Rising inflation, Dollar weakens

The consumer price index (CPI) ticked up 1.14% (year-on-year) for April 2016, on the back of higher oil prices. Core CPI (excluding energy and food) eased slightly to 2.15%.

CPI and Core CPI

Inflation is muted, but a sharp rise in hourly manufacturing (production and nonsupervisory employees) earnings growth (2.98% for 12 months to April 2016) points to further increases.

Manufacturing Hourly Earnings Growth

Despite this, long-term interest rates remain weak, with 10-year Treasury yields testing support at 1.65 percent. Breach would signal another test of the record low at 1.50% in 2012. The dovish Fed is a contributing factor, but so could safe-haven demand from investors wary of stocks….

10-year Treasury Yields

The Dollar

The US Dollar Index rallied off long-term support at 93 but this looks more a pause in the primary down-trend (signaled by decline of 13-week Momentum below zero) than a reversal.

US Dollar Index

Explanation for the Dollar rally is evident on the chart of China’s foreign reserves: a pause in the sharp decline of the last 2 years. China has embarked on another massive stimulus program in an attempt to shock their economy out of its present slump.

China: Foreign Reserves

But this hair of the dog remedy is unlikely to solve their problems, merely postpone the inevitable reckoning. The Yuan is once again weakening against the Dollar. Decline in China’s reserves — and the US Dollar as a consequence — is likely to continue.

USD: Chinese Yuan

Goldman Cuts 2017 Oil Price Forecast Due To Slower Market Rebalancing | Zero Hedge

Goldman Sachs has cut its long-term crude oil forecasts:

The inflection phase of the oil market continues to deliver its share of surprises, with low prices driving disruptions in Nigeria, higher output in Iran and better demand. With each of these shifts significant in magnitude, the oil market has gone from nearing storage saturation to being in deficit much earlier than we expected and we are pulling forward our price forecast, with 2Q/2H16 WTI now $45/bbl and $50/bbl. However, we expect that the return of some of these outages as well as higher Iran and Iraq production will more than offset lingering issues in Nigeria and our higher demand forecast. As a result, we now forecast a more gradual decline in inventories in 2H than previously and a return into surplus in 1Q17, with low-cost production continuing to grow in the New Oil Order. This leads us to lower our 2017 forecast with prices in 1Q17 at $45/bbl and only reaching $60/bbl by 4Q2017.

But these forecasts are premised on a Chinese recovery:

Stronger vehicle sales, activity and a bigger harvest are leading us to raise our Indian and Russia demand forecasts for the year. And while we are reducing our US and EU forecasts on the combination of weaker activity and higher prices than previously assumed, we are raising our China demand forecasts to reflect the expected support from the recent transient stimulus. Net, our 2016 oil demand growth forecast is now 1.4 mb/d, up from 1.2 mb/d previously. Our bias for strong demand growth since October 2014 leaves us seeing risks to this forecast as skewed to the upside although lesser fuel and crude burn for power generation in Brazil, Japan and likely Saudi are large headwinds this year.

While production growth continues to surprise:

…..This expectation for a return into surplus in 1Q17 is not dependent on a sharp price recovery beyond the $45-$55/bbl trading range that we now expect in 2016. First, it reflects our view that low-cost producers will continue to drive production growth in the New Oil Order – with growth driven by Saudi Arabia, Kuwait, Iran, the UAE and Russia. Second, non-OPEC producers had mostly budgeted such price levels and there remains a pipeline of already sanctioned non-OPEC projects. In fact, we see risks to our production forecasts as skewed to the upside as we remain conservative on Saudi’s ineluctable ramp up and Iran’s recovery.

We expect continued growth in low-cost producer output
Saudi Arabia, Kuwait, UAE, Iraq, Iran (crude) and Russia (oil) production (kb/d)

Tyler Durden has a more bearish view:

While there is much more in the full note, the bottom line is simple: near-term disruptions have led to a premature bounce in the price of oil, however as millions more in oil barrels come online (and as Chinese demand fades contrary to what Goldman believes), the next leg in oil will not be higher, but flat or lower, in what increasingly is shaping up to be a rerun of the summer of 2015.

Source: Goldman Cuts 2017 Oil Price Forecast Due To Slower Market Rebalancing | Zero Hedge

Iron Ore Wrap

From Andy Semple at Andika:

The iron ore price has slumped to a one-month low as investors fret over the strength of Chinese demand. The commodity weakened 1.7% to $US53.50 a tonne at the end of last week, its lowest price since April 11. It’s the commodity’s seventh red session in the past eight and the price has now dropped to below the [Australian] government’s recent budget forecast of $US55 a tonne.

