Friday, June 10, 2016

Caution Abounds Ahead of FOMC, Brexit Vote Weekly Market Update: Caution Abounds Ahead of FOMC, Brexit Vote
Fri, 10 Jun 2016 16:10 PM EST

Global markets were volatile this week as risk assets first recovered from the let-down of last week's May US jobs report and then succumbed to global jitters as funds rotated into fixed income. The ongoing oil market recovery propelled both WTI and Brent firmly back over $50 early in the week, helping boost the broader energy sector. Solidifying belief that the Fed will need to hold off on rate hikes at least little bit longer has helped gold and silver prices reach one month highs as well. In a widely anticipated speech on Monday, Fed Chair Yellen said nothing at to upset the apple cart, and there is a sense that a Fed rate increase in September is emerging as the new favorite view, although July is still touted as a 'live' meeting as well. The dollar arrested its decline without testing the lows seen in early May. Mid-week the DJIA and S&P500 approached but did not hit new all-time highs, as Brexit fears and interest rate jitters took over and pushed risk assets lower. For the week, the DJIA gained 0.3%, the S&P slipped 0.1%, and the Nasdaq fell 1%.

Treasury prices soared globally as panicky investors plowed into fixed income assets this week. The toxic combination of negative interest rates at the Bank of Japan, the ECB, and several other European central banks, fear of Brexit, and deep uncertainty about Fed rate hikes have fostered an extraordinary low yield environment. On Friday, the yield on the German 10-year bund sank to an all-time low of 0.025%, and some analysts suggested it could go to zero soon. Yields have fallen so far that more than $10 trillion of government debt worldwide is now trading with negative yields - Bill Gross took to Twitter to call the huge pile of negative-yielding sovereign a "supernova that will explode one day." The Japanese 10-year benchmark yield touched a record low of -0.15%. The 10-year UST yield fell as low as 1.649%, while the 30-year yield is at its lowest point since February 2015, at 2.45%, further flattening the yield curve to levels not seen since 2007. The 2-year/10-year UST spread has sunk below 90 bps, driving big losses this week in US financial stocks. Bond market analysts commented that the sustained level of demand for US Treasuries at this week's 10- and 30-year reopenings largely appeared to be driven by foreign buyers desperate for yield.

Some better US jobs data helped balance the narrative of a slowing labor market that emerged after last week's dire May payrolls report. The April JOLTS survey - Fed Chair Yellen's preferred gauge of US labor market health - saw an all-time high of 5.8 million job openings, up slightly from 5.76 million openings at the end of March. April hires fell to 5.1 million, slightly lower than the previous month's 5.3 million, while the key quits rate fell to 2.0% from 2.1% prior. Meanwhile, the jobless claims data showed the number of Americans filing for benefits unexpectedly fell in the week ended June 4th. Initial claims fell much more than expected, while continuing claims dropped 77,000 to 2.10 million, the lowest level since October 2000.

The annual US-China bilateral summit in Beijing saw tough rhetoric from both sides, with economic concerns taking a back seat to the tense situation in the South China Sea. Chinese officials blamed tensions in the South China Sea on the provocations of "certain countries for their own selfish interests." Secretary of State Kerry responded that China's plans to set up an air defense identification zone in area would be "a destabilizing act." Relations were smoother on the economic front, but there was still some tension. US Treasury Secretary Lew said good progress was made in currency talks and said China appeared committed to moving in an orderly way to a more market-oriented exchange rate. Lew pressed China to keep reforming bloated industrial sectors, especially steel, and told his Chinese counterpart that offloading excess capacity on the rest of the world was damaging global markets. Chinese officials stressed that Lew's critique only told half the story, as China's steel overcapacity resulted largely from the post-crisis stimulus plans, which themselves contributed to more than half of global growth in the 2009-11 period, helping lessen the impact of the Great Recession.

The China May trade report held good news and bad news for the world's second-largest economy. The bad: exports in dollar-denominated terms tanked 4.1% y/y, more than double April's 1.8% decline and slightly worse than estimates. The good: imports declined a mere 0.4% y/y, much improved from April's 10.9% slide and way ahead of expectations for a 6% decline. Softening global demand was clearly responsible for the worse exports component, while the ongoing recovery in commodities pricing and demand dovetailed nicely with the surprisingly robust imports component. In yuan terms, the trade report looked more positive, with exports up 1.2% y/y and imports 5.1% higher. The divergence with the dollar figures reflected the interruption of CNY's long-term appreciation trend against the dollar. Chinese Premier Li Keqiang once again reiterated this week that Beijing will be able to keep the yuan at a reasonable equilibrium level over the long term.

In Japan, the second and final reading of Q1 GDP confirmed the economy averted a technical recession, though concerns remain that the impact of Kumamoto earthquake could plunge the country back into contraction in the second quarter. Key components were better, with private consumption adjusted slightly higher to +0.6% from the preliminary +0.5%, and capex spending much improved to -0.7% from -1.4% in the preliminary. Skeptical analysts are quick to note that the data included an extra Leap Year day, and growth would have been slower if adjusted for that impact.

The referendum on the UK's further membership in the European Union is only two weeks away and a handful of polls this week have indicated the race is still too close to call. Three polls on Monday showed the 'stay' and 'leave' camps within a few points of each other, and the undecided camp remains in the double digits. Then on Friday an online poll from the Independent showed the 'leave' vote rising to 55%, further weakening the pound sterling. The pound continues to suffer from the heightened level of uncertainty, with GBP/USD dropping back toward 1.4200, for its lowest levels since late April. Last week there were reports that the ECB and the Bank of England were making provisional plans to provide liquidity guarantees for markets in the event of a vote in favor of Brexit, and this week BoE Chief Carney said that the Fed and BoJ are also looking to coordinate responses in case of excessive market volatility. In Parliament, a caucus of MPs in favor of remaining in the EU (totaling 454 MPs versus 147 in the 'leave' camp) is reportedly developing a plan to use their majority in the Commons to delay Brexit and keep UK within the single market because the 'leave' camp has refused to spell out what relationship it wants the UK to have with the EU in the future.

Three central banks around the Pacific Rim tinkered with their policy positions this week. The Bank of Korea surprised markets by cutting its seven-day repurchase rate by 25 basis points to 1.25%. The BOK statement expressed concern with rising household debt, slowing inflation, weakening consumption and declining exports. Analysts expect more BOK cuts are possible. The Reserve Bank of Australia signaled it was in no rush to cut interest rates again (it eased policy at the prior meeting) and kept the cash rate on hold at a record low 1.75%. The RBA acknowledged the recent recovery in trade, stating that exports and "areas of domestic demand" are expanding above trend. In New Zealand, the RBNZ kept on hold at 2.25%, while post-decision comments from Governor Wheeler indicated another rate cut was still built into projections. The statement emphasized inflation would strengthen, reflecting accommodative monetary policy, higher fuel and commodity prices, and a weaker NZD.

In M&A news, Westlake clinched a deal to acquire Axiall Corp, with the latter agreeing to be acquired for $33/share in cash. The deal values Axiall at $3.8 billion. The combined company will be the third-largest chlor-alkali producer and the second-largest PVC producer in North America, with expected combined pro forma revenues of $7.6 billion. Polycom received a competing acquisition offer to its deal with Mitel Networks. According to a Polycom filing, an unidentified private equity firm offered $12.25/share in cash, valuing the company at $1.66 billion. Back in April, Mitel agreed to acquire Polycom for $3.12/share in cash and 1.31 Mitel common shares for each share of Polycom. Weisman Group offered to acquire Ashford Hospitality Group for a $20.25/share, in a deal valued at $1.48 billion.