Offshore Renminbi – Change is in the Air

Standard Chartered’s Renminbi Globalization Index is a measure of how the Chinese currency is internationalizing. It is compiled using data on issues such as invoices and payments denominated in CNH and offshore CNH bond deals. The latest readings released in a report this week are for April and they show a 5.2%month on month drop, taking the index back to where it was in February 2014. Since April, the note reports that CNY and CNH were both exceptionally stable especially in May, before the recent strengthening of the currency against the USD. The research team at SCB think that exceptional stability reduces the internationalization of the currency. Moreover, the recent tweaking of the daily spot fixing regime to include a counter cyclical element, could add some volatility to the market, which could thus encourage more international usage of the CNH. The Chinese authorities are determined to stem outflows from China and to defy short sellers of the currency. To that end, they are willing to scale back efforts to globalize the currency. That is very apparent from the reading of the index. Click here for full report.

Food, Glorious Food, is Getting More Expensive

Peter Warburton and the team at Economic Perspectives produce some of the best work we read on inflation, here at Substantive Research, from the very big picture, to a component level and some excellent global heatmaps. We certainly recommend that you take a look at their work. In their latest Global Inflation Update they write that as expected, global inflation has paused after a breathless rush since last summer. While advanced economy inflation is seen to be consolidating, emerging economy inflation is waiting in the wings to shock and surprise. This inflation will migrate through supply chains and networks to drive a second wave of global inflation. Click below if you’d like access to their reports on inflation. They’re very happy to provide samples.

ECB and the ‘More Core’ Inflation Rate

You’re probably full on ECB previews, so we’ll steer clear of that today and highlight some work from TS Lombard that delves into looking at how inflation can be measured in alternative ways. TSL write that with inflation being a key factor in ECB policy, the spotlight will remain on core HICP inflation and its various influences, including the output gap, labour market slack and wage trends. To that end the ECB has created its own measure of underlying inflation, known as ‘super core’, which includes HICP items which have a significant relationship with the output gap. The idea here, say TSL, is that it will allow the ECB to obtain a better gauge of potential turning points in core inflation in response to changes in economic conditions. TSL have gone a step further with their own ‘similar but different’ model. By following a similar methodology to the ECB, but adding in measures most sensitive to a closing of the output gap, which they call the ‘more core’ inflation rate. Using similar values for output as the ECB estimates, and adding additional HICP items considered statistically significant, the ‘more core’ measure of inflation shows signs that it has been picking up since autumn 2016. If you would like to read the full note, click below to contact the provider to request access.

Japan; Inflation Imminent but Tapering is Not

We’ve been reading a lot lately about declining inflationary expectations in Japan and so wanted to highlight this non-consensus piece from UBS, published late last month. According to the report, the BoJ’s inflation forecast misses have stemmed largely from the consumption tax weighing on growth plus the plunge in oil. Assuming no further policy mistakes or exogenous shocks, econometric modelling shows how an increasingly positive output gap alone should lift core CPI through 1% over the coming months. To secure the 2% target, however, requires a significant step up in expectations, writes James Malcolm, chief economist for Japan at UBS. According Malcolm, herding behaviour in pricing could be key because which in Japan tends to cluster around fiscal year- and half-year end points. This October will be a litmus test for gauging underlying inflation pressure given newfound labour market tightness, says Malcolm. Meantime, investors shouldn’t get hung up on tapering, Malcolm adds. Fear that the central bank will soon adjust its stance on yield curve control is misplaced. This is likely to happen in 2018 at the earliest. UBS clients can find the full note under the same title above on UBS NEO.

Blockchain and Digital Fiat Currencies

With all the hype about bitcoin currently we thought we’d highlight some sector research that encompasses bitcoin. CM Research continue to impress with their extensive thematic reports on emerging investment themes in the technology sector. This report focuses on blockchain technology, which they argue will be a radically disruptive and transformative force in the world economy by 2030. Within the next 12-18 months there will be early evidence of its scope and prospects, the report says. The section on digital fiat currencies can be found on page 14. These ‘single theme’ reports fit into CMResearch’s overall research methodology – where they produce four tiers of thematic reports to help their clients select stocks: Single Theme, Multi-Theme, Sector Scorecard, and Best Ideas Report (These reports include our high-conviction stock ideas). If you’d like access to the vast amount of research CM Research have published in this space click below to contact the provider directly.

