Increased UK Tail Risks for Gilts and GBP

Sean Maher of Entext reckons tail risks are now rising for long-dated gilts and the GBP. Previously he’d taken a sanguine view of the UK referendum result last summer, because it simply wasn’t a systemic event for global markets, but since the election less than two weeks ago, he’s changed his mind. Moreover, helped by a Eurozone rebound, the economic fallout from the referendum was likely to be delayed, but it is now becoming apparent as real wages and retail sales soften, writes Maher. Add to that, UK voters have had enough of austerity, and there is now the growing prospect that Labour could come to power with a radical, interventionist agenda should the minority Conservative government implode under the stress of Brexit negotiations. Indeed, if this were to happen, a UK government would no longer be constrained by EU state-aid and competition regulations after 2019, so it could tax, nationalize and subsidize with nothing much to impose discipline apart from the bond market. Entext research can be purchased on RSRCHXchange.


Global Asset Allocation: A Disinflationary Boom

Sean Darby, chief global equity strategist at Jefferies writes  that the backdrop today is eerily similar to the late 1990s. Investors and CEOs have been paralyzed by a succession of ‘political shocks’, ‘euro break-up threats’ and ‘border taxes’ but inflation pressures have remained remarkably subdued. Furthermore, the threat from the digital economy has been replaced by the perils of ‘AI’ and ‘the internet things’. Today, companies are facing an onslaught of technological shocks to their business models. What ended the cycle? After Y2K occurred, the Fed lifted rates which eventually evaporated the cheap financing that had underwritten the technology boom. But the after effects of disinflation have been recirculating in the global economy ever since and the central banks are facing the all too familiar problem of low inflation and asset bubbles today. In this report, Darby sets out his team’s latest asset allocation recommendations. Jefferies clients can read the full note of the Jefferies research portal.


How the Weak Dollar Solves the Fed’s $2 trillion Problem

As long as the dollar keeps weakening, the effect of the Fed’s normalisation policy on US Treasuries will be muted. The Monthly Flow Report authored by Vincent Deluard from INTL FCStone explains the mechanics of foreign purchases of US Treasuries, which are largely driven by currency pegging regimes. As the dollar weakens, so these official agencies of governments – mainly in Asia – are forced to buy more US assets. This will allow the Fed to reduce its balance sheet, without having a precipitous effect on US Treasury yields. If you’d like to view this piece click below to request access from Deluard directly.

Gauging Spillover Risk from a Potential CNY Regime Shift

The J.P.Morgan FX strategy team looks into the shift in the daily CNY fix to see what risks might arise from the changes. It concludes that there is a low risk these new developments spilling over into other markets. They point out that the PBoC has repeatedly surprised the market in recent years. Sometimes this results in a protracted global macro reaction. Other times it is just treated as a local market idiosyncrasy. They believe that this new regime shift will be treated as a local issue. Of the move itself, they think it might be a reversal of the August 2015 floating of the fix, which brings back some discretion to what was a market based regime. This does not fit into the dominant China macro story line of slowing growth, increased financial repression and worries of a hard landing. But coming at a time of recent weakening of the USD against the currency, and heading into the NPC, it does hand more control back to the authorities. JPM clients can view the full note, JPM FX Weekly, on Morgan Markets.

Dr Copper and the ‘’Other Guys in the Oil Market’’

Here we highlight 2 separate BCA pieces that span the commodity complex and which consider the wider macro impacts. The first piece, contained within their US Investment Strategy report entitled: Still Awaiting The Next Pullback, they look at the price action of copper and other base metals and conclude that recent falling prices are not signaling a softening of global growth. In the second report, The Other Guys In The Oil Market, Redux, BCA look at the oil market examining the production outlook for the so-called ‘’other guys in the oil market’’ who account for half of the global supply. They conclude that outside of the three regions of sharply growing production (U.S. onshore, ME OPEC and Russia) that investors have primarily focused on, the other half of global production has been stagnant to declining, despite high oil prices and high levels of drilling during 2010-2015. If you would like to access these reports, or trial BCA’s extensive product suite, click below to contact the provider directly.

Fed Shaken?

