In financial markets there is often a tendency for some people to extrapolate recent events and draw some implausible conclusions. For instance, a few months ago the press was full of stories about China running out of FX reserves and how Saudi Arabia is in danger of running out of money. Neither were ever very likely.
Unsurprisingly, Saudi Arabia has begun steps to turn things around and last week Deputy Crown Prince Mohammed bin Salman outlined the Kingdom’s package of programmes over the coming four years to rebalance the country's balance sheet to boost non-oil income. The cornerstone of the package of programs is to restructure the Kingdom’s Public Investment Fund (PIF) into a Sovereign Wealth Fund, which will be the biggest ever seen and in time will mean that Saudi could rely on investment income from the fund being greater than income from oil within 20 years.
The PIF is expected to be $2 trillion in size, and would be funded by the selling of a stake in Saudi Aramco, the world’s largest oil company and then transferring the remainder of the company into the PIF alongside holdings in commercial and financial companies. The initial public offering for shares in Aramco will be as soon as next year, according to the Prince. Although Saudi Aramco has never published financial details, if we use a very conservative $10 per barrel for its reserves that puts its value around $2.5 trillion according to analysts.
News from China has also shown why it is dangerous to extrapolate recent trends. On Thursday, the People's Bank of China (PBoC) announced that foreign reserves were up over $10bn in March. FX reserve declines (not outflows) had averaged $98bn between November 2015 and January 2016 before slowing to $29bn in February. What many people have failed to realise, even though it should be obvious, is that China’s foreign exchange reserves are not all in US dollars. Most central banks will hold FX reserves in major currencies and those of their major trading partners. Consequently, China’s FX reserves will have a significant portion in non-US dollars. So fluctuations in the dollar will cause China’s FX reserves to fluctuate as well and part of the reason for the gain in March will be due to the decline in the dollar overall. Going forward the PBoC will also publish FX reserves measured in SDR’s which it hopes will help market participants understand better what is really going on. Whether this will make a difference to perceptions remains to be seen.
US Treasuries continued their recent rally and over the week 10-year US yields saw another 5 bps decline, closing on Friday at 1.72%. Whilst, as we said earlier, extrapolating the recent trend might be unwise, the fundamental story looks very positive for further gains in Treasuries and other high grade bonds. The global economy remains weak and US yields look very high compared to yields in Europe or Japan. At the same time the latest economic data in the US has weakened sufficiently for the GDPNow forecast for US Q1 GDP from the Atlanta Fed to come in at….just 0.1%!