QT: Term Premiums Not Responding Yet in US; Beware the European “zombies” When QT Comes

Bond term premiums have responded very little to Fed QT so far, say BAML in a report entitled ”Quantitative Frightening” published two weeks ago, adding that Central bank balance sheets are likely to remain large for the foreseeable future. This suggests a limited bond market sell-off and limited spillover into other asset classes. Writing in last week’s Rates Weekly, BAML strategists argue that the back up in yields is mostly due to healthy factors, including strong economic data, repricing Fed expectations, and technical factors. They expect rates to stabilize around current levels in the near term, but look for a modest further extension in coming quarters. In a separate note on QT effects, BAML’s excellent credit strategy team look at Europe where they write that investors need to beware of the multitude of “Zombie” companies that will find it harder to get funding in the absence of a QE backstop. BofAML sees a risk of a ”flash” jump in defaults in 2019. At risk are companies with largest relative growth in their debt outstanding through the QE era. They provide a comprehensive list of those companies at risk and a list of the safer names.


CNY Trading Volumes Spike the most Since 2016

Exante Data is a research firm founded by former Goldman Sachs and Nomura strategist Jens Nordvig. The firm has developed a global flow analytics platform that is designed to extract directional asset price signals from detailed capital flows analysis. Contained within the platform, they have a specific model that tracks flows for China, and in a report published Friday they highlight last week’s China FX flow data, where they say Friday saw the highest CNY trading volume since 2016, indicating that there is some significant nervousness in the market. Exante also include analysis on the fixings, forward points and an update on their CNY Equilibrium framework, which they say provides a more forward looking sense than traditional fair value models. Their equilibrium rate seems to suggest further weakness in the currency.  Here’s some information on Exante’s product in their Exante primer.


This Equity Market Fall is More Worrying Than in February

Ekins Guinness have developed a disciplined rules-based approach, based on Value and Trends/Momentum, which avoids opinion, emotion and forecasting. We think its key attribute is as an objective navigational tool for identifying turning points and opportunities, outright or relative value. In this report they say that the current equity market fall is more worrying than the setback in February. The Ekins Guinness model is designed to look through corrections, which can sometimes be vicious, but to avoid major or extended bear markets. This couldn’t be more relevant to market price action in recent weeks. Their model has been in equities since mid 2016 but was getting close to reducing equity allocations.  Now that’s come down to the lowest level for over 2 years. It could come down further, possibly significantly, Ekins Guinness say in their latest report. Click below to request a sample of their latest report.


A Case for EM Equities Re-entry is Building

The case for EM equities is steadily building, but it’s still low-medium conviction at this stage (pending greater move on sentiment, macro, value), writes Callum Thomas from Top Down Charts. One stand out fact favouring EM equities is that EM equities is now trading at a 30% discount to DM equities on a forward PE basis. On an RV basis it is also interesting to note that the apparent long-term double bottom in EM vs DM relative performance remains in play, Thomas adds. Furthermore, the equity risk premium for EM is likewise beginning to look attractive relative to history. However, not all of the pieces of the puzzle have fallen into place, TDC says. The earnings/macro pulse and sentiment aren’t quite sending the right signals yet. TDC is a weekly must read here at Substantive, with their excellent chart-based approach.


China’s Belt and Road Initiative May Bypass Trump’s Tariffs

Trump’s tariffs on China could end up looking like an outdated gesture if China expands its range of trading allies and reduces its dependence on the US through the Belt and Road Initiative, writes Standard Chartered in a special report published last week. The report argues that financial markets under appreciate the speed at which trade and investment between China and BRI partner countries is expanding. StanChart are well placed to make that judgement, with its footprint covering much of the OBOR roadmap. The report says trade between China and BRI countries is laying the groundwork for renminbi internationalisation, with some countries, like Vietnam and Malaysia, standing to emerge the winners as US trade tensions accelerate factory relocations. But, the sheer scale of the project presents significant challenges too, the report says. For instance, the BRI needs better and more transparent debt management to be sustainable. Countries such as Sri Lanka are being overburdened with debt due to Chinese investment. This crowds out more viable investments and raises country risk premiums. China may benefit from a Paris Club-like collective approach to handling distressed debtors. SC clients can read the full note via the research portal. Click below. If you’re interested speaking with StanChart analysts about OBOR, click here.


