Analysis of the global economy
David Llewellyn-Smith sums up Australian Treasurer Scott Morrison’s Budget with one chart:
According to Treasury, Australia’s terms of trade are going to settle at a gentlemanly plateau far higher than they have even been in history outside of the China boom.
Source: Welcome to the Banana Republic Budget – MacroBusiness
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.
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’
The Fed quit quantitative easing more than a year ago, limiting total assets on its balance sheet to $4.5 trillion. But more than $2.5 trillion of cash injected into the financial system had been deposited straight back into the Federal Reserve system by banks as excess reserves, earning 0.25% p.a.
Fresh money continued to leak into the financial system as banks drew down their excess reserves, highlighted above by the widening gap between Total Assets and Excess Reserves. In December 2015 the Fed doubled the rate payable on excess reserves to 0.50% p.a. The intention is clearly to attract more excess reserves and narrow the gap, or at least slow the rate at which excess reserves are being withdrawn to prevent further widening.
Easy money policies followed by central banks around the world are not achieving the desired result of reviving business investment. If we examine the Fed’s track record over the last two decades, sharp surges in business credit were accompanied by speculative bubbles — stocks ahead of the Dotcom crash and housing ahead of the GFC — with disastrous results. GDP failed to respond.
The latest rally in global markets is also driven by monetary easing, this time in China, with a massive surge in the money supply signaling PBOC intentions to print their way out of trouble (and into an even bigger hole).
Ineffectiveness of monetary policy in solving structural problems has often been described as “like pushing on a string”. But recent experience shows it is more like lighting a fuse.
This is a nightmare, which will pass away with the morning. For the resources of nature and men’s devices are just as fertile and productive as they were. The rate of our progress towards solving the material problems of life is not less rapid. We are as capable as before of affording for everyone a high standard of life …. and will soon learn to afford a standard higher still. We were not previously deceived. But to-day we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time – perhaps for a long time.
~ John Maynard Keynes: The Great Slump of 1930
From Justin Smirk at Westpac:
The headline CPI surprised in Q1 falling 0.2% compared to Westpac’s forecast for +0.4%….. The annual rate is now just 1.3%yr compared to 1.7%yr in Q4.
The core measures, which are seasonally adjusted and exclude extreme moves, rose 0.2% compared to the market’s expectation of 0.5% rise…. The annual pace of the average of the core inflation measures is now 1.5% from 2.0% in Q4 (Q4 was unrevised) and is the lowest print we have yet seen from this measure.
From Jens Meyer at The Age:
Today’s weak inflation numbers are a game changer for the Reserve Bank that will trigger a rate cut, says JPMorgan head of fixed income and foreign exchange strategy Sally Auld.
The investment bank now expects the RBA to cut by 0.25 percentage points next week and to follow this up with a further 25 basis points cut in August, taking the cash rate to 1.50 per cent.
Smirk disagrees:
…..But low inflation, on its own, is not a trigger for a rate cut. Sure, it unlocks the interest rate door for the RBA should it decide it needs to walk through that door as the Bank would not have to wait for another CPI update before doing so. However, it does not mean that the RBA will cut rates! A rate cut is dependent on local economic conditions demanding a rate cut. With unemployment on a new downtrend this is not so at the moment and we suggest that the RBA is waiting to see a new weaker trend in domestic activity and employment before it would embark on such a strategy.
Source: Australian 14 CPI 2016 | Westpac
Source: Three reasons for the Reserve Bank of Australia to cut official interest rates in May
Ruth Liew:
….the Reserve Bank of Australia pushes Australian banks to create the New Payments Platform, a new piece of open-source infrastructure being built that will move the payments system to real time. The RBA’s plans are echoed by the US and the eurozone, which are also planning to roll out real time payment infrastructure by next year. These payments would boost Australia’s economic activity, as money flow improves and Australians access their funds as they are deposited, [Don Sharp at InPayTech] argued.
Australian banks could lose $2.5 billion in interest earnings if instantaneous payments were adopted – and the figure could jump significantly as interest rates rise.
Payments held in the banking system are part of the “float” which banks use for interest-free funding of part of their balance sheet — a boost to interest margins. Switch to a realtime payments system would see this disappear.
Source: InPayTech plots capital raise and ASX IPO as real-time payments take off
Goldman Sachs (GS), last of bank heavyweights to release their first-quarter (Q1) 2016 earnings, reported a 55 percent fall in diluted earnings per share ($2.71) compared to the first quarter of last year ($6.05).
