Topics discussed this week:
- Divergence in Monetary Policy: Decidedly Dovish Camp
- Divergence in Monetary Policy: Not Dovish = Hawkish Camp
- Time for Asian Equities & FX to Take a Breather?
Divergence in Monetary Policy: Decidedly Dovish Camp
Over the last week or so, we’ve gotten a number of key macro data points that would suggest to us that, at least for the time being, the region’s intermediate-term monetary policy outlook has become increasingly divergent. This could, of course, change with further data, but for now we feel compelled to highlight the disparity because it could potentially set the table some notable divergences in cross-asset performance going forward.
China: Make no mistake about it, China’s FEB inflation report was flat-out dovish, with CPI slowing to a 20-month low of +3.2% YoY and PPI slowing to a 27-month low of +0.0% YoY. The sharp decline CPI was predicated by an even sharper decline in food inflation – a key factor we have been flagging in recent weeks as supportive of continued downside in EM CPI readings.
From a policy impact perspective, we continue to believe inflation statistics, rather than the trend in growth data carries more weight in China from a monetary policy standpoint – especially given the rising domestic focus on income inequality as flagged during the National People’s Congress by Politburo member Bo Xilai and NPC chief Wu Bangguo. Inflation remains a tax on China’s rural poor.
From a growth perspective, the Chinese economy continues to trend along with our expectations and the directional targets of the State Council. To that tune, China’s JAN-FEB data came in fairly light and, while we don’t expect the PBOC to overreact in a dovish manner given the State’s policy objectives, we do think the not-so-hot economic data only amplifies the monetary easing signals being transmitted via China’s inflation statistics.
Japan: Not really a traditional call on the country’s GROWTH/INFLATION dynamics, we think the Bank of Japan is actually under accelerating political pressure to increase the size of their ¥30 trillion asset purchase program for a second-straight meeting to affirm their commitment to reaching their recently-adopted +1% inflation target.
Regarding the target specifically, Japanese lawmakers on both sides of the aisle have been lobbying the central bank to actually increase it to +2-3%. While we don’t expect that to happen at next week’s monetary policy board meeting (MAR 12-13), we do expect Shirakawa and his team may appease policymakers in the form of incrementally dovish policy – if nothing but to shrink the growing political target on their backs. Both Japan’s currency (down -7.5% since the start of FEB) and Japanese breakeven rates agree with this view.
India: Overnight, the Reserve Bank of India came out and reduced the nation’s cash reserve ratio by -75bps to 4.75%. Two things stand out to us from this decision:
- The move was an acceleration in the magnitude of cuts to the cash reserve ratio, which was last reduced by -50bps on JAN 24; and
- The action came ahead of next week’s monetary policy board meeting (MAR 15), which suggests to us that they felt the urge to accelerate the steps they are taking to ease a liquidity crunch in the banking system. Thus far, the move has worked, with Indian banks borrowing the least of amount of cash from the central bank over any five-day period since early NOV.
The RBI’s increase in aggression with regards to monetary easing supports our view that rate cuts are definitively on the table at India’s upcoming monetary policy meeting. A recent string of weak growth data (slowing FEB Manufacturing and Services PMIs; Real GDP growth at a 10-quarter low in 4Q11) and benchmark wholesale prices slowing to a 26-month low of +6.6% YoY in JAN are supportive of this view as well as our near-term GROWTH/INFLATION modeling outlook.
