EM currencies keep up rally; grown ups take reins at White House
- Mnuch-Mnuch-Mnuchin at heaven’s door?
- Emerging market currency rally continues
- Grownups are back in charge in Washington
To make the point another way
Backward-looking models of default frequency suffer from the condition that the future has to be like the past. That ain’t necessarily so. Forward-looking variables tell us that high yield is fairly priced. The above chart shows the result of a simple regression model relating the High Yield credit default swap spread to three predictors: the S&P 500 Index (anticipates future earnings), the VIX index (the degree of investor certainty about those earnings) and the oil price hugely important for a high yield market with a high proportion of oil issuers. This simple model tells us that high yield spreads are on the screws as of this morning. — David Goldman
Moody’s thinks credit spreads are too narrow. The rating agency’s model of expected default among high yield borrowers hasn’t fallen as far as the VIX index of near-term S&P volatility. That’s an interesting observation but it’s also a case of apples and oranges. Investors may well think that the probability of a big S&P move in the next few months is very low, even if they are worried about future defaults. As it happens, the rising price of oil has thrown all the default models out of kilter. The high yield energy sector was by far the most vulnerable, and it has come roaring back as oil prices rise. All in all an inadequate presentation of the problem. — David Goldman
Citi bearish on South Africa
In a Feb. 23 note, Citibank economists said: “We are more bearish as cumulative fiscal slippage over the past few years has translated into an increase in issuance for FY17/18, the timing/level of debt stabilization keeps moving further out/higher, and State-Owned Companies will, in our view, continue to hinder fiscal consolidation plans…We initiated a long USDZAR position via 3m forwards yesterday where we are targeting 13.75 (spot ref) with a stop-loss at 12.80. …we are also concerned that some of the recent negative political signals could gain momentum over the next few weeks.”
Mnuch-Mnuch-Mnuchin at heaven’s door?
The new Treasury Secretary signaled a change of tone by citing a 3% growth target, a very modest improvement from the 2% growth regime under the Obama Administration. That’s at most, but also eminently achievable with a bit of deregulation and a reasonable tax cut.
Oil and related names are the big gainers in the S&P 500 today as the oil price continues to creep up.
US-China trade war? Not just yet
As President Trump rails against US trade relationships in a meeting today with manufacturing CEOs, China lauded a decision that may hurt US tire manufacturers. The US International Trade Commission (ITC) concluded Wednesday that subsidized Chinese truck and bus tires did not materially injure US tire manufacturers.
Wang Hejun of China’s Ministry of Commerce responded Thursday that the ruling was “objective and fair,” and that they hope the two countries’ manufacturers will “maintain an open and fair trade environment for the good of the people of China and the US,” Chinese media reported. As Trump continues with his hawkish trade rhetoric, we will have to wait and see whether calmer heads behind the scenes are sympathetic to Wang’s perspective. — Chris Scott
KC Fed data confirms broad manufacturing strength
The Kansas City Federal Reserve manufacturing activity diffusion index printed at 14 this morning, above the expected level of 9. All the regional federal bank indices show a sharp recovery from the doldrums of 2015 and 2016. — David Goldman
Turkish lira back in line with EM index
The Turkish lira has traded in line with the JP emerging markets currency index for the past four years — except for the June-to-January period in which it went into free fall. That was the consequence of the coup attempt that roiled the country last summer. Since January 10, TRY has returned to its old trading pattern with the emerging market index, an important sign of normalization. — David Goldman
Time to rotate to Asia?
Brazil leads year-to-date returns among emerging market ETF’s in US dollar terms. Is it time to rotate to Asia?
Emerging market currency rally continues
The JP Morgan Emerging Market spot currency index continued to surge today, despite the continuing rise of the dollar’s trade-weighted index. EM currencies usually suffer when the dollar is strong (a strong dollar means deflation, and debt-ridden, commodity-exporting EM currencies like inflation). This year’s development is therefore an anomaly, and an interesting one from an investment perspective.
China’s RMB is rising against the dollar despite dovish talk from Treasury Secretary Mnuchin about declaring China to be a currency manipulator (which would give China room to let the RMB depreciate). Mexico’s peso is soaring despite a tough exchange over immigration between Washington and Mexico City. Turkey’s lira continues to outperform. In fact, the EM currency rally has lifted virtually all boats. That suggests a change in the economic outlook: higher world economic growth, lower risk, a revival in world trade, and better prospects for the high-beta emerging markets generally. — David Goldman
PBOC to take lead in asset management regulation: MNI
MNI reports February 22: ” The People’s Bank of China (PBOC), along with the China Banking Regulatory Commission (CBRC), the China Securities Regulatory Commission (CSRC) and the China Insurance Regulatory Commission (CIRC), are drafting a new set of unified regulatory rules for asset management products for all financial institutions.
“The new rules provide a complete regulatory framework for all kinds of asset management products, including wealth management products and would explicitly prohibit financial institutions from offer guarantees that there will be no losses for their products.
“The rules include detailed requirements for asset management products, including upper limits for leverage and risk concentration ratios, according to a draft of the new regulations obtained by MNI.