Gold Monthly: An Uncertain Future

In the latest edition of their comprehensive gold monthly Redward Associates decomposes the main drivers of gold prices to understand the supply and demand dynamics and the valuation outlook. Redward has a mildly bullish stance on gold, where he believes that the US economy will continue with the re-emergence of inflation and a gradual tightening of monetary policy, leading to temporary strength in gold. Redward’s gold model is driven by the value of the USD — after all gold is priced in USD — the yield on 10-year government bonds which captures the opportunity cost of holding gold, and the Bloomberg base metals index which captures substitute stores of value and also acts as a proxy for global demand. At present, this model suggests the ‘fair value’ for gold is around USD1,274/oz, implying modest near-term upside to the price of gold, while a decomposition of the constituent drivers suggests that it’s been boosted by all three factors. If you’d like access to this monthly report, click below to request from the provider directly. They are happy to provide on a case-by-case basis. Redward also produces an excellent Iron Ore and Steel Monthly and a Dairy Monthly (where we consider Redward to be the industry expert).

The End of the Reflation Trade & Stocks

Last year markets were “surprised” by the reflation trade, only catching up with it after Trump’s election, and then into the first quarter. One analyst who was well ahead of the game was Julian Brigden from MI2 Partners, who made a very early call on the reflation trade in Q1 last year. In March of this year Brigden suggested the trade now faced disappointment as cyclical growth/inflation data peaked. This proved to be correct again. In his latest piece Brigden turns his attention to the impact on US stocks. His analysis points out that prior oil induced growth/inflation cycles (like H2 16 into 2017) ended with sharp equity corrections. In terms of the structure of current equity markets, since Trump’s election the market has been characterised by heavy rotation and a narrow breadth in stick allocation, therefore, bubbles should be a major concern, concludes Brigden. This report focuses on some of the momentum stocks that are driving the majority of the gains in the US equity market, many of which are starting to exhibit “classic bubble” characteristics. Purchase this piece on RSRCHXchange, alternatively contact the provider directly.

The Rocky Road to Reflation

With Central Banks questioning the determinants for a rise in inflation and the economic data showing a disappointing picture, Goldman Sachs revisits its bottom-up inflation model to reassess the inflation outlook. Many of the largest drivers of the decline seem to be unsystematic. The most significant of these is the sharp decline in cell phone service prices which reduced the core by over 19bp alone over the last three months, states GS. Other components also slowed meaningfully, including motor vehicles, motor vehicle insurance, and apparel. The second largest contributor to the decline, worth about 6bp, was a deceleration in shelter inflation. By considering these idiosyncratic components, the economics team at GS recreated their model which disaggregates the core into 19 components. Their results highlight three main reasons why core inflation is likely to rise. First declining slack and rising wage growth is a driver of the acceleration. Second, the very large decline in cell phone service prices will drop out in 2018 and appears unlikely to be repeated. And third, the driver of the acceleration is the fading effect of dollar pass-through on both core goods and the foreign travel services category. The GS team still believes that despite weak inflation numbers, two additional rate hikes and the announcement of balance sheet runoff will happen this year since the negative inflation surprise has coincided with a roughly equivalent upside labor market surprise. Goldman clients can view the full note of the same title above on Goldman 360.

Brazil; 8 Reasons to be Cheerful

Are strong fundamentals enough in Brazil’s unstable political environment? Richard Briggs from Credit Sights believes so. He argues that even though, corruption allegations in Brazil drove large swings on Brazilian assets last week, now the dust is settling, and it’s worth looking at the fundamentals. This note discusses 8 reasons why Brazil’s debt position looks stronger than other emerging markets. The scandal is likely to bring further volatility in Brazilian sovereign and corporate bonds as new revelations emerge, but the fundamental story is strong enough to build exposure on any new weakness, says Briggs. To read the full note, click below to request from the provider directly.

Gold Remains Expensive Insurance

In this note, Grant Sporre head of metals strategy at Deutsche Bank, walks the reader through the definition of gold for valuation purposes. By comparing different metrics, gold appears to be overpriced, unless seen as a reverse currency. DB developed a four-factor model with a correlation coefficient of 87%, with discrete periods when gold trades above the model forecast as well as below, explained by the market going through a period of heightened risk perceptions. However, even though the model suggests an overvaluation, there is a short-term scenario (3 month) which would justify gold trading higher, says Sporre. DB clients can read the full note on the bank’s research portal.