Friday, April 15, 2016

Investor Optimism Grows on Hopes China Bottomed and the Fed Will Remain Patient Weekly Market Update: Investor Optimism Grows on Hopes China Bottomed and the Fed Will Remain Patient
Fri, 15 Apr 2016 16:13 PM EST

Global equity markets have more or less filled the gap from the moves lower seen in the first two months of the year. Fears about Chinese growth and the US manufacturing industry may be slowly receding, while the Fed continues to push out rate hike expectations. The US economic data generally supported various Fed officials' calls that the prudent stance remains that the FOMC stay patient in normalizing rates. Earnings season began this week with a disappointing report from Alcoa, but some slightly better-than-expected bank earnings. The next several weeks will see whether the rest of corporate America can beat greatly diminished expectations for what everyone agrees was a crappy first quarter. US Treasury yields were ultimately little changed on the week. An early week back-up in rates gave way to buying, following particularly strong 10-year and 30-year reopenings on Wed and Thursday. For the week, the DJIA added %1.8, the S&P500 gained 1.6% and the Nasdaq rose 1.8%.

March US inflation data saw a continued deceleration in pricing trends, further complicating the outlook for Fed monetary policy. Core PPI fell for the 49th month in a row and slipped into negative territory on a m/m basis, while core CPI inflation cooled off a bit in March, with both the m/m and y/y rates lower than expected and lower than both January and February. Analysts blamed the weaker dollar in part for the lower inflation levels, and cited pricing softness in apparel, shelter, and health care. The reports suggest that the PCE data, the Fed's favored measure of inflation, will be barely positive for March. Atlanta Fed President Lockhart (a non-voter in this cycle) said that he had changed his mind and would not advocate for a rate hike in April, given the continued lag in inflation. Meanwhile, notorious Fed critic Jeffrey Gundlach said there were no good chances for rate hikes in June, September or December, and predicted there was at best one Fed hike this year

The raft of Chinese data for the month of March out on Friday indicated big improvements from the weakness in the first two months of the year. March industrial production, retail sales, fixed asset investment, and new yuan loans reports all beat estimates. Industrial production figures hit a nine-month high, urban real estate buying recovered, and construction spending YTD surged 19% y/y, and retail sales were up more than 10% y/y. China Q1 GDP perfectly met expectations at +6.7%, right in the middle of the party's guidance for 2016 and an exact match the IMF's own 2016 forecast for China.

Data out of Japan strongly suggested that the BoJ's negative interest rate policy is backfiring. The March lending report showed bank credit fell to 2.5 year lows, for the second straight month of lower lending activity. The yen entered the week around 107.75, its strongest level against the dollar in 21 months, but softened notably in the wake of the lending data, with USD/JPY moving back up toward 110 in the latter half of the week. The BoJ's Kuroda applauded the softer yen, welcoming the correction in the "excessive" yen gains, while Finance Minister Aso rattled his saber, warning the government would not hesitate to intervene in FX markets if conditions became disorderly.

The loonie pushed to a nine-month high against the dollar on Wednesday after the Bank of Canada held rates steady at a scheduled policy meeting. USD/CAD dropped to 1.2745 after the decision, but this marked the high water mark for CAD, capping three months of steady gains, as the pair turned around for the latter half of the week and backed out to 1.2890. BoC Governor Poloz offered cautious comments, calling recent CAD strength mostly an artifact of shifts in expectations for US monetary policy. The greenback dropped to its weakest level against the euro on Wednesday, with EUR/USD at 1.1465, although the pair consolidated below 1.1300 heading into week's end. The Bank of England decision was a real snooze, with no changes and not much movement in GBP/USD, which remains right in the middle of the range seen since mid-January, around 1.4200.

The halting recovery in crude prices continues to run into upside resistance. Saudi Arabia and Russia appeared to have reached a consensus this week that the oil production freeze will not depend on Iran's participation, removing the only barrier remaining to an OPEC/non-OPEC deal. Meanwhile, there was lots of talk that whatever sort of pact emerges from the freeze talks will hardly be very strict, taking the form of a gentleman's agreement rather than a binding deal. Separately, both Iran and Iraq posted surprisingly strong production figures for March, and in Iraq, crude output rose to a record high of 4.55M bpd in the month. WTI prices briefly traded above $42 at one-month highs and then moved lower, mirroring the price action seen in mid-March. Brent saw stronger gains, but did not manage to break $45. Both contracts were more or less flat on the week.

The IMF cut its global economic forecast for the fourth time in the last 12 months, further trimming 2016 and 2017 GDP forecasts. The IMF lowered its call for every major economy in its World Economic Outlook (WEO), except for China, which got a small bump higher. The IMF cut 2016 global growth from +3.4% to +3.2%, and cut its 2017 forecast from +3.6% to +3.5%. The IMF warned that a return of last year's financial market turmoil was still a big potential downside risk. The organization specifically called out Beijing, warning about the potential global impact of unwinding prior excesses in China's economy as it transitions to a more balanced growth path.

The FDIC and Federal Reserve called out five big banks for failing to submit effective plans for winding down operations in the event of a bankruptcy. The five "too big to fail" banks - BofA, JPMorgan, Bank of New York, State Street and Wells Fargo - did not submit acceptable living wills. The firms have until October to fix their plans, and the Fed and FDIC could start imposing strict prudential remedies if they are still found to be deficient at that time. If after two years they do not have a proper plan, the regulators could force the banks to divest certain assets and scale back the size of the institutions. Note that the FDIC rejected Goldman Sachs' plan, while the Fed alone found Morgan Stanley's plan deficient. Citigroup was the only big bank to have its plan approved by both regulators.

The March quarter earnings season began with a poor report from Alcoa. While ex-items earnings beat expectations slightly, sales were a miss. The company also added 1K to anticipated job cuts, lowered its FY16 aluminum demand growth outlook to +5% from +6%, and revised its three-year revenue targets lower. The banks reporting this week generally beat greatly diminished expectations, given that the analyst community has predicted the worst for banks in what is usually their best quarter of the year. Both Citigroup and JPMorgan beat top- and bottom-line expectations, although both profits and revenues were lower y/y at the two banks. Bank of America missed expectations, while Wells Fargo was the only big bank reporting this week to eke out revenue growth. Delta's profits soared 30% y/y while revenue was right in line. The airline spent one-third less on fuel than it did a year earlier, and indicated they were willing to cut capacity if profitability measures don't improve. On Friday, Japanese press reports indicated Apple plans to maintain its reduced production of iPhones into the April-June quarter, citing soft 6S and 6S Plus sales, which put pressure on the tech giant and its suppliers' shares into the end of the week.

Canada's Mitel Networks has reached a deal to buy fellow voice and telephony equipment manufacturer Polycom for about $1.96 billion in cash and stock. Polycom's holders will get $3.12 in cash and 1.31 Mitel shares for each of their shares. Canadian Pacific ended its $25 billion bid for its US counterpart Norfolk Southern, the latest giant merger deal to fall apart over recent weeks. CP began its pursuit of NSC last fall, under pressure from activist investor Bill Ackman's Pershing Square. This is the second failed deal attempt for CP, after its bid for CSX fell apart in 2015. Separately, there were press reports about growing opposition in Germany to Deutsche Borse's planned $20B merger with the London Stock Exchange, partly because of growing concern about the consequences for the merged entity should Britain leave the EU.