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From Guy Haselmann of ScotiaBank

Mini-Contagion

The US economy has shown some hints of improvement, but overall it is plodding along at a pace that is neither strong nor awful. Most economists expect momentum to improve slowly to a 3% GDP growth pace in 2014, and something slightly above that in 2015. These forecasts are probably the best-case scenario. Therefore, they have asymmetrical skew to the down side. Due to crowded positions, valuations priced to perfection, and a confluence of global economic headwinds, the riskiest financial assets also have downside distribution skews of potential outcomes.

The most visible worry for investors is coming out of China, as Beijing and the PBoC attempt to tame growing imbalances and a dangerous credit boom. Recent defaults and sharp drops in many industrial commodity prices are not random events, but rather intricately connected to official plans for economic transformation. Premier Li said people should be prepared for bond and financial product defaults. In addition, PBoC announced plans for full interest rate liberalization by 2016. These changes are necessary in order for the Chinese government to pursue its ultimate goal of the Renminbi someday becoming a reserve currency.

Beijing maintains tight capital account controls. In recent months, the PBoC has expressed concerns about ‘hot money’ inflow. Total fund inflows amounted to approximately $500 billion in 2013. Officials who are trying to liberalize markets have not liked the perceived one-way bet on the Renminbi. One of the most popular (levered) trades has been to borrow in Yen and invest the proceeds in Renminbi. The trade made  sense, because the investor earned the large interest rate differential, while also benefiting from what had appeared to be the governmentally-controlled direction of each currency (Yuan stronger, Yen weaker).

One factor that may have prompted Beijing’s forceful currency move was anger at the Japanese who have driven their currency down 25% on a trade weighted basis. Their angst has likely been heightened by the fact that the US has refrained from any criticism of Japan’s policy. Recently, elevated geo-political uncertainties with Russia and EM, means that the Yen’s status as a safe haven has been putting upward pressure on the Yen. Thus, both currencies are moving the wrong way, further decimating investor yen-carry trades.

The changes being implemented to China’s economic development model are changing the behavior of State Owned Enterprises and local banks. Fewer loans are available, and loan refinancings, if available, require worse terms. Chronic overcapacity is now combining with slowing economic growth to increase debt servicing problems. Cross-guarantees risk a series of chain defaults which could then hit key supply chains.

Overcapacity is partially being blamed for plunging prices in copper, iron, cement, aluminum, solar panels and coal. Real asset collateral for trade finance arrangements ‘gone bad’ have resulted in further downward price pressures.

Lower prices and the drop in demand for key commodities products have proven to be disruptive not just for speculators, but for emerging markets in particular. The mini-contagion already appears to be leaving its mark on financial markets and the global economy.

In the past, during signs of economic weakness, the Chinese government was quick to authorize new large infrastructure projects or encourage new credit creation, but this time, those options are not desirable by officials as they are much riskier options at this point.

China, Japan and the US are the three largest economies in the world. Each country is currently in the midst of highly-significant policy maneuvers. The Fed is bringing QE to an end. China is dealing with the credit bubble issues outlined above. Japan is lifting its consumption tax from 5% to 8%. Japan’s hike in 1997 from 3% to 5% pushed the economy into a recession. In addition, Russian sanctions could magnify and potentially take a large bite out of global economic growth.

Portfolios will need to adapt to this changing environment. Just about everyone is anticipating higher Treasury yields. Most PM’s are short duration. However, the term premium is falling quickly. The technical chart looks outstanding on the long end. Macro factors are also beginning to align. I believe the next 50bps in the 30year (yield) is shaping up to be a move toward lower (not higher) yields. Portfolios are ill-prepared.

