Macro Roundup – August I

Macro Roundup: Markets and Stress Tests

Colin Lloyd – featured on Linear Talk

Colin Lloyd is the author of macroeconomic investment letter service ‘In the Long Run‘. Serving as Linear Talk’s co-presenter along with Linear’s Chairman, Jerry Lees, Colin regularly reviews the markets, hedge fund performance, and prevalent macro events in his macro roundup. 

After the tumult of June, July was a relatively quiet month for financial markets. A number of trends established in the wake of Brexit were partially reversed and some new macro themes began to emerge.

Global stocks finished the month at 11 months highs amid expectation of further central bank accommodation, or, in the case of the Federal Reserve, hopes that tightening of monetary policy will be delayed.

The US$ was subject to reversal, having appreciated in the aftermath of Brexit. The US$ Index touched 95.33, the lowest since June, whilst the Euro Index closed at two month highs. JPY weakened versus the USD to 107.48 on the 21st only to rebound after PM Abe announced a record JPY 28trln fiscal stimulus package. The BoJ followed suit by increasing its purchases of ETFs at month end.

Bond markets continued to test new lows in yield. US 10yr Notes trading 1.32% on 6th. 10yr Bunds saw a similar flight to quality testing -0.20% on the same day only to stage a substantial reversal in the run up to the ECB meeting on 21st testing +0.03%. They swiftly returned to negative territory as ECB Governor Draghi suggested September would see further accommodation.

The political landscape in Europe is complicated which may explain the ECB’s summer torpor. September 4th through 18th sees German state elections in Berlin and Western Pomerania. September 25th marks elections in the Basque region of Spain. Austria has presidential elections on October 2nd and Italy holds a referendum on PM Renzi’s reform package, which may yet break his government, sometime later in the month.

Largely ignoring the machinations of Europe, 10yr JGBs behaved in an uncharacteristic manner towards month end. After making a yield low of -0.29% on 8th they collapsed (a relative term) to close the month at -0.16% in the wake of the fiscal stimulus package from the LDP and the BoJ’s increase in ETF purchases. Negative interest rate policy (NIRP) has been met with much criticism in Japan where paper money is used much more widely than in the rest of G7. A dramatic rise in the sale of personal safes and an acceleration in the decline of the velocity of money might lead the BoJ to abandon NIRP in favour of a broader “qualitative” approach.

Gilts were a mere side show compared to last month. Yields backed up to 0.89% for 10yr maturities after the BoE failed to cut interest rates, however, expectations of an August rate cut saw them close at new lows of 0.69%

Stocks, led by the US, closed at or near their highs; the S&P achieving a record close. Eurostoxx also rallied after making lows on 6th but are still well below their levels of April 2015. The Nikkei had a more mixed month end; after following the US to a low on 8th it rallied more than 1,800 points to a high of 16,939 on 21st only to drift lower despite substantial stimulus from the government and the BoJ. The Nikkei appears to be reacting more negatively to JPY strength of late.

Stress Tests and Gold Mines
On the 29th July the European Banking Association (EBA) announced the results of their latest bank stress tests. This is the third set of test, the previous ones having taken place in 2011 and 2014. Interestingly this year’s tests included only 51 banks – previous testing had covered 124 institutions. The table below is excerpted, but it shows some of the “problem children” of the banking world. The EBA do not impose a “pass” or “fail” rate and European banks, in aggregate, have dramatically increased their capital base over the past few years, but the uncomfortable truth is that many banks, despite their splendid marble halls, are still inherently weak:-

Bank Euros/100
Monte dei Paschi -0.9
ABN Amro 2.9
Deutsche Bank 3
Commerzbank 3
Unicredit 3.1
ING Group 3.3
BNP Paribas 3.5
Barclays 3.5
RBS 3.6
HSBC 4.3

Source: EBA

In terms of geographic regions the most exposed banks are to be found in Italy, followed by Ireland, Austria and Spain, the banks of several smaller European countries do not even appear on the EBA list. The weakness of the banks can be clearly linked to the percentage of loans which are non-performing – Monte dei Paschi has more than 30% alone. The table below is sobering:-

Country NPF %
Norway 0.5
Sweden 0.9
UK 2.3
Belgium 3
France 3.3
Germany 3.3
Netherlands 4.2
Portugal 5.4
Austria 7.6
Spain 8.5
Italy 15.6
Ireland 16
Greece 33.4

Source: ECB, Eurostat

The Italian government has proposed a bank bail-out along the lines of the US TARP programme, however, under EU rules the banks cannot be bailed out unless the bond holders are bailed in. Many Italian bank bond holders are Italian citizens rather than institutions, to bail them in would promulgate a domestic political crisis for the Renzi government – the French term for this is impasse.

A very different environment is evident in the gold mining sector where nearly $10bln of deals have been transacted in the first half on 2016. The latest, last month, was Barrick’s sale of their Australian operation to Newmont, for a rumoured $1bln, hot on the heels of Newmont’s sale of its Indonesian assets to a local consortium for $1.3bln and Centerra’s purchase of Thompson Creek for $1.1bln.

Despite weakness in the commodity sector, gold mining has seen an extraordinary level of merger activity as the table low shows. 2016 looks set to be as active as the last two years:-

Year Deal value
2012 $13bn
2013 $11bn
2014 $20.5bn
2015 $21.5bn

Source: Bloomberg

With Chinese PMI declining for the first time in five months to 49.9 in July, the price of oil has fallen back towards the lows of April. Brent started the month at $48.38 but closed just above the lows of $40.57. Saudi Aramco cut its prices to Asian customers and shows no indication that they will curtail production. Perhaps due to concerns about the production potential of Russia and a sanction-free Iran, despite recent data to the contrary. This bodes well for inflation even in countries such as the UK, where pump prices are now lower than before Brexit.

Hawkish comments from New York Federal Reserve President William Dudley, suggesting that the Fed could tighten even before the US presidential election, seem to be falling on deaf ears. St Ledger’s day is the 2nd October. It might be wise to accumulate some more stocks before the return of the herd.