Month: September 2016

Via Dana Lyons' Tumblr,

Key indices across the U.S. equity market are testing their uptrend lines stemming from the February lows.

It’s only fitting that today’s Chart Of The Day includes a trendline considering our regular “Trendline Wednesday” feature on Twitter and Stocktwits (follow us on both platforms: @JLyonsFundMgmt). Granted, it’s not the most profound trendline we’ve ever monitored. However, it very well may be quite significant on an intermediate-term duration. Furthermore, as the subheading indicates, there are many other segments of the market presently being impacted by trendline dynamics similar to those illustrated in the example here.

So what are we looking at? The index is the broad NYSE Composite and the trendline is the uptrend defining the post-February rally. Specifically, the trendline originates at the February lows in the NYSE and connects the June Brexit lows as well as the early September lows. Why is this line so important? First of all, because it traces out the precise lower bound of the NYSE’s post-February rally. Secondly, the NYSE is presently testing the top of this line.

 

So is this line going to hold? In a vacuum, the assumption is always that a trendline should hold – until it doesn’t. Therefore, in this instance, the recent price weakness should be contained at these levels. Thus, if one is looking to “buy the dip”, this seems a reasonable spot to do so.

That said, price does not operate in a vacuum. There are many factors at work in determining the direction of a market. And while the price of one index, in and of itself, is the final arbiter of direction, price is not really a forecasting tool. So, while price can tell us where a security is, it doesn’t reliably tell us where where the security is going. On the other hand, there are other market inputs that can provide us with clues about the future direction of prices.

For us, chief among these “other inputs” is our proprietary Risk Model. This Model, which we’ve been utilizing for nearly 4 decades, is primarily an amalgamation of market breadth, momentum and money flows and is designed to instruct us as to the direction of the overall, broad stock market. The Model is significant on an intermediate-term duration (i.e., 6 weeks to 6 months), aimed at exploiting those substantial moves that can occur within that time frame. Often times, especially at major tops, this Risk Model will turn Negative prior to the prices of the major averages turning south. The Risk Model has recently turned Negative.

There are other factors that have us questioning the likelihood of the NYSE holding its uptrend line, including sentiment, seasonality and the fact that prices have now tested the trendline twice within a few weeks. That frequency is a change in character and suggests caution in assuming the trendline holds.

Now, is it the end of the world if this line gets broken? Not really, but it may be the end of the post-February intermediate-term rally in stocks. Or, at a minimum, it may signal the end of the post-Brexit phase of the rally. Considering the way the NYSE has closely adhered to the trendline, prices certainly seem to “respect” the line. Thus, in the short-term, upon a hypothetical break of the trendline, a quick acceleration to the downside would seem to be a reasonable risk.

Again, a break of this trendline doesn’t necessarily mean the larger trend has turned down. It may just mean a shallower trajectory once the rally resumes. But it certainly opens the market up to not insignificant short-term risk. And on an intermediate-term basis, it would be one of the first chinks in the armor of the impressive post-February rally.

*  *  *

More from Dana Lyons, JLFMI and My401kPro.

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An often-perceived analysis in the gold community is that gold is the constant in our global economy. But is this true? Yes and no. Allow me to share my observations. Although gold has an exceptionally constant nature, and we have yet to see another currency that can compete with gold’s constant nature, the reality is, that there is no exact constant in economics. In any market all goods, assets, currencies, etc. continuously fluctuate in value relative to each other due to ever changing supply and demand dynamics. Having said that, in this post we’ll examine gold’s constant nature by measuring its purchasing power in the short (weeks) medium (years) and long term (decades). Additionally, we’ll compare our findings to fiat’s nature.

We will find that when gold is officially recognized as the center of a monetary system – throughout history there have been several forms of gold standards – gold is approximately constant in the short, medium and long term. Since the gold standard has been abandoned, the metal has become less constant in the short and medium term, but has remained impressively constant in the long term. 

In turn, fiat can have periods of being constant in the short term, but will always loose value in the medium term and evaporate in the long term. Thereby, due to fiat’s fragile nature and the current stress in global finance, there are also risks fiat can significantly devalue overnight. Hence, gold is highly suitable to secure one’s purchasing power.

When examining the value of gold we have to measure it in terms of goods and services. In this day and age one might forget the end goal of any participant in the economy is goods and services. All else traded in our vast financial system is merely a means to an end. All sorts of money, but also stocks, bonds, credit default swaps, options, futures, etc., have no use-value for humans as we can’t eat, drink or wear them. Only goods and services we can truly use (for more information regarding use-value please read my post The Concept Of Money.) Therefor, to measure the stability of gold’s value we have to compute the amount of goods and services gold can buy.

For the sake of simplicity, we’ll use publicly available Consumer Price Index (CPI) and Wholesale Price Index (WPI) data to measure the value of goods and services.

Gold’s Purchasing Power In The Short And Medium Term

On occasion we can read gold commentators stating that when the price of gold rises or falls in the short term, it’s actually fiat that is falling or rising. As, according to this analysis gold is the constant. Let’s test if this analysis is accurate. In the week from January 4 until January 9, 2016, the price of gold in British pounds surged 5.9 % from £23,096 pound per Kg to £24,469 per Kg. We can be quite sure that the price of goods and services in the UK remained flat during this period. As a consequence, in this example gold could buy 5.9 % more goods and services at the end of the week, whilst sterling could buy exactly the same amount of goods and services all week long. So, in this particular example, what was more constant? It was sterling. The reason is that currently the international monetary standard is fiat.

Graph created with BullionStar Charts.

Moving on to the medium term. In the chart below I’ve plotted the purchasing power index of gold versus the British pound, based on CPI data and the gold price, from July 2010 until June 2016.

Over this period we can observe that the British pound was more constant than gold in the short term, but it’s purchasing power has been declining in the medium term due to the inherent inflationary policies by the central bank of the UK. Gold’s purchasing power has been volatile in the short and medium term, but in this case has remained its purchasing power over the shown period. Though, it should be clear that if I would’ve adjusted the period gold’s purchasing power could’ve shown an increase or decrease.

Gold’s Purchasing Power in the Long Term

To get the best understanding of his subject, let us zoom out and have a look at gold and the pound’s purchasing power since 1500. The following chart is conceived by Nick Laird from GCRU, based on data collected by himself and Roy Jastram. The chart is perhaps more difficult to interpret than the previous one. To be clear, we can see 3 index lines:

• The red line reflects gold’s purchasing power index (1930 = 100)
• The blue line reflects the price of gold index, denominated in British pounds (1930 =100). Note, until 1914 the blue line was mostly straight which shows fixed parities between sterling and gold.
• The green line reflects the wholesale (/goods) price index, denominated in British pounds (1930 = 100)

As you can see, if the price of gold (blue) transcends wholesale prices (green), as a consequence gold’s purchasing power (red) is escalated – and vice versa.

Courtesy Nick Laird, from GCRU. Note the scale is logarithmic.