“The only thing I knew how to do was to keep on keeping on.” – Bob Dylan

via Zero Hedge http://ift.tt/1rqqgkF Tyler Durden

Spending just $3.33 on US-produced goods every year by every person in the USA would create 10,000 jobs. We obviously don’t have that much money to spend or we don’t care. Or, we don’t produce it in the USA these days. Spending that little amount of money would be easy. But, why don’t we do it? Instead we worry over the fact that China might be doing this or cutting that. We ponder the effects of the Purchasing Manager’s Index and the Gross Domestic Product of another country rather than looking at our own labor market.

The USA doesn’t produce all of its own flags (the US imports $3.2-million worth of them from China). There are no televisions that are manufactured in the USA (since 2004 when Five Rivers Electronic Innovations went bust). Levi’s Jeans are manufactured (except for one single line of jeans) outside of the USA. Even the USA’s 2012 Olympic uniforms were made in China.

According to a survey carried out in the USA a few years ago about American sentiment regarding Made in the USA, respondents stated that 99% of them would buy American if they could and 42% said they would do so even if it were more expensive!

So, what do we do? We rely on other countries because we can’t purchase what we want at home. That means every time China starts moving up or down, we in the USA get the jitters and see our investments disappearing.

China contracted in the first quarter of 2014 according to data that is released today from a preliminary Purchasing Managers’ Index survey by Markit/HSBC. Although it is not the official PMI released by China onApril 1st, it provides a good gauge that China is not doing as well as they/we might like. The Markit/HSBC PMI takes into consideration private companies that are smaller than those that are in the official PMI for China.

The Markit/HSBC figure stands at 48.1 for March and that’s an all-time low for the past eight months.February’s figure was 48.5, which means that the Chinese are well below the level of 50 and they have been ever since the start of this year.

The world has been questioning the economic activity of China for over a year now and it seems that these concerns will be reinforced when the official figures are released. China is indeed slowing down. It can be expected that China too will now take the long road of stimulus to boost its economy. This may include:

• Lowering entry barriers for private investment.
• Spending to target public housing. 
• Spending on air-pollution. 
• Loosening monetary policy so that the economy will continue to grow at 7.5%.
• Reducing lending rates.

Already last year the Chinese economy officially grew by 7.7%, which is the same figure as for 2012. Deceleration is suspected to continue well into the second quarter of this year.

The Vice Finance Minister Zhu Guangyao stated in an interview that they would not be making the same mistakes as in the past by over-stimulating the Chinese economy.

However, the Finance Minister Lou Jiwei stated that it was the labor market that was more important than the economy and reaching healthy levels for workers was essential, even more so than getting 7.5% in economic growth. If Beijing wishes to improve consumption in the country, then the question is whether or not they will be willing to forego economic growth in the meantime while they bring that about. Secondly, how much will they be prepared to sacrifice? The Chinese economy is slowing down and some believe it will weaken even more so in the coming months. Growth is expected to fall to about 7% in 2015 and 2016.

Economists believe that this contracting is the sign of last summer’s interbank rate soaring to over 10% amid concerns that there was a credit squeeze and a shortage of liquidity in Chinese banks.

It would seem that it’s domestic demand that is proving to be the problem at the moment for China. March is expected to see a rebounding PMI in normal times, because the Chinese New Year is over and there should be a return to orders and activity. However, this is not the case. Output and new orders have been weakened according to the figures; although new exports grew.

Who will benefit from China’s contracting? Some now believe that just because China will be slowing down it doesn’t mean that the world is going to nose-dive into chaos and economic slump. The world may actually benefit from balanced growth (although commodities will certainly come in for a rough ride). But, isn’t it the Chinese state that has engineered their own economic slow-down? So, in theory if it fell too much, they would be in a position to counter-act that; or at least control means avoiding a crash-landing. If they tripped up, however, they would make the rest of us fall too. The commodity-based economies would have a knock-on effect on the rest of the world. However, it might also open up new opportunities.

If only China could get contracts rather than contracting. If only the USA had more home-made products that would mean the Americans could comfortably buy from home rather than importing and worrying about Chinese PMI.

