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Mon, 20th February 2017

Anirudh Sethi Report

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Archives of “deflation” Tag

Next Week -Watch out :Week ahead: Greece, Fed minutes, Buffett letter

Don’t be fooled by the the holiday-shortened trading week in the US. Next week promises to give investors plenty to watch, including the Greek bailout, minutes of the Federal Reserve’s last meeting, Bank of England governor Mark Carney’s testimony, retail earnings and Warren Buffett’s annual letter.

Here’s what to look for in the coming days.

Greece

The meeting has also gained additional significance, as the last major one slated before European elections begin next month, starting with the Dutch.

“With the two largest eurozone economies facing elections this year, we believe it is in
their policymakers’ interests to contain any potential risks from Greek disruption,” said economists at Nomura. “We therefore expect some transitory agreement to be reached at least at the eurozone level, with the IMF decision on programme participation likely to be delayed even further”.

Carney testimony

Following Federal Reserve chair Janet Yellen’s semi-annual testimony to Congress, investors get to hear from her UK counterpart when Mark Carney testifies before the UK parliament’s Treasury Committee on Tuesday. Mr Carney’s testimony comes after the BoE upgraded its economic forecast, while leaving its inflation forecast and interest-rate policy on hold.

“Since the inflation report was published two weeks ago, we’ve seen downside surprises to wage growth, inflation, and retail sales,” said strategists at TD Securities. “So even after the IR was more dovish than markets expected, we may see a further dovish tone with the IR testimony given the soft tone of the recent data releases.”

Fed minutes

The Federal Reserve will release the minutes of its last monetary policy meeting on Wednesday, though they may seem dated since investors have just heard from Ms Yellen. In her testimony to Congress this week, she painted an upbeat view of the US economy and warned that it would be “unwise” to wait too long before raising interest rates.

Bank of America economists say they believe the minutes will reflect “a great deal of focus on both upside and downside risks,” even as Fed officials “become increasingly constructive on the outlook for the economy.”

Moreover, any discussion on the Fed’s balance sheet is likely to garner interest. “Yellen reiterated the view that the primary tool remains rates and that the balance sheet will only be addressed once the normalization of the fed funds rate is well under way,” said the folks at Bank of America. “We expect the minutes to reinforce this view, but there might be some discussion among members on the issue.”

BOJ on edge after Trump claims devaluation

While Bank of Japan officials see no grounds for Donald Trump’s accusation of currency devaluation, they still worry that the bank’s unique measure to control long-term rates could become the next target as the president continues his rhetorical battles.

“I have no idea what he is saying,” said one baffled BOJ official after learning about the criticism Trump leveled against the central bank. 

 Bond investors seem similarly perturbed. Yields on 10-year Japanese government bonds temporarily rose 0.025 percentage point Thursday, hitting 0.115% — the highest since the BOJ announcement of negative interest rates Jan. 29, 2016. The climb also reflects market anxiety over whether the central bank will continue buying up JGBs at the current pace.

BOJ Gov. Haruhiko Kuroda refuted Trump’s accusation in the Diet on Wednesday, saying Japan’s monetary policy is designed to defeat persistent deflation and not to keep the yen weak. “We discuss monetary policy every time Group of 20 finance ministers and central bankers meet,” he said. “It is understood among other central banks that [Japan] is pursuing monetary easing for price stability.”

In fact, U.S. monetary policy is chiefly responsible for the yen’s depreciation against the dollar. The Federal Reserve in 2015 switched to a tightening mode after keeping interest rates near zero for years, judging quantitative easing to have worked its expansionary magic on the economy. The gap between American and Japanese rates is now the widest it has been in around seven years, encouraging heavier buying of the dollar — the higher-yielding currency — than the yen.

Demonetisation double whammy for India Inc: Demand slows as input prices surge

Companies are going to face a potentially peculiar situation following demonetisation, if the recently released inflation data are any indication. While a demand slowdown following the cash crunch could force producers to either cut or hold prices, their input prices are tending to go up owing to rising global commodity rates.

Latest data revealed retail inflation touched a two-year low of 3.63% in November, while wholesale price inflation eased to 3.15% from 3.39% in October. However, the Thomson Reuters/CoreCommodity CRB Commodity Index, which tracks the movement of 19 major commodities, has advanced 11.1% in the past one year and 8.6% so far in 2016.

Pronab Sen, former chairman of the National Statistical Commission, told FE: “The demand slowdown following demonetisation should put a downward pressure on prices, while the increase in input prices due to rising global commodity rates will put an upward pressure on prices. And what the net effect will be is very difficult to predict now. But companies may have to recalibrate their (pricing) decisions accordingly.”

