Financial markets calm in Feb after Jan’s chaos; all eyes on China cbank

Subdued inflation could force policymakers to postpone rate hikes

United States

After a volatile start of 2015, the Chinese Yuan spent most of 2015 trading in a very narrow range before authorities decided to start devaluating the currency in August of last year.

In 2016, all eyes turn to China to determine whether the PBoC will continue on the devaluation path in an attempt to reclaim their lost share of global growth in a global deflationary environment.

After a rocky January, February seems to have brought some markets calmness, especially after the minutes of the latest FOMC meeting were released during the week.

Globally, with the ongoing persistence of the oil glut known to be the main reason for oil prices to linger near the lows, only an acceleration of the global economy could see prices move in the other direction. With the IMF and the OECD downgrading global growth amid the Chinese slowdown, oil prices aren’t likely to move higher in the short term and market stress are likely to come back in 2016. Moreover, as global inflation continues to be subdued, policymakers would rather postpone any rates hike. In some cases, as in Japan and Europe, Central banks are even reducing rates into the negative territory to try to spur growth in their respective economies.

As January proved to be a difficult month in term of US fundamental news, various economic indicators improved again last week with both initial jobless claims at 262k against expectations of 275k and the Philly Fed manufacturing index at -2.8 against expectations of -3.0. The improvement in the four-week moving average for claims was seen as positive in the current environment. With expectations of the next Fed hike pushed all the way to February 2017, the current calm environment could continue and volatility might drop in the short term.

For the moment, all the attention is shifted towards commodities, especially oil prices and the global economic slowdown.

On the foreign exchange side, the Yen remains very volatile trading between a high of 114.87 and a low of 112.31. The currency performance continues to be highly negatively correlated with the Nikkei, and investors continue to sell the rally in the Dollar while awaiting further action from the BoJ. The latest measures taken by the BoJ to cheapen the currency have failed for now and sent a negative signal to equity markets.

The Euro on the other hand lost some ground against the Dollar this week. The ECB verbal intervention continues as Draghi vows to do whatever it takes to spur Europe economic growth. The Euro fell under pressure and dropped to 1.1130 by the end of the week.

Despite the good economic figures in the UK, and the signs of progress in the ongoing negotiations between the UK and EU this week, the lack of agreement left the Pound stranded, closing the week around the 1.4406 level. The short term direction in the currency remains highly dependent on the progress, or lack of it, of the talks in Brussels.

On the commodities side, this week’s negotiations in Qatar yielded little in terms of a fundamental change in either OPEC calling for non-OPEC cooperation, or market expectations of supply growth this year. As talks moved from cuts to a freeze in production, such a freeze would come from producers who weren’t expected to raise production such as Russia, Venezuela, Saudi Arabia and Qatar.

The IMF published an update to its World Economic Outlook last week, saying that the pick-up in global growth was weak and uneven across economies, with emerging markets and developing economies set for slower growth. The Fund projects global growth of 3.4% this year down from 3.6% in October and 3.6% in 2017. The IMF estimates that the global economy grew 3.1% last year. According to one of the director of research, “This year is going to be a year of great challenges and policymakers should be thinking about short-term resilience and the ways they can bolster it, but also about the longer-term growth prospects.”

In parallel, the Organization for Economic Co-operation and Development also cut its global growth forecasts last week. According to the report, the world economy is expected to growth by 3% this year lower than its previous forecast and the same pace as 2015. That included a downgrade to its US forecast to 2% this year while China is expected to grow 6.5%.

In a complete turnaround for one of the most Hawkish members of the Fed, James Bullard, St. Louis Fed president said it would be “unwise” for the U.S. Federal Reserve to continue hiking interest rates given declining inflation expectations and recent equity market volatility. For much of last year, Bullard argued for an earlier rate hike, but said he now feels key assumptions supporting higher rates have been undermined.

Inflation expectations have fallen “too far for comfort,” making it more probable inflation itself will fall and continue to miss the Fed’s 2% target. “I regard it as unwise to continue a normalization strategy in an environment of declining market-based inflation expectations”. In addition, declining equity prices and other tightened financial conditions have made dangerous asset bubbles “less of a concern over the medium term.” In parallel, San Francisco Fed President Williams stuck to his view that ‘a gradual pace of policy normalization as being the best course’. Williams said that the US economy ‘still needs a gentle shove’ from monetary policy headwinds but that the economy is ‘all in all, looking pretty good’. On the popular topic of negative rates, Williams said that the chances of the Fed cutting rates below zero were ‘very remote.’

