Month: May 2016

Authored by Satyajit Das (Author of A Banquet of Consequences), via The Independent,

There are a number of potential triggers to a new crisis.

The first potential trigger may be equity prices.

The US stock market runs into trouble. A stronger dollar affects US exports and foreign earnings. Emerging market weakness affects businesses in the technology, aerospace, automobile, consumer products and luxury product industries. Currency devaluations combined with excess capacity, driven by debt fuelled over-investment in China, maintain deflationary pressures reducing pricing power. Lower oil prices reduce earnings, cash flow and asset values of energy producers. Overinflated technology and bio-tech stocks disappoint.

Earnings and liquidity pressures reduce merger activity and stock buybacks which have supported equity values. US equity weakness flows into global equity markets.

The second potential trigger may be debt markets. Heavily indebted energy companies and emerging market borrowers face increased risk of financial distress.

According to the Bank of International Settlements, total borrowing by the global oil and gas industry reached US$2.5 trillion in 2014, up 250 percent from US$1 trillion in 2008.

The initial stress will be focused in the US shale oil and gas industry which is highly levered with borrowings that are over three times gross operating profits. Many firms were cash flow negative even when prices were high, needing to constantly raise capital to sink new wells to maintain production. If the firms have difficulty meeting existing commitments, then decreased available funding and higher costs will create a toxic negative spiral.

A number of large emerging market borrowers, such as Brazil’s Petrobras, Mexico’s Pemex and Russia’s Gazprom and Rosneft, are also vulnerable. These companies increased leverage in recent years, in part due to low interest rates to finance significant operational expansion on the assumption of high oil prices.

These borrowers have, in recent years, used capital markets rather than bank loans to raise funds, cashing in on demand from yield hungry investors. Since 2009, Petrobras, Pemex and Gazprom (along with its eponymous bank) have issued US$140 billion in debt. Petrobras alone has US$170 billion in outstanding debt. Russian companies such as Gazprom, Rosneft and major banks have sold US$244 billion of bonds. The risk of contagion is high as institutional and retail bond investors worldwide are exposed.

A third possible trigger may be problems in the banking system fed by falling asset prices and non-performing loans. European banks have around €1.2 trillion in troubled loans. Chinese and Indian bank problem loans are also high.

A fourth potential trigger may be changes in liquidity conditions exacerbate stress. Since 2009, asset prices have been affected by the central banks’ attempted reflation. Today, as much as US$200-250 billion in new liquidity each quarter may be needed to simply maintain asset prices. However, the world is entering a period of asynchronous monetary policy, with divergences between individual central banks.

The US Federal Reserve is not adding the liquidity it did between 2009 and 2014. While the Bank of Japan and European Central Banks continue to expand their balance sheets, it may not be sufficient to support asset prices.

Falling commodity prices also reduces global liquidity. Since the first oil shock, petro-dollar recycling, the surplus revenues from oil exporters, has been an essential component of global capital flows providing financing, boosting asset prices and keeping interest rates low. A prolonged period of low oil prices will reduce petrodollar liquidity and may necessitate sales of foreign investments.

Declines in global liquidity driven by falling petrodollar liquidity and emerging market currency reserves affect asset prices and interest rates globally.

A fifth potential trigger will be currency volatility and the currency wars that are not, at least according to policy makers, under way. A stronger dollar may weaken US growth. But a weaker dollar means a stronger Euro and a stronger Yen affecting the prospects of the Euro-zone and Japan.

A sixth potential trigger may be weakness in global economic activity. One factor will be the weaker energy sector. The belief that lower oil prices will lead to an increase in growth may be misplaced, with the problems of producers offsetting the benefits for consumers. Approximately US$1 trillion of new investment may be uneconomic at lower oil prices, especially if they continue for an extended period of time. When combined with the reduction in planned investment in other resource sectors as a result of lower prices, the effect on economies will be significant.

There are also increasing problems in emerging markets. Growth is slowing as a result of slower export demand from developed markets, unsustainable debt and unaddressed structural weaknesses. For commodity producing nations, lower revenues will weaken economic performance triggering a rerating. The problems will spread across emerging markets.

Slowing growth, low inflation and financial problems will refocus attention on the level and sustainability of sovereign debt. The unresolved public debt issues of Japan and the US will attract renewed investor scrutiny. In Europe, the sovereign debt problems will affect core nations such as Italy and France.

A seventh potential trigger may be a loss of faith in policy makers. A critical appraisal of government and central bank policies and find them wanting. The artificial financial stability engineered by low interest rates and QE is undermined by concern about the long term effects of the policies and the lack of self-sustaining recovery.

A final trigger is political stress. With existing political elites seen as captured by businesses, banks and the wealthy, electorates are turning to political extremes in search of representation and solutions. The resulting policy uncertainty and inconsistency further suppresses recovery. The geopolitical situation has also deteriorated sharply.

In reality, it will not be a single factor but an unexpected concatenation of events, that result in a financial crisis, driving global contagion and an economic slowdown.

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In the traditional post payrolls data lull, we’re kicking off what’s set to be a much quieter week for data this week with just German factory orders data and the latest Sentix investor confidence reading for the Euro area this morning. There is nothing of note due to be released in the US on Monday.

Tuesday morning is all about China where the April CPI (no change to 2.3% yoy expected) and PPI data will be released. Following that in Europe we’ll get the German trade data for March along with the latest industrial production print. In France we’ll also get the latest industrial production data as well as the Bank of France business sentiment print, while later on in the UK the March trade balance will be released. In the US on Tuesday the main focus will be on the March wholesale inventories and trade sales report, along with the NFIB small business optimism survey and JOLTS job openings for March.

Wednesday kicks off in Japan with the leading index print. That’s before we get the latest industrial production report for the UK, while in the US on Wednesday the April Monthly Budget Statement is the sole release. We’re starting Thursday in Japan again with the latest trade data. In Europe the main focus will be on the Euro area industrial production report, while France’s CPI print for April will also be released. The big focus will be on the UK however with the BoE meeting with the inflation report also due to be released.

Over in the US on Thursday we’ll get initial jobless claims data as well as the import price index reading.

The bulk of the big releases are reserved for the end of the week on Friday. In Germany we’ll get the final revisions to the April CPI report, while the preliminary reading for Q1 GDP will also be out. Wages data in France will also be released before we get the preliminary Q1 GDP report for the Euro area (expected at +0.6% qoq). In the US the big focus will be on April retail sales which are expected to have advanced +0.9% mom at the headline, while the April PPI print, March business inventories and finally the first read for the May University of Michigan consumer sentiment print will also be released.

Away from the data there is more Fedspeak for us to digest this week. We’ll hear from both Evans and Kashkari today, Rosengren and George on Thursday and Williams on Friday. The ECB’s Constancio is also scheduled to speak this morning. Earnings season is beginning to wind down meanwhile. We’ve got just 20 S&P 500 companies due to release their quarterlies including Macy’s and Walt Disney. In Europe there are 90 Stoxx 600 companies due to report however including more of the Banks.

