Articles in Category: Macroeconomics

Last week was quite the week in Europe.

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U.S. readers may only be picking up the roller coaster in Italian politics via the fluctuations in their pension fund share portfolio values, but it is probably no exaggeration to say European democracy has been tested this week … and the process is far from over.

Italians kicked the process off with March parliamentary elections that ushered in months of wrangling between the two biggest winning parties, the anti-establishment Five Star Movement (or M5S) and the far-right League, formerly known as the Northern League. Both are considered to be the most extremely populist parties Europeans have voted for in decades. When they finally formed a working coalition with an aim to form a government, markets got nervous that many of their campaign promises may actually be put into practice.

Sound familiar?

Well, those fears crystallized when Five Star Movement head Luigi Di Maio announced the appointment of Euroskeptic economist Paolo Savona for finance minister, before the Italian president overruled them (at the behest of Brussels, many believe).

Even if President Sergio Mattarella acted in isolation, his willingness to go against the politically elected representative with the avowed aim of protecting the Euro and the European ideal, is a remarkable case of prioritizing European stability over national democracy. His actions were no doubt attended by sighs of relief in Brussels, Paris and Berlin, where the rise of populist parties in Europe and elsewhere have been met with disdain and derision.

Savona is well known for his anti-Euro views and his proposed appointment spooked markets, which promptly took fright. Investors dumped Italian debt and spreads between Italian and benchmark German rates spiked.

Source: Reuters, Adam Samson/Financial Times


Meanwhile, bank shares across Europe were dumped as investors feared Italy could crash out the Euro and banks would be left nursing massive liabilities, despite the fact most debt is held by the European Central Bank (ECB) after months of bond buying under quantitative easing (QE).

The bank share price collapse is what led downfalls in share prices across the world. Yet, after a few days of uncertainty, markets are recovering after M5S indicated it may be willing to reconsider the appointment of Savona. The League is not sounding quite so conciliatory, but the two parties are back in discussion to try to find a solution.

The irony is if Italy is forced back to the polls, the two parties will probably increase their share of the vote. There has been widespread support across Italy for their actions since the March election, but if they increase their share of the vote it will provide an even clearer mandate for an anti-austerity, reflationary, debt-fueled agenda.

Early comments from European politicians — such as Günther Oettinger, Germany’s E.U. commissioner — that upheaval in the markets would exert healthy, pro-European discipline on Italian voters were met with derision across the country, as it was seen as Brussels telling the Italians how to vote. Oettinger’s comments on German television — “My concern and expectation is that the coming weeks will show that developments in Italy’s markets, bonds and economy will become so far-reaching that it might become a signal to voters after all to not vote for populists on the right and left” — were promptly slapped down by more media-sensitive officials, like European Council President Donald Tusk, forcing Oettinger to issue an apology.

Italian President Sergio Mattarella tried to appoint Carlo Cottarelli, a former International Monetary Fund (IMF) official, to form an interim government, but that simply encouraged M5S and the League to get back to the negotiating table to find a solution of their own.

This story has a long way to run.

Italy has lagged behind the rest of Europe’s major economies for the last decade with minimal growth. Voters blame the E.U. — and, in particular Germany — for the trend. Germany is running a persistent current account surplus of 6%, well above E.U. rules, yet is not being held to account.

Italy feels if Germany can break the rules to the detriment of fellow E.U. states, then why cant they? Why should the economy be hobbled by debt limits and austerity when fellow E.U. members flout the rules?

You can see their point.

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In such an atmosphere, the rise of populist parties is understandable, even if their solutions make little economic sense.

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It is a question we often see on the financial pages of newspapers or news sites, but rarely take time to seriously consider the consequences – why is the West apparently in a period of stagnant productivity growth?

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A recent article in The Telegraph explores the position for the U.K., but many of the trends observed — and, likely, reasons behind — Britain’s poor productivity growth are very similar to those in the U.S. and the rest of Europe.

For the sake of good order, we should define productivity growth. Simply put, it is a measure of the efficiency of production, usually measured as the ratio of inputs to outputs, or output per unit of input. Clearly, for workers to be paid more without a firm going bankrupt, just as for a country to raise living standards without living beyond its means, productivity per unit of labour has to increase over time. And so it has broadly over time, but not in a straight linear fashion, and therein lies a clue to our current malaise, the authors of the article suggest.