Key global oil-producing countries’ decision to cut back on output has already driven up crude oil prices. Also, although China’s appetite for raw materials has been strained since last year, a renewed focus on manufacturing (along with services) by the US under President-elect Donald Trump has only complicated outlook of global commodity demand. “As more firms shift from the informal to the formal sector following demonetisation, “there is also a risk that tax increases are passed to consumers,” Nomura’s Sonal Varma said.

5 things to watch in Janet Yellen’s testimony Thursday

In the Wall Street Journal, in their ‘5 things to watch’ format – Janet Yellen’s testimony coming up at 10 NY time Thursday

  1. All ears will be listening for Ms. Yellen to affirm recent statements from her colleagues that the Fed remains on track for a December rate increase.
  2. Yellen’s view of the market’s election result reaction – including a rise in government bond yields.
  3. The potential economic effects of Mr. Trump’s proposed fiscal policies
  4. Yellen to make the case against political interference in the Federal Reserve
  5. Yellen’s views on the risk of a sharp upturn in inflation

Bank of Japan Gov. Haruhiko Kuroda ‘disappointed’ at failure to hit 2% inflation in 2 years

Bank of Japan Gov. Haruhiko Kuroda admitted for the first time his disappointment at not being able to reach its target of 2% inflation within the two-year deadline originally set.

Kuroda entered office in March 2013, promising to reach 2% inflation at the earliest possible time, initially with “two years in mind.” Almost four years on, and despite throwing everything but the kitchen sink at Japan’s deflation problem, he has not been able to deliver on the promise.

 Kuroda did not stray from his usual tactic of blaming external factors on Tuesday after the BOJ’s two-day policy meeting. The governor cited the fall in oil prices, weak consumer spending after the consumption tax hike and the slowdown in emerging market economies as contributing factors. “The situation is similar with the central banks in the U.S. and Europe as well,” Kuroda said. But ultimately he was forced to admit he was “obviously disappointed that 2% inflation could not be achieved within 2 years.”

Odds of 2016 Federal Reserve rate rise climb to near 5-month high

Market expectations of a 2016 Federal Reserve rate rise have climbed to the highest level since early June amid growing anxiety among policymakers over the potential side-effects of historically low interest rates and easing tension about the US election.

The odds of at least one rate increase this year rose on Monday to 70 per cent, up from 67 per cent at the end of last week, according to Bloomberg data on federal funds futures.

Expectations have been slowly rising this month, from about 60 per cent at the end of September, as Fed policymakers have taken a slightly more hawkish tone, inflation has continued to heat-up and uncertainty stemming from the US election has cooled.

Several top Fed policymakers who have spoken this month have pointed to the rising risk of a potentially caustic overshoot in inflation as a key reason to add to the December 2015 rate increase sooner rather than later.

FOMC Minutes: Several voters thought rates should rise ‘relatively soon’

Highlights of the minutes of the Sept 21, 2016 FOMC decision:

  • Policymakers noted there was a ‘reasonable argument’ for either hiking in Sept or waiting for additional data
  • Voting policymakers generally agreed the case for hiking had strengthened
  • Several voters and non-voters said it was a ‘close call’ on whether to hike in Sept
  • Many noted few signs of inflation and slow progress
  • Cautious approach could allow labor market to heal more
  • A few expressed worries over reference to postponing hike ‘for the time being’
  • Fed sees risks to growth domestically and abroad as tilted to the downside
  • Inflation risks also tilted to the downside
  • Full text

We’ve heard the ‘close call’ talk from Fed speakers since the meeting so it shouldn’t be a big surprise. Overall, it’s a tad hawkish but with Dec already priced at 70%, I’m not sure it can move much higher.

“It was noted that a reasonable argument could be made either for an increase at this meeting or for waiting for some additional information on the labor market and inflation,” the Minutes said.

Here’s the dovish view, which is also something we’ve heard:

Here’s why RBI has room for rate cut now, not December

With inflationary pressures ebbing and likely to fall further after a good monsoon, the Reserve Bank of India (RBI) could well trim the key repo rate by 25 basis points when it reviews monetary policy on October 4.

The central bank last cut the repo rate by 25 basis points to 6.5% on April 6, taking it to the lowest level in six years. The cut would be aimed at getting banks to drop loan rates thereby boosting demand for credit at a time when growth has been subdued.