The full detail from Goldman Sachs

Monday, May 9

• 5:10 AM Chicago Fed President Evans (FOMC non-voter) speaks: Federal Reserve Bank of Chicago President Charles Evans will be participating in a panel at the International Financial Services Forum in London. Recently, President Evans remarked that inflation data are likely to heavily inform the Fed’s decision to raise interest rates.
• 10:00 AM Labor Market Conditions Index, April (consensus -1.0, last -2.1):  Consensus expects the Labor Market Conditions Index to increase slightly to -1.0 from -2.1 previously.
• 1:00 PM Minneapolis Fed President Kashkari (FOMC non-voter) speaks:  Federal Reserve Bank of Minneapolis President Neel Kashkari will be speaking at the Economic Club of Minnesota. Q&A is expected. Recently, President Kashkari has suggested the Fed is unlikely to aggressively raise interest rates.

Tuesday, May 10

• 06:00 AM NFIB small business optimism index, April (consensus 93.1, last 92.6): Consensus expects the small business optimism index to increase slightly in April.
• 10:00 JOLTS job openings, March (consensus 5,400k, last 5,445k): Job openings edged down in February following an upward revision to January. Consensus expects job openings to move down slightly in March.
• 10:00 AM Wholesale inventories, March (consensus +0.1%, last -0.5%): Consensus expects wholesale inventories to edge up slightly in March.

Wednesday, May 11

• 02:00 PM Monthly Budget Statement, April (consensus +$110bn, last +$156.7bn): Consensus expects a federal budget surplus of +$110bn in April.

Thursday, May 12

• 08:30 AM Initial jobless claims, week ended May 7 (consensus 270k, last 274k): Continuing jobless claims, week ended April 30 (consensus 2,120k, last 2,121k): Consensus expects both initial jobless claims and continuing claims to move down slightly from the previous week. Last week, initial claims rose to 274k and the four-week moving average edged up to 258k. However, we suspect that some of the increase may be due to seasonal effects related to spring break holidays and temporary auto plant shutdowns.
• 08:30 AM Import Price Index, April (consensus +0.6%, last +0.2%): Consensus expects the import price index to rise 0.6% in April, a faster pace than the 0.2% increase in March.
• 11:00 AM Cleveland Fed President Mester (FOMC voter) speaks: Federal Reserve Bank of Cleveland President Loretta Mester will give a speech on monetary policy in Reichenau Island, Germany.
• 2:15 PM Kansas City Fed President George (FOMC voter) speaks: Federal Reserve Bank of Kansas City President Esther George will give a speech on the economy in Albuquerque, New Mexico. At the April FOMC meeting, President George dissented, citing her preference to raise the target range for the federal funds rate.

Friday, May 13

• 8:30 AM Retail sales, April (GS +0.9%, consensus +0.8%, last -0.3%); Retail sales ex-auto, April (GS +0.5%, consensus +0.5%, last +0.2%); Retail sales ex-auto & gas, April (GS +0.3%, consensus +0.3%, last +0.1%); Core retail sales, April (GS +0.4%, consensus +0.3%, last +0.1%): We expect core retail sales to rebound to a +0.4% month-over-month pace after a weak print in the advanced report last month. Higher gasoline prices and sales last month, in addition to stronger auto sales, likely will boost headline retail sales as well.
• 08:30 AM PPI final demand, April (GS +0.3%, consensus +0.3%, last -0.1%); PPI ex-food and energy, April (GS +0.2%, consensus +0.1%, last -0.1%); PPI ex-food, energy, and trade, April (GS +0.1%, consensus +0.1%, last flat): We expect core PPI (ex-food, energy, and trade) to edge up +0.1% in April after a softer-than-expected report in March. Headline PPI likely rose +0.3% due to higher energy prices.
• 10:00 AM University of Michigan consumer sentiment (preliminary), May (GS 90.5, consensus 89.5, last 89.0):  We expect the University of Michigan consumer sentiment index to improve in the May preliminary estimate, following last month’s modest decline.
• 7:00 PM San Francisco Fed President Williams (FOMC voter) speaks: Federal Reserve Bank of San Francisco President John Williams will give a speech on the economy in Sacramento, California. Q&A is expected. Last week, President Williams suggested that if the U.S. economy continues to show improvement, two or three interest rate increases would be reasonable this year.

And the full week charted courtesy of BofA:

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Following this weekend’s news that the massive Calgary fire, while still spreading, may soon be under control courtesy of some wet weather and favorable winds, as well as the stunner from Saudi Arabia that Ali al-Naimi was out, replaced with a puppet of the hawkish deputy drown prince Mohammed bin Sultan – a succession many saw as bearish for future oil prices – algos had refused to give up on recent momentum, and pushed WTI just why of $46/bbl overnight. However, to Bank of America this proved too much, and the bank’s strategist Paul Ciana has come out with a new trading recommendation as follows: “Sell WTI Crude Oil: Sell crude oil into event driven stress at $45.75, stop at $48.25. Target market profile levels of $38.50 and possibly $35.25.“

If this was Goldman, we would say sell everything and buy WTI on 3x margin. With BofA, however, we are less sure – this may even be a correct recommendation…

Here are the details from the BofA technician:

Price action at fair value resistance suggests correction

Three intraday crude oil rallies were sold last week resulting in prices closing near the open of the trading day. According to Japanese candlestick analysis; Wednesday, Thursday and Friday each formed a doji* candle suggesting indecision amongst market participants to effectively push prices higher. On April 29th crude oil reached an intraday high of $46.78 and closed near the open of the day forming the first of four doji candles in six trading sessions. Thursday can loosely be considered a gravestone** doji, which as the name implies is bearish.

Aggregate volume and open interest bearishly diverge

The rally to the YTD high occurred on light volume. Considering the total (aggregate) volume across all WTI crude oil futures contracts, volume during the rally in the latter half of April was less than the rolling 15 day average. The decline from the YTD high occurred on greater than average volume. Since the rally began from the YTD low, the trend in aggregate open interest has bearishly diverged from price.

A look back at the golden cross is insignificant

Since 1983 there have been 23 occurrences when the 50 day moving average crossed above the 200 day moving average. By the time the 50 day average crossed back below the 200 day average, price was higher only 9 out of 23 times. When analyzing price action between the up cross and down cross points, the high price was before the low price 13 out of 23 times.

Refreshed market profile chart provides updated levels

In our March 1st report, our market profile chart implied a close over $34.25 would prompt a rally to $39-$40, and it did. We later pointed to a sustained rally to $45.50  that would continue to fill the remainder of the prior distribution gap. Price reached this level in the end of April filling some of the 8/1/2015 – 2/29/2015 distribution gap.

Our updated market profile chart now shows $46.75 is the top of the value area in the 8/1/2015 – 2/29/2015 distribution and that aligns with the bottom of the value area of the 1/1/2015 – 7/31/2015 distribution. This ($46.75) is a major resistance level. A close through it could prompt a rally to $51.00 which opens the possibility of filling another distribution gap. However previously mentioned technical conditions suggest a decline and so we see $38.50 (3/31 POC) and $35.25 (value area 3/31) as major support levels.

Preliminary signs of a developing base

If crude oil prices were to decline for the next four to eight weeks, it would start to form the right shoulder of a head and shoulders bottom. While this is very preliminary, a decline to the mid to upper $30’s followed by a rally through resistance of about $45 would form an intermediate sized head and shoulders bottom that could project crude oil prices much higher.