Clearly the red line has remained roughly flat, around 100, for hundreds of years! This shows gold’s remarkable constant nature. Note, since the gold standard has been gradually dismantled (1914) gold's purchasing power became more volatile but remained robust in the long term.

Furthermore, we can see that prior to 1914 wholesale prices were also fairly constant but this is due to the fact sterling was tied to gold during this era. Since the gold standard was abandoned step-by-step from 1914 onwards, the blue and the green line have skyrocketed, evaporating the purchasing power of sterling. Since 1971 the British pound has lost over 93 % of its purchasing power – in 1975 inflation topped 20 %.

We can conclude, while there is no exact constant in economics, the stability of gold’s purchasing power is unprecedented. Not only on a gold standard the metal shows it’s constant nature, but also off the gold standard gold’s purchasing power is remarkably constant, albeit more volatile in the short term.

For the future, if the current fiat international monetary system will breach its limits and has to be re-anchored to gold, I expect gold to become more constant in both the short and medium term when providing a center pillar in finance.

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The potential collapse of Deutsche Bank and the systemic risk it poses to banks and the European financial and monetary system moved into the German political sphere yesterday. The German government denied it was preparing a rescue of the embattled bank and the Bundestag attempted to ask questions of ECB President Mario Draghi about the causes of the “systemic risks” posed by the bank.

Ralph Orlowski | Reuters
ECB President Mario Draghi refused to answer questions in German parliament

The ECB president brazenly “refused to answer questions” regarding Deutsche Bank during a closed-door meeting in the German parliament. Afterwords in conversation with journalists, he denied that the negative interest rates being imposed by the ECB are partly responsible for Deutsche Bank and the German financial system’s troubles.

However, many analysts rightly assert that zero interest rate policies (ZIRP) and now negative interest rate policies (NIRP) are a factor and partly contributing to the challenges facing banks in much of the western world. Not to mention causing bubbles in many property markets and indeed in stock and bond markets.

Source FT

“If a bank represents a systemic threat it cannot be because of low interest rates. It has to be for other reasons,” Mr Draghi asserted to reporters somewhat dogmatically and simplistically. He was contradicted by the head of Germany’s BdB banking association, Michael Kemmer, who told Deutschlandfunk radio that the ECB’s low interest rate policy was partly responsible for the current problems that Deutsche Bank and Commerzbank are facing.

This morning, Commerzbank, the second-biggest bank in Germany after Deutsche, suspended its dividend and revealed it is slashing more than 9,000 job losses as it too desperately tries to shore up its business in the face of ultra-low interest rates and increasing loan losses.

Anxiety over eurozone banks has risen since the market turmoil following the June UK vote to leave the EU. Until recently, however, concerns have focused on the bloc’s periphery, particularly banks in Italy.

Now the banking crisis is moving to the core. This poses the real risk of financial contagion in the European monetary system and the global banking system.

See “Euro Might Start To Unravel” If Collapse Of Deutsche Bank

Gold and Silver Bullion – News and Commentary

Gold extends losses as dollar, stocks rise (Reuters)

Gold prices mostly steady in Asia as rates, politics and OPEC mix (Investing)

WTO cuts 2016 world trade growth forecast to 1.7 percent, cites wake-up call (Reuters)

City-by-city look as house price gains slow (MarketWatch)

IMF sounds alarm bells over trade slowdown and low inflation (Telegraph)

What the return of politics means for your money (MoneyWeek)

Dollar Going the Way of the Denarius (InternationalMan)

Transition of Price Discovery in the Global Gold and Silver Market (SafeHaven)

Will Deutsche Bank’s Collapse Be Worse Than Lehman Brothers? (GoldEagle)

Deutsche Bank To Blow Up and Create Euro “Chaos”? (DollarCollapse)

Gold Prices (LBMA AM)

29 Sep: USD 1,320.85, GBP 1,016.92 & EUR 1,177.14 per ounce
28 Sep: USD 1,324.80, GBP 1,020.10 & EUR 1,181.06 per ounce
27 Sep: USD 1,335.85, GBP 1,031.01 & EUR 1,187.84 per ounce
26 Sep: USD 1,336.30, GBP 1,033.23 & EUR 1,188.91 per ounce
23 Sep: USD 1,335.90, GBP 1,027.17 & EUR 1,192.16 per ounce
22 Sep: USD 1,332.45, GBP 1,019.59 & EUR 1,186.68 per ounce
21 Sep: USD 1,319.60, GBP 1,015.96 & EUR 1,183.81 per ounce

Silver Prices (LBMA)

29 Sep: USD 19.01, GBP 14.61 & EUR 16.95 per ounce
28 Sep: USD 19.12, GBP 14.69 & EUR 17.05 per ounce
27 Sep: USD 19.42, GBP 14.99 & EUR 17.26 per ounce
26 Sep: USD 19.44, GBP 15.04 & EUR 17.29 per ounce
23 Sep: USD 19.82, GBP 15.28 & EUR 17.66 per ounce
22 Sep: USD 19.88, GBP 15.22 & EUR 17.69 per ounce
21 Sep: USD 19.43, GBP 14.95 & EUR 17.43 per ounce

Recent Market Updates

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India conducted “surgical strikes” on suspected terrorist camps just across the border in Pakistan, marking its first direct military response to an attack on an army base it blames on Pakistan. The military offensive was the worst since 1999, when then-Prime Minister Atal Bihari Vajpayee – also a member of Modi’s nationalist Bharatiya Janata Party – responded to what he said was repeated cross-border infiltrations by militants in Kashmir.

At the same time, Pakistan said two of its soldiers had been killed in exchanges of fire and in repulsing an Indian “raid”, but denied that India had made any targeted strikes across the de facto frontier that runs through the disputed Himalayan territory of Kashmir.

The region is held equally by India and Pakistan but claimed in full by both. Terrorist violence killed 201 people in Kashmir in 2016, the deadliest year since 2010, according to the South Asia Terrorism Portal.

India’s announcement of the targeted strikes on terror camps in Pakistan is “very significant,” said Shashank Joshi, a fellow at the Royal United Services Institute in London. “India has conducted covert, retaliatory cross-border raids on many occasions in the 1990s and 2000s, but to prominently announce them is a provocative new approach,” he said in an e-mail. “Depending on how far the Indians penetrated and the nature of the targets, these might also represent much more ambitious operations.”

Domestic pressure had been building on Modi to take a tough stand over rising violence in the disputed region of Kashmir, Bloomberg reports, including through non-military measures such as reviewing a 1960 water-sharing treaty.

According to Reuters, the cross-border action inflicted significant casualties, the Indian army’s head of operations told reporters in New Delhi, while a senior government official said Indian soldiers had crossed the border to target militant camps. The Indian announcement followed through on Prime Minister Narendra Modi’s warning that those Delhi held responsible “would not go unpunished” for a Sept. 18 attack on an Indian army base at Uri, near the Line of Control, that killed 18 soldiers.