The article draws substantially on comments made and work done by Ben Broadbent, the Bank of England’s deputy governor. Broadbent fears Britain is past its peak and destined for a sustained period of poor growth in living standards due to stagnant productivity growth. Measuring productivity growth is far from easy, not least because “work” changes. In the days when most outputs were delivered by the manufacturing industry, it was easier to measure inputs and outputs; in today’s digital world, many services, like the internet, are largely free at the point of use.

Yet even so, the trend is clear: over the past decade, productivity has grown by just 2.1%, according to the Office for National Statistics as quoted by the news source. That is compared to before the financial crisis, when it typically grew by more than 2% every year. As a result, for much of the 2008-2014 period, real wages were in negative territory, a situation that was variously blamed on the financial crash, low interest rates perpetuating companies that would otherwise go bust, and lack of finance to allow firms to invest.

But Broadbent believes it is more deep-seated than those reasons, saying the wave of benefits seen from digitization we accrued in the 1990s and early 2000s has now passed. In addition, he argues, our position now is more akin to the industrial world’s lull between the age of steam and the onset of electricity – the big gains arising from steam had all been made yet and the benefits of electrification had not been felt, such that firms did not have a technological advantage encouraging investment, growth and expansion or face the threat of being left behind.

So far, there is limited evidence of new technologies like the mobile internet, artificial intelligence and mass automation transforming productivity. Broadbent believes it is simply too soon, but that given time and further technological progress, we could see these technologies having a transformational impact.

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Let’s hope so. Combined with the impact on traditional manufacturing jobs that globalization has had in mature markets and the growing disparity in incomes during this century, populist politics could have a destabilizing effect on Western societies, which will only be encouraged by a prolonged period of flat, or worse, negative growth in standards of living.

India has over-promised and under-delivered on so many fronts over the decades.

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Home of the world’s largest and, despite its young age and huge diversity, still thriving democracy, it has promised growth to rival China. Apart from brief bursts of activity, it has generally failed to live up to its plaudits expectations.

One reason often cited, apart from chromic infrastructure and the legacy of a British love of bureaucracy, is endemic corruption.

Graft had become so deeply engrained in Indian business culture that many had written the country off from delivering sustainable long-term growth for its hundreds of millions of poor. The relatively very few rich got richer while the miserably small middle class grew so painfully slowly compared to China that many thought India would never haul itself out of its emerging-market status.

But critics had not factored in Narendra Modi. While not everyone would support his Hindu-biased populism, he has brought immense progress to India, overcoming entrenched interests with a politically astute skill and dynamism.

There is still a long way to go, but a recent Economist article describes how he has taken the fight to the ruling business elites in a blitzkrieg campaign to dismantle tycoons’ practices of personalizing gains and socializing losses.

Founding shareholders of Indian companies have long made use of a loophole of Indian corporate law that prevents banks from seizing companies in default on their loans, so owners of companies can run their organizations badly or, worse, suck out funds for personal gain with little fear of losing their money-making enterprise.

The system has actively perpetuated this system with a bunged up judicial system that takes months, if not years, to hear cases and state banks’ lending to firms on the basis of personal connections rather than sound business-lending principles. This cronyism was almost encouraged by officials not wanting banks to post losses, such that state banks are kept afloat by the government yet are carrying massive debts which will never be repaid.

Modi’s government new bankruptcy code came into force in May 2016. After almost two years of preparation, the first big cases have hit the headlines last month, The Economist reports. The fate of 12 troubled large concerns amounting to 2.2 trillion rupees ($33.4 billion) of non-performing debts is due to be settled within weeks. Another 28 cases worth a further 2 trillion rupees are set to be resolved by September. Between them, these firms account for about 40% of loans that banks themselves think are unlikely to be ever be repaid. In total some 1,500 companies are said to be insolvent, according to The Economist.

A new set of dedicated courts, backed by a cadre of insolvency professionals, is on hand to help banks seize assets and sell them to fresh owners, the article states. To focus the minds of both bankers and borrowers, if no deal can be cut within nine months the firm is shut down and its equipment sold for scrap.

As a result, those looking for cheap, distressed assets are already circling for pickings from the current 12 and 28. Such turmoil on this scale will create a short-term drop in investment as firms hold off to see what becomes available. In the longer term, the process of death and renewal will probably be highly dynamic for the economy.

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It will also focus the minds of today’s Indian tycoons on running their businesses better and courting political favor less. Indian business is shifting focus from “who you know” to “what you know,” which is definitely a good thing for the health of the country in the future.

Be assured there will be a next crisis — there always is, sooner or later.

It is the nature of economic cycles that markets get out of balance and have to readjust. That sounds like rather a benign process, but of course we all know there is plenty of pain and many casualties when it happens.