Seasonal average trends show May is bad for crude

When comparing the 5, 10 and 30 year average price trends, May stands out as a weak month. Prices have declined on average over the past 5 and 10 years in May. The average trend over the past 30 years also leans lower.

Macro risks: Alberta fires, Saudi Oil Minister replaced

According to Bloomberg, wildfires in Canada have spread to the main oil-sands facilities knocking out approximately 1 million barrels of production per day. However the new Saudi oil minister, Khalid Al-Falih is said to be a close ally of Prince Mohammed bin Salman who is known for prioritizing market share (supply) over prices. These events could add increased short term volatility to trading.

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Back in February we showed that it is not only China which is troubled by non-performing loans: America’s own nascent private Peer 2 Peer industry was having very similar issues, evident most notably in the books of category “leader” LendingClub, whose write-offs had soared to nearly double the company’s own forecasts.

First, a quick reminder on the industry dynamics over the past year. As we reported last May, P2P loan volume was set to surpass $76 billion in 2015 and one driver of the boom is demand from the likes of BlackRock, Morgan Stanley, and Goldman, who had all underwritten securitizations of loans originated on P2P platforms like LendingClub, the number one player in the space. For those unfamiliar, P2P loans create the conditions whereby borrowers can refi high-interest debt via personal loans, transferring credit risk from large financial institutions to private lenders in the process.

It’s not entirely clear what the implications of that shift might ultimately be, especially if the market continues to grow rapidly. “One thing,” we said, “is clear”: Using a relatively low-interest P2P loan to pay off a high-interest credit card is no different in principle than using a new credit card that comes with a teaser rate to pay off an old credit card. In the end, the borrower will very often max out the old card again and thus end up with twice the original amount of debt.

 

The same dynamic applies to P2P lending. “So what’s to stop consumers from levering their credit cards back up?” Bloomberg asked last year. “Such behavior could spell bad news for investors in P2P loans if an interest rate hike or an unforeseen shock pressures borrowers,” Michael Tarkan, an equities analyst at Compass Point Research said.

 

“We’ve created a mechanism to refinance a credit card into an unsecured personal loan,” he added. “This may prove to be a superior model, but we just don’t know because it hasn’t been tested yet through a full credit cycle.”

 

No, we “just don’t know”, but we may be about to find out because a new presentation from LendingClub indicates that the cracks are starting to show. “LC Advisors, an investment adviser owned by LendingClub that helps people buy loans arranged by the company, said last week in a presentation that some of the debt is ‘underperforming vs. expectations,’” Bloomberg wrote on Friday. “A chart on one of the slides shows that write-off rates for a portion of five-year LendingClub loans were roughly 7 percent to 8 percent, compared with a forecast range of around 4 percent to 6 percent.” Here’s the slide in question:

 

What the slide above shows is that LendingClub is terrible at assessing credit risk. A write-off rate of 7-8% may not sound that bad (well, actually it does, but because P2P is relatively new, we don’t really have a benchmark), it’s double the low-end internal estimate. That’s bad.  In other words, we said, the algorithms LendingClub uses to assess credit risk aren’t working. Plain and simple.

Our warnings about LendingClub continued:

“Their business is to take data and use that to underwrite risk,” the aforementioned Michael Tarkan told Bloomberg by phone. “If you’re an investor in the loans on the platform, this creates a concern around that underwriting model.”

 

It sure does, as does common sense. Matching up individual borrowers and lenders may sound like a good idea in principle, but effectively, you’ve got a brand new set of companies (the P2Ps) attempting to assess individual borrowers’ credit risk on the fly in cyberspace, an absurdly difficult proposition and one that obviously comes with myriad risks especially when those credits are sliced up and sold to investors. 

 

Securitizations of these loans are just consumer ABS deals. That is, they’re no different than securitized credit card receivables or the nightmarish deals that emanate from Springleaf and OneMain.   

 

Throw in the fact that LendingClub is raising rates “to prepare for a potential slowdown in the US economy” and the fact that 70% of the jobs created by America’s supposedly “robust” labor market are in the food and bev/ retail sector, and you can bet that charge-offs will skyrocket should the US careen into a recession.

 

Then again, it could be worse for LendingClub investors. The company could be run by Ding Ning.

Moments ago all these warnings were validated (quite painfully for those still long the company) and the Peer2Peer bubble may have finally burst, when as part of its Q1 earnings release, the board of directors announced that on May 6, 2016 it had accepted the resignation of Renaud Laplanche as Chairman and CEO. His resignation followed an internal review of sales of $22 million in near-prime loans to a single investor, in contravention of the investor’s express instructions as to a non-credit and non-pricing element, in March and April 2016.

“A key principle of the Company is maintaining the highest levels of trust with borrowers, investors, regulators, stockholders and employees. While the financial impact of this $22 million in loan sales was minor, a violation of the Company’s business practices along with a lack of full disclosure during the review was unacceptable to the board. Accordingly, the board took swift and decisive action, and authorized additional remedial steps to rectify these issues,” said Mr. Morris. “We have every confidence that Scott and the management team are well positioned to lead Lending Club forward.”

The company also announced that Scott Sanborn will continue in his role of President and will become acting CEO, assuming additional managerial responsibilities for the Company. Mr. Sanborn will be supported by director Hans Morris, who has assumed the newly created role of Executive Chairman.

However, the reason why LC stock has wiped out over a quarter of its market cap in the premarket is that the market is much more concerned not about what was said, but what was left unsaid. The fear is that the board merely used one specific infraction by the CEO to fire him, even as the entire underlying portfolio is deteriorating at a rapid pace (as shown in the analysis above).

So is this the beginning of the end for the P2P lending model? We expect the answer will reveal itself as we get more details not so much about the now former CEO Laplanche’s transgressions as about the book quality of both LC and its peers. As of this moment, the market is now very optimistic on the future prospects before the P2P lending space, especially since there is rarely just one cockroach.

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• China stocks plunge again as hopes for economic recovery fade (Reuters)
• European Stock Gains Defy China Data That Hurt Metals; Oil Rises (BBG)
• Yen falls after Tokyo warning (Reuters)
• Soros Chart Signals BOJ Bond Buying Already Enough to Weaken Yen (BBG)
• Dollar Jump Catches Traders Short in One More Currency Calamity (BBG)
• Even China’s Party Mouthpiece Is Warning About Debt (BBG)
• Fed’s Evans sees U.S. growth picking up to 2.5 percent, favors ‘wait and see’ on rates (Reuters)
• Alberta Fire Set to Move From Oil-Sands Sites in Wind Shift (BBG)
• Canada hopes cooler weather aids battle with Alberta wildfire (Reuters)
• Noble Group Slumps Most Since ’11 After Fitch Debt Ratings Move (BBG)
• Bill Gross, Mohamed El-Erian Warn Against Counting the Fed Out (BBG)
• Euro zone finance ministers to start talks on Greek debt reprofiling: EU officials (Reuters)
• Greek lawmakers pass painful reforms to attain fiscal targets (Reuters)
• Greek reforms must be reviewed before any debt restructure: Germany (Reuters)
• Economic A-Team Down to Last Man as Erdogan Exerts His Power (BBG)
• Russia showcases Syria hardware in Red Square military parade (Reuters)
• For Rousseff-Hating Investors, a Bullish Trade Becomes Personal (BBG)
• Pentagon report reveals confusion among U.S. troops over Afghan mission (Reuters)
• Miami Faces Glut of Upscale Hotel Rooms as Brazilians Stay Home (BBG)
• Technicians from SWIFT left Bangladesh Bank exposed to hackers – police (Reuters)