The strikes also raised the possibility of a military escalation between nuclear-armed India and Pakistan that would wreck a 2003 Kashmir ceasefire. Lt General Ranbir Singh, the Indian army’s director general of military operations (DGMO), said the strikes were launched on Wednesday based on “very specific and credible information that some terrorist units had positioned themselves … with an aim to carry out infiltration and terrorist strikes”. In other words, rather similar to what US-coalition forces do in Syria when they claim to attack ISIS when instead they kill members of the Syrian army.

Singh said he had called his Pakistani counterpart to inform him of the operation.

#IndianArmy conducted surgical strikes y’day, to foil infiltration attempts; resulting in significant casualties to terrorists: DGMO @adgpi http://pic.twitter.com/mkv6FmdhMY

— PIB India (@PIB_India) September 29, 2016

However, Pakistan’s military spokesman slammed the Indian account as “totally baseless and completely a lie”, calling the claim of surgical strikes an “illusion” and saying the contact between DGMOs only included communication regarding cross-border firing, which was within existing rules of engagement.

“We deny it. There is no such thing on the ground. There is just the incident of the firing last night, which we responded to,” Lt General Asim Bajwa told news channel Geo TV. “We have fired in accordance with the rules of engagement[…] We are acting in a responsible way.”  Pakistan said nine of its soldiers had also been wounded. Neither side’s account could be independently verified.

India’s disclosure of such strikes was unprecedented, said Ajai Sahni of the Institute for Conflict Management in New Delhi, and sent a message not only to his own people but to the international community. “India expects global support to launch more focused action against Pakistan,” Sahni told Reuters. “There was tremendous pressure on the Indian prime minister to prove that he is ready to take serious action.”

While both nations’ nuclear weapons deter all-out war, Modi was probably frustrated after Pakistani Prime Minister Nawaz Sharif rebuffed several diplomatic overtures, said C. Raja Mohan, director at the Carnegie India think-tank in New Delhi. Sharif in 2013 became Pakistan’s first leader to win power in a democratic transfer, but the nation has been ruled for almost half of its history by the military, which still wields great influence.

“There will be repercussions,” Mohan said. “And the management of the repercussions will be the next challenge. Now let’s see what they do. The ball is in Pakistan’s court.”

Quoted by Bloomberg after India’s announcement, Sharif said that Pakistan’s army is capable of defending its borders. He condemned firing across the de facto border that he said killed two Pakistani soldiers. Pakistan’s cabinet will meet Friday to discuss the “Indian aggression,” Radio Pakistan reported.

The millitary escalation between the two nations, who have fought three wars since 1947, have risen since a Sept. 18 assault on an Indian army camp in Kashmir that India blamed on Pakistan, though Pakistani leaders denied involvement. The attack left 18 Indian soldiers dead. China hopes issues between India and Pakistan are settled through dialogue, Foreign Ministry spokesman Geng Shuang said Thursday at a regular briefing. U.S. National Security Adviser Susan Rice called her Indian peer Ajit Doval on Wednesday, condemning the Sept. 18 “cross-border” attack and reiterating America’s expectation that Pakistan act against terrorists, the White House said in a statement on Wednesday.

“There is an escalation while global powers are asking both countries to sit and resolve the Kashmir issues,” said Rashid Ahmed Khan, professor of international relations at the University of Sargodha in Pakistan’s Punjab province, adding that both countries will probably calm down and move toward talks. “What India and Pakistan are doing to each other is to satisfy domestic constituencies and compulsions by taking hard positions.” Modi this week canceled a planned visit to Islamabad in November for a regional summit, and next week is due to review India’s ‘most favored nation’ trade status for Pakistan, although trade between the two nations is small.

While the “surgical strike” will likely not lead to significant escalation, India’s assets took the brunt of the attack: the rupee fell 0.6 percent to 66.8525 per dollar as of 2:14 p.m. in Mumbai, halting a five-day gain.

Indian stocks slump after government says it attacked terrorist camps in Pakistan http://pic.twitter.com/ysC1gzsvJP

— Richard Frost (@frostyhk) September 29, 2016

The benchmark S&P BSE Sensex dropped 1.5 percent. Pakistan’s benchmark equity gauge declined 0.4 percent.

Additionally, escalating tensions could sour sentiment for foreign investors who have pumped the most money into Indian stocks and bonds this quarter since March 2015.

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• Stocks Jump as OPEC Splits Markets; Indian Assets Drop on Attack (BBG)
• In U-Turn, Saudis Choose Higher Prices Over Free Oil Markets (BBG)
• Congress Passes Spending Bill to Keep Government Running (WSJ)
• Wells Fargo chief Stumpf heads to Hill with pressure mounting (Reuters)
• Lawmakers Won’t Let Wells Fargo Forget Its Scandal Anytime Soon (BBG)
• In escalation, India says launches strikes on militants in Pakistan (Reuters)
• U.S. weighs tougher response to Russia over Syria crisis (Reuters)
• Trump Tries to Reclaim His Pre-Debate Swagger (BBG)
• Clinton enlists former foe Sanders in appeal for youth votes in U.S. presidential race (Reuters)
• Och-Ziff to Pay $400 Million to Settle U.S. Foreign Bribery Probe (WSJ)
• Obama Says Backing Third-Party Candidate Is ‘a Vote for Trump’ (BBG)
• Russia says U.S. Syria statement shows Washington supports terrorism (Reuters)
• Russia Says It Would Support 48-Hour Cease-Fire in Aleppo to Allow in Aid (WSJ)
• Hot Mess: How Goldman Sachs Lost $1.2 Billion of Libya’s Money (BBG)
• Hillary Clinton’s Key Aide Huma Abedin Is a Lightning Rod for Attacks (WSJ)
• China armed forces warn Japan against South China sea patrols (Reuters)
• How the IRS Helps the Rich Get Richer (BBG)
• As Chicago Staunches Fiscal Bleed, Schools Are Awash in Red Ink (BBG)

 

Overnight Media Digest

WSJ

– National Amusements Inc is set to urge the boards of the companies it controls – CBS Corp and Viacom Inc – to explore a merger. http://on.wsj.com/2dsYdnK

– Takata Corp is negotiating with the U.S. Justice Department to resolve allegations of wrongdoing over its faulty air bags. http://on.wsj.com/2dsYUx8

– Anheuser Busch InBev won approval for the $100 billion plus takeover of rival SABMiller Plc, after shareholders from both companies voted in favour of the merger. http://on.wsj.com/2dsZuee

– Blackberry Ltd said on Wednesday it would stop making its smartphone devices and would outsource the development of the devices to focus on its software business. http://on.wsj.com/2dsZzia

– Samsung Electronics Co Ltd said it was in discussions with the U.S. Consumer Product Safety Commission to address potential safety issues of some of its top-load washing machines manufactured between March 2011 and April 2016. http://on.wsj.com/2dt0qQ5

– Och-Ziff Capital Management Group LLC will pay more than $400 million to settle charges that it paid bribes to African government officials, while its unit will plead guilty to criminal charges. http://on.wsj.com/2dsZtqU

 

FT

Oil prices settled up nearly 6 percent on Wednesday after OPEC struck a deal to limit crude output at its policy meeting in November, its first agreement to cut production since 2008 and after the market crashed on oversupply.