If only pigs could fly…

Originally posted: China Contracts

 

via Zero Hedge http://ift.tt/1jo5eSz Pivotfarm

Let’s examine what happened from the beginning.  An extreme right wing group, with US and NATO support (according to released internal transcripts), overthrew the legitimate Ukrainian government (illegally) via violent coup.  The fact that this group had western support is not important really, but should be noted.  So according to ‘international law’ – this ‘country’ is NOT Ukraine.  Ukraine cease to exist when this happened.  The new ‘government’ – not popularly elected, seized control by force.  If anything we could call this country (still yet to be defined) the “New Ukraine” – of course if the current ‘government’ suggested this it would diminish their power; it serves them to mislead the world (those who are uninformed) that this is in fact the Ukraine, the same country that existed before.  Once the legal process breaks down, there’s no going back.  

Now, the smoking gun:

 

Why is this important?

When Russia went into Crimea, they claimed that they were protecting Russian citizens (who are the overwhelming majority there), which at the time sounded as an excuse for ‘annexation’ of Crimea (although Crimea was always part of Russia and mostly Russians are living there).  Is it possible that Russian intelligence received such real threats to Russians in Crimea?  Also to note the vehement anti-Russian stance of Western Ukrainians, at least those in power.  

RT commentators saying this recording is right out of “Dr. Strangelove” – only problem, Ukraine doesn’t have nuclear weapons.  Is she referring to her western friends?  If they hate Russians so much, why not leave Crimea to them?

Where US interest lies

The US has few economic or political ties to Ukraine, other than the NATO agenda to expand further into Europe and Eurasia (Grand Chessboard).  But the US has very strong economic ties with Russia.  Russia is a huge consumer of USD, invests in the US, and has provided transportation and other logistic services to US forces in Afghanistan.  Not to mention US corporations now doing business in Russia:

U.S. companies have also made sizable wagers in Russia. In 2010, PepsiCo agreed to buy Russian dairy and juice manufacturer Wimm-Bill-Dann Foods for over $5 billion, or about 16 times earnings before interest, taxes, depreciation and amoritization. The deal was seen as a way to boost the company’s revenue growth, which had slowed as PepsiCo’s mainstay U.S. market matured.

..

Today, Russia accounts for about 7 percent of PepsiCo’s total revenue. PepsiCo declined to comment.

Ford has two plants in Russia, as does General Motors. Meanwhile,Renault/Nissan and Hyundai also have large operations in Russia.

Russians have also been gobbling up US real estate at an increasing pace, even financing new developments:

Russian Deputy Economy Minister Andrei Klepach recently said that he expects Russians to invest $80 billion outside of Russia over the next few months, up from the $65 billion that he predicted originally.

Until now, investment in the U.S. only accounted for a small fraction of that number. But that may be changing. Mermelstein expects Russian real estate investment in the U.S., both commercial and residential, to double from its current share of 5 percent of Russian investment abroad to 10 percent in 2012.

Not to mention other sectors, such as the Steel industry: 

Russian steelmaker OAO Severstal yesterday said it is buying a Western Pennsylvania coal company for $1.3 billion in cash, adding to the surge of Russian money into the United States.

Russia holds $136 Billion of US Government Debt.  Ukraine on the other hand, holds so little they are categorized under ‘other’ (according to data from the US Treasury).

What happened to ‘the customer is always right?’

Russia is certainly not the largest customer of the US.  But they are a significant one.  And with US companies in Russia, trade has been two way.

Part of the motivation of dismantling the Soviet Union was to create a capitalist ‘open market’ system, that the US could do business with Russia.  They have done that.  Their economy has grown, and they’ve learned from the American system, adopting many US-led economic practices.  They have even replicated the ‘open markets’ model creating a commodity and derivatives exchange:

In February 2011 JSC “Saint-Petersburg exchange” and JSC “RTS Stock Exchange” carried out a joint project on organization of trading of commodities futures. In this project organizer of trading is JSC “Saint-Petersburg exchange”, clearing organization is CJSC “CC RTS”, settlement organization is “Settlement Chamber RTS”. Trading is carried out on the basis of trade system and risk-management system of FORTS derivatives market. It ensures the principle of single money position in all markets for the participants of trading.