Australia: Kudos to Glenn Stevens and Co. for resisting political pressure to lower interest rates (in order to provide some relief to the currency) at the last monetary policy board meeting on MAR 5. Based on the latest string of domestic and international growth data, however, we don’t think the Reserve Bank of Australia will be able to resist cutting it benchmark interest rate at their upcoming meeting on APR 2:
- FEB Unemployment Rate: +5.2% vs. +5.1% prior
- FEB Payrolls: -15.4k MoM vs. +46.2k prior
- Full-Time: flat MoM vs. +15.3k prior
- Part-Time: -15.4k MoM vs. +30.9k prior
- FEB Services PMI: 46.7 vs. 51.9 prior
- FEB Manufacturing PMI: 51.3 vs. 51.6 prior
- FEB Construction PMI: 35.6 vs. 39.8 prior
- 4Q GDP: +2.3% YoY vs. +2.6% prior
- QoQ: +0.4% vs. +0.8% prior
- FEB TD Securities Unofficial CPI: +2% YoY vs. +2.2% prior
China (25.1% of Aussie exports):
- YTD Industrial Production: +11.4% YoY vs. +13.9% in DEC
- YTD Urban Fixed Assets Investment: +21.5% YoY vs. +23.8% in DEC
- YTD Retail Sales: +14.7% YoY vs. +17.1% in DEC
Japan (18.9% of Aussie exports):
- FEB Manufacturing PMI: 50.5 vs. 50.7 prior
- FEB Machine Tool Orders: -8.6% YoY vs. -6.9% prior
Ahead of the APR 3 monetary policy announcement, Australia will release its MAR Manufacturing PMI on MAR 31, its FEB CPI (unofficial reading) on APR 1, and its FEB Retail Sales data on APR 2. We expect each data point to continue trending dovishly with respect to monetary policy. Interestingly, Australian interest rate markets are misaligned with our near-term fundamental view from a directional perspective and, as such, we expect the Aussie dollar to come under pressure on an immediate-term TRADE duration given that our view is likely to get priced in over the coming weeks.
Thailand/Taiwan/Philippines/Vietnam: Officials from each central bank have come out in recent weeks pledging to maintain accommodative monetary policy amid heightened risks to domestic and global growth. Keeping it brief for now; we’re happy to follow up more if you’d like.
Divergence in Monetary Policy: Not Dovish = Hawkish Camp
South Korea: Rhetorically, Korean policymakers have been the most hawkish throughout Asia in recent weeks:
Bank of Korea Governor Kim Choong Soo at the G20 Summit (FEB) and per the latest monetary policy report (MAR 7):
- “Oil prices are adding to inflation pressures.”
- “The Bank of Korea will seek to lower inflation expectations.”
- “I am suspicious that more macroeconomic stimulus by advanced economies can be a solution to reviving growth.”
- “The South Korean economy is unlikely to slow further.”
Finance Minster Bahk Jae Wan:
- “Monetary policy in advanced economies is also adding to price pressures in [South Korea]. It’s not only the oil price hike but also quantitative easing in the major countries, like the U.S. and the European countries and Japan. Because of that there is an abundance of liquidity going around the world, so there is also an inflationary pressure from the outside.”
- “While inflation is likely to dip this month below the +3.4 percent rate in January and be even lower in March, instability in the oil market threatens to push overall consumer prices above the government’s +3.2 percent target for the year.”
- “Rising oil prices are one of the biggest concerns for South Korea... A +10 percent increase in the cost of crude pushes inflation up by +0.12 percentage point.”
- “I am hopeful that the Korean economy will bottom out in the first quarter and go on the path of recovery in the second quarter.”
Looking forward, we don’t expect the Bank of Korea to actually hike rates anytime soon – a view supported by two things:
- The U.S. Dollar Index is holding above its intermediate-term TREND line of support and we view stability/strength in the USD as a clear headwind for commodity inflation/perpetuator of commodity deflation; and
- Our baseline GROWTH/INFLATION/POLICY model suggests Korea is under no pressure to move rates higher at least through 2Q.
That said, however, Korean interest rate markets certainly side with our fundamental view that there is asymmetric risk for the Bank of Korea to tighten, rather than ease monetary policy over the intermediate-term TREND. For example, even throughout the thralls of the 2H11 risk aversion, neither 1yr Sovereign Yields nor 1yr O/S Interest Rate Swaps began pricing in any rate cuts out of the Bank of Korea – a notable divergence from many of the region’s other economies.