European Central Bank President Mario Draghi rejected German criticism that sub-zero interest rates were impoverishing savers and straining top lender Deutsche Bank AG, saying its monetary policy was a necessity to get the euro zone back on the path to growth and revive inflation.

French financial regulators offered on Wednesday to speed up the process of registering financial firms leaving London for France by handling their files in English.

Luxury carmaker Jaguar Land Rover’s strategy director said in a speech ahead of the Paris Motor Show that any new tariffs introduced after Britain leaves the European Union will make its business uncompetitive and put jobs at risk.

 

NYT

– Ronald Stanton, a refugee from Nazi Germany who made a fortune in petrochemicals and then gave or pledged more than $300 million to various charities, most of them in New York, died at his home in Manhattan. He was 88. http://nyti.ms/2dF4lYV

– House lawmakers questioned Janet Yellen, the Federal Reserve chairwoman, on Wednesday about the handling of the Wells Fargo accounts scandal, with some calling for tougher punishment of the biggest banks and their senior managers when they violate the law. http://nyti.ms/2dgd5SK

– Maurice Greenberg, the former chief executive of American International Group Inc, clashed with a New York State prosecutor on Wednesday over the extent of his role in a transaction at the center of his civil accounting fraud trial. http://nyti.ms/2dsY2Zu

– OPEC’s 14 oil-producing nations agreed to modestly cut their collective oil output later this year in an effort to bolster sagging prices, according to a cartel official. http://nyti.ms/2dgdIvM

 

Britain

The Times

BlackBerry Ltd said that it would no longer develop its own hardware, outsourcing the work to Indonesia. The announcement marked the end for a device that sparked a revolution in mobile working. (http://bit.ly/2dsDbRl)

Deutsche Post DHL unwrapped a £242.7 million ($316.38 million) deal for UK Mail yesterday and thereby greatly expanded the German company’s British network. (http://bit.ly/2dsDDiH)

The Guardian

Tidjane Thiam, chief executive of Credit Suisse, said the banking sector is “not really investable” and warned about the problems plaguing the sector as the focus remained on Deutsche Bank’s battle to reduce a $14billion penalty from U.S. authorities. (http://bit.ly/2d81clL)

Apple Inc is planning to move its UK headquarters to Battersea power station in a major boost for the £8bn regeneration of the Grade II-listed building. (http://bit.ly/2d82g8V)

The Telegraph

Bidders for National Grid’s £11 billion ($14.34 billion)regional gas networks business may be preparing to overpay based on mistaken assumptions about the returns that will be on offer in future years, energy regulator Ofgem has warned. (http://bit.ly/2d83W2a)

The London Stock Exchange is exploring plans to sell the French wing of its clearing house in order to soothe the concerns of Europe’s competition watchdog, which has launched an investigation into its planned merger with Deutsche Boerse . (http://bit.ly/2d830eq)

Sky News

The Treasury is lining up bankers to steer it through the latest crisis to engulf Royal Bank of Scotland’s efforts to offload a network of 300 branches. (http://bit.ly/2d83yRi)

The Independent Minouche Shafik, a deputy governor of the Bank of England, has said she thinks it likely the central bank will cut interest rates still further to help the UK economy cope with the impact of the Brexit vote. (http://ind.pn/2d85UzB)

Just a month after the final store closed, Al Mana Group, which bought the international and online operation, said it had retained UK staff and suppliers to begin sales via a new web platform. (http://bit.ly/2d86U6U)

 

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Goldman has done it again. Two days after the central banker-incubator cut its year end price target from $50 to $43, admitting the previously anticipated rebalancing will take longer to achieve, and now expects “a global surplus of 400 kb/d in 4Q16 vs. a 300 kb/d draw previously”, and followed the next day by a report in which it said that not even an OPEC deal would stop oil going lower, overnight the very same analyst, just 24 hours after saying the opposite, Goldman’s Damien Courvalin said that the OPEC agreement will “likely provide support to prices, at least in the short term” and added that the announced production quota should boost the price of oil by $7/bbl – $10/bbl. Again: this is two days after cutting the 2016 price target by $7, and one day after saying an OPEC deal would have no impact.

Still, trying to avoid looking like a total flip-flopper, Courvalin adds that “at the historical average 4.8% production beat relative to quotas, this target would be 33.7 mb/d, above current production levels. It has historically taken a fall in oil demand to ensure quota compliance, as in that case, production is forced lower by a decline in refinery intake around the world. This is not the case today with resilient demand growth” and said that “we maintain our year-end $43/bbl and 2017 $53/bbl WTI price forecasts given: (1) uncertainty on this proposal until it is ratified, (2) likely quota beats if ratified, (3) potential for production above our cautious forecasts in areas of disruptions (as was the case today in Libya and KRG), and (4) our conservative supply forecasts outside of OPEC for next year.”

Then again, the only thing that will be stuck in algos’ random access memory is that Goldman now expects oil to rebound by up to $10/bbl, which may explain why oil is now rolling over.

Here is Goldman’s full note for those who care:

OPEC buys time

OPEC members agreed to limit output today, although no quotas were formally set. This agreement is the first since the oil bear market started in 2014 and as such will likely provide support to prices, at least in the short term. However, we maintain our year-end $43/bbl and 2017 $53/bbl WTI price forecasts given: (1) uncertainty on this proposal until it is ratified, (2) likely quota beats if ratified, (3) potential for production above our cautious forecasts in areas of disruptions (as was the case today in Libya and KRG), and (4) our conservative supply forecasts outside of OPEC for next year.

OPEC members agreed today in Algiers to reduce production to a range of 32.5 to 33.0 mb/d, down from 33.2 mb/d in August (based on OPEC secondary sources). As of now there are no further details and the agreement is scheduled to be ratified at OPEC’s next official meeting on November 30. This agreement is the first since the oil bear market started in 2014 and as such will likely provide support to prices, at least in the short term. However uncertainty is set to remain high in coming months, with so far no comments from the Saudi minister. Further, the Iraq minister commented that secondary sources for oil production are too low, with his country’s output potentially 300 kb/d higher than such measure implies, a gap of nearly half of the proposed production cut.

If this deal follows the proposal made by Algeria as reported by Bloomberg this morning, it would leave Libya and Nigeria exempt, feature a production target for Saudi Arabia, allow for some growth in Iran and Venezuela and require a 1.6% production cut elsewhere relative to average January-August production levels.