Steven Blitz joined TS Lombard in March this year, bringing with him a reputation for deep data analysis when looking at the markets. In a recent edition of TS Lombard’s US Watch Weekly report, he provides some perspective on the most recent weak payroll number and what it might mean for the Fed’s outlook. He believes the low print will not be enough to knock the Fed off the path it has set itself. This makes the bull flattening of the yield curve slightly puzzling. Blitz believes that it is due to the global demand for dollar collateral for dollar lending, given global growth rates. Moreover, the Fed is very aware of the global demand for dollar assets and is taking this into account as a way of softening any effects of its normalisation process. For access to more of Blitz’s work click below to request from TS Lombard directly.

Scrapping it out in China’s Steel Market

What’s driving iron ore prices lower? A number of reasons are being put forward, including the continued rise in port inventory. Perhaps the more interesting reason -with longer-term implications – is the rapid rise in the use of scrap metal. So we wanted to flag up this piece from the Caixin Insight Group, who take a quite detailed look at this new dynamic in the China steel market. Scrap steel will increase significantly in the next decade, and result in the overall supply of scrap steel to increase substantially over the next decade. CIG believe that iron ore demand will decline by 5% and prices will come under pressure if domestic supply of scrap steel is sufficient in 2017.

The Complications of a $40-$60 Oil

JPMorgan’s John Normand writes that the recent OPEC/Russian decision to extend output restraint into 2018 has disappointed a consensus apparently expecting deeper cuts, while reinforcing perceptions that crude should maintain the $40-$60/bbl range it has held for the past 12 months. As a result volatility in oil, which is one of the few markets where implieds have resisted a global downtrend towards decade (FX, rates) or multi-decade (equities) lows, is falling quickly. As comforting as the prospect of a lower-vol oil market might seem, a $40-$60/bbl zone is depressed enough in terms of average prices and wide enough between the barriers to complicate a few, typical reflation trades like shorting bonds, owning inflation breakevens and owning some commodity currencies over the next year, says Normand in this report. Of course, ranges do not persist indefinitely for the simple reason that underlying fundamentals are fluid, so it’s worth thinking about both the short-term opportunities and medium-term risks from the environment that OPEC is perpetuating, the report says. Normand makes three key observations: 1.) Even with production restraint, average oil prices should remain near decade lows and below most producers’ fiscal breakevens. 2.) Low average prices have created only a few, one-time winners (narrows trading opportunities. 3.) Volatility within a tighter $40-$60 range is non-trivial for markets with position skews. JPM clients can read this piece on Morgan Markets.

Why a China Hard Landing is Unlikely

Simon Hunt, from Simon Hunt Strategic Services, is a veteran China analyst with a focus on the changing geopolitical and financial structures in China. From his most recent visit, Hunt reinforces his bullish stance on the country’s future growth. While the market would disagree on his optimistic views given the high levels of debt, a financial crisis on the horizon, growth slowing down and the aggressive foreign policy, Hunt explains his positivity towards the region. In his first report, he addresses the clear concerns of the market but argues that the strong signs of the economy lead to an upbeat outlook. With rising productivity, due to the leadership’s focus on automation, innovation and the development of new and evolving industries centered around the ‘Internet of Things’ and the development of a cleaner environment, says Hunt, the focus shifts towards the State Grid, infrastructure investment and commodities consumption ( see part II). Hunt’s expected infrastructure growth gives a positive outlook in China’s copper consumption which already exceeds 40% of the total worldwide demand. His notes from his latest trip, present an interesting and unusual argument about China’s future. His two-part report can be purchased on ReseachPool, alternatively contact the provider.

The Fed’s Balance Sheet – Mind the Gaps

Expect two small rate hikes at the next two meetings and then the Fed will start reducing its balance sheet, perhaps even by October this year. So say MIG in an extensive special report on the Fed’s balance sheet. Not only does the report have a thorough Q&A giving the background to the current thinking of the Fed. It also makes the point that the market is discounting an aggressive Fed normalisation path because the Fed has not been aggressive in raising rates. At root this is a communication problem for the fed. But it also leaves US Treasuries and in particular MBS paper, very mispriced.