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David Fuller and Eoin Treacy's Comment of the Day
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Kuroda Confident Can Raise Wages, Prices "Significantly"

This note by Chua Baizhen Bloomberg may be of interest to subscribers. Here it is in full:

“The mindset is still quite cautious about inflation expectations, but I’m quite sure that with continuous accommodative monetary policy, supported by fiscal policy, we’d be able to eventually raise wages and prices significantly,”

CNBC cites BOJ Governor Haruhiko Kuroda in interview.

* Projected growth rate of 1.5% “not great” but it’s well above medium-term potential growth rate

* Means output gap to shrink and become positive while labor market continues to tighten

* Wages, prices would eventually rise to achieve 2% inflation target around fiscal 2018

* Yield curve control “has been functioning quite well”

* 10-yr JGB target should, for the time being, be maintained around 0%

* Acknowledges that “headline inflation has been quite slow to adjust upward” in part because of weakness in oil prices

 



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Fed Sticks to Gradual Rate-Hike Approach Despite Slowdown

This article by Jeanna Smialek and Christopher Condon may be of interest to subscribers. Here is a section:

The widely expected decision contained no concrete commitment to the timing of the next rate increase. Even so, investors increased bets on a move in June after absorbing the Fed’s sanguine assessment of the outlook and its encouraging observations on inflation, following data showing first-quarter economic growth of 0.7 percent and monthly price declines in March.

“Nothing in the statement today, which was voted unanimously by the FOMC, leads me to believe that the Fed is even close to changing its mind on rates,” Roberto Perli, a partner at Cornerstone Macro LLC in Washington, wrote in a note to clients. “Base case is for a couple more rate hikes this year -- probably in June and September -- and for the beginning of balance sheet shrinkage in December.”



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Fed May Finally Be Ready to Change Course

This article by Mohamed A. El-Erian for Bloomberg may be of interest to subscribers. Here is a section:

Nevertheless, this will be an interesting test of the view, which I and some others have espoused, that the Fed is in the process of shifting operating regimes -- from following markets to being more willing to lead them.

Last week’s disappointing reading of 0.7 percent gross domestic product growth for the first quarter, the lowest in three years, added to other data releases (such as retail sales, inflation and autos) suggesting that the U.S. economy -- and consumption in particular -- is going through a softer economic patch. In previous years, this would have provided the Fed with the excuse to soften its policy signals, assuring markets that monetary policies will remain ultra-stimulative and minimizing the risk of financial asset volatility. Indeed, these are the signals that the European Central Bank reiterated last week when its governing council met. And the ECB did so despite official recognition that, in the case of the euro zone, economic conditions have improved and forward downside risk is lower.

The Fed’s inclination to repeat past practices is countered by three considerations.

* An element of the recent data weakness is likely to be both temporary and reversible.

* The Trump administration has reiterated its intention to pursue a large tax cut that, if approved by Congress (a big if), would most likely lead to a considerably wider budget deficit, at least in the short-run until economic growth and budgetary receipts pick up (especially given the lack of large revenue measures).

* Though even harder to quantify, the Fed is not indifferent to the collateral damage and unintended consequences of prolonged reliance on unconventional monetary policies.



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Two Frances Collide in Battle to Shape Europe's Future

This article by John Follain for Bloomberg may be of interest to subscribers. Here is a section:

Tergnier may be Macron’s toughest sell.

The town, with a population of 13,000, used to vote Communist and then Socialist. It turned to the National Front as its sprawling rail freight station — once one of France’s biggest — shed hundreds of jobs. Steelworks, a sugar-manufacturing plant and other firms closed down or moved elsewhere leaving the jobless rate at 15 percent. The national average is 10 percent. Thirty-six percent of voters backed Le Pen last month, among her highest votes in the country.

“Globalization is bad for Tergnier,” said mayor Christian Crohem, 67, who heads a mainly leftist coalition. “We’ve brought more countries into the EU and we’ve allowed businesses to move around, so we’re up against workers from abroad who don’t play by the same rules, it’s unfair competition.”

He tells the story of a 70-year-old woman who came to see him recently because she didn’t have enough money to feed herself. Sitting in his office, she cried with shame as she asked him for a handout to buy food.

