Ukraine Tensions Rise, Russian Markets Fall. Will Investors “Run the stops” on the Yuan?

Observations on the Capital Markets – Week Ended April 25, 2014

Ukraine tensions increased, people died, and Russia is threatening, while the U.S. and EU appear weak/passive. S&P cut Russia’s sovereign debt to BBB- with a negative outlook. Two Russian sovereign bonds auctions failed due to an “absence of bids” according to the Russian Finance Ministry. Russia’s Central Bank increased its key rate another 50 bps to 7.50% (after a 150 basis point hike on March 3) due to “higher inflation risks.” Russian stocks were among the week’s biggest losers.

The Chinese yuan was down almost 3.5% against the dollar year to date. Perhaps more important, it crossed 6.25 per dollar, a level where (some say) lots of highly leveraged derivative products known as “target redemption forwards” could turn sour. In my youth, if lots of investors had stop-losses or similar triggers at some price point, markets would have a propensity to go through that price, triggering the stop-losses, then reversing, imposing losses on the investors who had stop-losses: it was called ”running the stops.” We’ll see.

The U.S. economy continues to look OK (March’s figures)

  • Durables orders topped expectations, up 2.6%. Strength was widespread.
  • The LEI (index of leading indicators) rose 0.8%.
  • The Richmond Fed index rose from -6 and -7 in the prior two months to +7.
  • Markit’s U.S. flash manufacturing Purchasing Managers Index (PMI) was 55.4; services were 54.2 . . . solid.
  • The Chicago Fed’s National Activity Index dipped to 0.2 (consistent with modest/moderate growth).
  • The Kansas City Fed index slipped from 10 to 7 . . . ok.
  • Initial unemployment claims rose to 329k. The last 2 weeks had been surprisingly low . . . the trend is ok.

Homebuilding isn’t looking like a driver of 2014 growth

New Home Sales

  • New home sales were far below expectations, down 13.3% year over year (y/y) but the median price was up 12.6%.
  • Existing home sales shrank for the seventh time in eight months. Year-on-year, they are down 7.5%.
  • The average price for existing home sales rose 7.9% y/y.
  • The FHFA house price index (Fannie/Freddie conforming loans) was up 6.9% y/y . . . the rate of appreciation is slowing.

Europe continues to improve (except for the situation on the eastern front, that is)

  • Eurozone April flash composite PMI strengthened further; both services (53.1) and manufacturing (53.3) rose. France (50.9 and 50.3) continues to lag its neighbors.
  • The German April Ifo overall business climate index was 111.2 . . . rising back toward the January (pre-Ukraine) cycle high.
  • Portugal raised €750 million in 10-year 3.6% debt.

Draghi draws a red line—one that could justify imminent action

  • ECP President Mario Draghi said, “The Governing Council is committed — unanimously — to using both unconventional and conventional instruments to deal effectively with the risks of a too-prolonged period of low inflation.”
  • This red line (“the risks of a too-prolonged period of low inflation”) might already have been reached.
  • Recall that the ECB’s goal is ‘close to, but below 2%’ and y/y inflation fell to 0.5% in March.
  • On April 30, the next Eurozone inflation figure will be out. Will it influence the ECB?

China: still slowing: but still, so big

  • The HSBC April flash manufacturing PMI was below 50 again, at 48.3 . . . growth is still slowing.
  • Urban employment rose 3.44 million in the first quarter; the registered urban unemployment rate was 4.1%

Imported oil continues to hamper the Japanese economy

  • March Consumer Price Index (CPI) was 1.6% y/y. Excluding food and energy, it was 0.7%.
  • Japan’s FY2013 trade deficit hit a record high. Exports are up 2% y/y while imports are up 18%.

Last week in the capital markets: OK U.S. and European economic news balanced by rising Ukraine tensions. Earnings and M&A are positives for the stock market

Earnings season is going well: with roughly half of the S&P 500 having reported, three fourths of companies are beating consensus estimates, slightly above average.
Merger and acquisition activity and deal speculation are up.

  • Equities: Developed global equity markets ended the week essentially flat; emerging and frontier markets didn’t.
    • The S&P 500 ended the week down 0.1%. Only Utilities (up 1.8%) and Health Care (up 0.8%) were up. Telecoms (-3.6%) lagged.
    • MSCI Europe was up about 0.5%; with Ukraine tensions escalating, Germany lagged; the UK led. MSCI Japan was down about 0.4% (it doesn’t like a strong yen).
    • MSCI Frontier Markets (+1.5%) and MSCI Emerging Markets (-1.8%) were outliers in opposite directions. The Frontier index is up about 15% ytd. In the Emerging Markets index, Russia (-6.5%) and China (-3.5%) were notable drags.
  • Bonds: Global bond markets were calm on the surface last week. 10-year Treasury yields fell 4 basis points to 2.68% on better economic news and worse news from Ukraine; the 10-year TIP yield fell 4 bps to 0.48% . . . the low end of its YTD trading range. The yield curve flattened: the 2-10 spread narrowed 7 bps.
  • Currencies: A pretty quiet week for the “big 3” with the Yen up a couple of tenths of a percent against the dollar and Euro. Most EM currencies (including the Chinese Yuan) faded modestly against the dollar. The Brazilian Real recovered much of its prior week underperformance.
  • Commodities: Oil was down 3.5% (U.S. inventories are at an 83-year high); gold was about flat. It’s unclear whether either is trending.

Next week: lots of economic data points . . . the Fed meets . . . also: watch the BoJ

  • The Senate Banking Committee will (probably) confirm Stanley Fischer as Fed vice chair and Lael Brainard and Jerome Powell as Board members.
  • Economy: Q1 GDP (first estimate . . . probably 1-1.5%, given the weather).
  • Employment: monthly employment report (jobs, unemployment rate, workweek, etc.), initial claims
  • Business: ISM and Markit manufacturing PMI indexes, Chicago PMI, Dallas Fed survey, construction spending, factory orders
  • Housing: Pending home sales (they’ve fallen for nine straight months), Case-Shiller price index
  • Consumer: Personal income, personal consumption expenditures
  • Inflation: PCE inflation (the Fed’s favorite), employment cost index
  • On April 30, the Bank of Japan board meets. They’re not hinting they plan to ease, but my sense is that the market (some investors) may be disappointed if they don’t.
  • April 30 (later that same day), the Fed announces policy. The consensus forecast is a taper to $45b.
  • Also on April 30, Eurozone inflation. Given Draghi’s comments, markets will be paying attention. It might nudge the ECB.

Data Sources: The Wall Street Journal, Financial Times, Bloomberg.

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About Sam Wardwell

Sam Wardwell, CFA, is Senior Vice President and Investment Strategist at Pioneer Investments. He joined Pioneer in 2003.
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