Greenback finds support

The US Dollar Index rallied off long-term support at 93 but this looks more a pause in the primary down-trend, signaled by decline of 13-week Momentum below zero, than a reversal.

US Dollar Index

Explanation for the Dollar rally is evident on the chart of China’s foreign reserves: a pause in the sharp decline of the last 2 years. China has embarked on another massive stimulus program in an attempt to shock their economy out of its present slump.

China: Foreign Reserves

But this hair of the dog remedy is unlikely to solve their problems, merely postpone the inevitable reckoning. The Yuan is once again weakening against the Dollar and decline in China’s reserves, and the US Dollar as a consequence, is likely to continue.

USD: Chinese Yuan

Asia: Shanghai weakens

The Shanghai Composite Index broke medium-term support at 2900, warning of another test of primary support at 2700. Reversal of Money Flow below zero would warn of a decline to 2400*.

Shanghai Composite Index

* Target calculation: 3000 – ( 3600 – 3000 ) = 2400

Japan’s Nikkei 225 Index is edging higher but trend strength is weak. Breakout above resistance at 17000 was followed by a retreat to 16000. Support is weak and breach of 16000 would signal another test of primary support at 15000.

Nikkei 225 Index

* Target calculation: 17000 – ( 20000 – 17500 ) = 15000

India’s Sensex is more bullish, testing its upper trend channel at 26000. Short retracement is a bullish sign and breakout above 26000 would signal that the down-trend is ending. Recovery of 13-week Twiggs Momentum above zero would strengthen the signal.

SENSEX

* Target calculation: 23000 – ( 25000 – 23000 ) = 21000

The real reason for low savings rates

Also from Michael Pettis:

This is the great irony of the global financial crisis. China, Russia, and France want to lead the charge to strip the US of its exorbitant privilege, and the US resists. And yet if the US were to take steps to prevent foreigners from accumulating US assets, the result would be a sharp contraction in international trade. Surplus countries, like Europe and China, would be devastated, but the US current account deficit would fall with the reduction in net capital inflows. As it did, by definition the excess of US investment over US savings would have to contract. Because US investment wouldn’t fall, and in fact would most likely rise, US savings would automatically rise as lower US unemployment caused GDP to grow faster than the rise in consumption.

But what about the extremely low savings rates in the US. Don’t they prove, as Yale University’s Stephen Roach has often pointed out, that the US is savings-deficient and relies on Chinese and European savings to fund US investment, or at least the US fiscal deficit, because the US consumes beyond its means?

“What the candidates won’t tell the American people is that the trade deficit and the pressures it places on hard-pressed middle-class workers stem from problems made at home. In fact, the real reason the US has such a massive multilateral trade deficit is that Americans don’t save.”

This is one of the most fundamental errors that arise from a failure to understand the balance of payments mechanisms. As I explained four years ago in an article for Foreign Policy, “it may be correct to say that the role of the dollar allows Americans to consume beyond their means, but it is just as correct, and probably more so, to say that foreign accumulations of dollars force Americans to consume beyond their means.” As counter-intuitive as it may seem at first, the US does not need foreign capital because the US savings rate is low. The US savings rate is low because it must counterbalance foreign capital inflows, and this is true out of arithmetical necessity……

Source: The titillating and terrifying collapse of the dollar. Again. | Michael Pettis’ CHINA FINANCIAL MARKETS

The titillating and terrifying collapse of the dollar. Again. | Michael Pettis

Michael Pettis explains why the US dollar as reserve currency is a burden rather than a privilege for the US:

Historically, neither Europe nor Japan, and certainly not China, have been willing to permit foreigners to purchase significant amounts of government bonds for reserve purposes. When the PBoC tried to accumulate yen three years ago, for example, rather than welcome the friendly Chinese gesture granting the Bank of Japan some of the exorbitant privilege enjoyed by the Fed, the Japanese government demanded that the PBoC stop buying. The reason is because PBoC buying would force up the value of the yen by just enough to reduce Japan’s current account surplus by an amount exactly equal to PBoC purchases. This, after all, is the way the balance of payments works: it must balance.