Through 2017, such a proposal would keep production 480 to 980 kb/d on average below our forecast. Strictly implemented in 1H17 and all else constant, the production quotas announced today should be worth $7/bbl to $10/bbl to the oil price. However, at the historical average 4.8% production beat relative to quotas, this target would be 33.7 mb/d, above current production levels. It has historically taken a fall in oil demand to ensure quota compliance, as in that case, production is forced lower by a decline in refinery intake around the world. This is not the case today with resilient demand growth.

We reiterate our year-end $43/bbl and 2017 $53/bbl forecasts given: (1) uncertainty on this proposal until it is ratified especially as it relates to Saudi cuts and Iran caps, (2) likely quota beats if ratified, (3) upside surprises to disrupted production as announced today (Libya, KRG) with potential for more given our cautious forecasts in these countries, and (4) our conservative supply forecasts outside of OPEC for next year. Since we see risks to production from countries not targeted by today’s quota as skewed to the upside, we view a strict implementation of today’s OPEC proposal as normalizing the risks around our projected price path.

• Today’s proposal does not impact our expectation for weaker fundamentals in the coming months: (1) the deal does not impact current production as it is scheduled to be finalized at the November 30 meeting, and (2) we learned today that production in Libya/Iraq is currently 180 kb/d above our expectation.
• Longer term, we remain skeptical on the implementation of the proposed quotas, if ratified. Strict implementation of today’s deal in 2017 would represent 480 to 980 kb/d less output than we forecast. However, our forecasts assume little reversal in the c.1.0 mb/d of short-term disrupted production, with recent data for these countries already putting that forecast at risk. Further, we have remained cautious on the delivery of new projects outside of OPEC next year, with a combined 400 kb/d lower forecast vs. guided deliveries. The net of all these risks is close to zero, on our estimates, instead of skewed to higher production before today’s quota announcement. As a result, we reiterate our $43/bbl year-end forecast as well as our $53/bbl for next year.
• Our conviction that OPEC production cuts will be ineffective long term is rooted in our view that the flattening of the oil cost curve created by shale will lead to a loss of pricing power by low-cost producers, leaving them with only volume growth to sustain fiscal revenues. As a result, if this proposed cut is strictly enforced and supports prices, we would expect it to prove self defeating medium term with a large drilling response around the world. This is what occurred following the January 1987 OPEC production cut which led to a rebound in non-OPEC onshore rigs before prices sold off again setting the stage for a decade long steady increase in OPEC drilling.

Exhibit 1: No formal proposal has been announced except for a headline production level. The below table illustrates the proposal made by Algeria ahead of the meeting.
Crude oil production (thousand barrels per day)

 

Exhibit 2: Compliance to quotas is historically poor, especially when oil demand is not weak
OPEC production of countries under quota vs. their production target (lhs); Year-over-year change in global oil demand (rhs). In thousand barrels per day

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After oil soared over 5% yesterday, its biggest jump since April which pushed the commodity to a three week high on the unexpected announcement that OPEC had agreed on cutting as much as 700kbpd in production (without providing any actual detail who would cut), overnight skepticism and doubts have emerged about the viability and compliance with the deal, coupled with a boost in production by non-OPEC producers, and as a result WTI has dipped back under $47, down 0.5%, suggesting that the OPEC surge may be short-lived and modestly pressuring US equity futures.

“Skepticism on the implementation is probably weighing on prices today – but we also need to see how the U.S. market reacts,” says Giovanni Staunovo, commodity analyst at UBS.

The modest rolloff in oil prices has also put a “cap” on US equity futures overnight, which were trading roughly unchanged during the overnight session, but not before yesterday’s euphoria pushed stocks in Asia and Europe higher. India’s assets fell after it attacked terrorist targets in Pakistan.

Energy companies led gains on the MSCI All-Country World Index, which is on course for its best quarter since 2013. Sovereign bonds fell amid speculation higher energy prices will revive inflation. After posting its biggest gain in five months, crude slipped under $47 a barrel. India’s rupee fell the most in three months after the biggest military escalation since 1999.

For those who missed yesterday’s main event, Bloomberg conveniently summarizes that OPEC said its members agreed a preliminary deal to trim production to a range of 32.5 million to 33 million barrels per day following informal talks in Algiers, although it won’t decide on targets for each country until a November meeting in Vienna.

A global oil glut has weighed on crude prices for more than two years as a result of the Saudi historic November 2014 decision to break away from the OPEC cartel in order to put shale companies out of business (a decision which appears to have been undone as of yesterday, handing the victory to US shale), damping inflation, hurting corporate earnings, and leading to negative bond yields in two of the world’s four biggest economies. 

“It really caught people on the hop — we weren’t expecting a cut in output at all,” said Derek Mitchell, a fund manager at Royal London Asset Management in London. His fund owns shares of Royal Dutch Shell Plc and BP Plc and has assets under management of 93.8 billion pounds ($122 billion). “It sends a message that there’s now a floor under the oil price. A tighter oil market will support earnings. There’s rightly a great deal of skepticism as to whether this cut will last, but for the time being, it’s a very nice thing to wake up to.”

Some of the winners from OPEC’s plan include:

• Energy markets, from natural gas to coal and carbon were buoyed by the announcement.
• The Norwegian krone, the currency of Western Europe’s largest oil producer, touched its strongest level against the euro since August 2015, before giving up gains.
• Equity markets in Russia, Dubai, Qatar and Malaysia.
• Industrial metals lead and tin climbed to the highest in more than a year, as higher oil prices raise the cost of production.
• A global gauge of energy stocks rose. Tullow Oil Plc led gains among European oil-related companies.

Some of the losers from OPEC’s plan include:

• Bonds fell, while measures of the market’s inflation outlook in the U.S. and U.K. climbed.
• Travel-and-leisure stocks fell in Europe, with airlines including Deutsche Lufthansa AG leading the drop on prospects of higher fuel costs.
• Japan’s yen slumped amid speculation that increased oil costs will help the central bank achieve its policy goals.

The global reaction to the OPEC announcement was broadly bullish for risk assets which soared in kneejerk response, and the MSCI global index gained 0.4% as in early trade, extending this quarter’s advance to 5.4%. A gauge of energy shares jumped 1.5 percent after surging 2.8 percent in the last session. The Stoxx Europe 600 Index rose 0.7 percent, with oil companies leading the charge. Africa-focused explorer Tullow Oil jumped 7.1 percent, while Total SA and Shell added 4.5 percent or more. 

Lenders took their rebound into a second day, with Deutsche Bank AG up 0.9 percent. Commerzbank AG bucked the trend, falling 0.6 percent after announcing plans to reduce 9,600 jobs and suspend dividends as Chief Executive Officer Martin Zielke seeks to shore up the German lender’s profitability. Travel-and-leisure stocks were among the casualties of the OPEC deal, as higher fuel costs make traveling more expensive and erode profits at companies including Lufthansa, which fell 2.7 percent, and Ryanair Plc, down 2.9 percent. Thomas Cook Group Plc dropped 3.6 percent.

