Articles in Category: Macroeconomics

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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.

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If you thought China’s environmental crackdown on polluting industries during this winter heating period was a one-off effort, think again.

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Liu Youbin, a spokesman at the Ministry of Environmental Protection, is quoted by Reuters as saying that Beijing intends to extend its policy over the 2018-2022 period.

“The new three-year plan will continue to make Beijing-Tianjin-Hebei its key focus but it will also focus on other major regions like the Yangtze river delta, the northeast and Chengdu-Chongqing,” he is quoted as saying.

China’s previous effort, covering 2013-2017, was a largely unmitigated disaster.

Concentrations of hazardous particles known as PM2.5 were supposed to be reduced by 25%, Reuters reports, but with near-record PM2.5 readings in January and February last year, it was clear more drastic action was required.

Northern China only managed to meet 2013-2017 air quality targets by the end of 2017, largely thanks to a campaign that forced polluting factories in 28 cities to reduce output over the winter, Reuters reports. The resulting clampdown on the worst offenders among steel mills, coke plants and aluminum smelters has had a profound impact on supply, demand and prices in those markets. So, news that Beijing intends to roll out the program to include the Yangtze and Pearl River deltas further south, in addition to regions in the northeast, means the story has much further to go.

Concentrations of PM2.5 have fallen by up to 70% to 36 micrograms per cubic meter, almost meeting the state standard of 35 micrograms. Readings in the Yangtze and Pearl River regions, which include Shanghai and Guangzhou, actually increased. As a result, readings for the whole of China only dropped by 20% for the month of January to an average of 65 micrograms, underlying the scale of the challenge ahead.

Still, where there is a centralized will there is a centralized way. You can be sure Beijing will prosecute this campaign with considerable vigor in 2018.

When the current heating period ends in late March, controls will be relaxed but the indications are it will not be business as usual. Although the low-hanging fruit of coal-fired domestic and small commercial premises will be the primary target, greater attention will also be given to larger enterprises and, indeed, whole industries.

China continues to need steel, aluminum, zinc and a range of other energy-intensive metals, so the most likely outcome is tighter regulations and investment in more advanced, and, hence, cleaner technology.

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That is admirable, of course, but it will also encourage a more rapid move up the value chain for producers looking to get payback on their new kit.

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News that Goldman Sachs is advising investors that Wall Street is set for a sharp correction should come as little surprise following five years of almost uninterrupted growth in equity markets.

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The investment bank’s prediction that a correction was a “high probability” is almost a no-brainer when you hear the comments of Peter Oppenheimer, chief global equity strategist at Goldman Sachs which were reported this week in The Times. The S&P 500, which tracks the share prices of America’s 500 largest public companies, and the MSCI World Index, which tracks about 1,650 companies across the world, are in their longest periods without a correction of more than 5%.

“This does not mean that the market must have a correction,” Oppenheimer said. “It just suggests that one is overdue.”

Goldman’s comments are echoed by Bank of America Merrill Lynch, saying Wall Street is very likely to suffer a short fall in the next few weeks.

Some might consider Goldman’s comments as prescient in view of this week’s selloff in government bonds equities on both sides of the Pacific, Others might wonder whether Goldman had already shorted the market, helping ensure its prediction became self-fulfilling. The selloff in equities was fronted by the international selloff in government bonds.

The Financial Times reports that the yield on 10-year U.S. Treasury hit 2.733% in Asian trading on Tuesday, after reaching 2.72%, the highest level since April 2014, the previous day. It has since pared its losses, settling just above 2.68%. After hitting record highs on Friday the S&P 500 and the Dow Jones industrial average both closed lower this week, along with Japan’s Topix and the Hong Kong Hang Seng. European stocks seemed less troubled but still close lower as profits were taken.

Interestingly, Goldman does not see the correction as the end of the bull story, saying global growth is running at about 5% — the strongest pace since 2010 — in a broad and synchronized economic recovery.

The bank sees any correction as an opportunity to buy, saying a correction of 5% this year which still only take global equity markets back to where they started 2018 and would be unlikely to cause much concern or damage. Typically, market corrections during long-running bull markets average some 13% over a four-month period, but take only four months to recover the lost ground. The depth of this selloff may be clearer from next week onwards with the current focus shifting towards the earnings season releases from the U.S. and Chinese market heavyweights in the tech sector.

Markets were also looking to Donald Trump’s State of the Union address this week as to whether it includes the long promised — but so far ineffectual — infrastructure spending that was such a significant part of equity market enthusiasm immediately following his inauguration last year.

Why would we worry about equity markets at MetalMiner, you may ask?

It’s simple: commodity prices have shown a strong correlation in recent years to equity markets, contrary to the position just after the financial crash when commodities and shares went in opposite directions. Maybe not surprisingly, oil has come off this week despite little change in supply and demand, and ignoring the growing threat of implosion in Venezuela.

No bull market runs forever and this has been going for some time. Many expect sharp rises in borrowing costs as central bank rate rises later this year or next to be the trigger for an end to the run.

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So, it’s possible Goldman have this right and all we will get is a correction. Let’s hope they are right.

We have long since stopped believing official China growth data. If that’s the case, what is the “real” growth rate in China and should we care that the numbers appear to be manipulated?