 

Overnight Media Digest

WSJ

– Twitter Inc cut off U.S. intelligence agencies from access to a service that sifts through the entire output of its social-media postings, the latest example of tension between Silicon Valley and the federal government over terrorism and privacy. (http://on.wsj.com/1Yhf496)

– Hillary Clinton is consolidating her support among Wall Street donors and other businesses ahead of a general-election battle with Donald Trump, winning more campaign contributions from financial-services executives in the most recent fundraising period than all other candidates combined. (http://on.wsj.com/1Yhf8FF)

– A California judge is expected to rule Monday on whether to dismiss the lawsuit challenging media mogul Sumner Redstone’s mental competency after he signaled Friday that the petitioner faced an uphill climb. Both sides filed court briefs over the weekend to sway the judge to their side. (http://on.wsj.com/1YhffRE)

– Beijing Higher People’s Court ruled in favor of U.S. social media giant Facebook Inc in a trademark case against a Chinese beverage company that owned the trademark “face book.” (http://on.wsj.com/1YhfhsQ)

 

FT

* The UK’s Pensions Regulator started investigating BHS’s pension scheme stretching back to the time when Philip Green sold the struggling business for 1 pound ($1.44) last year.

* Environment and Food Secretary Liz Truss said British whisky benefited from trade deals brokered by the EU to open up export markets and leaving the EU will place one of the UK’s most successful exports in jeopardy.

* Barclays will partner with Bottomline Technologies to offer UK companies the ability to send payments instantly to customers using their mobile phone number.

* The amount of whistleblowers complaining about UK companies not complying with pension laws rose nearly a third last year.

 

NYT

– The behind-the-scenes lobbying has become fashionable in Washington as the battle over encryption shifts to Capitol Hill between police and tech giants. It is the next phase of a bitter divide that spilled into public view this year when Apple refused to comply with a court order to help bypass security functions on an encrypted iPhone. (http://nyti.ms/23ADwDC)

– William C. Dudley, the Federal Reserve Bank of New York president, who helped pilot the Fed’s post-crisis stimulus campaign, believes that the central bank is on the right track and sounded pretty calm about the nation’s current economic situation. (http://nyti.ms/1OjEoFV)

– For two decades, Saudi Arabia’s oil minister, Ali al-Naimi, was the architect of Saudi and OPEC cartel policies, including the one that has now sent the price of oil into a deep collapse. However, Naimi was unceremoniously ousted and replaced by Khalid al-Falih over the weekend. (http://nyti.ms/1O9TQcS)

– Manuela Herzer, a former lover of the ailing media mogul Sumner M. Redstone, who is waging a legal battle over his mental competency, made a last-ditch attempt over the weekend to keep her salacious lawsuit alive.(http://nyti.ms/23ABMu5)

 

Canada

THE GLOBE AND MAIL

** Alberta’s oil sands have been spared a direct hit from the devastating wildfire that forced the shutdown of more than 1 million barrels per day of production, but it remains unclear when companies can restart operations. (http://bit.ly/1T6yAXJ)

** Toronto-based insurer Manulife Financial Corp is doing away with drawing blood, testing urine and collecting other biometric data for term life insurance policies of up to C$1 million ($774,233) purchased by new customers from ages 18 to 40. (http://bit.ly/1T6yG1q)

** The Canadian tourism industry is grappling with a demographic problem that could threaten its future: Millennials are spending far more of their travel dollars outside the country than at home. (http://bit.ly/1T6yKhE)

NATIONAL POST

** A legislative fix that appears to have been effective in reducing marriage fraud is about to be repealed for political and ideological reasons. (http://bit.ly/1T6zumU)

** Alberta Premier Rachel Notley said the massive Fort McMurray wildfire that forced 80,000 people to evacuate last week had stabilized to the point that she’s able to visit the devastated oilpatch city. (http://bit.ly/1T6zxPD)

 

Britain

The Times

Brexit will raise risk of world war, PM claims

David Cameron will today raise the spectre of war if Britain votes to exit the European Union as he asks whether leaving is a risk worth taking. (bit.ly/1Ojpxez)

Carmakers ‘will quit UK’ if steel crisis drags on

Nick Reilly, one of the British motor industry’s most senior executives, has warned that volume carmaking will disappear from the country if the steelmaking crisis is not resolved. (bit.ly/1O9scfY)

The Guardian

Offshore finance: more than $12tln siphoned out of emerging countries

More than $12 trillion (8 trillion pounds) has been siphoned out of Russia, China and other emerging economies into the secretive world of offshore finance, new research has revealed, as David Cameron prepares to host world leaders for an anti-corruption summit.(bit.ly/1Wj8VvG)

ADVERTISING

inRead invented by Teads
Blacklisted workers win 10m pounds payout from construction firms

About 10 million pounds will be paid in compensation to more than 250 building workers who were “blacklisted” by some of Britain’s biggest construction firms under a settlement to be announced on Monday.(bit.ly/23AcUmh)

The Telegraph

Saudi Aramco plans London listing but doubts grow on $2.5 trillion claim

Saudi Arabia is planning a three-way foreign listing in London, Hong Kong, and New York for the record-smashing privatisation of its $2.5 trillion oil giant Aramco, anchored on a triad of interlocking ties with three foreign energy companies. (bit.ly/1NnH0rr)

Downing Street accused of ‘manipulating’ spy chiefs after they warn against Brexit

David Cameron has been accused of “manipulating” the former head of MI5 into warning that Britain’s national security would be put at risk by a Brexit. (bit.ly/24ECNav)

Sky News

Referendum Rivals Clash Over Single Market

Brexit campaigner Michael Gove has said the UK would be better off outside the single market, with the Chancellor hitting back and calling the prospect “catastrophic” for jobs and incomes.(bit.ly/1Txwjix)

Top pensions lawyer to aid MPs’ BHS probe

A leading pensions lawyer is being drafted in to assist a parliamentary probe into the collapse of BHS, the high street retailer, amid a furious row about the stewardship of its 20,000-member retirement schemes.(bit.ly/1VPEIUr)

The Independent

David Cameron to invoke war dead as he makes case for EU as guardian of peace

Pulling out of the European Union would usher in an era of British isolationism that would be a betrayal of our history and against our fundamental future national interest, David Cameron is to warn. (ind.pn/1WhLmmy)

TTIP trade deal under threat after Germany claims US not making ‘any serious concessions’

The controversial Transatlantic Trade and Investment Partnership (TTIP) has been thrown into further doubt after a senior German minister claimed the United States was not willing to make “any serious concessions”. (ind.pn/1WTVlxh)

 

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Two weeks after Austria’s dramatic result in its first round presidential elections which saw the right wing, anti-immigrant Freedom Party sweeping its competition, gathering over 35% of the vote and leaving the other five candidates far behind, moments ago Austria unveiled the latest casualty from Europe’s anti-refugee, right wing revulsion when the country’s Chancellor Werner Faymann resigned after losing the support of his colleagues in the Social Democratic party.