What is more, because the current account surplus is by definition equal to the excess of Japanese savings over Japanese investment, the gap would have to narrow by an amount exactly equal to PBoC purchases. Here is where the exorbitant privilege collapses. If Japan needs foreign capital because it has many productive investments at home that it cannot finance for lack of access to savings, it would welcome Chinese purchases. PBoC purchases of yen bonds would indirectly cause productive Japanese investment to rise by exactly the amount of the PBoC purchase, and because the current account surplus is equal to the excess of savings over investment, the reduction in Japan’s current account surplus would occur in the form of higher productive investment at home. Both China and Japan would be better off in that case.But like other advanced economies Japan does not need foreign capital to fund productive domestic investment projects. These can easily be funded anyway. In that case PBoC purchases of yen bonds must cause Japanese savings to decline, so that its current account surplus can decline (if the gap between savings and investment must decline, and investment does not rise, then savings must decline). There are only two ways Japanese savings can decline: first, the Japanese debt burden can rise, which Tokyo clearly doesn’t want, and second, Japanese unemployment can rise, which Tokyo even more clearly doesn’t want.

There is no way, in short, that Japan can benefit from PBoC purchases of its yen bonds, which is why Japan has always opposed substantial purchases by foreign central banks. It is why European countries also strongly opposed the same thing before the euro was created, and it is why China restricts foreign inflows, except in the past year when it has been overwhelmed by capital outflows. The US and, to a lesser extent, the UK, are the only countries that permit unlimited purchases of their government bonds by foreign central banks, but the calculus is no different.

It turns out that foreign investment is only good for an economy if it brings needed technological or managerial innovation, or if the recipient country has productive investment needs that cannot otherwise be funded. If neither of these two conditions hold, foreign investment must always lead either to a higher debt burden or to higher unemployment. Put differently, foreign investment must result in some combination of only three things: higher productive investment, a higher debt burden, or higher unemployment, and if it does not cause a rise in productive investment, it must cause one of the other two.

The two conditions under which foreign investment is positive for the economy – i.e. it leads to higher productive investment – are conditions that characterize developing economies only, and not advanced countries like Japan and the US. These conditions also do not characterize developing countries that have forced up their domestic savings rates to levels that exceed domestic investment, like China.

Source: The titillating and terrifying collapse of the dollar. Again. | Michael Pettis’ CHINA FINANCIAL MARKETS

IMF warns about Chinese debt

From FT (via the Coppo Report at Bell Potter):

China’s leaders need to look beyond the current solutions being floated to tackle the country’s mounting corporate debt problems and come up with a bigger plan to do so, the International Monetary Fund’s top China expert has warned. The IMF has been expressing growing concern about China’s debt issues and pushing for an urgent response by Beijing to what the fund sees as a serious problem for the Chinese economy. It warned in a report earlier this month that $1.3tn in corporate debt — or almost one in six of the business loans on Chinese banks’ books — was owed by companies who brought in less in revenues than they owed in interest payments alone. In a paper published on Tuesday, James Daniel, the fund’s China mission chief, and two co­authors, went further and warned that Beijing needed a comprehensive strategy to tackle the problem. They warned that the two main responses Beijing was planning to the problem — debt­-for­-equity swaps and the securitization of non­performing loans — could in fact make the problem worse if underlying issues were not dealt with. The plan for debt­ for equity swaps could end up offering a temporary lifeline to unviable state­ owned companies, they warned. It could also leave them managed by state­ owned banks or other officials with little experience in doing so.

Bad debt is bad debt …… and nonproductive assets are nonproductive assets. Financial window-dressing like securitization or debt-for-equity swaps will not change this. The assets are still unproductive. Effectively, China has to stump up $1.3 trillion to re-capitalize its banks. And that may be the tip of the iceberg.

Carl Icahn warns of ‘day of reckoning’

Reuters:

Billionaire activist investor Carl Icahn ….. said he was “still very cautious” on the US stock market and there would be a “day of reckoning” unless there was some sort of fiscal stimulus.

…..Icahn, who owned 45.8 million Apple shares at the end of last year, said China’s economic slowdown and worries about how China could become more prohibitive in doing business triggered his decision to exit his position entirely.

Icahn is right about fiscal stimulus. Easy money policies implemented by central banks around the globe are an effective tool to stem the flow when financial markets are hemorrhaging but they are not a long-term solution. The only effective means of halting the long-term, downward spiral is fiscal stimulus.