Indonesia: Since the start of 4Q11, Bank Indonesia has been among the world’s most aggressive central banks, lowering its benchmark interest rate -100bps to 5.75% in a series of three cuts (-25bps, -50bps, -25bps). Their aggression has been well-deserved; Indonesian CPI has been nearly halved, slowing from a cyclical peak of +7% YoY in JAN ’11 to +3.6% in FEB.
At its latest meeting, however, the bank refrained from lowering rates further, as President Susilo Bambang Yudhoyono’s cabinet proposes to hike the price of subsided fuel by +33% to 1,500 rupiah per liter in addition to a proposed +10% hike in electricity prices. If enacted, both proposals threaten to apply a fair amount of upside pressure on domestic inflation readings in the coming months. In its latest policy decision, Bank Indonesia board members said they would “respond to a surge in costs, if needed”.
For now, Indonesia’s sovereign debt and currency markets foresee a continued dovish outlook; as a result, the latter is underperforming other regional currencies vs. the USD across multiple durations:
- 1 WK: IDR/USD -0.2% vs. a regional median decline of -0.1%
- 1 MO: IDR/USD -1.7% vs. a regional median decline of -0.2%
- 3 MO: IDR/USD -0.6% vs. a regional median gain of +2.2%
- 6 MO: IDR/USD -6.1% vs. a regional median decline of -0.3%
- 12 MO: IDR/USD -3.8% vs. a regional median decline of -0.4%
- YTD: IDR/USD -0.3% vs. a regional median gain of +3.0%
All told, the energy price proposals loom in the distance and are very likely to shape the course of Indonesian monetary policy throughout 2012. We’ll find out more soon; approval of the 2012 budget review is due over the next month or so.
Given the likelihood of passage amid the recent run-up in global petroleum prices, we would expect to see the rupiah outperform other regional currencies over the intermediate-term TREND – a trend that is likely to be coincident with a continuation of Indonesia’s recent equity market underperformance. In leading fashion, the Jakarta Composite Index is up only +4.4% YTD vs. a regional median gain of +12%.
New Zealand/Malaysia: Officials from each central bank have come out in recent weeks highlighting domestic and international inflationary pressures amid holding interest on rates. Keeping it brief for now; we’re happy to follow up more if you’d like.
Time for Asian Equities & FX to Take a Breather?
While it’s certainly not in our nature to make a bevy of broad, explicit calls across an entire region, we are keen to flag what we think could be appropriate opportunities to revisit one’s exposure to certain asset classes from a short-to-intermediate-term perspective. On that note, we think there is a great deal of good news priced into Asian equities and currencies at the current juncture. While that is not to say additional gains are not to be had in the near term, we would be leery of further strength across Asian equity markets and FX over the intermediate term.
Generally speaking, global investor complacency is just shy of APR ’11 highs, as measured by our proprietary Global Macro Volatility Index – a series that coagulates various volatility measures across multiple asset classes (equities/FX/fixed income/commodities).
Of course, investor complacency can last for unreasonably long amounts of time, so we aren’t making the call that reaching this level will be followed promptly by a sell-off. We are, however, flagging that there is an asymmetric setup for mean reversion over the intermediate term. To note, our volatility index is inversely correlated to the MSCI All-Country Asia Pacific Equity Index to the tune of -64% over the past three years and the inverse correlation is even higher for Asian currencies (-83% over that same duration).
Fundamental Price Data
All % moves week-over-week unless otherwise specified.