“Drafting these new comprehensive regulations will enable the PBOC to take the lead in supervision of asset management products, which is ‘very necessary’, Chen Wenhui, vice chairman at CIRC, said at a briefing Wednesday.”
US needs Mexico’s help to tackle immigration: Foreign Policy
From the Council on Foreign Relations Daily News Brief: “The biggest immigration headache for the United States doesn’t originate in Mexico—but requires Mexico’s help to tackle. Illegal crossings into the United States from Mexico have sunk to their lowest levels in four decades, and among Mexican immigrants, the flow has in fact reversed since 2009, at the tail end of the Great Recession. Rather, it’s the violence-ridden countries of the ‘Golden Triangle’—Guatemala, Honduras, and El Salvador—that have been the primary drivers of migration through Mexico to the United States in recent years, as seen in spikes of unaccompanied minors at the border,” Molly O’Toole writes for Foreign Policy.
Asian ETF’s open higher in New York
EPHE (Philippines) +.88%, EWY (Korea) +.71%, TUR (Turkey) +.99%.
French-German yield spread continues to tighten
Unity in the French center raised optimism that the French Establishment would unite against front-runner Marine Le Pen of the National Front, the Frexit candidate. Yesterday Stephane Le Foll, the agriculture minister in the ruling Socialist government, declared his support for the centrist candidate Emmanuel Macron, the rallying-point of the moment against Le Pen. If the French body politic unites round Macron, he will beat Le Pen handily in the May 7 runoff. But there’s still a risk that the fractured Socialists — now far behind in the polls — will refuse to back the centrist Macron and unite around their own candidate. In that scenario Le Pen still could win, so French bond spreads aren’t bulletproof yet. Not by a long shot. — David Goldman
Meanwhile, back at La Rancia
Italian-German yield spreads continue to widen as the Italian government and the Brussels bureaucracy continue to wrangle over terms for the bailout of the Monte dei Paschi Bank. Italy and France are different trades. If Le Pen loses France will stay in the Eurozone and the risk premium on French bonds will vanish. Italy’s economy is a basket case and its political system makes the problem worse. Even if Italy remains in the Eurozone there’s a risk that Italy’s government debt load, now at 130% of GDP, will require an eventual debt renegotiation.
There’s a reasonable case to buy French bonds (although I wouldn’t just this morning). There’s no reason to buy Italian debt unless you are a European central bank and required to do so under quantitative easing rules. — David Goldman
Stock prices rise as real yields fall
Dollar-based investors willing to lend money to the US Treasury for 30 years expect an after-inflation yield of less than 1%. That compares to a 7%-8% return assumption for most pension funds. Equities may be expensive at 21 times trailing earnings on the S&P (or 18 times estimated forward earnings), but that’s still an earnings yield of around 5%, or 3% after inflation. As long as real yields remain low investors will buy equities, barring a major policy mishap. With the grownups back in charge in Washington, the likelihood of a mishap is smaller. — David Goldman
Laggards start to outperform in Europe
Telecoms, one of Europe’s worst-performing sectors during the past year, followed by banks and financial services, led Europe’s market rise this morning with gains of 0.78% and 0.48% respectively at 7:00 a.m. EST. — David Goldman
Asset management reform buoys Cinda
China Cinda Asset Management Co. rose more than 5% in Hong Kong overnight, leading the HSCEI. The rally in asset management shares follows a strong performance by China’s major banks during the past several weeks, and reflects market hopes that structural reforms and regulatory changes will benefit asset managers. China has had a start-and-stop approach to securitization of nonperforming loans, but Chinese regulators are likely to open the way for large-scale packaging of problem assets as part of the overall reform program. — David Goldman
Grownups are back in charge in Washington
Asia Unhedged just watched Treasury Secretary Steve Mnuchin talk about tax reform and market response. “This is a market-to-market business,” said Mnuchin, the former head of Goldman Sachs’ mortgage-backed securities trading desk. Mnuchin cited rising stock prices and a rising dollar as evidence that the market liked what the Trump Administration was doing. He declined to give details of the forthcoming tax package, or to say whether the result would look like the border adjustment tax promoted by the House Republican leadership. People are “running the numbers,” the Treasury Secretary said, and “working behind the scenes.” That’s a marked contrast from public rumination about possible currency war from Trump’s advisor Peter Navarro (as in “Navarro-Navarro Land”), who triggered worries that Washington might try to impose a dollar devaluation on the rest of the world. Mnuchin was poised, confident, and professional.
Asia Unhedged continues to like US equities. Most macro-economists miss an obvious feature of the present landscape: the Obama administration was so hostile to business that even minor shifts in policy have a big effect on business confidence. The most extraordinary fact about the Obama years was the absence of small-business job creation during 2009-2015 (there was a bit in 2016), a reversal of the usual pattern for economic recoveries. A corporate tax cut in any form benefits smaller firms who lack the global accounting apparatus to reduce tax bills, and repeal of Obamacare removes a big hurdle for small businesses trying to expand. A friendlier regulatory environment benefits shale in particular just as higher oil prices make horizontal drilling profitable again. Most important: long-term real yields remain suppressed so the alternatives to equities remain unattractive. — David Goldman