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The answer to "What's going to give the Fear Index a boost ?" was staring us in the face all along .... The threat of Thermonuclear War,...

August 11, 2017

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The problem with playing catch-up is where to begin ? China .... ? Oil .... ? Turkey .... ? Anyway, some quick thoughts .....

June 27, 2018

 

ref :- "China's Yuan Drop Blindsides Traders, Spurs Worry on Impact" , Bloomberg Markets

ref :- "OPEC Supply Buffer Shrinks as it Heeds Call to Pump More Oil" , Bloomberg Markets

ref :- "Erdogan election honeymoon fades fast for assets" , Tail Risk, The Financial Times, Markets & Investing

 

CHINA :

 

It's all too easy to jump to conclusions in any walk of life, but in this business that can be a particularly dangerous pastime. For example, since the currency took a slide in August 2015 we've become accustomed to seeing the People's Bank of China keep pretty firm control of the value of the Yuan / Renmimbi (hereafter referred to as simply "Yuan") . So its recent fall in value  --  0.5% a day for the last three days and from below 6.40 versus the dollar to above 6.60 in under two weeks  --  represents a significant move. But just how significant ?

 

Since it's the world's second largest economy it sometimes seems strange to still refer to China as an emerging market. That's what it is, though  --  albeit a very large one  -- and it's the anchor to which to some degree or other all emerging nations are attached. For that reason alone, the move merits the tag "significant". But there are people  --  and it's not such an outlandish idea that we should label them as conspiracy theorists  -- who see something deeper in all this. As part of the escalating trade war (can we now call it that ?), they would maintain that China's loosening of the reins on their currency is deliberate and that a recent easing of financial conditions by the central bank is further evidence of that fact.

 

Mmm .....we're not so sure about that, not yet anyway. Some argue that the whole trade thing is just part of Mr Trump's bullying (and successful) negotiating style somehow akin to his threatening to annihilate N. Korea just weeks before becoming bosom-buddies with its leader. We're not sure about that either. But what is undeniable is that taken at face value, the trade war/spat/dispute is degenerating fast and weakening the currency would be an effective weapon if China felt that it was short of leverage given the direction of travel of most China / US trade.

 

But .... it seems more likely that the motivation behind any doveish central bank moves is a faltering in China's growth prospects, something that Beijing would be loathe to accept. One also has to accept that with the deadline to the imposition of tariffs fast approaching (July 6th), some weakening of the Yuan is to be expected. But beyond all that, the main reason why we doubt that the fall in the currency has been deliberately engineered lies in painful memories of that devaluation in 2015. The capital outflows that would be the result of major currency weakness would seem to be much too big a price to pay in terms of its effect on the economy. But things may change of course, and will bear close watching .....

 

OIL :

 

Okay .... now that the dust has settled on the OPEC meeting , how are we left ? Trouble is, the dust hasn't really settled at all. We know that OPEC + agreed to pump 1 million more barrels per day to keep a lid on prices, and that the decision was a victory for the Saudis and their allies and Russia, at the expense of Iran and Venezuela in particular. Sounds a bit bearish for prices, right ?

 

Now, regulars might know that we get a bit nervous when everybody starts talking the same way but contrary to the intentions of OPEC +, everywhere we look this morning people are suggesting that the risks to the price of crude is on the upside .... and it would seem to make sense.

 

The Saudis will make up the large part of the increase in production (they're the only ones with plenty to spare), but that will leave the world with a buffer equivalent to just 2.6% of global supply. That means that OPEC's ability to react if there are further disruptions to supply is going to be pretty limited. And guess what ? There are plenty of those on the horizon .... in Angola and Nigeria, and in Libya where production of 400,000 bpd was lost last week due to attacks by militias and which remains vulnerable to more disruption.

 

And then there are the two big ones :  1.) Venezuela, where production has already dropped by 40% since 2015. As that sad nation sinks deeper into recession, civil unrest, worker exodus and legal attacks from former commercial partners, one can only expect further lowering of production levels. And 2.) Iran, of course .... and President Trump is now pushing for the US allies to cease buying Iranian crude entirely by November. That would effectively take 1.5 million bpd from the market.

 

Right now, the supply/demand equation is finely poised, but the consensus seems to be that the balance of risk for the future is on the side of a shortfall of supply. Is there any reason why we might see a slackening in demand ? Slower global growth perhaps, or even a global recession ? It's a bit pessimistic, but a global trade war that turned very nasty might do the trick, we suppose .....

 

TURKEY :

 

Fascinating .... We heard the news about President Erdogan's victories in both the presidential and parliamentary elections at the weekend and fully expected Turkish assets to be on the retreat on Monday morning. Definitely NOT the case, as it turned out.... the opposite was true. There we were thinking that giving Mr Erdogan free rein must imperil the independence of the central bank and magnify the chances of him applying his own rather eccentric economic beliefs to a mighty problem, which is to say that the way to lower inflation is to LOWER interest rates (yes, really !) In the event, the markets were concentrating on the certainty that the election provided .... and liking it.

 

Now, we often hear (and repeat) that markets HATE uncertainty .... and it's absolutely, undeniably true. But there are limits ..... and after a few hours, the market gains were more than reversed when investors began to think about what Mr Erdogan's sweeping victories (well, with the help of a coalition partner) might mean for Turkey economically. It was one of those moments that the quick-witted had an opportunity to make some money .... IF they maintained the courage of their convictions, which is not always easy to do when the markets are heading against you. Actually, as we write the markets have headed back to where they started from, which suggests that nobody's quite sure which way things will go.

 

At one level, that too is a surprise. Above and beyond his thinking on interest rates, Mr Erdogan is committed to huge infrastructure spending to maintain growth rates (above 7% last year). Massive projects revolve around the centenary of the founding of the Turkish Republic in 1923 by Mustafa Kemal Ataturk, who remains a hero to many Turks. As another nationalist, populist leader, albeit neo-Islamic rather than secular like Ataturk, Mr Erdogan might look fondly on any comparisons, but the trouble is that this kind of policy is exactly the sort of thing that has put Turkey in trouble. The economy has overheated, bringing a large current account deficit and inflation over 12% and rising. That, in turn, undermines the currency .... what the economy needs is rigour and discipline, and the LAST thing it needs is more stimulus.

 

 

We know what the elections mean for democracy in Turkey, and the news is probably just as bad for Turkish relations with the EU and the West. We ought to be worried about what an Erdogan without domestic restraint might do to the economy. But there is one very significant source of restraint that the President will have little or no control over ..... the markets. If they take a very dim view of what he's up to, they'll make life very uncomfortable for him indeed .....

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