S&P futures were fractionally lower, after U.S. shares advanced Wednesday on the back of rising oil prices. Investors will look to data Thursday, including wholesale inventories, gross domestic product, initial jobless claims and pending home sales, for indications of the health of the world’s biggest economy.

Federal Reserve Chair Janet Yellen is scheduled to speak Thursday, as are regional Fed chiefs for Atlanta, Minneapolis and Philadelphia. These will follow yesterday’s Fed speeches by dissenter Esther George (Voter, Hawk) who said the diversity of views is healthy for the FOMC and added the Fed needs to move forward on rate hikes slowly and surely. Fed’s Mester (Voter, Hawk) said the Fed could ruin its credibility by not acting on data and may fall behind curve if there is a delay in a hike. Mester also commented that sometimes being prudent means increasing rates and that fundamentals of the economy remain sound.

Bond market measures for the inflation outlook climbed from the U.S. to the U.K. following OPEC’s decision. The 10-year break-even rate in the U.K. was set for its highest close since July last year. A similar measure in the U.S. approached its highest level since June. The yield on 10-year U.S. Treasuries was steady at 1.58% and that for German bunds increased by three basis points to minus 0.12 percent. “The rise in Treasury yields after the OPEC news was contained because the decision to really cut production won’t be finalized until November,” Shinichiro Kadota, an FX strategist at Barclays told BLoomberg. “The Fed’s rate-increase path isn’t gaining momentum, making it unlikely for yields to extend their climb.”

Market Snapshot

• S&P 500 futures down less than 0.1% to 2162
• Stoxx 600 up 0.7% to 345
• FTSE 100 up 1.1% to 6922
• DAX up 0.9% to 10533
• German 10Yr yield up 3bps to -0.12%
• Italian 10Yr yield up 2bps to 1.2%
• Spanish 10Yr yield up 3bps to 0.92%
• S&P GSCI Index down less than 0.1% to 360.1
• MSCI Asia Pacific up 0.4% to 141
• Nikkei 225 up 1.4% to 16694
• Hang Seng up 0.5% to 23739
• Shanghai Composite up 0.4% to 2998
• S&P/ASX 200 up 1.1% to 5471
• US 10-yr yield up 1bp to 1.58%
• Dollar Index up 0.1% to 95.53
• WTI Crude futures down 0.6% to $46.78
• Brent Futures down 0.9% to $48.23
• Gold spot up less than 0.1% to $1,322
• Silver spot down 0.3% to $19.14

Top Global News

• Saudis Shock Oil World With Higher Prices Over Free Markets: OPEC to cap production at 32.5-33mbbl/d; revisit quotas at Nov. meeting.; Shale Drilling Revival Seen Ahead as Oil Price Recovers
• India Strikes Pakistan Terror Camps as Modi Hits Back for Attack: Heavy casualties inflicted on militants assembled to infiltrate India, according to India’s director general of military operations Ranbir Singh said.
• 9/11 Victim Families Can Sue Saudis; Obama Veto Overturned: Other countries may respond by allowing lawsuits vs U.S. for actions by American soldiers, diplomats or corporate executives.
• California Suspends Wells Fargo From Bond, Investing Work: U.S.’s largest issuer of municipal bonds WFC from underwriting state debt, handling its banking transactions.
• Elliott’s Paul Singer Buys More of GE’s 3-D Printer Target: Singer plans to acquire additional voting rights in SLM Solutions Group in the next 12 months.
• Sears, Claire’s at High Risk of Retail Failures: Fitch: Cos. named in report that found retailers wind up liquidated almost 3x more often than other companies in bankruptcy.
• Fed Politics in Spotlight as Yellen Cornered by Lawmaker: Republican congressman cornered Fed chair on whether key policy maker would have conflict of interest in discussing presidential post.
• Och-Ziff Unit Said to Plan to Plead Guilty Over Bribes: Agreed to enter deferred-prosecution agreement, also subsidiary plead guilty in probe into bribes funneled to African officials.
• Compromise Said to Be Discussed Ahead of FCC Set-Top Box Vote: FCC chairman offered concessions to win support for proposal to make it easier for consumers to buy set-top boxes from cos. other than their cable TV provider.
• YouTube Hires Ex-Def Jam Boss to Smooth Music Industry Ties: Hired Lyor Cohen as its global head of music.
• Yahoo! Hacked by Criminals, Not State Sponsor: Security Firm: Accounts were hacked in 2014 by cybercriminals, InfoArmor says.

Looking at regional markets, we begin in Asia where stock markets traded higher across the board as the energy sector coat-tailed on the 5% surge in crude, following the agreement by OPEC to cut output for the first time since 2008. This boosted oil names in both the ASX 200 (+1.1%) and Nikkei 225 (+1.4%), with the latter outperforming on JPY weakness after USD/JPY surged above 101.00. Shanghai Composite (+0.4%) and Hang Seng (+0.5%) conformed to the positive risk sentiment, although gains were capped amid rising repo rates, which followed a weaker liquidity injection by the PBoC ahead of next week’s Golden Week holiday. 10yr JGBs recovered initial losses amid a lack of demand due to the positive risk sentiment seen across Asia. Furthermore, today’s 2yr auction was tepid in which the b/c fell to its lowest since June 2015, while the latest securities transactions data showed foreign investors offloaded the largest amount of Japan bonds last week since 2014.

Top Asian News

• Deutsche Bank Said to Face Hurdle Moving China Sale Proceeds: German lender raising up to $3.9b from Huaxia sale
• China’s Big Ball of Money Isn’t Going Anywhere Near Stock Market: Investors flock to property, spurring bubble warnings
• Fulham’s Billionaire Rises From Dishwasher to Takata Bidder: Flex-N-Gate is said to be one of five bidders for Takata
• Turnbull Steps Up Attack on Renewables After Australian Blackout: Says Australian states’ renewable targets risk energy security
• Korean Court Rejects Arrest-Warrant Request for Lotte Chief: Prosecutors sought arrest on embezzlement allegations

European equity cash markets have seen buying support following the upside witnessed in the futures overnight, following OPEC agreeing on a production limit. The energy sector is the predicable outperformer in equity markets, up 5% on the session as WTI Crude futures now trade around USD 47.00/bbl with the next key resistance level being August’s 49.00/bbl high. Oil prices have weighed on airline names; Easyjet (-1.6%) and Lufthansa struggle in the Dax, (-2.4%). German Banks continue to be in focus with Commerzbank releasing downbeat news; source reports stating that the Co. is to lay off 20% of their workforce (10,000 employees) and furthermore, the bank is to suspend their dividend payments, expecting a write-down of EUR 700mln, although do still expect a small profit this year.