Russia is depicted in the media as a wasteland.  Moscow has built a downtown filled with skyscrapers comparable to many international business districts.  A growing middle and upper class in Russia puts in on par if not more advanced than Western economies:

Stable gross domestic product growth, declining inflation and a record-low unemployment rate are pointing to positive consumer purchasing power in Russia. The Russian middle class, which stands at 104 million strong, is fueling that power. This segment of the population is projected to rise 16 percent between now and 2020, at which point it will represent 86 percent of the population and amount to $1.3 trillion in spending—up 40 percent from 2010, based on a global study of the emerging middle class and related databases by Dr. Homi Kharas of the Brookings Institution.

“There is an equal share of money at the top and in the middle,” said Dr. Venkatesh Bala, chief economist, The Cambridge Group, a part of Nielsen. “Russia’s middle class today has the same share of income as the upper class and has remained an untapped opportunity by many international corporations.”

While the top 20 percent of income earners in Russia represent 47 percent of the country’s total income, the middle 60 percent accounts for 48 percent, according to federal statistics from the Bank of Russia (2012). The bottom 20 percent comprise the remaining five percent of income.

Ukraine on the other hand, has done none of this.  Many of the media depictions of Russia are more applicable to Ukraine.  

Finally, since this issue has become polarized, just to compare the 2 choices.  Is it better to support a coup government that seized power by force, with few economic and political ties (Ukraine); or Russia, a legitimate country, world power, with many economic ties, who has proven in the past 10 years that it has accepted the suggested economic reforms?

Supposedly as traders we look at economic data and make economic decisions.  Following the ‘sanctions’ logic to the end, we have much more to lose by supporting ‘Ukraine’ than Russia.  Taking what they have learned from the West, it would not be difficult for Russia to internally reorganize their economy, and make new partnerships that have already been in the making for years (such as with China, India, and others).  Russia also sits on vast natural resources, which could be used internally or sold to China.

Irony of fallacious policy

Hundreds of billions of dollars were spent on propoganda, intelligence, and other means, during the Cold War, trying to convince the Russians to go capitalist.  Open their markets.  Finally it suceeded, and they have developed a sophistocated, capitalist market system.  All of those efforts are now in jeopardy. 

Now, for reasons unknown, the West is sending the opposite message.  Through the use of account freezing, trade sanctions, and other economic tactics, the West is doing exactly what the West tried to convince the Russians not to do for decades.  

No matter the outcome, the West (US and Europe) has much more to lose in any scenario.  

Market approach

Traders should only be concerned about the message being sent to the markets.  Markets operate based on a series of rules.  The market opens at a certain time, closes at a certain time.  Contracts are defined in quality and quantity.  Although traders may be emotional and irrational, they cannot operate outside of market rules (for example, if you are not happy with the outcome of a trade, you cannot just delete it from your account).  A violation of market rules opens a pandora’s box.  

What’s next? Politicians will decide that in order to support the US market (because it’s now suffering due to billions flowing out because of sanctions, or assets are frozen) that now to support our efforts overseas, we can only buy (not sell)?  Or that IRAs are converted to tbills to ‘save Ukraine’?  Since when did any Westerner care about Ukrainian politics?

..44 percent weren’t sure about the name of the former Ukrainian president with close ties to Russia who was recently removed from office. Only 40 percent correctly chose Viktor Yanukovych from the list. Sixteen percent selected an incorrect answer.

 

A relative lack of knowledge, however, doesn’t stop some from giving their opinion on various policy questions. The poll found that 24 percent of Americans were willing to express an opinion on whether the nonexistent Ukraine Administrative Adjustment Act should be repealed in light of the conflict. Respondents who gave an answer were divided evenly, with 12 percent backing repeal and 12 percent opposed.