“That kind of thing really gets to you,” he says. “People here feel abandoned, and so do we, the officials they elect.”

 



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The Global Investment Outlook

Thanks to a subscriber for this report from RBC GAM which may be of interest. Here is a section on bond yields:

The arguments for higher bond yields
The global economy is experiencing a cyclical recovery regardless of the political noise, and its performance should remain the key driver of fixed-income markets over the next 12 months. U.S. data releases have been strong and the employment picture continues to improve, leading many investors to prepare their portfolios for reflation. We believe that Trump’s loosening of financial regulations should re-ignite the animal spirits that went missing after the 2008 financial crisis, creating self-sustaining economic growth. Corporate America will likely invest and hire more, pushing up the cost of capital and inflation. 

Aiding this momentum will be an administration stocked with business-minded department heads and White House advisors. Trump has appointed Steve Mnuchin, a former Goldman Sachs executive, as Treasury secretary and billionaire investor Wilbur Ross to head the Commerce Department. Gary Cohn, the recently departed Goldman Sachs president, is Trump’s top economic counsellor. These appointments help to validate the optimism towards streamlining  regulations and promoting business investment. 

A tight labour market is another source of economic optimism and will foster inflationary pressures as higher wages embolden consumers to spend more. A higher-inflation, faster-growth environment would be a departure from the slow growth mindset that has prevailed since 2012. 

Assuming that the government spending materializes as advertised and stokes economic growth, we would expect yields to be pulled higher by competition for capital between Treasury bonds and businesses and individuals seeking loans. Here’s why: capital must be financed either from abroad and/or with domestic savings, and administration proposals aimed at reducing imports would increase the importance of domestic savings as a source of capital. Domestic private savers as a group tend to demand higher compensation for loans than foreign entities, potentially leading to higher rates as growth quickens. 

 



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The voter apathy that helped Donald Trump win is about to hit France

This article from quartz may be of interest to subscribers. Here is a section:

The paralysis has no quick fix. Last night (April 4), in an effort to lift spirits, France’s presidential debate organizers decided to trot out all 11 eligible candidates for the second televised debate, rather than just the top five. The barrage of small candidates on stage left each with “no room to develop an idea,” and voters no time “to exercise their judgment,” one critic (link in French) argued. “Does this really help the undecided to form an opinion?” another asked (link in French).
All the better for France’s far-right wing. Voter turnout in France (80% in 2012) has long upstaged that of neighboring Germany (71%), the UK (66%) and Switzerland (47%). But as that number drops in France’s multi-round system, the odds of a far-right win creep up.

That’s because fervent support for Le Pen in the first round will likely carry over to votes for her in the second. But candidates with more tepid support, including centrist Emmanuel Macron, conservative François Fillon, and socialist Benoît Hamon, may suffer if non-Le Pen voters abstain (paywall) in the second round. Right now, Le Pen and Macron are neck-and-neck in French polls for the first round.

The predicament was similar in 2002, when candidate Jacques Chirac’s famous slogan (link in French) “Vote for the Crook, not the Fascist” helped him secure a landslide victory against Le Pen’s father, Jean-Marie Le Pen, in the second round. This time, voters may have had their fill of crooks and fascists both.

 



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Email of the day on Japanese equity index composition

I wonder if you could please analyse why the historic charts of Japan's main equity market are so divergent? 

As you know, the Tokyo market reached its "bubble era" peak in Jan. 1990 at 38,564 but has since recovered to around 19,063. 

The Topix bank index peaked at the same time at 1,480 but is still languishing at a fraction of that level, 182.64 today. 

The Topix 2nd Section index on the other hand is now at an all-time high from its peak of 4,500 reached in 1990 to approaching 6,000. 

Normally the banks are the lead indicator but Japan's banks underwent immense restructuring so I can understand why they have languished but the discrepancy between these charts seems huge.

 



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Euro-Pound Hedging Costs Rise on Brexit Trigger, French Election

This article by Vassilis Karamanis for Bloomberg may be of interest to subscribers. Here is a section:

The premium on one-month options over the rate of actual market swings remains near a 10-week high set on Tuesday. It may increase further should Brexit-related negativity be less than feared in the near term, which would reduce realized volatility, and also as the implied rate should rise on capturing the second round of the French elections due May 7.

