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The real effective exchange rate of the RMB has appreciated by 10% on the producer price measure since 2016. While the divergence in profits growth suggests domestic consumption has remained solid, we believe policymakers will be less tolerant of a further rise in the trade weighted RMB as growth pressures mount in H2. The focus on curbing debt in the financial sector and on reining in unauthorised government financing is set to weigh on growth in the coming quarters. However, China is unlikely to engineer a significant depreciation of the RMB. In the current global political climate, a sharp decline in the exchange rate could be interpreted as Beijing firing the first shot of a currency war. We expect the RMB's trade-weighted appreciation to come to a halt.
RMB index peaked at 97.85 on 22 June 2018 and fell back to 93 as trade war fears were priced in. Far from depreciating the currency the authorties intervened to prevent a more rapid fall than markets would have priced in.
The oil market is in a sweet spot and, so long as demand stays solid, crude prices could see further upside. That said, the sweet spot is maturing, paving the way for a pick-up in volatility going into 2019. Three factors underlie this prospect.
First, while it is too soon to call time on the cyclical world economic upswing, oil is no longer as cheap relative to global growth momentum as it was, say, six months ago. Some demand destruction can be expected gradually to set in. What is more, as inflation expectations respond to rising crude prices, sharp bond yield increases could pose challenges for growth and, therefore, oil consumption.
Second, a smooth transition to the next stage of OPEC+ strategy is by no means guaranteed. With the approach of next month’s review, the different perspectives of the two pillars of OPEC+ – Saudi Arabia and Russia – look set to become more apparent. Riyadh has been signalling since last year that it favours postponing any reversal of the production restraint agreed in November 2016 and has meanwhile found it expedient to over-deliver on its output cuts. The Saudi preference for keeping the oil price higher for longer is unmistakeable.
By contrast, Russia would be comfortable with a price range of US$50-60/bbl; and while taking care to avoid giving any impression of serious disagreement with the Saudis, Moscow would prefer to stick to the global inventories criterion that underlay the 2016 agreement. This would point to a decision to increase output.
Third and finally, by mid-2019 new pipeline infrastructure should be up and running in the Permian, ready to accommodate higher US shale production.
We have long held the view that OPEC+ action was a defensive supply taper in the hope of stronger demand. This hope has materialised, but OPEC’s initiative can no longer be described as defensive. The pendulum is now swinging in the other direction, stoking a price overshoot that will raise the stakes for all parties involved: producers, consumers and investors
WTI prices continued to rise to $74pb in July before range trading. In early October volatility was back in large style. WTI fell from $76bp to $60bp in one month.
We downgrade AUD from 0 to -1 vs USD on domestic risks and monetary policy divergence. AUD is particularly exposed to two of the major factors roiling markets: FOMC policy tightening and trade war risk.
Following the FOMC’s rate hike last month, the RBA cash target rate is lower than fed funds for the first time in almost 20 years. The last time this happened, in the late 1990s, AUD lost one-third of its value against USD. In the 1990s the gap reached 50bp in favour of fed funds; based on market expectations of monetary policy this year the gap could widen to at least 75bp this time. The 2y yield spread is already at -50bp, and could yet test the 1990s level of -100 bp. In our Macro Strategy portfolio we own AUD/USD downside through a calendar put spread, betting that AUD will react to this erosion of yield support by the end of the year.
External demand for Australian commodities at risk. We expect Chinese GDP growth to slow moderately this year, to 6.5%, due mainly to a cooling housing market. This implies reduced demand for Australian iron ore. Sure enough, prices have already dropped 20% since the end of February.
Online retail market share rising. Amazon Australia started trading in December. According to the latest figures, online retail turnover in Australia has increased by 40% since February 2017, In Germany, the UK and the US, where online retail sales are around 14% of the total, the Amazon effect has produced high street price disinflation and weakened the Phillips curve. The prospect of something similar happening in Australia is likely to stay the RBA’s hand, lending further support to our AUD downgrade from 0 to -1.
AUD/USD spot was 0.78 at the time we made the call. Our Asset Allocation recommendations have a 3 to 6 month time horizon. Over 3 months AUD had fallen 5% vs. USD and this deepened to 9% over 6 months.
In the US, Fed policy has had the funds rate inching towards zero in real terms, in line with the growing bias of firms to add capital rather than labour to boost output. Inflation, however, is starting to pick up and the FOMC decision-making process now has to consider a markedly easier fiscal policy that is mostly targeting capital-intensive industries, through tax reforms and increased defence spending. Fed Chair Powell is, in our view, more sensitive to market mischief than to price indexes. As such, he may very well be compelled to act more aggressively than the market expects if he thinks greed is getting out of hand. We believe the base case is four 25bp rate hikes in 2018 with the impact of fiscal policy still on the policy horizon.
Fed incresased the Fed funds rate four times in 2018 as we predicted.
