4 months (almost to the day) and the bear-market drawdown in the S&P 500 has been undone. In 2018, the S&P 500 fell a fraction over -20% between late September’s peak and what turned out to be a Boxing Day sale in equities. Apart from the +-5% whipsaw over three low volume trading days around Christmas, US equities have steadily clawed back losses to yesterday touch new highs of 2,936 following another run of strong earnings.
The White House confirmed yesterday that they would not extend waiver extensions in regard to Iranian oil exports, which is totally against markets expectations. This is thought to leave major importers from Iran, China at 613k b/d, South Korea at 387k b/d and India at 258k b/d open to secondary US sanctions relating to their Iranian oil imports and also opens further upside potential to oil pricing as the supply side is curtailed.
Brent crude is trading ~USD71.41 per barrel, ~32.75% higher YTD, so it is only likely to be a matter of time before Donald Trump takes to twitter again to voice his displeasure that prices are too high. Tuesday’s API report showed a decline in US crude inventories for the prior week, when expectations had been for an increase, pointing to a further tightening in the market. Wednesday’s EIA data also showed crude inventories declining, the first decline in four weeks.
With the Shanghai Motor Show being a good excuse to talk about the electric car market, yesterday we made some brief comments on EV supply and how it’s possible to see it accelerating over the next few years as a trifactor (at least) of developments approach maturity. Today follows with some brief comments on the demand side of the equation. Projecting demand for EVs into the future is harder with fewer and less reliable leading indicators. But a good starting point is looking into the dynamics which have driven recent demand – notably in China where the most extraordinary boom in this market has occurred – and evaluating drivers that could push it still higher (or be introduced in other markets) alongside potential constraints that could dampen the trend.
One of the largest car shows in the world’s largest auto market began today; it is of course the Shanghai Motor Show. It’s a chance to ogle as new cars like the Aston Martin Rapide E are unveiled – their first electric vehicle – which with 600hp becomes another contender to Tesla in this ever broadening market. Also on the horizon are cars like the Lotus Type 130 “electric hypercar” confirmed at the show by Geely: the Chinese manufacturer that bought a majority in Lotus last year.
The IMF has issued a warning to governments across the globe that the world economy is in a delicate place and policymakers, along with central banks, should be very careful how they proceed. With the world economy on somewhat of a knife edge, the IMF believes countries that are in the black, such as Korea and Germany, are in a position to provide a lot of stimulus, however, are choosing not to. Only a few days ago the IMF also called on Switzerland to increase its public spending.
Greater and better representation of growing or important bond markets in global indices continues to be an important theme this year. For example, we have highlighted the inclusion of Bahrain, Kuwait, Qatar, Saudi Arabia and the UAE in the JP Morgan Global Diversified Emerging Market Bond Index (EMBI-GD) in phases from January 2019 and how this is helping to promote greater investor interest in and flows into the GCC region. But also of great importance is the greater representation of China’s local bond market in global indices: as of April 2019 the Bloomberg Barclays Global Aggregate Index will start to include renminbi denominated onshore Chinese government and policy bank bonds.
We are constantly asked how we find something every day for this report; well today it is a mishmash of items as we endeavour to avoid Brexit and the US China trade deal, which really seems the only news of note.
We start with an update, after two days of the Saudi Aramco deal being frantically bought and sold across the screens, volume was huge, it has settled down this morning with the ten year issue down about 20 cents from the reoffer price. In fact four of the five tranches are down in price with the longest maturity the 30 year issue the exception, which has seen life assurance buying pushing the price up about 15 cents.
We commented yesterday ahead of the maiden issuance of Saudi Aramco debt which ended up coming to market at lower spreads than the sovereign: the 10-year tranche came in at just 105 basis points above US Treasuries (versus 117 basis points for Saudi government bonds) and total issuance across five tranches increased to $12bn, above the originally planned $10bn. The markets were clearly attracted to such yields from a highly rated and highly profitable entity versus the broader universe. Our value monitors put the issuance at 1.3 notches cheap versus a typical A1 rated bond, but still around a half-notch premium versus the sovereign to be a part of this historical debut.
Saudi Aramco is tapping the debt market, and demand across the six tranches has rocketed to ten times the planned $10bn issuance. The debut of this Saudi government owned behemoth comes as Brent crude holds around 5-month highs of $71 a barrel and in the wake of long-awaited transparency into the company’s workings and profitability. The 470-page prospectus and accompanying reports show last year’s profits of $111bn which is more than Exxon, Chevron, Shell, Total and BP… combined; and with a market cap in the region of $1-2tn, even if the company doubled their debut issuance it would still be just a drop in the Ghawar Oil Field.
