Themes to Ponder Before the Weekend

There are five things investors should know before the weekend. 

1.  The Chinese yuan finished the tumultuous week on a subdued note.
2. Greece’s parliament approved the two measures needed for a third aid package
3.  Yesterday’s record of the ECB meeting expressed disappointment with the eurozone’s recovery.  Today, the three biggest economies reported weaker than expected growth
4.  Oil prices have continued to fall and on heavy volume.  
5.   This week’s US data points included a new cyclical low in the four-week moving average of weekly initial jobless claims and a good, even if not spectacular, rise in July retail sales.  Today, July PPI will be reported.

Price action: The dollar is mixed in narrow ranges.  The euro is trading at $1.1150 and sterling at $1.5620. The dollar is stable against the yen at ¥124.20 and is underperforming against the Norwegian and Swedish currencies, trading around NOK8.19 and SEK 8.44. MYR is the clear underperforming amongst EM currencies (see below). Turkey continues to underperform after coalition talk broke down yesterday and markets begin to contemplate the risks from a new round of elections. The yuan was quite today, with the fix slightly higher against the dollar. Asian equities were mostly higher led by a 1.9% of the India Sensex. The Nikkei was down lightly and the Shanghai Comp up slightly, though it gained nearly 6% this week, the best in nearly two months. European stock and US futures are down slightly.

There are five things investors should know before the weekend.

1. The Chinese yuan finished the tumultuous week on a subdued note.  The central reference rate for the yuan (the fix) was set slightly higher (lower for the dollar).   The dollar finished the mainland session a little lower, just above CNY6.39, having peaked near CNY6.45 midweek.  The onshore yuan (CNY) fell 2.8% this week.  There is still a large gap between the onshore and offshore yuan (CNH).  CNH has fallen about 3.5% this week.  The gap does not simply reflect fears from the offshore market of further depreciation, but also appears to be caught up in unwinding of existing positions and hedges.   The PBOC stated yesterday that there was not a basis for a sustained decline in the yuan.  For all practical purposes, the modest decline in the yuan this week is too small to have much economic impact.  Provided it remains small, it will encourage participants to focus on the new fixing mechanism as the key development rather than the precise level of the currency.  The fixing mechanism remains a black box.  Precisely how it is set remains opaque. We know that between 10 and 20 banks, including some foreign banks, submit prices.  We understand that some of the extreme prices are dropped from the calculation.  We do not know how much subjectivity the PBOC exercises, or how a currency can be driven by market forces and be stable.

2. Greece’s parliament approved the two measures needed for a third aid package.  It could cost Tsipras dearly.  He had to again rely on opposition party votes.  It is suggested that a confidence vote could be called later this month or in September.  Some do not expect him to survive the confidence vote.  This would force new elections.  Although Tsipras remains among the most popular politicians in Greece, and could be re-elected, it would add another element of uncertainty into the mix.  In particular, it could impair the implementation of the reforms needed to free up aid for Greece itself rather than the funds needed to service its debt.   There is a Eurogroup meeting today, and it will likely decide if there is sufficient time for several national parliaments to give their approval before the August 20, 3.2 bln euro payment to the ECB is due.   The German parliament is key.  The indication is that it may take up the issue on August 18.   A bridge loan is still possible, and the point is that one way or the other Greece will service its debt.  The role of the IMF is still being discussed, but yesterday the IMF reiterated its position. It cannot participate in more aid until two conditions are met:  debt relief is provided that makes Greece debt burden sustainable, and Greece begins implementing its new program.

3. Yesterday’s record of the ECB meeting expressed disappointment with the eurozone’s recovery.  Today, the three biggest economies reported weaker than expected growth.  German growth was put at 0.4%, not the 0.5% the market expected, though still a tad faster than the 0.3% growth recorded in Q1.  The French economy unexpectedly stagnated, whereas the consensus was for a 0.2% expansion.  The upward revision in Q1 to 0.7% from 0.6% makes the slow down even more pronounced.  Italy had been expected to have expanded by 0.3%, but instead grew 0.2%.   This expands the streak to three-quarters without a contraction, which is the longest since Q4 10-Q2 11.   Growth in the eurozone as a whole slowed to 0.3% from 0.4% in Q1.  The consensus was for the pace to have remained the same.

4. Oil prices have continued to fall and on heavy volume.  Through yesterday, each futures session this week has seen aggregate volume of over one million contracts.  WTI is falling faster than Brent as the largest US Midwest refinery shut 2/3 of its capacity for repairs that could take several weeks.   Efficiency gains by US producers, including re-fracking, opening of new pipelines and other measures appear to be lowering the cost of production.  Later today, the rig count will be announced. It has risen in five of the last six weeks.  Some are suggesting that the decline of the yuan this week is weighing on prices, even though the most recent Chinese import data showed its demand for crude oil (and some other commodities) remained firm.  Commodity prices were falling before what is actually a small move in the yuan.  On a real effective basis, the yuan is less strong but hardly weak.  The expiration of some futures contracts may also be weighing on front-month prices.  In addition, among other things, this week marked the resumption of a nuclear plant in Japan.

5.  This week’s US data points included a new cyclical low in the four-week moving average of weekly initial jobless claims and a good, even if not spectacular, rise in July retail sales.  Today, July PPI will be reported.  A 0.1% increase in the headline and core is expected.  Unless there is a big miss, PPI typically is not a market mover.  Instead, the focus will be on industrial output.  The consensus is for a 0.3% rise, which would be the second (and consecutive) increase this year.  The risk is on the upside and comes from utility output (hotter weather), the new oil rigs and some increased output, and manufacturing.  Manufacturing output is expected to have risen by 0.4%.  This follows a flat report in June.  It would be the highest since last November.  Note that auto plants, which usually shut down for a few weeks over the summer are either being shut for shorter periods or some are not being shut at all.  Although earlier in the week, developments in China and commodities market spurred some speculation that the Fed’s lift-off will be delayed, we note that the September Fed funds futures imply half a basis point lower rate that at the end of last week, following the employment report.

  • Separately, we note that the Malaysian ringgit is down 1.8% on the day. Aside from the ongoing corruption issues and the plunge in oil prices, now the market is focusing on reserve adequacy. This was prompted in part by comments by Governor Zeti Aziz saying that the bank will need to rebuild reserves after it has fallen sub $100 bln. Foreign holdings of Malaysia bonds have also continued to fall, now down 20% from its 2014 peak.
  • Indonesia’s Q2 current account data widened to $4.5 bln, equivalent to 2.1% of GDP. The bank also revised prior numbers lower.  This was considerably better than expectations for a widening of the deficit to $5.4 bln, although it well larger than the $3.8 bln in the previous quarter.  The external accounts are generally improving, though this is largely driven by a faster pace of contraction in imports demand rather than exports.
  • GDP prints for Q2 were released today for Hungary, Poland and Czech Republic. Czech was the only upside surprise, with advance GDP rising to 4.4% y/y, well above the 3.4% expected. In contrast, Hungary’s preliminary reading fell to 2.7% y/y, against 3.2% expected, while Poland’s GDP preview came in at 3.3% y/y against expectations for an unchanged rate of 3.6% growth. Despite the considerable misses, there was little sustained price action following the data.