How QE reversal will impact on financial markets

The Federal Reserve last year announced plans to shrink its balance sheet which had grown to $4.5 trillion under the quantitative easing (QE) program.

According to its June 2017 Normalization Plan, the Fed will scale back reinvestment at the rate of $10 billion per month and step this up every 3 months by a further $10 billion per month until it reaches a total of $50 billion per month in 2019. That means that $100 billion will be withheld in the first year and $200 billion each year thereafter.

How will this impact on financial markets? Here are a few clues.

First, from the Nikkei Asian Review on January 11:

The yield on the benchmark 10-year U.S. Treasury note shot to a 10-month high of 2.59% in London, before retreating later in the day and ending roughly unchanged in New York. Yields rise when bonds are sold.

The selling was sparked by reports that China may halt or slow down its purchases of U.S. Treasury holdings. China has the world’s largest foreign exchange reserves — holding $3.1 trillion, about 40% of which is in U.S. government notes, according to Brad Setser, senior fellow at the Council on Foreign Relations.

Chinese officials, as expected, denied the reports. But they would have to be pondering what to do with more than a trillion dollars of US Treasuries during a bond bear market.

Treasury yields are rising, with the 10-year yield breaking through resistance at 2.60%, signaling a primary up-trend.

On the quarterly chart, 10-year yields have broken clear of the long-term trend channel drawn at 2 standard deviations, warning of reversal of the three-decade-long secular trend. But final confirmation will only come from a breakout above 3.0%, completing a large double-bottom.

Withdrawal or a slow-down of US Treasury purchases by foreign buyers (let’s not call them investors – they have other motives) would cause the Dollar to weaken. The Dollar Index recently broke support at 91, signaling another primary decline.

The falling Dollar has created a bull market for gold which is likely to continue while interest rates are low.

US equities are likely to benefit from the falling Dollar. Domestic manufacturers can compete more effectively in both local and export markets, while the weaker Dollar will boost offshore earnings of multinationals.

The S&P 500 is headed for a test of its long-term target at 3000*.

Target: 1500 x 2 = 3000

Emerging market borrowers may also benefit from lower domestic servicing costs on Dollar-denominated loans.

Bridgewater CEO Ray Dalio at Davos:

We are in this Goldilocks period right now. Inflation isn’t a problem. Growth is good, everything is pretty good with a big jolt of stimulation coming from changes in tax laws…

If there is a downside, it is likely to be higher US inflation as employment surges and commodity prices rise. Which would force the Fed to raise interest rates faster than the market expects.

ASX banks spoil the iron ore party

I underestimated the strength of iron ore which has now broken resistance at 70, suggesting that a bottom is forming. Strength of the latest rally indicates that the next correction is likely to find support at 60.

Iron Ore

The Resources sector responded, with the ASX 300 Metals & Mining index headed for a test of its February high at 3200 after recovering above support at 3000.

ASX 300 Metals & Mining

Banks have been on the receiving end, however, with the ASX 300 Banks index testing short-term support at 8500. A Twiggs Money Flow peak below zero warns of strong selling pressure. Breach of 8500 would signal another test of primary support at 8000.

ASX 300 Banks

The ASX 200 continues to form a narrow line, consolidating between 5600 and 5800. Declining Twiggs Money Flow, with a peak below zero, warns of selling pressure. Breach of support at 5600 remains likely, despite the iron ore rally, and would signal a primary down-trend.

ASX 200

ASX stalls

Iron ore is testing resistance at 70. Respect would warn of another test of primary support at 53, while breakout would suggest that a bottom is forming and the next correction is likely to find support at 60.

Iron Ore

The Resources sector remains wary, with the ASX 300 Metals & Mining index retreating after a false break above resistance at 3050.

ASX 300 Metals & Mining

The ASX 300 Banks index retraced from resistance at 8800, heading for a test of the rising trendline and short-term support at 8500. Twiggs Money Flow continues to warn of selling pressure despite indications from APRA that they are unlikely to require further capital raising. Reversal below 8500 would warn of another test of primary support at 8000.