Realized volatility could find support as the euro-pound pair’s prospects look increasingly bearish on charts, with current market positioning significantly skewed toward sterling declines. Leveraged net short positions in the pound this month are at the highest level since November.

Not all investors have given up on the pound, with the British economy performing better than expected. BlackRock Inc., which reduced some of its exposure to sterling ahead of the triggering of Article 50, has said it is still marginally long as an expected slowdown of the U.K. hasn’t materialized.

With the latest reports suggesting that the European Central Bank isn’t anywhere close to reducing economic stimulus, a short-squeeze on the pound could materialize.

 



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Six Impossible Things Before Breakfast

Thanks to a subscriber for this report by James Montier for GMO which may be of interest. Here is a section:

It appears that asset markets are priced as if secular stagnation were a certainty. Certainty is a particularly dangerous assumption when it comes to investing. As Voltaire stated, “Doubt is not a pleasant condition, but certainty is absurd.”

In order to believe that asset market pricing makes sense, I think you need to hold any number of “impossible” (by which I mean at best improbable, and at worst truly impossible) things to be true. This is certainly a different sort of experience from the bubble manias that Ben mentioned in the opening quotation, which are parsimoniously captured by Jeremy’s definition of bubbles – “excellent fundamentals, irrationally extrapolated.” This isn’t a mania in that sense. We aren’t seeing the insane behaviour that we saw during episodes like the Japanese land and equity bubble of the late 1980s, or the TMT bubble of the late 90s, at least not at the micro level. However, investors shouldn’t forget that the S&P 500 currently stands at a Shiller P/E of just over 28x – the third highest in history (see Exhibit 17).

The only two times that level was surpassed occurred in 1929 and in the run-up to the TMT bubble. Strangely enough, we aren’t hearing many exhortations to buy equities because it is just like 1929 or 1999. Today’s “believers” are more “sophisticated” than the “simple-minded maniacs” who drove some of the other well-known bubbles of history. But it would be foolish to conflate sophistication with correctness. Current arguments as to why this time is different are cloaked in the economics of secular stagnation and standard finance work horses like the equity risk premium model. Whilst these may lend a veneer of respectability to those dangerous words, taking arguments at face value without considering the evidence seems to me, at least, to be a common link with previous bubbles.  

 



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Citigroup Canary in the Coal Mine

Thanks to a subscriber for this article by Christopher Whalen for theinstitutionalriskanalyst.com which may be of interest. Here is a section:

Citi’s equally large credit card book – in nominal terms the most profitable part of the business – has a gross spread of almost 1,100bp, but also reported over 300bp in defaults in 2016.  Still, with a 800bp net margin before SG&A, credit cards are Citi’s best business.  Indeed, Citi’s payment processing and credit card business are the crown jewels of the franchise.  If there were some way to sell the rest of the Citi operations, the payments processing and credit card business could be worth a multiple of Citi’s current equity market valuation. 

The trouble with Citi and many other US banks is that their business are dominated by consumer credit and real estate exposures, with little in the way of pure C&I loans.  When you look at most US banks, the vast majority of the exposures are related to real estate, directly or indirectly.  Thus when the Fed manipulates asset prices in a desperate effort to fuel economic growth, they create future credit problems for banks.  As our friend Alex Pollock of R Street Institute wrote in American Banker last year:

“[T]he biggest banking change during the last 60 years is… the dramatic shift to real estate finance and thus real estate risk, as the dominant factor in the balance sheet of the entire banking system. It is the evolution of the banking system from being principally business banks to being principally real estate banks.”

So whether a bank calls the exposure C&I or commercial real estate, at the end of the day most of the loans on the books of US banks have a large degree of correlation to the US real estate market.  And thanks to Janet Yellen and the folks at the FOMC, the US market is now poised for a substantial credit correction as inflated prices for commercial real estate and related C&I exposures come back into alignment with the underlying economics of the properties.  Net charge offs for the $1.9 trillion in C&I loans held by all US banks reached 0.5% at the end of 2016, the highest rate since 2012.

 



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