“I am thankful for seven and a half years and wish my successor much luck,” he said at a hastily arranged press conference, the oe24.at news site reported. “I am standing down because I no longer have support in the party.”

As the Guardian notes, Austria has been braced for political turmoil ever since rightwing populist Norbert Hofer won a landslide victory in the first round of the country’s presidential elections last month.

Hofer, of the rightwing Freedom party, defied pollsters’ predictions to beat the Green party’s Alexander Van der Bellen into second place, gaining 36% of the vote. The two candidates will go head to head in a run-off ballot on 22 May.

Faymann faced calls to resign after the vote, saying at the time that the result was a “clear signal to the government that we have to cooperate more strongly”.

Many commentators say the crisis of the political establishment in Austria has much to do with the fact that the two centrist parties have governed the country in a “grand coalition” for the past 10 years.

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The overnight session has been one of alternative weakness and strength: it started in China where stocks tumbled 2.8% to a two month low following an unexpected warning in the official People’s Daily mouthpiece that debt and NPLs are too high, not to expect more easing will come, and that the Chinese Economy’s performance won’t be U- or V-shaped but L-shaped.

 

This took place after another month of disappointing, sharply weaker trade data as fears about China’s slowdown returned. An expected freefall in key commodity prices led by a crash in the iron ore complex did not help Chinese sentiment, as China’s latest commodity bubble has by now clearly burst.

Concerns about China, however, were promptly forgotten and certainly not enough to keep global assets lower, with European stocks gapping higher at the open and rallying from a one-month low, shaking off the Chinese trade data drag that pushed Shanghai shares lower along with industrial metals, driven by a “surprising” surge in the USDJPY which has moved nearly 200 pips higher since its post-payrolls low. Another driver is the jump in oil, which rallied just shy of $46 a barrel, buoyed by Canadian wildfires that are curbing production and speculation that the Saudi Arabian oil minister succession will be bullish for oil prices.

Certainly helping Europe rebound was the latest Goldman trade recommendation which came out about an hour ago, and was as follows:

• GOLDMAN SACHS CUTS STOXX 600 12-MONTH TARGET TO 345 FROM 380
• GOLDMAN SACHS CUTS EURO STOXX 50 12-MOS. TARGET TO 3070 VS 3500

As is common knowledge always do the opposite of what Goldman recommends and at last check, the Stoxx Europe 600 Index advanced 1.4% with health care and technology companies leading the gains. Apart from mining companies, all of the 19 industry groups on the Stoxx Europe 600 Index advanced. Copper fell to its lowest in almost a month after imports into China slipped from a record, while iron ore tumbled following an increase in stockpiles at Chinese ports. Oil climbed as high as $45.94 a barrel in New York and gold retreated as a gauge of dollar strength rose for a fifth day.

S&P 500 futures added 0.3 percent, after U.S. stocks Friday halted a three-day decline amid investor speculation that the payrolls data will encourage the Federal Reserve to raise interest rates gradually. Traders are pricing in little chance of higher borrowing costs next month, with December the first month with more than even odds of a hike.

Putting the global rebound in perspective, consider that Chinese trade figures released over the weekend showed exports fell in dollar terms in April and imports dropped for the 18th month in a row, while U.S. jobs figures on Friday were weaker than economists forecast, several Federal Reserve officials have said over the past week that U.S. interest rates are headed higher, comments that have given a boost to the greenback; this happens as earnings season is set to conclude the worst quarterly report in decades.

In other words, lots of central bank multiple expansion, and lots of buybacks are taking place behind the scenes.

Euro-area finance ministers and International Monetary Fund officials are meeting Monday to decide whether Greece’s government has done enough belt-tightening to gain another aid disbursement. Germany reported a bigger increase in March factory orders than economists forecast, while companies including Enel SpA and Tyson Foods Inc. are scheduled to announce earnings.

Global Markets Snapshot

• Stoxx 600 up 1.4% to 336.3
• Eurostoxx 50 +1.6%,
• FTSE 100 +0.8%, CAC 40 +1.4%,
• DAX +1.9%, IBEX +1.5%
• FTSEMIB -0.1%
• SMI +1.3%
• S&P 500 futures up 0.3% at 2058
• Brent Futures up 1.5% to $46.1/bbl
• Vstoxx Index down -2.1% at 24.6
• MSCI Asia Pacific down 0.2%
• Nikkei 225 up 0.7% to 16216
• Hang Seng up 0.2% to 20156.8
• Kospi down 0.5% to 1967.8
• Shanghai Composite down 2.8% to 2832.1
• Euro down 0.09% to $1.1394
• Dollar Index up 0.07% to 93.96
• German 10Yr yield up 2bps to 0.16%
• Italian 10Yr yield down 1bps to 1.49%
• Spanish 10Yr yield down 1bps to 1.59%

Top Global News

• Brexit Battle Rages in Week of Bigwig Barrage on U.K. Risks: Carney, Lagarde, Osborne due to speak as decision day nears
• Cameron Evokes War, Churchill Memory in Bid to Avoid Brexit: Britain has ‘fundamental national interest’ in EU, Cameron says
• Bill Gross, Mohamed El-Erian Warn Against Counting the Fed Out: Gross says Fed rate increase may come in June as wages rise
• Bloomberg Editorial: The IMF Is Right About Greece’s Need for Debt Relief: any plan to resolve its financial crisis has to involve debt relief
• Filipinos Vote as Populist Mayor Rides Wave of Discontent: Duterte leads main rivals by 11 points in final opinion polls
• World’s Most Expensive Rough Diamond Sells for $63m: 813- carat diamond recovered by Lucara in Botswana last year
• Twitter Cuts Off U.S. Spy Agencies From Analytics, WSJ Reports: move comes after Apple battled with Justice Department

Looking at regional markets, Asia stocks started the week mostly lower following Friday’s NFP miss coupled with weak Chinese trade data in which exports and imports printed below estimates. ASX 200 (-0.4%) was pressured with sentiment soured by a decline in imports from its largest trading partner, although advances in oil amid uncertainty after Saudi replaced oil minister Al-Naimi helped stem losses. Nikkei 225 (+0.7%) outperformed after a 6-day losing streak as JPY weakness boosted exporter names, while the Shanghai Comp (-2.8%) led the region lower amid weak trade data and the PBoC decreasing its liquidity injection. 10yr JGBs traded lower amid increased appetite for riskier assets in Japan, while mild support was seen early in the long-end as the 20yr yield declined to fresh record lows, with the BoJ also in the market to purchase around JPY 1.2trl of government debt.

