Category: Banks & Interest Rates

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Gold tanked? Not yet!

Gold broke below its recent flag formation, warning of a test of support at $1200/ounce.

Gold

Selling is driven by expectations of a Fed interest rate hike in June …..and recent Chinese stimulus which postponed Yuan devaluation against the Dollar. But expectations of a rate hike are causing a sell-off of the Chinese Yuan, with the USDCNY strengthening over the last few weeks.

USDCNY

…Which in turn will cause the Chinese to sell foreign reserves to support the Dollar peg (…..else devalue which would panic investors and cause a downward spiral). Sale of Dollar reserves by China would drive the Dollar lower.

Dollar Index

…and Gold higher. I remain bullish as long as support at $1200/ounce holds.

Disclosure: Our Australian managed portfolios are invested in gold stocks.

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Treasuries fall and Dollar strengthens on latest Fed minutes

Treasury yields rose and prices fell sharply after release of minutes from the Fed’s latest monetary policy meeting. The April minutes reveal that policy makers see a June interest-rate hike as appropriate if labor markets and economic growth continue to strengthen. The 10-year Treasury yield jumped 12 basis points, suggesting a rally to test resistance at 2.0 percent.

10-year Treasury yield

The Dollar strengthened against China’s Yuan, testing medium-term resistance at CNY 6.55. Breakout would force the PBOC to further deplete foreign reserves in support of the Yuan. The alternative of an uncontrolled descent would instill panic and encourage capital flight to gold and the USD.

USDCNY

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Oil turns lower as greenback rallies on Fed minutes

From Mark Shenk:

Oil dropped from a seven-month high as the US dollar surged after the Federal Reserve published minutes of its latest monetary policy meeting suggesting a June hike is possible. Commodities fell as the Bloomberg Dollar Spot Index, which tracks the US currency against 10 others, surged. The April minutes showed that policy makers saw an interest-rate hike appropriate in June if labour markets and economic growth continued to strengthen…..

Source: Oil turns lower as greenback rallies on Fed minutes

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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

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Stan Druckenmiller: This Is The Endgame | Zero Hedge

Hedge fund legend Stan Druckenmiller, founder of Duquesne, addressing the Sohn Conference:

….The Fed has no end game. The Fed’s objective seems to be getting by another 6 months without a 20% decline in the S&P and avoiding a recession over the near term. In doing so, they are enabling the opposite of needed reform and increasing, not lowering, the odds of the economic tail risk they are trying to avoid. At the government level, the impeding of market signals has allowed politicians to continue to ignore badly needed entitlement and tax reform.

Look at the slide behind me. The doves keep asking where is the evidence of mal-investment? As you can see, the growth in operating cash flow peaked 5 years ago and turned negative year over year recently even as net debt continues to grow at an incredibly high pace. Never in the post-World War II period has this happened. Until the cycle preceding the great recession, the peaks had been pretty much coincident. Even during that cycle, they only diverged for 2 years, and by the time EBITDA turned negative year over year, as it has today, growth in net debt had been declining for over 2 years. Again, the current 5-year divergence is unprecedented in financial history!

And if this wasn’t disturbing enough, take a look at the use of that debt in this cycle. While the debt in the 1990’s financed the construction of the internet, most of the debt today has been used for financial engineering, not productive investments….

Source: For Stan Druckenmiller This Is “The Endgame” – His Full ‘Apocalyptic’ Presentation | Zero Hedge

Hat tip to Houses & Holes at Macrobusiness.

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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.

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Lighting a fuse

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.

Fed Total Assets and Excess Reserves

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.

Business Credit Growth v. Nominal GDP

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

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Will the RBA cut interest rates in May?

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

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Real-time payments could hurt banks

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

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Goldman Sachs ends a dismal season

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*.

Morgan Stanley (MS)

* Target calculation: 140 – ( 170 – 140 ) = 110

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