Net revenues dropped 40%, primarily due to a sharp 53% fall in Market Making and a 23% fall in Investment Banking. A 29% cut in non-interest expenses was insufficient to compensate.
Basel III Tier 1 Capital (CET1) decreased slightly to 12.2% (Q1 2015: 12.4%) of risk-weighted assets, while Leverage (SLR) improved to 6.0% (Q1 2015: 5.9%).
The dividend was held at 65 cents (Q1 2015: 65 cents), increasing the payout ratio to a still modest 18%.
We have had six heavyweights, JPM, BAC, WFC, C, MS and GS all report declining earnings per share. Most had cut non-interest expenses but insufficient to compensate for falling revenues and rising provisions for credit losses. The results reflect a tough environment.
GS is in a primary down-trend, having broken primary support at $170. Long-term Momentum below zero confirms. Expect a rally to test resistance and the descending trendline at $170 to $175 but respect is likely and would warn of another test of primary support at $140. Breach would offer a target of $110*.
* Target calculation: 140 – ( 170 – 140 ) = 110
Sylvain Leduc, Kevin Moran, and Robert J. Vigfusson in the FRBSF Economic Letter:
Why has consumption not responded more to cheap oil? Clearly, the U.S. economy was buffeted by headwinds over the past year, like weak foreign growth and the substantial appreciation of the dollar, that may have masked the positive effects of cheaper oil. Moreover, the decline in gas prices has been more muted than the drop in the price of oil. However, another possible reason is that the impact of changes in oil prices on the economy depends not only on the magnitude of the change, but also on its perceived persistence. Consumer spending is more likely to rise if people believe the decline in oil prices will last for a while; by contrast, if consumers think lower oil prices are not here to stay, they may simply decide to save what they don’t spend at the pump.
Figure 4: Estimated share of permanence in oil price movements
Source: Economic Research | The Elusive Boost from Cheap Oil
Morgan Stanley (MS) is the latest bank heavyweight to release their first-quarter (Q1) 2016 earnings, reporting a 53 percent fall in diluted earnings per share ($0.55) compared to the first quarter of last year ($1.18).
Net revenues dropped 21%, primarily to a sharp 43% fall in the Institutional Securities (Trading) business and an 18% fall in Investment Banking. Non-interest expense cuts of 14% were insufficient to compensate. Declines were widespread, with Europe, Middle East & Africa (EMEA) (-36%) the worst affected.
Tier 1 Capital (CET1) improved to 14.5% (Q1 2015: 11.6%) of risk-weighted assets, while Leverage (SLR) improved to 6.0% (Q1 2015: 5.1%).
The dividend was held at 15 cents (Q1 2015: 15 cents), increasing the payout ratio to a still modest 27%, from 13% in Q1 2015.
Bob Doll’s newsletter this week says:
The uneven market uptrend in place since mid-February resumed last week, with the S&P 500 Index climbing 1.7%. The primary catalyst appeared to be better-than-expected corporate earnings results in the still-early reporting season, particularly from the banking sector. As a result, bank stocks performed particularly well, rising 7% last week, marking the best weekly gain in over four years. Investors also focused on better economic data coming from China and ongoing evidence that the U.S. economy is growing slowly.
We have had five heavyweights, JPM, BAC, WFC, C and MS all report declining earnings per share. Most had cut non-interest expenses but insufficient to compensate for falling revenues and rising provisions for credit losses. I’m afraid there isn’t much evidence of growth in the US economy and banking results reflect a tough environment. Beating earnings estimates doesn’t mean much if your earnings are falling.
MS is in a primary down-trend, having broken primary support at $30. Long-term Momentum below zero confirms. Expect a rally to test resistance and the descending trendline at $30 but respect is likely and would warn of another test of the band of primary support at $20 to $22. Breach would offer a target of the 2011 low at $12*.
* Target calculation: 30 – ( 40 – 30 ) = 20
Goldman Sachs (GS) is due to report Tuesday.
Societie General on China’s resurgence:
In our view, the most obvious underlying factor behind this recovery is credit. In Q1, increases in total credit exploded to CNY7.5tn, up 58% yoy and equivalent to 46.5% of nominal GDP – one of the highest ratios ever. Credit growth accelerated to 15.8% yoy to end-March, the quickest pace in 20 months.
Credit growing faster than nominal GDP is unsustainable in the long-term.
Source: Special report: Measuring China’s resurgent construction boom – MacroBusiness