Froth coming off the market, but stars still aligned for oil prices. Volatility to pick up over 2018 as the sweet spot matures.
Some froth is now coming off oil prices – a healthy development. But not much has changed in terms of the underlying fundamentals. Higher real interest rates mirror solid global macro momentum and have some way to go before they restrict activity. Demand for crude remains strong and the global inventory glut is shrinking – a supportive combination for prices. In addition, we expect the dollar to remain soft and view output disruptions in Venezuela and geopolitical tension in the Middle East as posing upside risks for prices.
We stick to the scenario laid out in our recent LSR View: 2018 looks to be a sweet spot year for both OPEC and US producers. But with OPEC+ output guidance approaching a crossroads and US supply gathering pace, the sweet spot is maturing. OPEC’s strategy was always to be viewed as a supply taper in the hope of stronger demand. With the global economy on the mend since mid-2016, this hope has materialised. Sustained oil consumption growth is now required for prices to maintain current levels. For the time being, the market looks well supported. But as supply dynamics become more challenging and Goldilocks investing loses its shine, oil market volatility is set to rise.
WTI rose from $59pb at time of publication to $74pb in July, then range traded. The volatility we predicted arrived in early October and prices slid from $76pb to $60pb in a month.
Most analysts agree that the rate of China's debt build up is cause for alarm. Some predict an imminent blow up in the form of a major financial crisis. Others predict a Japan-style series of 'lost decades' as the debt burden drags down economic growth.
Market forces do not operate in the usual way in China. Opting for a slow adjustment process does not mean that Beijing is simply sitting on the fence. This, in short, is deleveraging by stealth. The nature of China's debt rules out the likelihood of a systemic crisis, and the crux of the issue lies in the overall balance sheet. We make a debt distribution adjustment by combining the debt of the government, SOEs and local government funding vehicles to estimate the overall debt of the state. These adjustments do not change the total amount of debt, but the mix alters dramatically: corporate debt looks far less frightening from a default perspective. The implication is the central government still has room to absorb the current level of debt onto its balance sheet without triggering a crisis.
We identify four main reasons why the government's position is stronger than is assumed by those who are predicting a crash landing: 1) the state can make all the difference; 2) the overall balance sheet is healthy; 3) the level of external debt is low and that of domestic savings high; 4) and real estate, which is widely used as a form of collateral, has not yet collapsed.
Unlike many China sceptics, we believe policymakers are proactively seeking to contain financial risks by means of the following measures: 1) pooling the risks among different sectors, 2) stealth restructuring and controlled defaults, 3) increasing SOE efficiency without privatization and de-monopolization, 4) forcing financial deleveraging and strengthening regulatory coordination, 5) narrowing the credit gap with nominal GDP.
There has been no financial crisis or debt blow-up. Defaults have been allowed to rise in certain specific cases as healthy part of a more macro-prudential policy. Deleveraging by stealth continues.
Charles Dumas joined TS Lombard in 1998, becoming Chief Economist in 2005. He is recognised as one of the world’s leading macroeconomic forecasters. He has written several books on the global economy, including ‘Globalisation Fractures’ (2010), which earned praise from Bank of England Governor Mervyn King: “To understand the causes of the financial crisis, read this insightful analysis.”
Charles has 40 years’ experience as an economist and financial markets professional. In the 1980s he was Head of Research for JP Morgan in London. In the 1970s he was Director of European Economics for General Motors.
Before that he worked on tax reform for the Conservative Party and as a journalist on The Economist newspaper. He was a Managing Director in JP Morgan's New York M&A department from 1988 to 1992 and had previously worked in its capital markets group in New York and London.
Larry has more than 35 years’ experience as an international economist and investment strategist working for major global financial institutions. Larry was a co-founder of Trusted Sources in 2007. He looks at cross-EM and macro strategy themes, identifying major global trends that originate in and/or impact on emerging economies. He was co-head of Emerging Debt Markets at Goldman Sachs before becoming global head of Emerging Market Research at Chase Manhattan Bank.
During the 1980s he was the head of economic committees responsible for advising creditor banks on restructuring the sovereign debt of Mexico, Brazil, Poland, Yugoslavia and Nigeria. Throughout his career Larry has focused on emerging markets, especially Brazil, China and Russia. He received a PhD in economics from the University of Chicago.
Steven joined the company in 2017. His professional experience as economist and portfolio manager began in the late 1970s.
It includes econometric modelling at Data Resources Inc., creating interest rate and FX derivatives strategies at Salomon Brothers, managing US and global fixed-income portfolios at OFFITBANK, being global head of fixed-income at Lazard Asset Management and, more recently, as Chief Economist at M Science he developed “big data” to underpin his analysis of the economy, central bank policies, and capital market pricing.
Aside from his extensive client-facing work, Steve is a well-known commentator on economic and financial issues, is frequently quoted in the financial press, appearing on TV and radio, and writing guest columns for financial publications.