ASX 300 Banks

The ASX 200 has stalled, consolidating between 5600 and 5800 over the last two months. Declining Twiggs Money Flow, with a peak below zero, warns of selling pressure. Breach of support at 5600 is more likely, with an ensuing down-trend, but a lot depends on how iron ore behaves in the next few weeks.

ASX 200

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.

~ Mark Twain (Samuel Clemens)

ASX 200: It’s down to iron ore

Iron ore encountered resistance at $70 per ton. Another test of primary support at $53 is likely. But a failed down-swing would be a bullish sign.

Iron Ore

The ASX 300 Metals & Mining displays a similar pattern, retreating below 3000 after testing 3050. A failed down-swing that ends above 2750 would be a bullish sign, while breach of support at 2750 would confirm the primary down-trend.

ASX 300 Metals & Mining

APRA eased pressure on the big four banks to raise more capital; the ASX 300 Banks index responding with a rally to 8800. Retracement that respects support at 8500 would be a bullish sign, signaling continuation of the up-trend. The industry is still light on capital but recent remarks by APRA chair Wayne Byres indicate that they are prepared to tolerate a more gradual adjustment rather than a new round of capital raising. Dividends may still come under pressure, however, in banks with high payout ratios.

ASX 300 Banks

ASX 200 consolidation between 5600 and 5800 continues. Declining Twiggs Money Flow flags selling pressure. Breakout from the consolidation will indicate future direction but this is likely to be dominated by mining (iron ore) and the banks. If both are pulling in the same direction, the index is likely to follow. Banks are increasingly bullish but the question-mark over iron ore remains.

ASX 200

ASX buoyant as iron rallies

Iron ore broke resistance at $60 and is headed for a test of $70 per ton. This is a strong rally but it does not signal the end of the bear market. Only when the rally ends and there is another test of primary support at $53 will we be able to gauge long-term sentiment.

Iron Ore

The ASX 300 Metals & Mining index broke resistance at 3000, completing a double bottom reversal with a target of 3250. Breach of 2750 is unlikely at present but would signal a primary down-trend.

ASX 300 Metals & Mining

The ASX 300 Banks index is testing resistance at 8500 but Twiggs Money Flow below zero continues to warn of long-term selling pressure. Breach of 8000 remains likely and would confirm the primary down-trend.

ASX 300 Banks

The ASX 200 is consolidating in a small triangle (some would call this a large pennant) between 5600 and 5800. Breakout will signal future direction. A lot will depend on iron ore (China) and the banks, which seem to be pulling in opposite directions at present.

ASX 200

ASX 200: Banks run into strong resistance

Iron ore peaked at $60. Expect a sharp fall to test support between $50 and $52, typical of a bear market. Chinese housing price growth — a key driver of iron ore prices as illustrated last week — is slowing and likely to drag ore prices lower.

Iron Ore

The ASX 300 Metals & Mining index is still on the up but likely to respect resistance at 3000, given the reversal in iron ore. Breach of 2750 would confirm a primary down-trend.

ASX 300 Metals & Mining

The ASX 300 Banks index ran into strong resistance at 8500. Declining Twiggs Money Flow highlights selling pressure. Breach of 8000 is likely and would confirm the primary down-trend.

ASX 300 Banks

The ASX 200 displays strong selling pressure, with tall shadows on the last two weekly candles. Twiggs Money Flow dipping below zero for the second time warns of a primary down-trend. Follow-through below 5700 would test primary support at 5600. Breach of 5600 would complete a broad head and shoulders reversal, confirming a primary down-trend.

ASX 200

Credit Suisse contrary view on Iron Ore

Where is the Chinese iron ore inventory cycle?

By Houses and Holes at 9:06 am on July 5, 2017
Republished with thanks to Macrobusiness.