The latest Philadelphia Fed manufacturing survey for February suggest the manufacturing ISM is likely to remain in contractionary territory. The ISM Philadelphia declined to 44.7 in February in comparison to 47.5 in January and matches its recent October 2015 low. As long as the manufacturing ISM survey remains below 50, investors are likely to continue to worry about the US growth outlook.

This week’s housing starts also dropped, however according to analysts, this could be a direct relation to the bad weather experienced in January in some parts of the country. Industrial production came at 0.9% on a monthly basis against expectations of 0.4%. The number picked up strongly despite the downward revisions to the previous month.

The release of the January FOMC policy meeting minutes this week pointed towards the fact that the Fed was still in a wait and see mode, keeping options open but with clear uncertainty around the outlook.

Members turned their attention on the factors driving the turmoil in markets with the minutes showing that “while acknowledging the possible adverse effects of the tightening of financial conditions that had occurred, most policymakers thought that the extent to which tighter conditions would persist and what that might imply for the outlook were unclear, and therefore judged that it was premature to alter appreciably their assessment of the medium-term outlook”.

This week ECB minutes didn’t offer a whole lot new with the text revealing that the governing council was unanimous that policy ‘needed to be reviewed and possibly reconsidered’ at the March meeting, although there were some hints from certain policymakers that it would be ‘preferable to act pre-emptively’ rather than ‘wait after risks had fully materialized’.

Markets are expecting the ECB’s deposit rate to be cut another 10 basis points to -0.4% next month, while the 60 billion euros quantitative easing programme launched a year ago is likely to be increased. However, Jen Weidmann, president of the Bundesbank remains against the extension of the ECB’s asset- purchase program.

On the data front, France January consumer prices index came at -1.0% on a monthly basis with the Yearly figure staying unchanged at a +0.2%. The downturn in January came mainly from a seasonal fall in manufactured product prices and from the drop in prices of services tourism-related.

In Germany, the ZEW survey was out this week with the current situation index plunging by 7.4 points to 52.3 against market expectations of 55.0, the lowest in 12 months and clearly a reflection of the European banks, global growth and China woes which have played their part this year. The expectations survey came slightly better, dropping 9.2 points to 1.0.

This week, UK retail sales jumped the most in more than two years in January on the back of demand for clothing and computers. While expectations were for a increase of 0.7%, the figures came at 2.3% almost three times the pace of growth forecasted by economists. According to the report, growth was helped by post-Christmas price cutting as retailers looked to clear excess stock. On a yearly basis, retail sales rose 5.2%.

Asia

As China comes back from a week of holidays, markets were calmer following comments by the People’s Bank of China’s governor, saying he saw no basis for continued depreciation in the currency.

On the data side, exports fell 6.6% on a yearly basis in January following a 2.3% gain in December. Expectations were for a gain of 3.6%. It was the biggest fall in exports since the 8.9% drop in July 2015. In Dollar terms, the drop was bigger, with exports dropping 11.2% on a yearly basis. Imports also dropped 18.8% in dollar terms from a 7.6% drop in January versus expectations of a drop of 3.6%.

Chinese January inflation numbers were also released this week. CPI figures were up by 0.5% on a monthly basis driven by a surge in food prices with non-food prices relatively stable. The yearly rate was up by 1.8% although slightly less than market expectations of +1.9%.

On a different front, after a record lending figure of 2.51 trillion Yuan in new loans in January 2016, the People Bank of China decided on Friday to boost the amount of reserves some banks must lock away as it moves to contain risks after a January surge in credit by smaller lenders. The targeted increase in the reserve requirement ratio will affect regional banks. The step taken by the bank to increase the reserve ratio is aimed at curbing financial-system risks and doesn’t necessarily amount to monetary tightening by the PBOC.

This week, figures showed the Japanese economy shrank at a rate of 1.4% in fourth quarter down from a 1.3% advance in the third quarter and worse than expectations for a 0.8% contraction. Moreover, industrial production fell more than expected by 1.7% in January, compared to the 1.4% fall originally released by Japan’s economy ministry.

On a yearly basis, it fell 1.9% against expectations of 1.6% drop. The figures are likely to put additional pressure on the BoJ to support the economy.

Kuwait

The USDKWD opened at 0.29885 on Sunday morning.