Top European News

• Deutsche Bank Said to Face Hurdle Moving China Sale Proceeds: Govt creating potential headache for seeking to sell $3.9b stake in a Chinese lender, also seeking permission to move proceeds offshore.
• German Unemployment Unexpectedly Rises in Sign Economy Slowing: Number of people out of work increased by seasonally adjusted 1,000 to 2.68m.
• Commerzbank Plans to Cut Jobs, Suspend Div. in CEO Overhaul: Bank will take costs of about ~EU1.1b to restructure businesses.
• Man Group CEO Sees Event-Driven Hedge Fund Pressure: “When individual funds get too big, or when they get stale, or when they get lazy to be honest the money will flow away from them,” Man Group CEO Luke Ellis said.
• Renault Defends Electric-Car Headstart With Longer-Range Zoe: Car will be able to travel as far as 400km on a single charge, compared with 240km now.
• Spanish Socialists Crack Under Pressure to Let Rajoy Rule: Dispute over whether to let acting PM Mariano Rajoy return to office tore apart Spain’s Socialist leadership.

In FX, the Bloomberg Dollar Spot Index rose 0.2 percent from its lowest close in more than two weeks. The yen slid 0.7 percent, among the biggest losers of major currencies, as investors favored higher-yielding assets outside of Japan. the ringgit strengthened 0.4 percent, leading gains among the currencies of oil-exporting nations. The Norwegian krone slipped 0.3 percent following a 1 percent jump in the last session. South Africa’s rand lost 0.9 percent and Turkey’s lira declined 0.7 percent. Mexico’s peso retreated from near a two-week high before a monetary policy review on Thursday, with most economists predicting interest rates will be raised.  Taiwan also has a central bank meeting and its currency strengthened 0.2 percent from Monday’s close as trading resumed following a hurricane. Just over half of the economists in a Bloomberg survey forecast the island’s borrowing costs will be left unchanged, while the remainder were looking for a cut.

In commodities, crude oil fell 0.5 percent to $46.83 a barrel, retreating from a three-week high. The lower end of OPEC’s new production target equates to a nearly 750,000 barrels-a-day drop from what the group said it pumped in August. Saudi Arabia and Iran had signaled before the meeting that an agreement was unlikely in Algiers, while all but two of 23 analysts surveyed by Bloomberg predicted there would be no deal. Goldman Sachs Group Inc. said OPEC’s agreement to cut output could add as much as $10 a barrel to oil prices, though it remains skeptical along with other banks on how the accord will be implemented. Year-ahead European coal jumped to 20-month high amid increasing import demand from China. The equivalent Dutch gas contract surged to the highest for eight weeks and carbon permits rose to a three-month high. French and German power contracts both advanced to the highest since August 2015 amid reduced availability of French nuclear plants. Tin gained 0.5 percent to trade just shy of $20,000 a metric ton, a level last seen in early 2015. The metal used for solder in electronics has jumped 17 percent this quarter, the best performance on the London Metal Exchange. Lead rose 0.8 percent, heading for the highest since May last year. The LME index of six industrial metals is heading for a third successive quarterly gain for the first time since 2011 helped by an improving economy in China, the biggest consumer.

Looking at the day ahead, the main focus will be on the third reading of Q2 GDP. The market is expecting the reading to be revised up to +1.3% qoq from +1.1%. Also due out is the advance goods trade balance reading for August, wholesale inventories for last month, the latest initial jobless claims print and finally pending home sales data. Away from the data there’s no shortage of Fedspeak scheduled. Harker is due to speak at 10am BST followed by Lockhart, Powell and Kashkari. If that wasn’t enough, Fed Chair Yellen is also scheduled to address a minority banking conference. Away from the Fed we’ll also hear from the ECB’s Praet this morning and Constancio this afternoon, along with the BoE’s Forbes around lunchtime.

* * *

Bulletin Headline Summary from RanSquwk and Bloomberg

• European equities trade higher as European participants digest the fallout of yesterday’s OPEC announcement
• Naturally, energy names trade higher across the board with softness in airliners with not much else to report from the session thusfar
• Looking ahead, highlights include German unemployment, CPI, US GDP, weekly jobless data, as well as a host of speakers from Fed, ECB, BoE and BoJ
• Long-end Treasuries fall while global equities rally; oil prices drop after yday’s OPEC announcement sparked a rally in WTI.
• Goldman Sachs Group Inc. said OPEC’s deal to cut output could add as much as $10 a barrel to oil prices, though it remains skeptical along with other banks on how the accord will be implemented
• Oil analysts, many of whom were surprised by OPEC’s decision on Wednesday to set out the framework of a deal to limit oil production, remain split about the impact of the producer group’s plan
• BOJ’s Kuroda said in overnight speech that options for further easing include targeting lower rates in yield curve control, boosting asset purchases and increasing the pace of monetary base expansion
• Federal Reserve Bank of Philadelphia President Patrick Harker says U.S. “economy has reached a point where monetary policy has done what it can”
• Commerzbank AG plans to reduce 9,600 jobs, or about a fifth of the workforce, and suspend dividends as Chief Executive Officer Martin Zielke seeks to shore up profitability at the German lender
• German unemployment unexpectedly rose in September for the first time in a year, in a sign of concern among businesses over an economic slowdown and the consequences of Britain’s decision to leave the European Union
• Euro-area economic confidence unexpectedly improved in September in a sign the region’s recovery is maintaining its momentum
• Institutions face returns that will be lower than historical gains and in some cases less than what they need to meet their liabilities, according to Oaktree Capital Groups Howard Marks
• India said it attacked terrorist camps just across the border in Pakistan, the biggest military escalation since a standoff in 1999, as Prime Minister Narendra Modi retaliated for a deadly strike against Indian soldiers earlier this month

US Event Calendar

• 8:30am: GDP Annualized q/q, 2Q T, est. 1.3% (prior 1.1%)
• 8:30am: Wholesale Inventories m/m/m, Aug. P, est. 0% (prior 0%)
• 8:30am: Initial Jobless Claims, Sept. 24, est. 260k (prior 252k)
• 8:50am: Fed’s Lockhart speaks in Orlando, Fla.
• 9:45am: Bloomberg Consumer Comfort, Sept. 25 (prior 41.3)
• 10am: Pending Home Sales m/m, Aug., est. 0.0% (prior 1.3%)
• 10am: Fed’s Powell speaks at St. Louis Fed banking conference
• 10am: Freddie Mac mortgage rates
• 10:30am: EIA natural-gas storage change
• 2pm: Fed’s Kashkari speaks in Rapid City, S.D.
• 4pm: Fed’s Yellen Fed Chair Janet Yellen speaks via video link to Kansas City Fed banking forum

* * *

DB’s Jim Reid concludes the overnight wrap

It’s probably fair to say that over the last few weeks and months, markets had become somewhat accustomed to the flurry of jawboning, back-and-forth headlines and general bickering between the major Oil producing nations over whether or not to curb output. It therefore felt like the general consensus was leaning towards a ‘more of the same’ type outcome from the sideline OPEC meeting so when the headlines broke last night reporting that the cartel had agreed to the framework of a deal that will cut production, that was enough to send Oil related assets surging.