From Credit Suisse:

Iron ore turns up, once again confounds bears on the Street

Iron ore once again confounded those calling it down by jumping at the end of June. However, this was predictable. In late May and early June we were hearing anecdotally (Platts) that some steel mills were on-selling contractual cargoes of iron ore to repay quarterly loans due at the end of June. That was a destocking event which inevitably put pressure on the price by adding cargoes to the daily sales list. But by the end of the month, loans were met and destocking is always followed by restocking.

Street still focused on port stocks, China mills are not Iron ore has been nothing if not volatile so it has been a tough call, but the Street keeps getting it directionally wrong, doubling down when the price is sliding. We believe one big difference between the Street’s price forecasts and what actually happens is that analysts are looking at a different side of the supply-demand equation from the actual buyers – Chinese steel mills. The street is obsessed with ever-rising port stocks. These stocks seem a clear indication that iron ore is over-supplied so for commodity analysts, that means the price should fall until some supply is destroyed to restore balance. Therefore, when the iron ore price is rising, analysts publish grim warnings that this can’t last due to too much supply. When the price falls again, the analysts feel validated that they were right, and promptly down grade price forecasts because it’s “the end”. But then the price rises again….

Why do the steel mills keep buying?

China steel mills seem unconcerned about port stocks, although it is not clear why. We do note that steel mills own two thirds of the port stocks anyway (traders the remainder) so perhaps SOEs are taking contractual cargoes, but only using the high grade portions currently while steel prices are so high? They could buy other high grade supply from the traders’ stocks. As we found on our visit to Tangshan mills at the start of May, SOEs have no concerns obtaining bank loans so may not worry about working capital. They may plan to destock later when prices are lower. And interestingly, Mysteel’s survey of around 67 small to medium steel mills which will be private, seem to have normalised inventories rather than any build up. So larger SOEs may be the culprits.

Steel mill buying follows demand, not supply

But if we leave aside the port stocks issue, then steel mills’ buying decisions are based on demand, not supply. The volatile iron ore price is actually reflecting destock-restock cycles by steel mills. One influence on the stock cycles is seasonal and predictable, another is Chinese macro factors, particularly policy decisions and is very difficult or impossible to forecast. Macro factors and seasonal demand periods guide steel mills as to whether steel demand will be strong and prices strong. If it looks promising, they want to buy ore to run flat out. And when one is buying, all start buying to beat the iron ore price peak.

How has this worked in practice?

Seasonally we reached the construction season end in June, so rebar demand should have been lower, and it has been. But equally importantly it was clear from anecdotal reports in Platts that destocking was taking place – mills were dumping contractual cargo deliveries into the spot market, liquidating to raise cash for debt repayments due at the end of June. It is clear that near the end of the month, that would cease as debts were met. Instead, the mills that had sold incoming cargoes would need to go back and buy to continue steel production – restock follows destock. And so it has played out.

As commentators searched for an explanation for the price jump, they latched onto a speech about the economy by President Xi on 27 June that was the only notable macro event. It was not a rip-roaring call by the President, but may have provided reassurance. From Reuters’ reports we see that the President said the full-year growth target could be met, said China was capable of meeting systemic risks despite challenges and noted that maintaining medium to high speed long-term growth will not be easy due to the sheer size of the economy, but the Government is committed to bolstering consumer-driven growth and curbing excess capacity in industries such as steel and coal.

No change to our 3Q price forecast of $70/t

Despite the run-up in the iron ore price it remains below our 3Q price forecast of $70/t. But our call was not based on the end of a short-term destocking cycle. Instead, we are looking towards September and October, which is seasonally a strong period for steel production and consumption – after the summer heat and rain, but before the winter freeze. If steel mills want to be producing strongly in September, they need to be booking iron ore cargoes in late July and August, and these are typically months where the price lifts. June is normally the low point for iron ore, heading into the summer steel demand lull.

