Friday, May 6, 2016

Downside Risks Trump Recovery Hopes Weekly Market Update: Downside Risks Trump Recovery Hopes
Fri, 06 May 2016 16:04 PM EST

Over recent weeks there has been a recurring debate in markets about the prospects for the stalled global economic recovery. Many analysts saw the first quarter as a seasonal aberration and predicted the widespread economic softness would soon to be replaced by green shoots as oil prices rose, China stabilized and the US economy improved. The more pessimistic analysis said the problems seen in the first quarter were indicative of deeper problems, and developments this week seemed to favor the latter camp. The April US jobs report was soft, and the decline in the April US ISM factory data suggested manufacturing was not healing quite as quickly as expected. Other global data was similarly weak. The softer dollar trend appears to have plateaued, with EUR/USD unable to sustain gains above 1.1500 while the USD/JPY appears to holding above 105. A resurgent Dollar weighed on commodity prices in general before production hotspots pushed up oil prices late in the week. Treasury yields drifted lower aided by flows out of the equity markets pushing rates to levels not seen since mid-April. For the week the DJIA lost 0.2%, the S&P lost 0.4% and the NASDAQ fell 0.8%.

The April US non-farm payrolls missed expectations, dropping to +160K from the revised +208K figure in March. Unemployment held steady at 5%, while there was a slight uptick in wages. The NFP figure echoed the softness seen in the ADP report out earlier in the week. On Tuesday, Mark Zandi wrote that that "the job market appears to have stumbled in April. Job growth noticeably slowed, with some weakness across most sectors." Analysts suggested the data would greatly lower the chances of a Fed rate hike in June. After the data Fed funds futures repriced for only a 6% chance of a rate increase in June, while odds of a July move were at 24%. Traders now see the first rate increase coming in December.

Fed officials had plenty to say after last week's soft Q1 GDP reading, although these comments arrived before the weaker payrolls data. San Francisco Fed President Williams discounted the data, citing similar seasonal patterns in recent years, and asserted it was the GDP data that was out of sync with the rest of the data. The Atlanta Fed's Lockhart expressed concern that the lackluster GDP data could "turn out, in fact, to be persistent." While there will be relatively little Q2 growth data on hand by the June meeting, Lockhart said the probability of a rate move was higher than markets were pricing in. Fed hawk Bullard said there's a pretty big gap between market expectations of rate path and Fed's prior projections, and reiterated June is a "live" meeting for rates, though he was still undecided on the issue. Dallas Fed President Kaplan wants firmer GDP before advocating for another rate, but anticipates another rate hike this summer if the data keeps steady.

Chinese data out this week was a mixed bag. The official manufacturing and services PMIs fell slightly in April from March levels, but both remained in expansion territory - barely. The small- and medium-sized company focused Caixin manufacturing and services PMIs also declined in April m/m, with the factory index in contraction for the 14th straight month. Interestingly, prices paid saw good upticks across the board, rising at the highest pace in years. With deflationary effects abating, the outlook continues to improve for commodities demand, but on the whole economists with Commerzbank said the data reflects Beijing's campaign of "managed stabilization." Caixin wrote that the reports indicated the economy lacks a solid foundation for recovery and is still in the process of bottoming out. In the wake of the data, former PBoC advisor Yu Yongding called for the government to implement more fiscal stimulus to avoid an economic hard landing.

The Reserve Bank of Australia moved to head off fears of deflation and reduced the official cash rate for the first time since last May, cutting 25 bps to a historic low of 1.75%. Last week, the Q1 report showed q/q CPI dropping into negative territory for the first time in seven years, while the key core CPI measure fell to 1.5%, the lowest level on record and well below the RBA's target band of 2-3%. The RBA warned that labor indicators have turned more mixed (after a run of stronger prints earlier this year) and that economic growth has become more moderate. Later in the week, the RBA's quarterly policy statement deepened inflation worries by cutting the end 2016 CPI target to +1-2% from +2-3% prior and the end-2017 target to +1.5-2.5%. The move strongly suggests the central bank is leaving the window open for more easing. The aussie had been rebounding strongly over the last two months with the general uptick in commodity prices, however the RBA cut decisively reversed the trend. AUD/USD topped out two weeks ago around 0.7835 and has tumbled to 0.7350 as of Friday.