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Officially, China grew by 6.8% in the final quarter of 2017, taking annual growth to 6.9%. Yet, it is increasingly felt that the National Bureau of Statistics (NBS) numbers are massaged to iron out peaks and troughs from year to year and to support the authorities’ target growth numbers – to make the Party look like it is in total control.

In reality, The Telegraph suggests that 2016 official growth figure of 6.7% was probably overblown, with growth in reality being lower. Following an uptick in activity during 2017, this has resulted in the official figure for last year having to be reduced, as to report growth of more than 7% would have added to a disparity that builds up over time. Inflating poor years has to be balanced by underreporting good years, or eventually the statistics suggest the economy should be twice the size that it clearly is.

Independent assessments of 2017 growth are lower still. The Telegraph quotes Capital Economics, which believes growth to be nearer 6% for 2017, but their models agree that 2017 was better than 2016, saying they estimated GDP growth at 5.1% in 2016.

How this puts projections for 2018 is interesting, as most observers think there was a slowdown in the last three months of 2017, with official figures putting it at 1.6%, while independents, like Pantheon Macroeconomics, are putting it at just 1% for the same period (down sharply from an estimated 1.9% in the third quarter).

The reasons for a slowdown are not hard to see, as two factors are at interplay.

Drive Against Pollution

The first is Beijing’s drive to curb polluting activities, such as construction.

Output growth slowed in steel, cement and glass recently, as the government tried to rein in polluting industries in northern China. These restrictions will be eased at the end of the winter heating season and, as a result, activity is likely to pick up again in Q2.

Weakening Property Market

The property market in particular has weakened in the past six months, The Telegraph observes, noting average residential property prices rose by just 0.2% in December.

This raises a question, if construction activity and, therefore, the supply of new properties was constrained, logic would suggest prices would rise. The fact prices are easing may have more to do with the rising cost of borrowing in China following efforts by Beijing in early 2017 to limit the supply of money and dissuade growth in the shadow banking sector.

Interbank lending costs have risen as a result. If the Fed raises rates during 2018 as expected, global debt costs will rise regardless of currency. The knock-on effect may be that an increase in construction activity is rewarded with a fall in property prices later in the year.

As credit has become less readily available, the article notes, there has been a considerable slowdown in retail sales growth, falling to 9.4% in December from 10.2% in the year to November. A combination of a cooling property market, falling retail sales and an export market facing protectionist headwinds supports the hypothesis that growth in 2018 will be lower than last year.

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The Telegraph article concludes with Capital Economics’ prediction that growth this year could be just 4.5%. It will be interesting to see what quarterly numbers the NBS claims China is achieving as the year unfolds.

India is often touted as the next China — a similarly sized population is expected to offer vast potential, particularly coming from a low per capita usage of metals, energy and just about everything else.

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India just needs to be freed from bureaucracy and the shackles of its earlier obsession with socialism and it will boom, supporters have been saying for years.

Yet India’s growth has persistently fallen short of expectations, often to the dismay of Western firms investing billions in what they have hoped would be the next big thing.

It’s not that India isn’t growing. At 6.5%, it is almost certainly growing faster than China this year. Despite claims of “on target” 6.5% growth in China, a more realistic measure is probably 4.5%, according to Roger Bootle, chairman of Capital Economics, writing in the Telegraph.

Nevertheless, China has achieved an unprecedented rise in living standards, with perhaps the greatest achievement being the creation of a prosperous middle class numbering in the hundreds of millions.

It is this middle class that has allowed the switch from export-led to domestic consumption — without their combined demand auto sales, white goods and the construction sector (and the list goes on), it would be dead in the water.

India, by comparison, has a paltry middle class.

The top 1% of Indian adults, a rich enclave of just 8 million inhabitants making at least $20,000 a year, equates to roughly Hong Kong in terms of population and average income, The Economist says. The next 9% is akin to Central Europe, in the middle of the global wealth pack.

Even the top 1% would struggle on $20,000 per annum to afford $20,000 for a small BMW or over $1,000 for an iPhone.

The next 40% of India’s population neatly mirrors its combined South Asian poor neighbors, Bangladesh and Pakistan, hardly in the market at all for Western-priced brands. The remaining half-billion or so are on a par with the most destitute bits of Africa, explains a report in The Economist.

So why has India apparently failed where China succeeded?

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Some would argue the credit rating agencies do not have the best record in making predictions on the future direction of financial markets.

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However, they do have considerable resources at their disposal, so when they issue particularly dire warnings, common sense suggests we should pause and consider their analysis.

An article in The Telegraph quotes James McCormack, in charge of sovereign ratings at Fitch Ratings Inc., as saying the agency forecasts the U.S. Federal Reserve base rate could rise to 3.25% by the fall next year, as the Fed doubles the pace of rate rises in 2018 to head off the potential for higher inflation sooner rather than later.

Fitch is forecasting four rate rises this year, double the pace that the markets are currently expecting, The Telegraph reports.

Nor is the rating agency alone — the World Bank said financial markets are the biggest risk to the global economy and that markets are underestimating the turmoil rising rates will cause in the years ahead.

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