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An interesting article in The Economist analyzes the reasons why market crises arise and, from that, where it believes the next one is developing.

To quote the report, financial crises tend to involve one or more of these three ingredients: excessive borrowing, concentrated bets, and a mismatch between assets and liabilities.

The crisis of 2008 was so serious because it involved all three — big bets on structured products linked to the housing market, and bank-balance sheets that were both overstretched and dependent on short-term funding.

The Asian crisis of the late 1990s was the result of companies borrowing too much in dollars when their revenues were in local currency. The dotcom bubble had less serious consequences than either of these because the concentrated bets were in equities; debt did not play a significant part.

As for the next crisis? The Economist report indicates the cause of the next one is probably lurking in corporate debt.

Read more

Numerous factors weigh heavily on the base metals and commodity complex: the Chinese copper scrap ban, the Section 232 proclamation on aluminum and steel combined with country-specific exemptions set to expire on May 1, the Section 301 investigation, and multiple strikes at copper and nickel mines to boot. After the turmoil of the first few months of 2018, MetalMiner reviews how base metals and commodities performed during Q1.

Aluminum, copper and nickel on the rise

Aluminum, copper and nickel prices started 2018 weaker than at the end of 2017. The end of 2017 showed a sharp rally for these base metals, following the bullish uptrend that began in the summer of 2017.

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The short-term downtrend sounded alarms as prices dropped significantly, not finding a floor. However, LME prices started to climb at the beginning of April, leaving the downtrend behind.

Read more

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We have been far from alone in issuing periodic warnings about the implications of rising interest rates for a global debt market that is out of proportion to levels seen even before the last recession.

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Fortunately, one of the first test cases has deep pockets and enough experience to deal with it.

But even so, Hong Kong’s housing market is so overstretched it is at risk of collapse if rates rise too soon or too high. According to The Telegraph, 90% of Hong Kong’s mortgages are linked to three-month Hibor (HK interbank lending rates).

Because of its currency peg to the U.S. dollar, Hong Kong is being forced to intervene to defend the peg and stem capital outflows, as global interbank rates rise and the Fed tightens. According to The Telegraph, the authorities are preparing to sell “exchange fund bills” to drain liquidity, raising fears of a credit squeeze and a property correction that could quickly turn into a collapse. “The Hong Kong dollar is at its weakest level in 33 years. It suggests an imminent risk of capital flight,” Francis Chan, a bank analyst for Bloomberg Intelligence, is quoted as saying.

Source: U.S. Federal Reserve

The price-to-earnings ratio of the local property market has reached an all-time record of 19, compared to the previous peak of 14 at the onset of the East Asia crisis in 1998, the article states, noting that episode was followed by a 60% crash in house prices. The article notes the Bank for International Settlements says Hong Kong’s financial system is the most dangerously overstretched in the world.

Source: Nomura

The “credit gap” is 45 percentage points of GDP above its long-term trend, a sign of extreme behavior and the best-known predictor of banking crises. The BIS says that any persistent gap above 10 points is a warning. Currently, Hibor is still around 1%, while three-month U.S. dollar Libor rates have risen to a 10-year high of 2.29% – up 50 basis points since just early February.

Something has to give or the markets will borrow Hibor, invest Libor and massive capital flight will ensue.

Source: St. Louis Fed

Apparently Hong Kong’s banking system is 8.3 times GDP and the absolute scale is large enough to have global systemic consequences.

Some of the highest exposed are HSBC and Bank of China, who alone have Hong Kong deposits of almost $700 billion between, them the article states. Hong Kong’s banks are considered rock solid, with a liquidity ratio of 146%, the article assures, well able to weather the storm of a property collapse, but maybe not so well prepared are foreign banks and investors lending into the sector.

As the article notes, you cannot control the currency and monetary policy but still have open capital flows. In times of stress, one must give — and in short order, cheap money has to come to an end with a doubling of local borrowing costs an all but certainty over the next 12 months.

What that means for the highly leveraged housing market doesn’t bear thinking about, with roughly 90% of mortgages linked to three-month Hibor.

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Capital Economics expects house prices to fall by a third over coming years, noting that the property market “is living on borrowed time.”

The state sector has benefited better than most in China from Beijing’s environmental crackdown, which resulted in enforced closure of steel, aluminium, coke, alumina and coal-burning power plants.

