Friday, January 15, 2016

Historically Poor Start to 2016 Extends on Global Market Turmoil Weekly Market Update: Historically Poor Start to 2016 Extends on Global Market Turmoil
Fri, 15 Jan 2016 16:19 PM EST

The New Year's market mayhem went from bad to worse this week. Beijing took its campaign to create volatility in the yuan FX rate to Hong Kong, creating elevated levels of paranoia regarding the economic strategy behind its big interventions. On Wednesday, the Shanghai Composite slipped below 3,000 for the first time since last August, putting the index in a technical bear market, down 20% from its December highs. The index closed the week below its August lows at 2,900, down about 6.5%. US and European equities were whipped around by the continuing chaos, with highly volatile trading seen all week, however Friday's session was the real moment of truth, as options expiration, the coming three-day weekend and a real sense of panic in markets combined to drive a massive selloff, with the DJIA and S&P500 down more than 3% a piece and the Nasdaq down more than 4% at their worst levels. On Friday, the S&P500 plunged through its August low of 1867 in mid-day trading before recovering to close above it. The 10-year UST yield tumbled nearly 18 basis points from its high of 2.175% on Monday below 2.00% before the open on Friday. Short rates fell too, when futures traders used Friday's disappointing US data to push Fed rate hike expectations out further into 2016. And behind it all, WTI and Brent crude marched in lockstep to 12-year lows below $30.

For the five sessions through Thursday, the PBoC set the yuan fixing higher, then set it slightly lower on Friday. So after pushing down the yuan last week, the PBoC has worked hard to build it right back up again this week, driving confusion and chaos in domestic and overseas markets along the way. Many analysts say that is exactly the point, with the bank creating volatility to make betting against the yuan more expensive and tamp down the flow of money heading out of the country. Beijing's efforts to monkey with the yuan over recent months have paid off, as seen in the December Chinese trade data. China's December trade surplus in both CNY and USD terms was much higher than expected. Outbound shipments priced in CNY rose +2.3% v -4.1%e, and in USD terms the decline was just -1.4% v -8.0%e. The decline in imports in both CNY and USD terms were much less than expected.

Another theater of conflict in the Chinese crisis opened up in Hong Kong this week. On Monday, short-term rates in Hong Kong (HIBOR) to borrow offshore yuan (CNH) jumped to a record 13.4% from 4% on Friday. On Tuesday, HIBOR spiked to an astonishing 66.8%, and then settled back around 8% in the latter half of the week. Traders said the PBoC - via large Chinese banks - intervened in the offshore market by selling USD/CNH, to reduce the pool of offshore yuan liquidity, in an effort to crush the yuan carry trade, punish the short CNY trade and narrow the spread between onshore and offshore yuan. The CNY/CNH spread had spiked rapidly through the first week of the New Year to a five-year high, topping out around 1.02 before PBoC action crushed the spread back below 1.00. Meanwhile, the Hong Kong Dollar sank to its lowest level against the greenback in five years.

Brent and WTI crude prices cratered in lockstep, with both contracts closing out the week below $30, for 12-year lows. With Iran weeks or even days from achieving final compliance with the International Atomic Energy Agency (IAEA) on mothballing its nuclear program, there was little prospect of support for prices any time soon. Morgan Stanley, Goldman Sachs and Citigroup all published research pieces this week asserting that the price of oil would remain in the $20 handle over the near term as a result of China's slowdown, the appreciation of the USD and the fact that drillers are not curbing production despite the oil glut. USD/CAD touched a 13-year high of 1.4550 on the continued softness in crude, with traders waiting anxiously for a possible rate cut at next week's Bank of Canada policy meeting.

Two Fed presidents - dove Evans and hawk Bullard - aired their fears about the impact of plunging oil prices on inflation. Evans said he was nervous that inflation expectations might not be well anchored, citing downward pressure from the endless decline in oil prices. Bullard echoed his comments, warning that inflation expectations were becoming worrisome. Bullard took an even stronger stance than Evans and said the Fed may no longer be able to keep looking past crude prices when assessing inflation trends. Bullard said that low crude prices are now correlated with falling inflation expectations, could hold down actual inflation levels. Friday the Fed's Dudley offered little solace to plunging markets. Dudley opined he does not see much change in the economic situation and believes core inflation remains relatively stable.

It's no secret that US manufacturing has been seeing sequential declines over recent months, and data out on Friday confirmed that the trend is not improving. The January Empire manufacturing survey from the New York Fed (the first of the regional Fed factory surveys for January) was a total disaster, which declined to its lowest level since the depths of the recession in early 2009. The new orders and production indexes each deteriorated by nearly 20 points. US industrial production dropped for the third straight month in December. Analysts note that a major part of the month's decline was due to utilities cutting output amid unusually warm weather and energy companies reducing activity in the face of falling oil prices. The November figure was revised much lower, to -0.9% from -0.6% prior.

The Bank of England kept its key interest rate at a record low of 0.5% and made no changes to its asset purchase program. Both decisions were widely expected, as the outlook for UK growth and inflation has been crushed by negative developments in the energy markets and the world economy. The MPC voted 8-1 to keep rates at 0.5% where they have stood since March 2009, but voted unanimously to keep it's QE program unchanged. "Recent volatility in financial markets has underlined the downside risks to global growth, primarily emanating from emerging markets," the central bank said in minutes from its meeting. GBP/USD saw its highs of the week around 1.4600, then skidded lower to under 1.4300 in the chaotic trading on Thursday and Friday, to a fresh six-year low.

Alcoa marked the unofficial beginning of the fourth quarter earnings season on Monday. Alcoa's earnings topped analysts' expectations, but revenue fell just short of what was expected, as some high-growth segments helped to slightly negate headwinds in its legacy business. The firm's outlook for aluminum demand growth in 2016 was +6% y/y, down slightly from its last 2015 forecast of +6.5% y/y.

JPMorgan widely exceeded expectations in its fourth-quarter earnings report. Profits rose more than 5% y/y, while revenue was only up incrementally. The corporate and investment bank saw huge profit growth, however, the commercial bank and asset management unit both saw lower profits. Executives warned of rough waters ahead for the US economy. "We're not forecasting a recession - I think the US economy looks pretty good at this point," said CEO Dimon. Citigroup turned in good quarterly results, with profits up sharply y/y as the bank shakes off its legal woes, and revenue up 3% y/y, both beating expectations. Wells Fargo only just met top- and bottom-line expectations.

Shire has finally bagged Baxalta, with the latter agreeing to be acquired in a $32 billion deal valued at $45.47 in cash and stock. The deal includes an $18/shr cash component, not too far from the 40% cash portion rumored last week. Baxalta, which was spun out of Baxter International, generates a large portion of its sales from Advate, a drug for hemophilia. This is Shire's third major buy in just over a year, coming after last November's $5.9 billion Dyax buy and the acquisition of NPS Pharmaceuticals for about $5.2 billion a year ago.