The biggest obstacle to fiscal stimulus is resistance to increasing public debt. There is good reason for this as wasteful deficit spending in the past has left taxpayers with a massive debt burden and nothing to show for it. Governments ran deficits to cover a shortfall in tax revenue or an increase in expenditure without thought as to how the debt would be repaid.

But if debt is used to fund investment in productive infrastructure, revenue from the asset can be used to pay off the debt over time, or the asset can be sold to repay the loan. There is an immediate double benefit to government, with increased wages — directly from infrastructure projects and indirectly from suppliers of goods and services — boosting tax revenues while also saving on unemployment benefits. The long-term benefit is retaining and developing skills in the economy that would otherwise be lost through long-term unemployment.

Politicians have a poor track record, however, when it comes to selecting productive infrastructure projects. Instead favoring projects that will garner the most votes. This can be improved by setting up a non-partisan planning and selection process with a long time horizon. Also partnership with the private sector would eliminate projects with weak or unpredictable revenue streams.

Partnerships with the private sector also help to leverage funds raised through public debt, limit cost overruns and contain on-going running costs. But both sides must have skin in the game.

To be effective, infrastructure programs must address the long-term needs of the economy and should be carried out on a broad, even global, scale to re-invigorate the faltering global economy.

Source: Carl Icahn sells entire Apple stake on China worries, warns Wall Street of ‘day of reckoning’

Plenty of bottom signals

Global

Dow Jones Global Index is headed for a test of resistance at 320 after penetrating its descending trendline. Respect of 320 is likely but a bottom is forming and a higher trough would suggest an inverted head-and-shoulders formation. 13-Week Twiggs Momentum recovery above zero is bullish but another low peak would indicate that bears still dominate.

Dow Jones Global Index

North America

The S&P 500 continues to test the band of resistance at 2100 to 2130. Money Flow remains bullish but I expect stubborn resistance at this level, further strengthened by poor quarterly results, so far, in the earnings season.

S&P 500 Index

A CBOE Volatility Index (VIX) at a low 14 indicates that (short-term) market risk is low. Long-term measures are also starting to ease but we maintain high cash levels in our portfolios.

S&P 500 VIX

Canada’s TSX 60 is headed for a test of resistance at 825. Penetration of the descending trendline suggests that a bottom is forming. Resistance is likely to hold but an ensuing higher trough would be a bullish sign. Rising 13-week Twiggs Momentum is encouraging but a low peak above zero would indicate that bears still dominate.

TSX 60 Index

Europe

Germany’s DAX broke resistance at 10000 and is headed for a test of the descending trendline. Rising Money Flow indicates medium-term buying pressure. Retreat below 10000 would warn of another decline.

DAX

* Target calculation: 9500 – ( 11000 – 9500 ) = 8000

The Footsie is headed for a test of 6500. Rising Money Flow suggests decent buying pressure. Respect of resistance is likely but a bottom is forming and an ensuing higher trough would suggest a primary up-trend.

FTSE 100

* Target calculation: 6000 – ( 6500 – 6000 ) = 5500

Asia

The Shanghai Composite Index retreated below 3000. Breach of medium-term support at 2900 would warn of another test of primary support at 2700. Rising Money Flow suggests that breach of primary support is unlikely.

Shanghai Composite Index

* Target calculation: 3000 – ( 3600 – 3000 ) = 2400

Japan’s Nikkei 225 Index broke resistance at 17000, a higher trough signaling a primary up-trend. Expect retracement to test the new support level at 17000. Rising Money Flow confirms buying pressure.

Nikkei 225 Index

* Target calculation: 17000 – ( 20000 – 17500 ) = 15000

India’s Sensex is testing its upper trend channel at 26000. Penetration of the descending trendline would suggest that a bottom is forming. Respect, indicated by reversal below 25000, would warn of another test of primary support.

SENSEX

* Target calculation: 23000 – ( 25000 – 23000 ) = 21000

Australia

A sharp fall in the Australian Dollar as result of record low inflation numbers may precipitate some selling by international buyers. Further weakness in iron ore would impact both the ASX and the Aussie Dollar.

The ASX 200 has also penetrated its descending trendline, suggesting that a bottom is forming. But bearish divergence on 13-week Money Flow warns of selling pressure. Retreat below 5000 would warn of another test of primary support at 4700.

ASX 200

* Target calculation: 4700 – ( 5200 – 4700 ) = 4200