Asian Top News

• Takata Projects Second Annual Loss on Air-Bag Recall Charges: Company forecasts 13 billion yen loss; had estimated profit
• Soros Chart Signals BOJ Bond Buying Already Enough to Weaken Yen: Japan monetary base rises to 96% that of U.S. in dollar terms
• Japan Finance Minister Fires Another Verbal Salvo at Strong Yen: Aso says Japan has means to intervene
• Chinese Imports From Hong Kong Raise Red Flag Amid Yuan Worries: Import surge from Hong Kong may show capital exit, OCBC says
• Goldman Fund Manager Bearish on Aussie as Dollar Bets Falter: Fund bearish Aussie against kiwi, loonie after RBA rate cut
• Rajan Stimulus Working as Rare Issuers Revive Rupee Bond Market: Issuance in May has second-best start for month in 11 years
• Mitsubishi Heavy Surges After Profit Outlook Beats Estimates: Forecasts 13% increase in op. profit this fiscal year to 350b yen, exceeding est. of 334b yen
• Commonwealth Bank Profit Gains 4.5%, Bad-Debt Charges Rise: Provisions for impaired loans up 67% on corporate defaults

In Europe, equities trade firmly in the green this morning (Euro stoxx: +1.5%), opening higher and going on to close the opening gap throughout the session as higher oil prices fuel risk appetite with gains exacerbated by the upside in IT names. The notable movers this morning come from the materials sector, with the likes of Anglo American, ArcelorMittal, Glencore and Rio Tinto all among the worst performers in Europe after the soft trade balance data from China. Fixed income markets have seen similar price action to equities so far this morning, opening lower before going on to grind higher over the following 2 hours. Of note, EUR denominated corporate bond sales may pick up this week with some noting that a total of EUR 15bIn worth of debt could be sold, as companies look to take advantage of low interest rates after publishing their quarterly earnings as well as the prospect of ECB buying IG bonds in June as part of its QE program. Furthermore, it was also reported earlier in the session that Italy are exploring the sale of a 50yr bond.

European Top News

• Total to Buy French Battery Maker Saft in $1.1 Billion Deal: acquisition forms part of plan to expand clean-energy business
• Imagination Tech Climbs on Bid Speculation Spurred by Tsinghua: Chinese state-backed technology co. Tsinghua Unigroup buys 3% stake in co.
• Investec Finances Four Emirates A380s in $1 Billion Jet Deal: bank says low oil price makes superjumbo more attractive
• Glencore Becomes Top Holder in Iron Ore Miner After Debt Revamp: has also secured marketing offtake rights
• Ikea in Talks to Take Over Some BHS Stores, Times Reports: Swedish retailer registered interest with BHS’s administrators
• Italy Favors Erdemir-Led Group for Ilva vs Mittal: Repubblica: group seen as able to counter possible bid by Arcelor Mittal
• Korian Plans to Buy Foyer de Lork; Deal EPS Accretive This Year: deal to be financed with cash from Korian, available credit lines
• G4S 1Q Continuing Businesses Rev Rises 4.5% to GBP1.51b: comments ahead of CEO Ashley Almanza presentation at JP Morgan conf.
• Abengoa Assets Have EU1b Less Value Than Estimate: Confidencial: reports citing sources it doesn’t identify
• Adidas May Be Only Bidder for German Soccer Team Sponsoring: FAZ: cites unidentified people close to the negotiations

In FX, the Bloomberg Dollar Spot Index, which tracks the greenback against 10 major peers, rose 0.1 percent following its biggest weekly jump since November. The greenback’s reaction to weaker-than-expected U.S. jobs figures on Friday was muted by comments from Fed Bank of New York President William Dudley, who said in a New York Times interview that it remained a “reasonable expectation” the central bank would raise interest rates two times this year.

Aside from the one way surge in the USDJPY, moves across key pairs have been relatively quiet, though some early volatility seen in GBP, but losses since recouped with Cable back in the mid 1.4400’s. This may signal some moderation in the USD reversal we are seeing at the moment, with the greenback fighting back hard after the headline miss in US jobs on Friday. EUR/USD is proving resilient under 1.1400, as is USD/JPY ahead of 108.00, but direction hard to read as yet — as is usually the case on the Monday after US payrolls. CAD should perhaps be a little stronger with Oil moving higher again, but the USD perspective is strong, and specs are quick to pounce on any dip at present. USD/CAD still trading on a 1.2900 handle, but strong resistance seen ahead of 1.3000. AUD/USD through key support under .7400, but downside momentum lacking on stable stocks. EU Sentix investor confidence slightly better than expected this morning, while UK Halifax HPI showing some softening, but both to little effect on the markets.

In commodities, iron ore plummeted in Asia after port stockpiles in China expanded to the highest in more than a year, following moves by local authorities to quell speculation in raw-material futures. The SGX AsiaClear contract for June settlement tumbled 7.9 percent to $51.17 a metric ton, the lowest in a month, retreating alongside contracts for steel and coking coal.

Copper fell with industrial metals, extending its worst weekly slide since November, after China slashed purchases from a record high. The metal fell 1.7 percent to $4,728 a metric ton, having touched the lowest in almost a month. Nickel lost 2.7 percent and zinc dropped 1.5 percent. Gold fell 0.8 percent to $1,278.56 an ounce, declining for the fifth time in six days as the dollar strengthened. Silver dropped 0.4 percent and platinum slid 1.1 percent.

Crude rose as expanding Canadian fires knocked out about 1 million barrels a day of production, outweighing the new Saudi Arabian oil minister’s pledge to maintain the country’s policy of near-record output. China’s crude imports rose 7.6% Y/Y last month, marking the third straight month that crude imports surpassed 30 million tons. Day by day, China shipped in 7.9 min/bpd in April. In the first four months of the year, China imported 123.67 min tons of crude, which is equivalent to a 12% on-year rise. Saudi Arabia on Saturday replaced its long-serving oil minister Ali al-Naimi, who had held the post since 1995, with Khalid al-Falih, chairman of the state oil Co., Saudi Aramco as his replacement. In separate reports, Saudi’s new oil minister Khalid al-Falih stated that hat he will maintain Saudi’s stable oil policy. 

Bulletin Headline Summary from RanSquawk and Bloomberg

• Light newsflow thus far with European equities trading firmly in the green with higher oil prices helping fuel risk appetite.
• Saudi Arabia have replaced their long-serving oil minister Ali al-Naimi with Khalid al-Falih, chairman of the state oil Co., Saudi Aramco named as his replacement.
• Highlights today include US Labour Market Condition alongside Fed’s Kashkari.
• Treasuries little changed in overnight trading as global equities and oil rally, precious metals sell off; this week will see $62b in U.S. Treasury auctions.
• China’s problem with fake trade invoices appears to be getting worse. Imports from Hong Kong surged a record 204% last month, data on Sunday showed, intensifying the spotlight on a channel used to get capital out of the country
• The yuan fell the most in two weeks amid speculation depreciation concerns are prompting investors to shift money overseas and as the dollar headed for its biggest five-day gain since November
• China’s stocks capped their biggest two-day loss since late February, led by commodity producers and industrial companies, as trade data disappointed and the People’s Daily warned about the country’s rising debt in a front-page article
• For all the Communist Party’s rhetoric about giving a decisive role to markets, China’s financial system remains dominated by state-owned lenders. The PBOC has also been expanding support for “policy banks” that support government objectives
• Euro-area finance ministers will debate possible debt-relief measures for Greece Monday, after IMF Managing Director Christine Lagarde warned them that the fiscal targets envisaged in the country’s latest bailout agreement are not realistic
• Voters tuning into the fraught battle over the U.K.’s future will hear from heavy-hitters who have already warned about the risks of leaving the single market
• U.K. house prices fell 0.8% in April after a surge of rental investors rushing to beat a tax change bolstered the market earlier in the year, according to Halifax
• German factory orders advanced 1.9% in March from the prior month as strong global trade helped offset a lull in domestic demand, data from the Economy Ministry in Berlin showed
• U.S. economic fundamentals are “good” and “wait and see” stance for monetary policy is appropriate, said Chicago Fed Pres. Charles Evans, speaking on panel at International Financial Services Forum in London
• Three of the world’s most influential bond investors and the head of the Federal Reserve Bank of New York say the U.S. central bank is on course to raise interest rates even after an April jobs gain that was smaller than economists forecast
• Sovereign 10Y yields mixed, Greece rallies 25bp; European and Asian equity markets higher; U.S. equity- index futures rise. WTI crude oil rallies, precious metals drop

