable, with a number of analysts, including myself, sceptical as to the reported growth in GDP.

Chinese new home prices declined in 55 out of 70 major cities in June M/M, the most since early 2011. The problem is the high level of unsold properties. A number of developers face serious cash flow problems and further discounting looks likely. The government has urged the provinces to deal with the inventory overhang and, in addition, urged lenders to increase mortgage lending. Previous curbs on property purchases have also been abandoned.

Other
Minutes of the last meeting of the Australian Central Bank, the RBA, were released. The RBA expressed concern as to the “substantial decline in mining investment” and stated that “it was difficult to judge the extent to which (low interest rates) would offset the substantial decline in mining investment”. They also tried to talk the A$ down. The RBA is hoping that domestic demand will compensate for the decline in the mining sector.

Kiron Sarkar
19th July 2014

Category: Markets, Think Tank

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