Consumer inflation for August came in at 5.1% year-on-year and is expected to nudge closer to 4.5% y-o-y by December, well within the RBI’s comfort zone. While there are those who believe the central bank might hold off till December so as to get a better idea of the kharif output, others believe fairly good visibility on inflation would persuade the RBI to trim rates now. That’s because banks have not lowered their lending rates meaningfully even though borrowing rates have dropped sharply in the money markets—both at the long and short ends.

rbi

Samiran Chakraborty, chief economist at Citibank, observed the August CPI had opened up the possibility of a 25 basis points rate cut in the October 4 policy. “The upside risks envisaged by the RBI to its March 2017 CPI target have substantially diminished now,” Chakraborty wrote in a recent report. A good monsoon, he believes, should keep food prices in check estimating an average 0.5% month-on–month seasonally adjusted increase till March next year which is marginally lower than in the corresponding period of FY16. “These factors can push headline inflation closer to 4% by December,” he wrote.

UN Warns Next Global Recession May Trigger Sovereign Debt Default Contagion

The UN Conference on Trade and Development rang the alarm on the possibility of a global debt default contagion due to international economies’ over-reliance on deficit spending, low interest rates to stimulate economies.

The next economic crash may be the last warns trade economists at the United Nations cautioning that the next global recession could quickly get out of control plunging the world into an economic depression and resulting in a post-apocalyptic failing of major governments as the world’s bond market teeters on the precipice of a full-on meltdown.

“As capital begins to flow out, there is now a real danger of entering a third phase of the financial crisis which began in the United States housing market in late 2007 before spreading to the European sovereign bond market,” said the UN Conference on Trade and Development (UNCTAD).

In the wake of the 2008 economic collapse, countries around the world forced their economies afloat by flooding the market with cheap money by artificially lowering interest rates to near zero – an unprecedented rate point at which benchmark rates have remained for nearly 8 years now. “Alarm bells have been ringing over the explosion of corporate debt levels in emerging economies, which now exceed $25 trillion. Damaging deflationary spirals cannot be ruled out,” the report remarks. In the event of an economic slowdown, the experts caution, the massive debts held by bondholders may not be redeemed forcing whole economies into default. Large emerging economies including Brazil, Russia and South Africa may be the worst hit in the event of another economic slowdown as they are the most likely to face a credit crunch from lenders who are unwilling to renew their debt or buy more pushing borrowing costs to unprecedented levels.

What Will The BOJ Do? (Spoiler Alert: Probably Nothing)

One week after we explained not once but twice that next week’s main central bank event is not the Fed – which won’t do anything – but the Bank of Japan, even CNBC has finally figured it out, observing with about a 7 day delay that “Everyone’s waiting for the Federal Reserve in the week ahead, but the real action may be coming out of Tokyo.” Well, thanks for that.

But while it’s clear that Yellen won’t dare shock the market (which now trades with a 20% probability of a September rate hike and as we showed a year ago, the Fed has never hiked unless the market is already pricing in at lest 60% odds), the question remains – just what will Kuroda and the BOJ do, especially since as we wrote last week, not even the BOJ knows what it will do, and has instead flooded the market with news report trial balloons covering every possible, even contradictory, possibility. Which also makes the BOJ’s decision that much more important.

As DB points out, “this week will be the litmus test for whether central banks are in shift mode as regards ongoing accommodative monetary policy. Investor consensus revolves around the notion that monetary policy has run its course and it “needs” to be supplanted by fiscal policy or at least combined with fiscal policy, via helicopter money, to be effective. The potential for a BoJ move on short rates and a shift in QE plus a Fed insistence on hiking despite market expectations (including a “hawkish” hold for September) might be considered to be consistent with a steeper curve.”

Here is what DB’s Dominik Constam, one of Wall Street’s best credit strategists expects the BOJ will reveal on Wednesday: 

The BoJ is conducting a comprehensive review of monetary policy. It is fair to say that there is substantial uncertainty as to what they may choose to do but recent policy speak has suggested that further cuts in the deposit facility rate are possible as well as a shift in the duration target away from the 7-12 year sector towards the 3-5 year sector. The proposed logic would be to steepen the yield curve, offering extra NIM to banks whilst also alleviating pressure on the entitlement industry. Some Fed officials meanwhile have also chimed in regarding the concern for financial stability that emanates from low long yields that in turn have compressed risk premia across asset classes as part of a “hunt for yield”. The implication is that if long rates stay artificially low, there may be a case for earlier moves higher in short rates to compensate even if the data itself was less compelling for such a move, all else equal. In both cases the potential for a BoJ move on short rates and a shift in QE plus a Fed insistence on hiking despite market expectations (including a “hawkish” hold for September) might be considered to be consistent with a steeper curve. Even the ECB could be added to this mix after the recent “disappointment” around not committing to an extension of its QE program nor adjusting the parameters.