- Median: -0.8%
- High: New Zealand +1.7%
- Low: Hong Kong -2.2%
- Callout: Japan +17.4% YTD vs. a regional median gain of +12%
- FX (vs. USD):
- Median: -0.1%
- High: Philippine peso +0.4%
- Low: Australian dollar -1.5%
- Callout: New Zealand dollar +11.5% over the LTM vs. a regional median gain of +0.4%
- S/T SOVEREIGN DEBT (2YR YIELD):
- High: Indonesia +14bps
- Low: Australia -14bps
- Callout: Philippines +73bps YTD
- L/T SOVEREIGN DEBT (10YR YIELD):
- High: Indonesia +21bps
- Low: Australia, Vietnam -10bps
- Callout: Thailand +17bps YTD
- SOVEREIGN YIELD SPREADS (10s-2s):
- High: India, Indonesia +7bps
- Low: Philippines -12bps
- Callout: Indonesia +11bps YTD
- 5YR CDS:
- Median: -1.1%
- High: Australia +10.4%
- Low: China -10.7%
- Callout: Japan -6.4% over the last month vs. a regional median decline of -2.4%
- 1YR O/S INTEREST RATE SWAPS:
- High: India, Thailand +3bps
- Low: China -17bps
- Callout: China -107bps over the last six months
- O/N INTERBANK RATES:
- High: Japan +1bps
- Low: India -30bps
- Callout: China -22bps wk/wk
- CORRELATION RISK: The Hedgeye Global Macro Volatility Index is inversely correlated to the MSCI All-Country Asia Pacific Equity Index to the tune of -64% over the past three years and the inverse correlation is even higher for Asian currencies (-83% over that same duration).
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No Current Positions in Europe
Asset Class Performance:
- Equities: Bottom performers: Cyprus -7.9%; Slovakia -3.9%; Ukraine 3.9%; Spain -3.3%; Austria -3.0%. Top performers: Switzerland 60bps; Greece 40bps
- FX: The EUR/USD is down -0.61% week-over-week. Divergences: SEK/EUR -1.3%, NOK/EUR -1.1%; HUF/EUR -0.96%, GBP/EUR -0.34%; CHF/EUR +0.07%.
- Fixed Income: Excluding Greece, 10YR sovereign yields we largely flat week-over-week. Greek yields tumbled a 109bps on the PSI announcement, while the Italian 10YR yield saw the second greatest decline at -18bps to 4.77%. Spanish and Italian yields continue to trend lower, while Portugal flashes increased signs of risk.
Once again we’ve gotten past a hurdle in the market with confirmation just this morning that the Greek PSI received the critical participation rate, Collective Action Clauses (CACs) were activated, and ISDA ruled that the bonds swapped will trigger a CDS event. However, what’s lost in the near-term hurdles is the underlying flaws of a Union of disparate countries governed by one monetary policy. Namely without the ability to devalue one’s currency and inflate one’s way out debt obligations, or even default (which Eurocrats continue to suspend), Eurozone countries (like a Greece, Portugal, or Spain) can at best deflate wages to gain competitiveness. The problem with this policy, of course, is that it reduces domestic spending power, and therefore further stagnates total output.
The major fallacy that Eurocrats are running with is that through the Fiscal Compact they can manage governments’ budgets, initially by setting targets on debt and deficit levels and when necessary intervening to assure these targets are met. The flaw in this assumption is that countries are not likely to give up sovereignty to Brussels or Frankfurt to manage their spending, and that setting “artificial” targets is inappropriate for disparate countries, and hasn’t worked in the past (think Stability and Growth Pact). For economies that are not all created equal – for example, some may have large current account surpluses and others deficits or varying levels of capital accounts (investment) –a Union with one monetary policy inadequately addresses disparate levels of growth, and can distort the flow of goods and investment across countries.
While the above only begins to touch on the imbalance created in binding uneven economies to one monetary policy, here we’ll reiterate that we do think Eurocrats will do everything in their power to maintain this existing and flawed Union. We expect this to bring volatility to markets, like we’ve seen over the last 18+ months, and monetary policy to continue to drive a larger divergence in the “Have’s” versus “Have Nots” within the Union, which will ultimately lead to protracted economic weakness and fiscal imbalances.
