Fri, 26th May 2017

Anirudh Sethi Report


Posts Authored by: “Nayal Khan”

BREAKING – North Korea fires submarine-launched ballistic missile toward Japan

North Korea fired a submarine-launched missile on Wednesday that flew about 500 km (311 miles) toward Japan, a show of improving technological capability for the isolated country that has conducted a series of launches in defiance of UN sanctions.

The missile was fired at around 5:30 a.m. (4:30 p.m. ET) from near the coastal city of Sinpo, where satellite imagery shows a submarine base is located, officials at South Korea’s Joint Chiefs of Staff and the Defence Ministry told Reuters.

The projectile reached Japan’s air defense identification zone (ADIZ), an area of control designated by countries to help maintain air security, South Korea’s Yonhap News Agency reported.

The distance of the flight indicated the North’s push to develop a submarine-launched missile system was paying off, officials and rocketry experts said.

North Korea’s “SLBM (submarine-launched ballistic missile) technology appears to have progressed,” a South Korean military official told Reuters.

The launch comes two days after rival South Korea and the United States began annual military exercises in the South that North Korea condemns as a preparation for invasion, and has threatened retaliation.

Emerging Markets -An Update

EM ended last week on a soft note.  Fed tightening expectations were buffeted first by hawkish Dudley comments and then by the more balanced FOMC minutes.  
On net, the markets adjusted the odds for tightening by year-end a little higher from the previous week, and stand at the highest odds since the Brexit vote.  Yet despite the strong jobs data in June and July, odds of a move on September 21 or November 2 are still low, with the December 14 meeting seen as the most likely for the next hike.  
Fed chair Yellen speaks at the annual Jackson Hole Symposium on Friday, and will be the highlight of the week.  Given that Dudley mirrors Yellen quite closely, we think she could deliver a hawkish message this week.  If so, that would give the dollar more traction.  EM and risk are most vulnerable under this scenario.
Taiwan reports July export orders Monday, which are expected at -1.3% y/y vs. -2.4% in June.  It then reports July IP Tuesday, which is expected to rise 1.8% y/y vs. 0.9% in June.  The economy recovered in Q2, so it will be important to see if this continues in Q3.  Given the headwinds on the economy, we think the central bank will cut rates 121.5 bp again to 1.25% at its quarterly meeting in September.
Singapore reports July CPI Tuesday, which is expected at -0.5% y/y vs. -0.7% in June.  It reports July IP Friday, which is expected to grow 0.8% y/y vs. -0.3% in June.  The July trade data was much weaker than expected, and warns of downside risk to the IP reading.  Recent data have been soft, and we think the MAS will easy policy at its October meeting with another adjustment to its S$NEER trading band.

ECB Warns of Fresh Financial Woes Due to Post-Brexit Blowback

The European Central Bank (ECB) has warned that the shock decision of the UK to exit the EU has meant that the Eurozone faces damaging “new headwinds.”

ECB policymakers acknowledged that economic “downside risks had clearly increased,” in minutes from a European Central Bank July meeting released on Thursday. It added that shaken investors acting more cautiously following the UK’s shock June referendum result, has resulted in “a significant decline in government bond yields.”

“The uncertainty following the UK referendum was, in large part, of a political nature and due to the lack of clarity about the new relationship between the UK and rest of the EU.

“The uncertainty of the situation itself could affect the global economy in deeper and less predictable ways.”

“Markets Are Ripe For A Black Swan Event” – Why Most ‘Well Hedged’ Funds Won’t Survive

George Sokoloff, founder and CIO of Carmot Capital, recently explained why typical asset allocation strategies, including those employed by most “sophisticated” hedge fund managers, end up getting slaughtered during market shocks despite perceptions of being “well hedged”.  One has to look no further than the last “great recession” to get a glimpse of just how well the typical “hedged” portfolios fared during the last “Black Swan” event. 

Unfortunately, large pools of institutional capital have grown increasingly accustomed to making allocation decisions based on short-term returns and relative performance rather than absolute returns over extended periods of time.  Therefore, massive losses are ok as long as everyone is losing money at the same time, right?  Absolute returns only matter to the suckers that are actually planning to use those pension assets to retire at some point.  And, as for the hedge fund manager, don’t worry if your relative returns suffer as that’s not such a big deal either…simply shut your fund down…go on a really long vacation then come back and raise even more assets than before.  But we digress. 

In an interview with International Business Times, Sokoloff points out that most investment strategies follow a Taleb distribution that provide the appearance of low risk and steady returns but in reality offer investors a high probability of a small gain and a small probability of a devastating loss.  Unfortunately, as Sokoloff points out, the majority of institutional capital across the globe is levered to such strategies.  Just like in the “great recession,” funds that rely on “diversification” as a hedging strategy have a rude awakening during Black Swan events as correlations converge to 1 and the benefits of such diversification are erased.  

Moody’s revises outlook for 5 Australian banks to Negative

Say Moody’s:

The banks with revised outlooks include Australia’s four major banks, Australia and New Zealand Banking Group Limited (ANZ), Commonwealth Bank of Australia (CBA), National Australia Bank Limited (NAB), and Westpac Banking Corporation (Westpac). All four banks are rated Aa2 for senior unsecured debt.

Moody’s has also revised the rating outlook of Members Equity Bank Limited (ME Bank). The bank is rated A3 for senior unsecured debt.

The outlook change for Australia’s four major banks reflects Moody’s expectation of a more challenging operating environment for banks in Australia for the remainder of 2016 and beyond, which could lead to a deterioration in their profit growth and asset quality, as well as an increase in their sensitivity to external shocks.