Aside from favouring investment grade bonds from what we at Stratton Street deem ‘Wealthy Nations’ (NFA ranking above 3 stars), one of our most important criteria for inclusion in the investable universe is risk-adjusted relative value. A great example could be a bond issued by Singapore’s holding company, Temasek 5.375% 2039. Using our proprietary Net Foreign Asset Model, we calculate that Singapore is wealthy, with NFA exceeding 200% of GDP, thus achieving the highest, 7 star ranking. State-owned Temasek in-turn is rated AAA by both Moody's and S&P. In terms of risk adjusted relative value, we calculate that the USD bond maturing in 2039 offers an expected return and yield around 9.2%; thus cheap.
President Donald Trump yesterday stepped up the pressure on the independent Federal Reserve’s FOMC through his usual route, Twitter. ‘Despite the unnecessary and destructive actions taken by the Fed, the economy is looking very strong…..’
He has also told confidants that he will nominate Herman Cain to the Board of Governors following his last nomination of Stephen Moore. Moore had openly called for an immediate 50bp rate cut, but had caught some negative headlines in the New York Times which could make it difficult for him to get through the confirmation process, although it is reported that Moore has ‘no plans to step aside’.
Part IV: Staying the Course:
Even if growth exceeds the Fed’s low expectations in 2019 and 2020, the FOMC does not expect measured unemployment to decline or wages to accelerate significantly. The reason is that further job gains will translate into increased labour force participation among discouraged workers, especially younger persons, who are disenchanted with part-time jobs at low pay and with little upside. Labour force participation of youth has declined from about 55% in the 1990s to 35% today.
Part III: The Consequences of Trying Too Hard:
To be clear, The Fed is not reconsidering its ultimate goal of achieving long-term price stability but only whether it should revise the means of achieving that end. A new inflation targeting regime should meet some basic pre-conditions including clarity of purpose, transparency of execution, effectiveness in achieving the goal of price stability and a convincing case that trying harder will not cause collateral damage.
Part II: Options for a New Target:
Three possible options are 1) raising the inflation target to say 3%; 2) targeting an average inflation rate of 2% over an extended period of time; 3) targeting a price level consistent with steady state inflation rate of 2%. There may be other frameworks under consideration, but they probably will fall within these three general categories.
Over the next few days, we feature extracts from our macro-economist Bob Gay’s latest piece ‘Rethinking Price Stability’
Part I: Introduction & Origins of the 2% Target:
Central banks are not equipped to tackle the structural forces that underlie the deflationary bias of today’s global economy. The big issues are income inequality in both the developing and emerging economies, excess saving especially in East Asia, persistent trade imbalances, the human cost of rapid technological advances, and climate change.
March 29, 2019 was supposed to be the day the UK left the EU, the UK's very own ‘independence day’. After more than 2 years with the clock running, today was the day Prime Minister Theresa May pledged Britain would leave the European Union. Leavers were to be celebrating, champagne and bunting the order of the day. Remainers drowning their sorrows. However, as it stands, the champagne is still on ice, no tears have yet been shed, and the UK will not be leaving today, we may not even leave next month, or the month after, maybe not even in 2019.
Sovereign and quasi sovereign bonds from the GCC region remain one of our favoured areas for portfolio exposure as a good number of issues have strong credit profiles and screen attractively on our models. Plus, the GCC region is benefiting from greater investor interest and portfolio inflows due to larger index inclusion: For example, JP Morgan is including Bahrain, Kuwait, Qatar, Saudi Arabia and UAE in its Global Diversified Emerging Market Bond Index (EMBI-GD) in phases from January 31 2019.
the liquidity crunch as “taking a page of the Chinese currency manipulation playbook” accounting for a comparable degree of state influence over the banks; but the salient difference being the TCMB (Turkey’s central bank) has far less ammunition than the PBoC in terms of FX reserves. The TCMB had already been perceived to be propping up the lira pre-election following data last week that it had drawn-down on foreign exchange reserves
The US Treasury 10 year note fell below 2.4% last night, before closing just over that level, reaching the lowest level since December 2017 and 22bp lower than before last Wednesdays Fed statement.
However, more important is the inversion of the 3 month/10 year spread which traded at -7bp yesterday. This indicator has long been associated with a forecasting tool of an oncoming recession although the timing is difficult