Eurozone Q4 GDP -0.3% Q/Q and 0.7% Y/Y
Eurozone Retail Sales 0.0% JAN Y/Y vs -1.3% DEC [0.3% JAN M/M vs -0.5%]
Eurozone Sentix Investor Confidence -8.2 MAR vs -11.1 FEB
Germany Factory Orders -4.9% JAN Y/Y (exp. -1.7%) vs 0.0% DEC
Germany Exports 2.3% JAN M/M vs -4,4% DEC
Germany Imports 2.4% JAN M/M vs -3.9% DEC
Germany Industrial Production 1.8% JAN Y/Y (exp. 1.1%) vs 1.3% DEC [1.6% JAN M/M (exp. 1.1%) vs -2.6% DEC]
Germany CPI 2.5% FEB Final, in line w initial
France Manufacturing Production -1.2% JAN Y/Y vs 0.8% DEC
France Industrial Production -1.5% JAN Y/Y vs -1.2% DEC
France Bank of France Business Sentiment 95 FEB vs 96 JAN
France Non-Farm Payrolls -0.1% in Q4 Q/Q vs -0.2% in Q3 Q/Q
Greece Q4 GDP -7.5% Y/Y vs original est. of -7%
Greece CPI 1.7% FEB Y/Y vs 2.1% JAN
Greece Unemployment Rate 21.0% DEC vs 20.9% JAN
Portugal Q4 GDP -2.8% Y/Y vs -2.7% in Q3 [-1.3% Q/Q vs -1.3% in Q3]
Spain Retail Sales -4.8% JAN Y/Y vs -6.4% DEC
UK BOE/GfK Inflation next 12 months 3.5% FEB Y/y vs 4.1% JAN
UK Industrial Production -3.8% JAN Y/Y vs -3.1% DEC [-0.4% JAN M/M vs 0.4% DEC]
UK Manufacturing Production 0.3% JAN Y/Y vs 0.9% DEC [0.1% JAN M/M vs 1.1% DEC]
UK PPI Input 7.3% FEB Y/Y vs 6.6% JAN [2.1% FEB M/M vs 0.1% JAN]
UK PPI Output 4.1% FEB Y/Y vs 4.0% JAN [0.6% FEB M/M vs 0.4% JAN]
Sweden Industrial Production 2.1% JAN Y/Y vs -0.4% DEC
Norway CPI 1.2% FEB Y/Y vs 0.5% JAN
Switzerland CPI -1.2% FEB Y/Y (exp. -0.7%) vs -0.9% JAN
Switzerland Retail Sales 4.4% JAN Y/Y vs 1.7% DEC
Interest Rate Decisions:
BOE Interest Rate UNCH at 0.50% and bond purchasing program remains at 325 Billion GBP
ECB Interest Rate UNCH at 1.00%
CDS Risk Monitor:
Compared to previous weeks, we did not see huge moves in 5YR CDS on a week-over-week basis. Portugal rose the most at 42bps to 1229bps, followed by Spain (+37bps) to 396bps, Ireland (+32bps) to 620bps, and Italy (+10bps) to 369bps. One inflection to note is that Italian CDS traded below Spain, throughout the week. As the chart below shows, since August 2011, Italian CDS was priced comfortably above Spanish CDS.
The European Week Ahead:
Monday: Eurogroup Meeting; Q2 Germany Manpower Employment Outlook; Feb. Germany Wholesale Price Index; Feb. UK RICS House Price Balance; Q4 Italy GDP – Final; Jan. Greece Industrial Production
Tuesday: Mar. Eurozone ZEW Survey (Econ. Sentiment); Mar. Germany ZEW Survey (Current Situation and Econ. Sentiment); Jan. UK House Prices, Trade Balance; Feb. France CPI; Jan. France Current Account; Feb. Russia Budget Level (Mar 13-15); Jan. Russia Trade Balance; Feb. Italy and Spain CPI - Final
Wednesday: Feb. Eurozone CPI; Feb. UK Claimant Count, Jobless Count Change, Jan. UK Weekly Earnings, ILO Unemployment Rate
Thursday: Mar. Eurozone Monthly Report Published; Feb. Eurozone 25 New Car Registrations; Q4 Eurozone Labour Costs, Employment; Jan. Italy General Government Debt; Q4 Spain House Prices; Q4 Greece Unemployment Rate
Friday: Jan. Eurozone Trade Balance; Feb. Russia Industrial Production, Producer Prices; Jan. Italy Trade Balance, Current Account; Q4 Spain Labour Costs
Extended Calendar Call-Outs:
