Friday, February 19, 2016

Inflation, Crude Surprises Herald an Early Spring for Markets Weekly Market Update: Inflation, Crude Surprises Herald an Early Spring for Markets
Fri, 19 Feb 2016 16:10 PM EST

The heightened volatility of early February gave way to slightly calmer global markets this week. The biggest story was the joint effort between Venezuela, Saudi Arabia and Russia to freeze crude production levels and put a floor under the market. A provisional agreement was reached on Tuesday, although without much buy-in from Iran. China returned from the week-long Lunar New Year holiday without any major market upsets and guided the Yuan notably higher, and a handful of more positive inflation and loan data helped calm nerves. More monetary easing looks to be on tap in both Japan and the euro zone next month. Meanwhile in the US, January PPI and CPI inflation readings came in hotter, further complicating the outlook for the FOMC on rates. The week saw the first 3 day rally for US indices this year while Treasury markets largely consolidated last week's move higher keeping the benchmark 10-year yield pegged near 1.75%. WTI can't get much if any traction above $30 and natural gas is fallen back towards the Dec low to trade at $1.80. For the week, the DJIA gained 2.6%, the S&P rose 2.8%, and the Nasdaq added 3.8%.

There were no big surprises in the minutes from the January FOMC meeting. As expected, the committee expressed deepening concerns that the ongoing decline in commodity prices and the rout in financial markets posed more risks to the US economic outlook. However, the members "judged that the overall implications of these developments for the outlook for domestic economic activity were unclear." Markets took the minutes overall to indicate officials are increasingly reluctant to raise rates in March and possibly the first half of 2016. This week Fed fund futures were pricing less than a 50% chance of any further rate hikes this year.

In a bid to stabilize an oversupplied market, Russia and OPEC members Saudi Arabia, Venezuela and Qatar reached a preliminary deal on Tuesday to freeze production at January levels, provided that other major producers followed suit. Iran reacted tepidly to the deal, issuing non-committal statements of support for the agreement while still insisting they would continue to target returning to the pre-sanction level of oil production. Iraq also said it "supported" the effort, but said it would not formally commit to the production freeze until other major producers did. As reports on the negotiations emerged, crude prices had momentary gains - Brent lunged for $36 a few times and WTI almost broke above $32 - however prices closed out Friday flat on the week, without sustaining any of these short-lived gains.

In Japan, the week kicked off with a very weak GDP figure and a huge gain for equities. Fourth-quarter GDP saw its biggest drop in 12 months, as the headline q/q figure hit -0.4% and the y/y measure was -1.4%. The bad news further strengthened expectations that the Bank of Japan would be forced to offer more stimulus, driving the Nikkei up 7.2% on Monday, its biggest one-day gain in three years. PM Abe's advisor Honda addressed the terrible GDP print later in the week, noting that in addition to possibility of more BoJ policy easing, he would also recommend a fiscal stimulus package of around ¥5T and also the postponement of the second round of sales tax increase until April 2019. Subsequent press reports indicated that Abe was not keen on more government stimulus or delaying the tax increase. USD/JPY had lifted off the 15-month lows around 111 last week, weakening to 114.8 early this week, then strengthened back to around 112.50 by Friday.

The Shanghai Composite played catch-up with last week's global volatility as it reopened for trading after a week-long break for the Lunar New Year holiday, falling more than 2% on Monday. However, some less bad economic data through the week helped lift the index and dispel some anxiety about China's economic prospects. January new loans hit a record high level and the January M2 money supply hit a 19-month high, although analysts rightly point out that this came as the PBoC pumped record amounts of liquidity into the system ahead of the holidays, fearing an epic cash crunch. Moreover, many expect these positive reports will not likely diminish the chance of another RRR cut sometime in the first quarter. January CPI rose at a healthy +1.8% y/y rate, a five-month high, driven mainly by higher food prices. The data hinted that persistent disinflationary forces may be waning, but many analysts said much of the better data could be ascribed to seasonal holiday factors.

It is looking more and more likely that the ECB will ease monetary policy again at its March meeting. Multiple ECB speakers addressed the issue in speeches this week. Draghi reiterated that the subject would be under consideration at the meeting, and added that Europe is facing significant challenges and increasing concerns about the global economy. ECB Vice President Constancio said action would be taken if it was determined that conditions have delayed the expected rise in inflation later this year, warning there could be another bout of disinflation in the first half of 2016. The Bank of Italy's Visco had the strongest take, calling on the ECB to act pre-emptively before a dramatic fall in inflation expectations took hold.

The European Union's negotiations with the UK crept closer to a deal to keep Britain in the union. UK PM Cameron held all-night negotiations on Thursday with top EU officials and a handful of leaders with specific objections to the draft text, mostly concerning welfare payments to immigrants. By late Friday, reports indicated a tentative deal had been reached. The UK referendum on EU membership will likely take place in mid-June, and a TNS poll out on Friday showed 36% of respondents said they would vote to leave the EU while only 34% said they would vote to remain in the union. Separately, Greece and its European creditors continued negotiations over bailout compliance, and managed not to produce any more of the market-moving headlines seen last week.

Mexico's central bank took action to shore up the peso, delivering a surprise rate hike on Wednesday. Banxico raised its overnight rate by 50 bps to 3.75% at an intra-meeting decision and said that peso weakness was threatening inflation expectations, forcing action. Recall that Banxico raised rates at a scheduled meeting back in December for the same reason. USD/MXN has plunged about 9% this year and more than 30% over the past year and a half to record lows, the biggest losses against the dollar among leading emerging market currencies in the current cycle. As a major oil producer, Mexico has been battered by falling oil prices, which Banxico Governor Carstens also discussed in justifying the move. USD/MXN gained 4% in the wake of the decision. Separately, the Bank of Korea held rates steady at its scheduled meeting, but the bank issued a statement warning that recent won currency weakness was "excessive" and warned against intensifying "herd behavior."

Earnings season is slowly drawing to a close, with the major retailers among the last to discloses quarterly results. Shares of Walmart closed out the week down 2.5% after it disclosed y/y declines in earnings and revenue, and a FY outlook that was weaker than the qualitative view offered at the annual investor day last fall. Sales comps were lower than expected.

In a long-expected development, Yahoo's board has formed a committee to explore strategic alternatives. The company has hired advisors, and said one focus will be the Alibaba sale via a reverse spinoff. Recall that earlier this month, the company launched a fresh round of restructuring, including a plan to lay off 15% of the workforce. Reports have indicated that close to two dozen public and private firms have expressed interest in various Yahoo assets and on Friday the board is said to have started returning some of their calls.

In M&A news, home security firm ADT agreed to be acquired by Apollo Global Management for nearly $7 billion, or $42/share in cash, a 56% premium the prior closing price. Apollo intends to merge ADT with another home security firm it owns, Protection 1. Chinese aviation and shipping conglomerate HNA Group reached a deal to buy electronics distributor Ingram Micro for about $6 billion, or $38.90/share in cash. This is the latest in a string of overseas buys by Chinese companies, which have been aggressively splurging on foreign acquisitions to sidestep slowing domestic growth.