US Economic Calendar

• 10:00am: Labor Market Conditions Index, Apr. est. -1.0 (prior -2.1)
• TBA: Mortgage Delinquencies, 1Q (prior 4.77%)
• TBA: MBA Mortgage Foreclosures, 1Q (prior 1.77%)
• 11:30am: U.S. to sell $31b 3M, $26b 6M bills
• 1:00pm: Fed’s Kashkari speaks in Minneapolis

DB’s Jim Reid concludes the overnight wrap

It’s always a relatively quiet week after payrolls but the debate over Friday’s employment report will continue to rumble on with the 160k number below the 200k expected with the unemployment rate unchanged after hopes had been for a dip lower (5.0% vs. 4.9% expected). Those of a bullish persuasion might just conclude that this is reflecting an economy getting close to full employment and running out of workers. The bears might argue that full employment this cycle is less useful for the economy given the large amount of people who have left the work force. One concern we continue to have is that with corporate profits well off their late 2014 peaks, are the slightly softer recent employment numbers reflecting a corporate sector that is more reluctant to hire now with profits waning? As the chart we used in our 2016 outlook showed (repeated in last Thursday’s EMR), the last 11 recessions have started only after corporate profits peaked. The average time it took from peak profits to recession is 2 years. If profits have peaked then this is another of the supportive late cycle indicators we have and it will be interesting to see if employment slowly takes the brunt of reduced profitability over the next 12 months.

So as well as further digesting those employment numbers from Friday, there’s also been some important newsflow over the weekend to contend with. The first comes from the Oil market and specifically out of Saudi Arabia with the news that the Kingdom has appointed a new Oil minister. Khalid Al-Falih replaced Ali al-Naimi on Saturday following 20 years of service as part of a major reshuffle by King Salman. Much of the focus however is on what this means for Saudi production and output with the bulk of the commentary suggesting that we shouldn’t expect to see a huge change in policy. Ahead of the June OPEC meeting, Falih was reported as saying yesterday that Saudi Arabia would ‘remain committed to maintaining our role in international energy markets and strengthening our position as the world’s most reliable supplier of energy’. Indeed Bloomberg, the FT and the WSJ are all suggesting that the new appointment should result in some continuity in oil policy.

The other big story for energy markets are the tragic wildfires spreading through Canada currently. Over the weekend the fires which have raged through Alberta are now said to have spread to the oil-sands facilities north of Fort McMurray. The chatter is that roughly 1m barrels of production from the region could be impacted however the improving weather conditions overnight are helping to the slow the spread for now. A number of producers have declared a force majeure in the region while evacuations are taking place. This morning WTI opened nearly 3% on higher on the news and close to $46/bbl, but has settled slightly now and is currently +2% higher at around $45.50/bbl.

Meanwhile, the other news over the weekend concerns the latest economic data out of China. FX reserves were reported as rising unexpectedly last month by $6.4bn to $3.22tn (vs. $3.20tn expected), the second consecutive month that reserves have increased. The softer US Dollar last month and resulting impact on valuation adjustments looks to have been a big factor in that however. Also out over the weekend were the April China trade numbers. In US Dollar terms exports were reported as declining -1.8% yoy last month (vs. 0.0% expected) from +11.5% in March. That said, a sharper than expected fall in imports (-10.9% yoy vs. -4.0% expected; -7.6% previously) has resulted in the trade surplus increasing. In CNY terms exports were reported as increasing close to that expected by the market (+4.1% yoy vs. +4.3% expected).

lancing at our screens, bourses in China have opened this morning on the back of that data on a weak note. The Shanghai Comp and CSI 300 have tumbled -2.23% and -1.71% respectively, although it’s a bit of a mixed performance elsewhere in Asia. The Kospi (-0.67%) and ASX (-0.37%) are also lower, however the Nikkei (+0.54%) and Hang Seng (+0.61%) are off to reasonable starts. Base metals have weakened post the China data, although it’s a bit more mixed in currency markets.

Moving on. As you’ll see at the end in the week ahead, earnings season is winding down now with the vast majority of the big reports now behind us. With that, it’s a good time to recap how the quarter has gone so far. As it stands we’ve now had 437 of the S&P 500 companies report their latest quarterly numbers. Earnings beats are currently standing at 75%, which is roughly in line with recent quarters, while sales beats stand at 54% – a touch ahead of the recent trend. More importantly however, the bottom-up Q1 EPS of $27.01 is -5.3% yoy according to our US equity strategists, while bottom-up sales are currently -2.0% yoy. Significantly, if you strip out the impact of energy names, earnings are actually flat yoy while sales are +1.7% yoy. If you go further and strip out financials as well, then earnings are actually +3.4% yoy and sales +2.4% yoy. So the combined impact from those two sectors has been very material. Meanwhile, as we’ve noted previously this has been a massive quarter for downward revisions to earnings expectations. In fact, despite the Q1’16 EPS beat running at +2.4% versus a +3.2% average from Q1’11 to Q4’15, that EPS has been revised down by nearly 10% since the turn of the year which is the most since 2011 and compares to an average downward revision in that time of -3.9%.

Back to Friday and a quick recap of the rest of the data. Average hourly earnings for the US in April were reported as increasing +0.3% mom as expected last month. That’s had the effect however of lifting the YoY rate by two-tenths to +2.5%. The labour force participation rate declined two-tenths to 62.8% unexpectedly, while average weekly hours rose one-tenth as expected to 34.5hrs. The broader U-6 measure of unemployment edged down one-tenth to 9.7% and so matching the recent low in February. Markets reacted in a typical knee-jerk fashion with the US Dollar weakening, Treasury yields sharply lower and risk assets weaker. That said markets quickly went into reverse gear as investors digested the data. The USD index closed a smidgen higher (+0.12%) after being down as much as half a percent. 10y Treasury yields closed up over 3bps higher at 1.780% after touching as low as 1.703% in the immediate aftermath, while finally the S&P 500 ended up with a +0.32% gain after also being down as much as half a percent. Credit markets were little changed by the end of play however.