Looming winter cuts may add to 3Q iron ore demand

This year there is an additional factor to consider. The Environment Ministry has its widely publicized industrial curtailments planned for 26+2 cities over winter. Smog reaches hazardous levels over Beijing-Tianjin during the winter when coal burn for heating joins the normal industrial smoke. Next winter, a change is planned by reducing industrial emissions from mid-Nov to late-Feb. The steel industry in Hebei, Henan, Shanxi and Shandong is expected to cut output by 50%, If this policy is enforced – and smog is a high priority issue – then steel output may fall by 35-45Mt over the three months. If prices remain high, steel mills will want to keep selling so it might be possible for them to over-produce and build some inventory in 2H. If this is so, then 3Q iron ore buying could be extra strong.

Ahem, not a lot of humility there. CS was telling folks that iron ore was going higher at $94. It was it that missed the destock not the other way around.

Still, there’s some reasonable arguments here. The jump in price triggered by Li’s bland comments was a surprise. Mills have been lowish on stock so may be behind some of it. But let’s face it, when Dalian open interest also soars then we can be pretty sure that China’s loony tune retail speculators (Banana Man) also played some significant role.

Those rebar stocks are also bullish and it’s true that mills follow demand. Q3 may well hold up and mills replenish their inventories though $70 as average looks a big stretch from here. $60 would probably cover it.

But the September-November period is not seasonally bullish at all. It is seasonally weak and traditionally brings in a big destock. If we combine that with what I expect to be a slowing of growth at the margin by then, then mills will indeed follow demand and shed inventories into year end. Especially so given port stocks will be even higher before then if we see some price pressure in Q3.

ASX selling pressure despite iron ore rally

Iron ore roared back, breaking resistance at $60. But this is a bear market. Also port inventories are climbing, while housing price growth is slowing. Expect another test of support at $50 is likely. Breach would signal another decline.

Iron Ore

The ASX 300 Metals & Mining index rallied off support at 2750 but is likely to respect resistance at 3000. Breach of 2750 would signal a primary down-trend.

ASX 300 Metals & Mining

The ASX 300 Banks index also rallied but is likely to respect 8500. Breach of 8000 would confirm the primary down-trend.

ASX 300 Banks

The ASX 200 displays strong selling pressure, with Twiggs Money Flow dipping below zero for the second time. Follow-through below 5700 would test primary support at 5600. Breach of 5600, while not yet a high probability, would complete a broad head and shoulders reversal.

ASX 200

Daily iron ore price update (headfake) | Macrobusiness

By Houses and Holes
at 12:05 am on June 28, 2017
Reproduced with permission of Macrobusiness.

Iron ore price charts for June 27, 2017:

Tianjin benchmark roared 6% to $59.10. Coal is calm. Steel too.

The trigger of course was this, via SCMP:

China would like foreign businesses to keep their profits in the country and reinvest them, Premier Li Keqiang said in his keynote speech at the World Economic Forum in Dalian on Tuesday, although he added there would be no restrictions on the movement of their money.


China’s economic growth is gaining fresh momentum and there will be no hard landing in the world’s second-biggest economy. The unemployment rate in May dropped to 4.91 per cent, he noted, the lowest level in many years.

Market access

China will continue to open its markets in the services and manufacturing sectors. It will loosen restrictions on shareholdings by foreign companies in joint ventures and will ensure China will continue to be the most attractive investment destination.

Economic policy

The Chinese government will not rely on stimulus to bolster economic growth. Instead, it will use structural adjustment and innovation to maintain economic vitality. The government will keep stable macro policies – a prudent monetary policy and a proactive fiscal policy – to ensure clarity and stability in financial markets.

Financial risks

China is fully capable of containing financial market risks and avoiding systemic ones. There are rising geopolitical risks and increasing voices opposing globalisation. China will keep its promises in combating climate change and will work to promote globalisation.

Absolutely nothing new there. In fact it is a little reassuring to those of us that think reform is on the verge of returning.

But the market has been heavily sold and so it got excited. There is a little room for it to run given lowish mill iron ore inventories:

But, in all honesty, I’m stretching to be positive. The price jump will very quickly arrive at Chinese ports as bowel-shakingly higher inventories in short order:

And the economy is still going to slow at the margin as housing comes off leading to a destock in the foreseeable future:

The great thing about markets is they always off[er] second chances. On this occasion it is to get even more short.