China; Building The Northern Powerhouse

The endless supply of capital to China’s local government projects is a thing of the past. After a decade of splurging on infrastructure projects, China’s local governments are now having to cut back. But Beijing has continued to pour money into centrally supported initiatives, particularly Xi Jinping’s pet project for developing the region surrounding Beijing. In this piece, Gavekal’s Tom Miller reports on how this northern mega project is progressing. Click below to request this as a sample from Gavekal directly.


And the Latest Upside Inflation Surprise Comes from…..Oslo

Don’t get carried away with buying the NOK today after Norway’s latest inflation data came in above forecast today. This does not mean that Norges Bank will suddenly accelerate its rate hike cycle, say Commerzbank in a note today. In September, when it hiked interest rates, Norges Bank made it clear that it will stick to a very gradual rate hike cycle. It will also tolerate inflation temporarily overshooting its inflation target. Of course its tolerance is not unlimited, say Commerzbank, but the central bank expects inflation to slowly ease off a peak of 3% in the autumn anyway. According to Norges Bank’s forecasts the core rate will only peak in the second half of next year before weakening again. So, Commerzbank concludes that as long as the path of these projections does not change, Norges Bank will not change its view either. That means that over the coming months price data well above the inflation target should not irritate markets. A gradual rate hike cycle suggests that NOK will appreciate against the euro over the coming quarters, but short term the oil price remains the main driver in NOK, they say. Commerzbank clients can read this note and other notes from today including the how there seems to be a growing period of disenchantment with the euro as among other things, Macron is losing his shine.


Declining Japanese Policy Uncertainty; Another Buy Signal for Equities?

Post the chronic summer heat waves in Japan (We thought we had it bad in UK/Europe), there have been some major events that have come and gone -without major incident, it must be said – and which have now cleared the path of uncertainty for investors, writes Yujiro Goto from Nomura’s FX strategy team. Neither the BOJ meeting, the LDP leadership election or the US-Japan summit meeting provided major negative surprises for markets. The question now is, what does that mean for Japanese asset prices? Goto looks at historical patterns of policy certainty/uncertainty as a guide, and finds another tailwind for local equities and USDJPY. Nomura clients can read on the via research portal here, Other interested readers, click below.


Financial Conditions Too Easy; Fed Left Battling a Bear Steepening

In light of recent moves in long-term yields, we wanted to highlight this prescient piece by Julian Brigden from MI2 Partners published last month where he argued that the spread between 2yr and 10yr Treasuries was exaggerating the level of monetary tightness. That’s because when bond markets are this manipulated it is important to look beyond the curve to the level of underlying rates. At the same time, stoked by the Administration’s fiscal stimulus, inflationary pressures are continuing to build both in the form of PCE and CPI, but most importantly in wages which, after the best part of 3 years of treading water, are finally accelerating. The result is that Brigden expects to see 3.25% Average Hourly Earnings by spring next year. All this leads to a scenario which, unless it is quickly countered by a significant acceleration in the current path of rate hikes (unlikely), could easily leave the Fed behind the curve and battling a “bear steepener”, as yields at the long end spike, as we saw last week. MI2’s piece also comes with a trade recommendation, where Brigden recommends swaptions as the preferred instrument instead of cash. Even considering this week’s moves, Brigden told us last week that this is still a good entry point because IF we have really broken key levels in the long-end,  then it’s a multi year move to 4.5% in the 30-year part of the curve.


High Vacancy Ratios are Red Light for Labour Market Inflation

Inflation is a multi-faceted phenomenon with roots in demographics, socio-economic tensions and political contexts as well as monetary conditions, according to the  Economic Perspectives Global Inflation Update for September. Inflationary pressures are building most strongly in advanced economies, as shown by producer prices and labour market cost measures, the research shows. In fact, labour shortages are spilling over into wage bill acceleration, the research argues. Vacancy ratios in the US, the UK and the euro area are now flashing bright red. G7 GDP weighted unit labour cost annual growth is moving upwards, as is G7 wage bill annual growth, charts from Economic Perspectives indicate.