With the economy faltering as it is, a market based approach to the current situation would have given a boost to the economy, instead of putting further negative pressure.  

Looking economically, any trader should agree that if you can lose 100 and gain possibly  another 20 or more through solidifying the relationship (Russia) and lose a few; OR (Ukraine) gain a few, but in the process lose 100, it’s a no brainer trade.  That is the economic magnitude difference between Russia and Ukraine, based on above referenced economic data.  

The reason Nixon opened up China, was to further the US economy, not to meddle in Chinese politics.  Even recently, we’ve overlooked China’s domestic problems, such as human rights, the seizing of Tibet, rampant pollution, and other issues not acceptable by Western standards, in the interest of furthering trade.  And over a period of decades, with US cooperation, China has built itself into an industrial powerhouse, and supplies goods in almost every economic sector, and is the US biggest customer.   

Some important facts to note about Russia:

• 40% of EU energy comes from Russia.
• 45% of EU cars are sold to Russia.
• US poverty is 3% higher, than in Russia.
• More billionaires live in Moscow than any other city.
• Russia has no external debt!

via Zero Hedge http://ift.tt/1iVMqr8 globalintelhub

Submitted by F.F. Wiley of Cyniconomics blog,

[A]sset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases.
-March 19 FOMC statement

The excerpt above or some variation has appeared in every one of the Fed’s post-FOMC meeting statements since the beginning of QE3 in September 2012.

Unfortunately, it doesn’t give us much comfort. We don’t see evidence of the Fed’s economists accurately gauging QE’s “efficacy and costs,” notwithstanding its oh-so-slow wind down. On the contrary, history shows that these economists have an inflated view of what they can achieve with monetary policy.

Take the link between QE and jobs, for example. We were struck by the following question, asked recently by commenter “liongterm investor”:

How does a dollar (or trillion dollars) added to the Fed balance sheet create a job? This is a serious question; I am not trying to bait someone into an argument …  What I do understand about QE is how money the ends up [in] excess reserves earning interest from the Fed larger than what my deposits or short term treasuries earn. I also understand how the money can end up driving up equity prices. But job creation??

We don’t doubt that “liongterm investor” is aware of “wealth effects” – the idea that a booming stock market encourages happy investors to buy an extra luxury item or two, and this might eventually create a few positions at, say, Tiffany. But it’s not a very powerful effect, is it? Nor can we be sure that it won’t come back to bite us, for reasons we’ve written about in the past (see here, here, here or here).

What’s more, questions of what the Fed can and can’t achieve go beyond QE. We touched on the limitations of monetary intervention in recent research on where the economy stands today:

• “What Needs to Happen Before We See a Big Recovery?”
• “Corporate Capex Fallacies and Why You Shouldn’t Rely on CNBC”

We’ll build on that research below with a handful of charts showing that there are many things the Fed can’t do when it comes to manipulating the economy.

Household borrowing and spending: What the Fed can’t do

In a debt-saturated household sector, the Fed can’t prevent mortgage demand from stagnating:

Based on 40 years of history (and the fact that banks need to cover their costs), the Fed can’t shrink the spread between mortgage and deposit rates much further than it did in 2012:

Consequently, the Fed can’t push debt service costs much below current levels:

Nor can lower debt payments provide much of a subsidy in the first place, since falling debt service is matched by declining interest income:

More broadly, there’s a downwards trend in income after tax and financial obligations, and the Fed can do little about this:

Business borrowing and spending: What the Fed can’t do

The Fed can’t convince businesses to revert right away to the borrowing habits of recent bubbles:

Especially as net business debt is already at an all-time high:

And while the Fed can affect the amount of cash deposits, it can’t force businesses to make spending decisions based on those cash balances:

Consequently, business spending growth has slowed alongside consumer spending, and the Fed can do little about either of these developments:

Housing: What the Fed can’t do

The Fed can’t undo past overbuilding, and therefore, it can’t conjure up another residential construction boom (for awhile, at least):