Bo Zhuang joined TS Lombard in 2007 as an economist and went to Beijing three years later to establish the TS Lombard office which he heads. In his analysis he draws on his local experience, extensive travel through China and a network of expert sources. He focuses on China’s growth transition and the way its top-down policies affect the real economy. The main themes he covers include the country’s political-business cycle, shadow banking, municipal bonds, SOE reform, local government debt and the labour market. He has successfully called macro-economic developments since 2008, including growth, deflation, currency, reform, non-bank finance and debt.
Bo has a Master’s degree in economics from the University of Warwick and a Bachelor’s degree in economics and management from the University of London.
Dario Perkins joined the company in 2011 and is Managing Director, Global Macro. He covers a wide range of global macroeconomic themes and writes the fortnightly Macro Picture.
Dario has extensive experience as an economist in both the public and private sectors.
At the UK Treasury he co-ordinated Gordon Brown’s global economic forecasts and was responsible for designing the structure of the Bank of England’s Financial Policy Committee. He also produced an important review of the BoE following the 2008 crash.
At ABN AMRO he was the City’s top-rated European economist for three consecutive years, earning a reputation for his communication skills and central-bank forecasting record.
Shweta joined TS Lombard in 2011. She is Managing Director, Global Macro and Europe Economics. Shweta leads the coverage of euro area economics and ECB policy. She also focusses on international macro themes with an emphasis on identifying key trends and turning points in global financial flows.
Shweta started her career as a Researcher at the London School of Economics and Political Science (LSE). She has also worked as a Researcher at the UN. Before joining TS Lombard, she was an Economist at Morgan Stanley (MS) for four years in Mumbai and Singapore. At MS, she was a member of the top-rated Asia Economics team (Institutional Investor Survey).
Shweta is a regular commentator in TV and print media. She holds an M.Sc. in Economics from the LSE and an MSc. in Finance from the London Business School.
Konstantinos Venetis joined TS Lombard in February 2015. His coverage is global, with a focus on the UK, Australia, oil and industrial metals. He has well-rounded experience in financial markets, starting his career at Bear Stearns’ investment banking division and subsequently working as a trader, fund manager and research analyst.
Konstantinos holds an M.Phil. in Economics and a B.A. in Philosophy, Politics & Economics from Oxford University.
Shumita Sharma Deveshwar joined TS Lombard in 2007. She is co-head of the India team based in New-Delhi and focuses on India’s macro-economy. Major research themes include India inflation and RBI policy. She travels regularly to different regions to take the pulse there.
Before joining TS Lombard, Shumita was the India economist for DSP Merrill Lynch in Mumbai. Previously, she reported on emerging markets, focusing on debt and macroeconomic issues, for Dow Jones Newswires in New York and covered the Indian economy for the same company from New Delhi. She completed her Master's degree in international relations at Yale University and has a Bachelor's degree in economics from Delhi University.
Rory joined the company in 2018 as an economist covering China and South Korea. Prior to this Rory spent four years with PRC Macro Advisors, a Beijing based economic research firm specialising in China’s political economy. From 2016, Rory was located in Seoul where he led the company’s Korea research. During this period, he also continued to cover China, specialising in macroeconomic forecasting and industrial policy.
Rory has a BA (Joint Hons) in History & French from the University of Manchester. Rory was awarded two Chinese government scholarships in Economics and Mandarin, and obtained an MSc in Economics from Beijing Normal University in 2014. Rory speaks fluent Mandarin and French, and advanced Korean.
Davide joined the TS Lombard Macro team in January 2017. He covers various macroeconomic themes with a focus on the euro area (particularly Italy, France, and Spain). He has special interests in central bank liquidity, monetary policy, and inflation.
Prior to this, Davide spent a year and a half working for the Securities and Finance practice of NERA Economic Consulting in London, where he focussed on asset pricing. Davide graduated in Economics from Bocconi University in 2013, holds a M.Sc. in Economics and Management from the LSE.
Wilson joined the company in 2018 as an economist covering Brazil. Prior to this Wilson spent two years with the Bank of America Merrill Lynch economic research & fixed income strategy team in Sao Paulo covering Brazil economics and politics, after having worked at AXA Insurances with risk underwriting.
Wilson has a BSc in Economics from the University of Sao Paulo. He was awarded with an academic merit scholarship in Economics and spent one semester at the University of Coimbra, in Portugal. Wilson also studied Financial Modelling at Insper, in Sao Paulo. He speaks fluent English and Portuguese, and advanced Spanish.
Krzysztof has joined the company in 2018 as an economist covering South East Asia. He previously worked at CIMB Bank in Kuala Lumpur as a Research Fellow where he led preparation and production of consolidated ASEAN and individual country macroeconomic outlooks. His experience also includes internships in Rothschild Global Advisory and IBM.
He holds a BA and MA in Quantitative Methods in Economics from Warsaw School of Economics and a MSc in Corporate Finance from Cass Business School.
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