Indeed WTI rallied as much as 7% off the intraday lows before finishing the day with a +5.33% gain, the most since April 8th. Brent also rallied +5.92% and closed at the highest level ($48.69/bbl) since August 30th. WTI is up a further +0.20% this morning. The rest of the energy complex got a boost too with Gasoline (+6.03%) and Heating Oil (+5.75%) in particular up sharply. Oil sensitive currencies gained with the Russian Ruble (+1.35%), Norwegian Krone (+1.00%) and Canadian Dollar (+0.89%) coming out top. Unsurprisingly it was energy stocks which dragged US equities up from early session lows. The S&P 500 was down as much -0.38% but swung to a +0.53% gain by the closing bell with the energy sector alone up over +4%. Oil heavyweights Exxon Mobil (+4.40%), Chevron (+3.20%), Schlumberger (+3.56%) and ConocoPhillips (+6.97%) all leading the sector higher. In credit markets CDX IG ended 2bps tighter.

The move by OPEC to a preliminary agreement to cut production to 32.5m barrels per day is the first reduction since 2008 and according to our commodity strategists would lower 2017 production by 1.1m barrels per day based on their assumptions. The early indications suggest that the agreement may follow the outline of an Algerian proposal for a 1.6% reduction from the Jan-Aug averages for all member countries apart from Libya, Iran and Nigeria. Under this proposal, Iran would be permitted to raise production only up to 3.7m barrels per day which is a small increment from its reported August production of 3.64m barrels. The devil is in the detail though and as our colleagues highlight the precise country level production quotas will not be decided until the November 30th OPEC ordinary meeting. As a result countries may not act to reduce output until December. A more complete assessment of the overall impact will likely depend on the eventual shape of the final agreement which we might have to wait until the end of November to get, along with the potential participation of any non-OPEC producing countries.

So there are still the details to iron out and perhaps the greater question is whether or not the market will trust OPEC to follow through with action and actually cut. Waiting until November also brings a kicking the can type element to all this and one would imagine that implementing the individual country quotas could be where the disputes start but to be fair the preliminary agreement is certainly more than most would have expected.

This morning in Asia bourses are off to a decent start and it won’t come as a surprise to hear that the energy sector is leading the way. The Nikkei (+1.42%), Hang Seng (+0.34%), Shanghai Comp (+0.68%), Kospi (+0.81%) and ASX (+0.93%) are all up with energy sectors generally up between 3% and 6%. Emerging market currencies are on the whole stronger this morning while the Yen has weakened -0.60%. Credit indices are also 1-2bps tighter while US equity index futures are also pointing towards to positive start. The only data released this morning came in Japan where retail sales disappointed last month (-1.1% mom vs. -0.6% expected).

Staying in Asia, yesterday our Chief China Economist Zhiwei Zhang published a report titled ‘China’s Property Bubble’. Zhiwei believes that a property bubble is rising in some Chinese cities. After conducting a bottom up analysis of 252 land auctions in ten cities, Zhiwei found that property prices have already risen 23% yoy in these cities, but soaring land auction premiums revealed a very high expectation of further property price inflation. He notes that if property prices stay at the current level, developers in 105 cases may lose money, accounting for 53% of total land sales value. If property prices fall by 30%, these numbers would go up to 181 cases and 81% of total land sales value. Zhiwei and his team also believe that the risk of a bubble is spreading to more cities in China and notes that if the property cycle trends down from here with prices falling 10% nationwide, some 28% buyers in land auctions since July 2015 may lose money. The loss could be around RMB243 billion. To avoid a collapse of the property bubble Zhiwei is expecting the PBoC to cut interest rates in Q2 next year and loosen liquidity conditions. He has also trimmed his 2018 GDP forecast to 6%, but kept his 2017 forecast at 6.5% based on policy easing.

Moving on. Prior to the OPEC headlines last night the latest durable and capital goods orders numbers in the US made for a bit of mixed reading. The preliminary August data was broadly better than expected. Headline durable goods orders were unchanged last month versus expectations for a -1.5% mom decline while the ex-transportation declined a little bit less than expected (-0.4% mom vs. -0.5% expected). Core capex orders (+0.6% mom vs. -0.1% expected) also surprised to the upside. What was disappointing though were the downward revisions to the July data. Headline orders were revised down to +3.6% from +4.4%, ex transportation to +1.1% from +1.3% and core capex orders to +0.8% from +1.5%. As a result the Atlanta Fed trimmed its Q3 GDP forecast to 2.8% from 2.9%.

There was also a reasonable amount of Fedspeak to take stock of yesterday but none of which really moved the dial. The latest to speak was the Kansas City Fed’s George (a renowned hawk) who said that ‘we need to slowly but surely make progress in adjusting that interest rate so we don’t get far behind’. The Cleveland Fed’s Mester – another dissenter – said that ‘at this point, I think there’s a very compelling case to take the next step on a very gradual path’, warning also that any delay increases the risk to having to undertake a considerably steeper policy path later on. The rest of the comments came from the centrist and more dovish camp. The Chicago Fed’s Evans said that the ‘economy is actually doing quite well’ but that ‘if inflation were closer or at our objective then it probably would be closer to the time to be raising rates’. Meanwhile the Minneapolis Fed’s Kashkari said that ‘the economy still has room to run before it overheats’.

Elsewhere, Fed Chair Yellen was also speaking yesterday in a testimony before the House Financial Services Committee. Much of the testimony was focused on Yellen defending the regulatory role of the Fed and addressing accusations of potential conflicts of interest although the Fed Chair also highlighted that monthly job gains are well above a sustainable long run path, although she isn’t yet seeing upward pressure on inflation.

Her colleague at the ECB, Mario Draghi, was also busy defending recent action by the ECB from German lawmakers, saying on balance that savers, employees and pensioners across the Euro area are better off today and tomorrow because of the actions of the ECB. It was a better day for European stocks yesterday with the Stoxx 600 closing up +0.70% and the DAX +0.74%, the latter gaining for the first time since last Thursday.

Looking at the day ahead, this morning in Europe the early data release comes from Germany where the September unemployment rate print is due. Shortly following that we turn our attention to the UK where money and credit aggregates data is due, along with the August mortgage approvals data. We’ll then get various confidence indicators for the Euro area before its back to Germany with the preliminary September CPI report. Across the pond this afternoon the main focus will be on the third reading of Q2 GDP. The market is expecting the reading to be revised up to +1.3% qoq from +1.1% while our US economists have pegged an increase to +1.4%. Also due out is the advance goods trade balance reading for August, wholesale inventories for last month, the latest initial jobless claims print and finally pending home sales data. Away from the data there’s no shortage of Fedspeak scheduled. Harker is due to speak at 10am BST followed by Lockhart at 1.20pm BST, Powell at 3pm BST and Kashkari at 7pm BST. If that wasn’t enough, Fed Chair Yellen is also scheduled to address a minority banking conference tonight at 9pm BST. Away from the Fed we’ll also hear from the ECB’s Praet this morning and Constancio this afternoon, along with the BoE’s Forbes around lunchtime.

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