What the Fed can do

On the other hand, here are a few developments that our central bank can accurately claim to have achieved:

1. Lifting prices on stocks, houses and other risky assets, which creates a wealth effect and boost for high-end consumption.
2. Creating windfall profits for financial firms aiming to exploit the bubble, then bust and then bubble again pattern in the housing market.
3. Creating windfall profits for primary dealers through the Fed’s Treasury and mortgage purchases (even as central bankers may occasionally discipline traders who aren’t careful).
4. Preserving the “heads I win, tails you (the taxpayer) lose” mentality in the financial sector that leads to reckless risk-taking.

What the Fed shouldn’t do

Another way to look at the data and observations above is to ask why the Fed’s achievements have been so limited (and of dubious value). It’s evident that the economy isn’t growing strongly because of conditions that central bankers themselves created, by encouraging excessive borrowing and disregarding moral hazard.

In other words, the problem isn’t so much that the Fed can’t deliver another debt-fueled boom, but that it shouldn’t be trying to cure a credit bust with more borrowing in the first place.

Sadly, though, this idea falls in the same category as the notion that the Fed’s balance sheet isn’t the right tool for job creation. It’s too damning a thought to be accepted by central bankers who’ve shackled themselves to a philosophy of ceaseless intervention. It’s also too basic for economists who prefer abstract theories and mathematical models over reality-based thinking.

Such straightforward concepts as not fighting a debt hangover with more debt just don’t enter into the Fed’s calculus about “efficacy and costs,” even as they make perfect sense to so many of the rest of us.

via Zero Hedge http://ift.tt/NLuP97 Tyler Durden

While Naftogaz (Ukraine’s gas pipeline operator) states that all gas transportation from Russia to Europe is running normally, Bloomberg reports that Russian natgas exports to Europe are declining. Shipments are down over 4% from the prior week and also lower to Ukraine. This ‘adjustment’ follows increased sanctions by the West as Medvedev’s notable statement this morning that Ukraine owes Russia $16bn.

NatGas output is tumbling

The good news:

Gazprom today said natgas transit to Europe via Ukraine, supplies for Ukrainian consumption  

But Pay Up…

Ukraine owes Russia $11b after collapse of 2010 deal, Russian Prime Minsiter Dmitry Medvedev says to President Vladimir Putin at Security Council meeting, according to transcript on Kremlin website.

 

Medvedev adds $3b Ukraine bonds bought in Dec., ~$2b debt to Gazprom for natgas supplies

 

NOTE: In 2010, Russia agreed to sell natgas at discount in exchange for extending lease to Black Sea naval port of Sevastopol in Crimea to 2042 from 2017

Or Else…

Russian natgas exports to Europe and Turkey, excl. former Soviet Union, declined to 405.3mcm as of March 22,  according to Bloomberg calculations based on preliminary data from Energy Ministry’s CDU-TEK unit.

 

Avg daily exports to region were ~457mcm in March, lower than yr earlier: calculations based on CDU-TEK data

 

Shipments March 16-22 were 3.04bcm, 4% decrease vs level in week ended March 15

It is too early to see a trend, but for now, the direction is not hopeful for Europe.

Furthermore, Gazprom has cut its Diesel output by the most in 7 months…

 

and then… (via NY Times),

Russia is now asking close to $500 for 1,000 cubic meters of gas, the standard unit for gas trade in Europe, which is a price about a third higher than what Russia’s gas company, Gazprom, charges clients elsewhere.

 

Russia says the increase is justified because it seized control of the Crimean Peninsula, where its Black Sea naval fleet is stationed, ending the need to pay rent for the Sevastopol base. The base rent had been paid in the form of a $100 per 1,000 cubic meter discount on natural gas for Ukraine’s national energy company, Naftogaz.

And if that’s not clear enough…

 

Source: Bloomberg

via Zero Hedge http://ift.tt/1fVAtwn Tyler Durden