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The extent to which the resulting rise in prices benefited domestic aluminum smelters was revealed last week when Aluminum Corporation of China Ltd (Chalco), filed its results for the year in Shanghai. Chalco, the listed arm of state-run aluminum producer Chinalco, made net income of 1.38 billion yuan ($218 million) last year, against a revised net profit of 368.4 million yuan in 2016, according to Reuters.

Revenue came in at 180.1 billion yuan, up from an adjusted 144.2 billion yuan a year earlier. Although Reuters did not quote any tonnage figures for the firm, it is safe to say Chalco didn’t produce less than the year before; the state firm was largely protected from the closures enforced on others.

But reports that despite closures in some quarters smelters were still producing near-record output is being taken by many as a reason why Shanghai Futures Exchange (SHFE) stock have been rising inexorably during the year; the reading is the market remains in significant surplus.

But Andy Home, writing in Reuters last week, suggests the rise in SHFE inventory may have more to do with tightening credit and the pull of high SHFE prices in Q3 sucking metal from trade inventory.

If that is the case, then we may have been reading a distorted view of the market.

The realization that the winter closure program was not having as significant an impact as had been expected led to a fall in prices during the fourth quarter, from a peak of RMB 17,165 per metric ton in September that has continued into this year to stand at below RMB 14,000 today.

Not surprisingly, Chalco’s numbers were weak for Q4. The already meager margin for last year of 0.77% was further diluted in Q4, and many smelters are said to be at breakeven or less this year.

That factor is probably the only thing keeping aluminum prices in China at current levels. If smelters were making money, the restarts now that the winter heating season is over would be stronger and the overhang of stock would be worse (a precursor of further falls). The market is expecting restarts to be muted, restrained by the unprofitable prices and Beijing’s new-for-old program restricting the addition of substantial new capacity on top of existing production.

With exports likely to be impacted by President Trump’s 10% import tax, prospects for excess metal to find its way into export markets in the form of semis are less positive. But, anyway, falls in the LME have meant Chinese semis exporters have less of an advantage than they had in Q4.

The next 4-6 weeks may indicate the trend for the rest of this year. In a normal market, if primary prices fall further, the domestic market would move toward a more balanced position as smelters are idled.

China, however, isn’t a normal market, and regional or state support could keep plants running.

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Watch the domestic SHFE price via MetalMiner’s Indx. The trend this month has remained downward and inventory has continued to climb – whether it is new metal or repositioned metal previously in finance deals is not immediately clear to the market – they just see rising inventory and draw their own conclusions.

The facade of the Federal Reserve Bank. Aaron Kohr/Adobe Stock

We tend to hear the pronouncements of the Federal Reserve and take them as the all-knowing position of the Fed chairman with the unanimous support of his or her colleagues. Yet in actual fact, even arriving at a rate setting decision, let alone scoping the media announcement afterwards, requires extensive debate and the balancing of often fundamentally opposing views amongst the members of the Fed rate setting committee.

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The market expected prior to the recent volatility in share prices that the Fed would raise the reserve rate at its next meeting in March. That may still be the case, but comments reported in Bloomberg by James Bullard, president of the Federal Reserve Bank of St. Louis, highlight just how wide the range of views can be among the state Fed chairmen, ranging from doves to hawks.

Bullard led by saying the recent stock market rout was the most predicted selloff ever and should have come as no surprise given the elevated valuations of technology stocks and the absence of any recent price falls. “Something that has gone up 40% like the S&P tech sector will at some point have a sell-off,” Bloomberg quoted him as saying.

Not that Bullard believes that the market is correct in interpreting a surge in average hourly earnings as contributing to the rising Treasury yields. Bullard does not see wage growth as currently inflationary and remains confident that inflation will not derail robust U.S. GDP growth in the year ahead, saying he doesn’t see a need for the Fed to raise rates further while inflation is stuck below the central bank’s 2% target.

Indeed, Bullard appears more concerned with long-term, persistently low U.S. growth and although he is not among those Fed chairmen who will be voting on monetary policy this year, his still influential position is that there is little need to raise interest rates much in 2018.

Compare that to incoming Fed Chairman Jerome Powell, who is expected to follow Janet Yellen’s line of cautiously raising rates.

The market was widely expecting three rate rises in 2018 from Powell, but in recent weeks stronger wage growth and rising concerns about inflation have prompted more hawkish voices to call for four, with the first in March and the last one in December 2018.

What is less clear is what his policy will be on reversing quantitative easing. Considerable debate remains on how quickly the central bank should move on normalization and unwind the Fed’s $4.5 trillion balance sheets.

Hawks point out sooner or later there will be another recession (the current bull market, if it continues, will become the longest in history later this year).