In particular, the rating action reflects (a) Australia’s ongoing economic transition which, despite stable aggregate economic growth, has resulted in low nominal income and wage outcomes and persistently low interest rates, exerting in turn downward pressure on the banks’ profit growth; (b) Moody’s continued concerns regarding the banks’ exposure to tail-risks in the Australian housing market, which has been characterised over the recent past by strong price appreciation and rising household debt; and (c) rising bad debt within parts of the banks’ lending portfolios, in part reflecting these pressures.


Norway sovereign wealth fund returns 1.3% profit in 3 months

Norway’s $890bn oil fund eked out a small positive return in the second quarter, overcoming the market turmoil following the Brexit vote.

The world’s largest sovereign wealth fund returned 1.3 per cent in the three months to the end of June

Bonds performed best, returning 2.5 per cent, while equities returned 0.7 per cent and property minus 1.4 per cent.

Trond Grande, deputy chief executive of Norges Bank Investment Management, the manager of the fund, said:

After a period of relatively stable markets at the beginning of the quarter, the British decision to leave the EU sparked a sharp decline in Europe. Markets recovered relatively quickly, but with major variations between sectors.

The equity investments that returned the most in the quarter were Royal Dutch Shell, Novartis and Exxon Mobil. The worst performers were Apple, Lloyds Banking Group and Daimler.

The fund continued to warn that the strong performance of bonds this year cannot carry on forever.

Emerging Markets-An Update

EM FX ended the week on a soft note, despite the weaker than expected US retail sales report.Official concern about strong exchange rates is beginning to emerge. First it was Korea, then on Friday it was Brazil as acting President Temer said his country needs to maintain a balanced exchange rate, neither too weak nor too strong. We expect more pushback to emerge if the current rally is extended. Still, the global liquidity outlook for now favors EM and “risk.”
Looking at individual country risk, Brazil’s central bank is likely to continue selling reverse FX swaps to help limit BRL gains. In Russia, renewed tensions with Ukraine could continue weighing on the ruble. Turkey may get downgraded by Fitch, while higher than expected inflation data in India may derail the bond rally there.
Thailand reports Q2 GDP Monday, with growth expected to pick up slightly to 3.3% y/y. Optimists believe that the passage of the constitutional referendum will help improve sentiment and growth. The Bank of Thailand kept rates steady last week, ostensibly to maintain stability ahead of that vote. CPI rose only 0.1% y/y in July, and so we think the central bank will tilt more dovish if the economy remains sluggish after the referendum.

Value of negative-yielding bonds hits $13.4 Trillion

The value of negative-yielding bonds swelled to $13.4tn this week, as negative interest rates and central bank bond buying ripple through the debt market.

The universe of sub-zero yielding debt — primarily government bonds in Europe and Japan but also a mounting number of highly-rated corporate bonds — has grown from $13.1tn last week, according to figures compiled by Tradeweb for the Financial Times.

“It’s surreal,” said Gregory Peters, senior investment officer at Prudential Fixed Income. “It’s clear that central banks are dominating markets. There’s a race to the bottom. Central banks are the main drivers of this, it’s not fundamental.”

The New Zealand central bank became the latest to cut interest rates again, while the Bank of England recently restarted its quantitative easing programme to combat the economic slowdown that is expected to follow the UK’s vote to leave the EU. About a quarter of the global economy now has negative interest rates.

That has further squashed bond yields, and forced investors to scurry into emerging markets, junk bonds and ultra-long dated government debt to snap up what little remains of potential returns. Money is also spilling into the global stock market, helping the FTSE All-World index to a 5.3 per cent gain this year and pushing all three main US equity indices to a “trifecta” of fresh records this week.

BOJ medicine may be too strong for quiet summer stock market

Japanese stock trading is typically thin in August. Thus, the Bank of Japan’s purchases of exchange-traded funds may exert a disproportionately large and potentially unwelcome influence on the Tokyo stock market this month, observers say.

The Nikkei Stock Average closed at 16,735, down 29 points on Wednesday. At one point, the benchmark average dropped as much as 107 points, but shares came off their lows as investors bet the central bank may buy ETFs for the first time since Aug. 4.

 The market move may signal concern that the central bank’s purchases of ETFs will distort the market, as trading thins in August and the BOJ holds its buying steady. That would give the bank greater sway in the market.

If speculators dominate, anticipating BOJ buying, it may discourage longer-term investors. Some observers argue the central bank should rethink the ETF purchases at its next monetary policy meeting in September.

Overseas, stocks rose on Tuesday, as the markets “have incorporated risks that many participants were wary about,” according to Diam Co. Germany’s DAX hit a year-high, while the tech-heavy Nasdaq composite topped its all-time high.

As a period of risk aversion ends, investors are on the lookout for market movers.

ALERT- China 10-year bond yield dips below 2.7%

With investors already banking on Japan and Australia cutting interest rates again, some now appear to be betting China could get in on the easing action as well.

Purchasing in China’s onshore bond markets drove the yield on 10-year government bonds (which moves inversely to price) below 2.7 per cent in morning trading, a record low. That may come nowhere close to the negative yields of say, Japanese bonds, but further easing now looks to be on the cards.

Zhou Hao, senior emerging markets economist for Asia at Commerzbank, said the market “is pricing in aggressive easing measures from the central bank, which clearly points to rates/RRR cuts.”

But he added that despite appearances of a “liquidity trap”, the move could simply be part of the broader global trend of falling bond yields as investors everywhere face “a combination of gloomy growth outlook and lack of high-quality assets.”

In contrast to emerging economies across Asia where declining deflationary pressures are trimming the odds of rate cuts this year, China’s producer price index showed easing contraction for July while its consumer price index indicated softening inflation – leaving policymakers room to breathe and, if they so choose, ease.