Friday, January 22, 2016

Central Bankers and Higher Crude Stem the January Sell-Off Weekly Market Update: Central Bankers and Higher Crude Stem the January Sell-Off
Fri, 22 Jan 2016 16:14 PM EST

After three weeks of punishing declines, global markets may have found a bottom. Traders keyed on what appears to have been Wednesday's important intraday technical reversal for both stocks and oil prices. On that day trading volumes surged, negative market internals spiked, the VIX reached levels not seen since last summer ahead of a 400+ point reversal in the Dow. By Thursday many suggested sentiment was also improving upon markets hearing the distant sound of the central bank cavalry riding to the rescue. Mario Draghi promised the ECB would look at more easing at the next policy meeting, while there were rumors that the Bank of Japan could launch another helping of QE at the policy meeting next week. The PBoC was less sanguine, however they promised to expand use of a new medium-term instrument to provide markets with liquidity, and separately fixed the yuan reference rate higher for the tenth consecutive session on Friday, putting the yuan at its strongest rate to the basket since January 6th. The other big positive catalyst was crude, which found a short-term bottom below $28. Both WTI and Brent dipped into the $27 handle on Wednesday upon Feb options expiration, then rallied hard through the close on Friday. Prices gained more than 20% in 48 hours, with both WTI and Brent closing out the week above $32. Global elites gathered in Davos, where nearly every interviewee was asked at least once whether they saw recession in the offing (most hedged or said not really). In the background, Q4 earnings season slogged on with managements offering up cautiously optimistic outlooks based on more of same in terms of tempered economic growth. US stock indices posted their first weekly gains in a month: after losing over 500 points through Wednesday morning, the DJIA rallied to end up 0.7% on the week, the Nasdaq rebounded to post a 2.3% gain, and the S&P added 1.4%.

China's economy slowed in the final quarter of 2015 to +6.8%, the weakest quarter of growth since the crisis in 2009, as Beijing continues to push its economic transition to a consumer economy. The full-year 2015 China GDP figure was +6.9%, the weakest growth rate since 1990. December industrial production saw its weakest y/y growth in 25 years, while December fixed-asset investment expanded at the slowest pace since 2000. The anemic slate of economic data prompted hopes for yet another round of stimulus from the authorities, in the form of RRR cuts or spending programs. The PBoC said it would begin expanding use of mid-term lending facilities (MLFs) to add liquidity, and a PBoC economist commented that the MLF facility could be a substitute for RRR cuts, which somewhat confused markets.

The ECB took no action at its policy meeting this week, but ECB President Draghi said the committee would review and possibly reconsider monetary policy at the next meeting in March, when the latest round of ECB staff forecasts will be published. He repeated several times that the ECB has not only been highly successful with its prior unconventional monetary policy actions, but that it still has plenty of tools left to help it achieve its mandate. Draghi justified his more dovish stance by warning that conditions have changed since December, specifically citing the 40% decline in oil prices since that time, an increasing possible correlation between inflation expectations and lower oil prices, and the chance that 2016 inflation levels will drop even lower due to the commodity price implosion. EUR/USD saw lower lows this week, testing below 1.0800, but was still constrained at the upper bound by the 1.0990 level.

The Bank of Japan's upcoming policy meeting is scheduled for next week and expectations were building for the bank to introduce more QE in light of market conditions. The yen has strengthened notably since the start of the year, with USD/JPY dropping from the 120.50 area in late December to as low as 116.00 this week. Preliminary January manufacturing PMI data dropped to a three-month low, as the new orders component slowed to a six-month low and inflation-gauging input prices fell for the first time in over three years. At Davos, BoJ Governor Kuroda said that deflationary pressures were a real risk, but also cautioned that he did not believe the global economy was on the brink of a deflationary wave and highlighted that underlying Japan inflation was still above 1.0% and that inflation expectations were still well anchored. Kuroda hinted that the BoJ has room for more QE, if needed, but the bulk of his comments were dismissive of any need for more stimulus.

In the eye of the storm on Wednesday, Fed fund futures had significantly repriced the probability of more FOMC rate increases this year. Futures pointed to less than 1% probability of four Fed rate hikes in 2016, with just a 30% chance of a March rate hike, compared to 53% a month ago. Recall that the dot chart released at the December Fed meeting predicted four interest rate hikes in 2016. Fed fund futures priced a 40% chance of no further rate hikes this year. By Friday, the futures contracts had eased off those levels. The benchmark 10-year yield after touching 1.93% recovered back above 2.05% by weeks end.

While the jobs picture certainly argues in favor of more Fed policy tightening, the inflation front is much less rosy. After trending downward for more than a year, two key inflation gauges - the five-year, five-year forward inflation break-even rate and the yield premiums on regular USTs over TIPS - both tumbled to their lowest levels since April 2009. In a report out on Wednesday, US CPI inflation unexpectedly slipped lower m/m in December, after November's flat reading. Analysts said the softness in the sequential data was mostly due to lower energy costs. Meanwhile the y/y readings were stable. In the 12 months through December, core CPI rose 2.1%, the largest gain since 2012, after climbing 2.0% in November.

At Davos, Saudi Aramco's chairman made extensive comments about the oil market and Saudi Arabia's role in it. He said the Saudis would be able to withstand low oil prices for a long time, given they have the lowest cost of production and the ability to increase production at will. He also said oil prices have overshot to the downside and will likely rise by the end of the year. Also at Davos, the head of Russia's Direct Investment Fund said Russia may be ready to cooperate with OPEC, given how low prices have fallen.

The IMF cut its global growth forecast for the third time this year. Citing weakness in the developing world, the IMF said the world economy would grow 3.4% in 2016, down from an October forecast of +3.6%. It downgraded the 2016 outlook for developing economies to 4.3% growth from a forecast of 4.5% in October. The IMF trimmed its forecast for US economic growth to 2.6% this year from 2.8%, noting the prospect of higher interest rates. It kept its 2016 forecast for China's economy unchanged at 6.3%.

Wall Street earnings reports continued roll in this week. Morgan Stanley greatly improved its performance in the bank's fourth quarter, roundly beating both earnings and revenue expectations. Morgan grew both earnings and revenue on a y/y basis. Bank of America's fourth-quarter results were mixed, with earnings up nearly 10% y/y, beating expectations, even as revenue slightly undershot. On the conference call, executives disclosed that 2% of the bank's overall loans were to the energy industry. Goldman Sachs had a mixed report, with provisions for its RMBS legal settlement eating approximately 75% of its quarterly profit, while revenue fell slightly on a y/y basis. Goldman's key book value per share metric rose 5% y/y.

Three big Dow components held back the index late in the week. IBM reported its 15th straight quarter of contracting revenue, with sales at all three of the firm's major business lines lower y/y. The firm's FY16 forecast was weaker than expected. GE's revenue total in its fourth quarter missed analysts' expectations, although total profit beat and both profit and revenue were up modestly on a y/y basis. The firm's oil & gas revenue fell 16% y/y, but most of the other industrial businesses saw good growth. American Express tanked as investors tore into the firm's FY16 forecast. The new guidance range beat expectations, but only because it includes an expected $1 billion gain on the sale of its Costco credit card portfolio, which implies that underlying growth will be weaker than expected.