20 March: Greece’s €14.5 billion Bond Redemption due.
22 April: French Elections (Round 1) begins, to conclude in May.
29 April: Potential Greek Presidential Elections
30 June: Deadline for EU Banks to meet €106 billion capital target/the 9% Tier 1 capital ratio.
1 July: ESM to come into force.
Keith sold our long position in GLD in the Hedgeye Virtual Portfolio this morning. He noted, “Gold is snapping my intermediate-term TREND line again on a consequential USD Index breakout > TREND support. The Risk Management Process says take the loss here.”
The USD is breaking out above our TREND line of support, $79.03 on the USD index.
The inverse correlation between the USD and gold has strengthened to -0.75 on the 15d duration and to -0.78 on the 90d duration.
With gold flirting with its own TREND line of support, $1693, the proper risk management decision is to sell the position. While gold is stronger today after ISDA triggered the CDS insuring Greek debt, we think that the strength is transient and that the USD correlation will be the primary factor driving the price of gold on the go-forward.
Lastly, sentiment is increasingly becoming a headwind. Bloomberg reported earlier today that, “Gold traders are the most bullish in four months after investors accumulated more metal than ever and hedge funds raised bets on gains to a five-month high. Sixteen of 23 analysts surveyed by Bloomberg expect prices to gain next week and one was neutral, the highest proportion since Nov. 11. Investors increased their holdings in exchange- traded products backed by bullion for seven consecutive weeks and now hold 2,407 metric tons valued at $131 billion, data compiled by Bloomberg show.”
Some incremental changes coming to a MCD menu near you – what are the implications?
As first reported by Reuters, McDonald's “will be tweaking and expanding their value-priced items” at the end of March. MCD has not discussed this with the street due to competitive reasons.
As we learned in conversation with the company, they are focusing the menu on four tiers (not including combo meals):
- Premium: $4.50-$5.50+
- Core: $3.50-$4.50
- Extra Value Menu (new): $1.20 to $3.50+
- Dollar menu
In trying to understand the implications of what McDonald’s is doing, a restaurant industry consultant and associate of ours had this to say: “I get a kick out of these corporate guys at WEN and MCD pretending they have some magical formula for value pricing. It's 100% driven by food costs and customer behavior.” Given that MCD is seeing increasing inflation in 2012, we believe they are trying to manage check and margin by forcing consumers to trade up to the “extra value menu” from the “dollar menu.” This makes more sense when we consider that one of the biggest changes is to remove small drinks and small fries from the dollar menu and replace those items with fresh baked cookies and ice cream cones.
HEDGEYE: We see this as a big risk for MCD. If customer preference is to have the drink and fries as part of the dollar menu then there is a risk that this change negatively impacts customer satisfaction. The company told us that a “mini-combo meal” offering may bundle the fries, burger, and drink but a decision has not been made on that yet. Still, ordering the $1 items individually is being taken off the table.
The new "Extra Value Menu" will be advertised on March 26th. According to Reuters, “the new menu will include 20-piece chicken McNuggets, double cheeseburgers, chicken snack wraps, Angus snack wraps, medium iced coffees and snack-sized McFlurries, plus up to four regional options, that were previously listed elsewhere on its menu.” The idea for McDonald’s is to streamline and change what is highlighted on the menu. The company likes to phrase this differently, saying that they are, “making it easier for customers to find them [‘Extra Value Menu’ items]”.
HEDGEYE: From our perspective, the big problem is that the "Dollar Menu" has been around for a very long time. Inflation has made it an unprofitable but necessary evil. Customers, also pressed by inflation, have been migrating from the combo meals on the core menu, which can cost $6-7, over to the Dollar Menu where the value customers get is almost double from a price perspective. We view this latest change as an attempt by the company to stem this flow of business from the core menu to the dollar menu. This adds an extra emphasis on the importance of April sales; investors will be watching closely for an indication of whether or not the new menu strategy is working.
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