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At present, the Fed has little or no tools left in the bag to tackle another recession — with rates still low and a massive balance sheet, it hardly needs to add more.

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This morning in metals news, the American Iron and Steel Institute (AISI) reported finished steel imports accounted for 26% of the U.S. market, analysts expect the index that measures market volatility to come back down and General Motors reported strong 2017 earnings.

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Steel Import Market Share 26% in January

According to the Commerce Department’s most recent Steel Import Monitoring and Analysis (SIMA) data, steel import permit applications for January totaled 2.914 million net tons (NT), up from  17.7% from the 2.475 million permit tons recorded in December, according to an AISI report. It was up 18.9% from the December final imports total of 2.45 million NT.

According to AISI, finished steel imports occupied 26% of the market share in January.

Analysts Expect VIX Index to Drop After Early-Week Spike

The CBOE VIX index — the index which measures market volatility — spiked early this week as a massive selloff sent the Dow Jones plunging on Monday and Tuesday.

According to a Bloomberg report, however, analysts expect the index to come back down — albeit not as low as previous lows — indicating relatively low volatility.

GM Reports Strong 2017 Earnings

General Motors had a strong 2017, following on the heels of the a strong 2016, according to a company release this week.

The automaker reported full-year 2017 EBIT-adjusted of $12.8 billion.

“Results were driven by strong performance in North America, improvement in GM International led by strong equity income in China and a return to profitability in South America, sustained growth of GM Financial and an intense focus on costs,” the release stated.

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For the fourth quarter, GM posted EBIT-adjusted of $3.1 billion, up 18.7% year over year.

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Metals have suffered considerable volatility this month with prices sliding, then recovering, then sliding again at the end of last week. Metals markets are not alone in this — equities have been on a slide and many are beginning to ask if this is the end of the bull market that has stretched back nearly nine years.

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It is a bull market that has seen a convergence of rising commodities prices and rising equities, laying waste to the previous case that investments in commodities is a counter-cyclical move to equities.

A few harbingers of doom have been calling for an end to the equities run for months, if not the last couple of years, caused it has been variously expected by rising interest rates, a collapse in the Chinese property or debt markets, the implosion of the E.U. or another southern European state’s debt crisis – the list goes on.

What finally seems to have spooked the market – and we are not calling an end to the bull run, as this could well prove to be a correction – is inflation.

Reuters reported last week that U.S. job growth surged in January and wages increased further, recording their largest annual gain in more than 8 1/2 years. This has led to expectations that inflation will rise this year as the labor market hits full employment, Reuters reports.

Average hourly earnings have risen to 2.9%, the largest rise since June 2009, from 2.7% in December. The robust U.S. employment report underscored the strong global demand, and raised the fear that with employment low inflation could resurface. The hot labor market will add pressure on the Fed to raise rates faster and earlier than previously anticipated, increasing borrowing costs not just in the U.S. but globally. Rising rates means a stronger dollar, as investment funds flow back into the U.S. to seek higher returns. A stronger dollar also means lower commodity prices – the two invariably move in opposite directions, as we have frequently observed before.

But John Authers, speaking in the Financial Times, refines the argument, saying the selloff came as the market feared massive bets placed on a low level of volatility, on the assumption the status quo would continue through 2018, were undermined by the rate rise scenario, and that those bets will turn into massive losses, not just for the speculators but the banks providing finance behind them. The biggest selloff since 2011 and the second-highest volumes this decade suggest auto trades kicked in as the market fell exiting positons and shorting the market. Authers states the Vix volatility index hit 37.32 on Monday, its highest level since the Chinese currency devaluation of August 2015. That exceeded the levels reached during the Greek debt crisis of 2015 and after the 2016 Brexit referendum.

Nor does he expect volatility to now subside. Markets are twitchy and while there is plenty of liquidity ready to step in and buy on the dip, this will only add to significant swings up and down.

Markets’ next crunch point will the new Fed chairman Jerome Powell’s March rate review to see the degree of hawkishness the market can expect from the new administration.

Meanwhile, commodities in general will experience complex dynamics. A stronger dollar will undermine prices and contributed in part to falls in the price of crude and gold last week, but robust global demand and rising global GDP will be supportive of metals prices, particularly for supply-constrained markets like lead and nickel.

In fact, so tight is the lead market that treatment and refining charges in China are said to have fallen to zero this month as smelters fight to secure supplies.

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Volatility, therefore, appears to be the order of the day. Consumers looking to cover positions should look to buy on dips until trends reassert themselves or a new direction becomes clear.