It was hard to determine what swung sentiment back the other way. Some pointed to comments from the Fed’s Dudley, arguably one the closest-followed Fed officials. Dudley said that the employment report was ‘a touch softer, maybe, than what people were expecting, but I wouldn’t put a lot of weight on it in terms of how it would affect my economic outlook’. Dudley went on to confirm and stick to the Fed’s script of still expecting two rate hikes this year. The futures market gave little weight to this however as we saw the June probability dip into single-digit territory at 8% (from 10% at Thursday’s close).

Away from the employment report and later on in the evening, the March consumer credit reading printed at $29.7bn (vs. $16.0bn expected). The revolving credit component which includes credit card spending was reported as increasing at the biggest annualized pace since July 2000. Elsewhere, in Europe the sole data release was out of Spain where industrial production was reported as increasing +1.2% mom in March and more than expected. We’ll get the rest of the IP reports for Europe this week. Price action had been relatively mixed to close the week in Europe on Friday. The Stoxx 600 closed -0.36% however the DAX (+0.18%) managed to jump back into positive territory by the end of play.

Away from the data there is more Fedspeak for us to digest this week. We’ll hear from both Evans and Kashkari today, Rosengren and George on Thursday and Williams on Friday. The ECB’s Constancio is also scheduled to speak this morning. Earnings season is beginning to wind down meanwhile. We’ve got just 20 S&P 500 companies due to release their quarterlies including Macy’s and Walt Disney. In Europe there are 90 Stoxx 600 companies due to report however including more of the Banks.

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With stocks the biggest beneficiary of the late January “Shanghai Accord” (that shall not be named), it stands to reason that the US Dollar was the biggest loser. Sure enough, overnight the WSJ writes that the “powerful rallies that have lifted stocks, crude oil and emerging markets for the past three months have one important thing in common – the falling dollar – and investors are growing anxious that it could prove to be the weak link.”

But is a strong dollar about to make another appearance and unleash the next leg lower in risk assets?

While the dollar is down 4.5% this year and near a one-year low against a basket of currencies, other investments have surged. U.S. crude prices are up 69% from their February lows. Gold was up 16.5% in the first quarter, its best in three decades. And emerging-market stocks, bonds and currencies have enjoyed double-digit gains in 2016.

Morgan Stanley analysts quantified the relationship, and found that the correlation between a weak dollar and their own index of investor appetite for riskier assets is near its highest level in 20 years. As the WSJ writes, “the concern is that it is a relationship that could easily go in the opposite direction.”

 The dollar is heavily dependent on perceptions of what the Federal Reserve will do with interest rates, and those perceptions could change quickly. Meanwhile, analysts warn that the fundamentals for oil, emerging-market assets and even many stocks look too weak to support the recent price gains on their own.

“Currency is the most influential factor for markets this year,” said Graham Secker, head of European equity strategy at Morgan Stanley. “If the dollar starts moving higher, global risk appetite will fall.”

But just when you think the dollar tide is about to turn, you get such ugly US macroeconomic update as Friday’s payrolls report, and suddenly it feels like the USD has much more room to fall (and, in tried and true centrally-planned fashion, the worse the data, the higher stocks could rally).

To be sure, conventional wisdom and positioning agrees with a “lower dollar for longer” thesis: hedge funds and other speculative investors are now more bearish on the dollar than at any other time since February 2013, according to CFTC data.

However, that bearish positioning also means any sign the Fed is turning more hawkish could send investors scampering to buy dollars, pushing the U.S. currency sharply higher.

 

“The market has become complacent,” said Steven Englander, head of G-10 FX strategy at Citigroup Inc. “There’s the risk…the Fed gives a sudden indication that really surprises the market.”

The biggest risk, of course, is that Goldman will remain bullish on the USD as it has for the past 5 months, leading to thousands of pips in P&L pain for Goldman FX clients.

But maybe not even Goldman flip-flopping will be necessary for the USD to make a U-turn. 

Here is another report, courtesy of Morgan Stanley’s Hans Redeker, head of global FX, who believes that another round strength for the USD is “inevitable.” Here’s why:

Inevitable USD Strength

 

The USD bull market has paused for now but diverging global output gaps keep us confident that USD will resume its bull trend later this year, with the Fed raising rates in December and China’s cyclical recovery losing momentum. Currencies work as the great equaliser within open capital account economies, bringing diverging output gaps back into line. Here the work a higher USD needs to achieve is not yet complete. This week we marked-to-market our USD forecast, delaying the next appreciation phase.

 

Global imbalances have stayed strong but these imbalances are no longer expressed by current account differences and worries concerning foreign funding needs. Instead, current account differentials have developed into output gap differentials. Concretely, Asia’s current account surpluses have converged into supply, which within a world of demand deficiency has created overcapacity and falling investment returns.

 

Theoretically, there are three possible outcomes to deal with overcapacity. Austrian School-like destruction, increasing exports and finally providing debt-funded domestic demand. Creative destruction, once the backbone of a functioning capitalist system, is no longer seriously considered as the social costs of this approach appear unacceptably high. What remains are adjustments via exports and increasing local demand against ever-rising balance sheets.

 

Last autumn, China’s stakeholding economic model had opted for a debt-funded domestic demand push and increasing exports funded by falling export profit margins and the lower RMB. On a trade-weighted basis, CNY has fallen 4.6% since November and declining investment efficiency has undermined corporate profits. Debt continues to increase, reaching 260% of GDP, which is high for a middle income economy. Work from Reinhart and Rogoff further deepened by the BIS describes how debt reduces the credit multiplier and the potential of economies to grow.

 

These findings are important for FX investors. It has been China’s currently strong, but debt-funded, cyclical rebound in conjunction with the Fed broadening its reaction function pushing USD well off its January peak. USD measured by the Fed’s broad USD index has lost 6.4% since then and may fall further in the near term as investors monetise the EM risk premium. The Fed’s broadened reaction function, emphasising often globally determined financial conditions, has internationalised the Fed’s global reach, supporting EM investor confidence.

 

Importantly, China’s credit-fuelled demand push has propelled commodity prices and has converged global inflation rates somewhat, which has been a plus for the EM and commodity FX bloc. With an equivalent of US$9.9 trillion of DM sovereign bonds negatively yielding, demand for positively returning carry products is high. The ECB and the BoJ are seeing limitations within their remaining monetary toolboxes pushing their currencies lower, which has been an additional factor reducing USD demand.

 

Going forward, FX markets will have to deal with two questions in determining how long USD can stay offered. First, for how long will the Fed’s more international approach stay in place, and second, for how long will China’s economy surprise positively? At first glance, it appears as if the two questions are independent from each other. However, global output gap divergence results in diverging global inflation rates, suggesting central banks diverging and not converging policies. The Fed may increase rates only slowly, but other monetary authorities dealing with the deflationary characteristics of overcapacity and debt overhangs may have to deploy easier policies.

 

Tackling overcapacity via an autonomous increase in debt-funded demand may work within environments of low debt, but within high debt environments with implicitly low credit multipliers this approach only buys time. Time bought allows USD to correct lower, assets to rally and the global economy to look better. Once markets learn that diverging output gaps and hence global imbalances have not gone away, we believe that USD will rally once again. Indeed, the recent USD decline has not set the starting point of a long-term decline. Instead, we view it as a correction within a secular USD bull trend.

Who knows, maybe just once Goldman and its “strong USD” trade will, after being wrong for over 6 months, finally be right.

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