Crude prices pulled back a bit this week under fire from the weaker global economic data. After nearly taking out $47 last Friday, front-month WTI kept testing back down to $44 and did not manage to close out the week above $45. Brent retreated back to around $45 as well. Squabbling between Saudi Arabia and Iran over production quotas boded ill for a revival of the production freeze deal. There were some concerns about supply disruption as wildfires threatened to burn to the ground the Canadian city of Fort McMurray, at the heart of the country's oil sands region. In Libya, a stand-off between eastern and western political factions prevented some oil cargos from being loaded. However, they did not help crude mark fresh recovery highs.

In Europe, there were reports that the ECB would be comfortable to remain in wait-and-see mode for the next several months. Sources said there was little desire at the ECB to take any more action before September as the bank gauged the effects of negative rates. Meanwhile there were political developments in peripheral states. Spain's King Felipe VI dissolved parliament and scheduled new elections on June 26th, ending months of political deadlock caused by inconclusive elections last December. Polls suggest Spaniards might be in for more of the same after the elections. Greece and its creditors continued talks all week about additional contingency measures needed to help hit its budget surplus targets and unlock further bailout payments. Athens agreed to vote on pension reforms this coming Sunday allowing for a Eurogroup meeting to convene on Monday. Greece has several big debt repayments due in the coming months, most critically in July when it faces a €2.3B repayment to the ECB.

The week in politics was highlighted by Donald Trump clinching the Republican nomination with a convincing win in Indiana, which was seen as the last possible firewall for the 'stop-Trump' movement. His has two rivals immediately dropped out, clearing the field for a confrontation with Hillary Clinton. In the UK, voters choose Sadiq Kahn to fill the high profile post of London mayor, which will make him the city's first Muslim mayor. The win for the Labour Party candidate is also a slap in the face of PM Cameron just a year after his Conservative party won the Parliamentary election by a landslide and as the PM has failed to influence the too-close-to-call polling for the Brexit referendum in June.

As the earnings season rolled through its peak week, pharma giant Pfizer saw modest gains after raising its FY view, while Merck was down on another quarter of revenue contraction. AmerisourceBergen sank 11% on the week after it cut its FY guidance and warned that deflation in the generics space was undermining its pricing power. Media names Time Warner and CBS saw good revenue growth, but only CBS sustained durable gains while TWX was in the red on the week. Kellogg dropped on further revenue contraction and stiff FX headwinds. Valero sank as lower gasoline prices squashed margins and profits missed expectations. Tesla moved its target for achieving a 500K unit annual production volume by two years, to 2018, citing the overwhelming demand for is upcoming Model 3, but the stock tumbled as investors worried about the automaker's growing capital needs.

Another megadeal was thrown into the dustbin of history this week as Halliburton's plan to merge with Baker Hughes finally collapsed under the weight of antitrust opposition. The companies cancelled their $28 billion deal on Sunday after more than a year trying to get approval in the US, the EU, Brazil and Australia. Regulators were not convinced the remedies proposed by Halliburton would prevent the reduction of choice in oilfield services, ultimately running a risk of higher energy prices. Shares of HAL have risen 40% and BHI has gained 12% in the three months to the deal cancellation as the prospects of closing the acquisition looked worse and worse. Note that there was plenty of talk that BHI remains a takeover target now that Halliburton is out of the way. In other merger news, Quintiles and IMS Health agreed to a merger of equals. The two health care information and technology providers would combine to create a firm worth $17.6 billion based on market capitalization and with $7.2 billion in pro forma revenue.