ABSTRACT: The current rout in the bond markets continued into its sixth week with rapidly rising yields and increased volatility in government bonds. Despite the outflow of funds from the typical safety net of government-issued debt, both stocks and commodities like crude oil and precious metals tracked lower throughout the week.
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GOVERNMENT & POLICY
IMF Loudly Suggests Fed Delays Rate Hike
It’s not often that the International Monetary Fund or its officers make public pronouncements about highly specific monetary policy decisions. In most cases, it’s not the place of the institution to micromanage the affairs of individual countries (even when their governments are highly indebted to the Fund. See: Greece). Nonetheless, IMF Director Christine Legarde felt compelled to speak out on the Federal Reserve’s pending decision for when it will begin the process to normalize interest rates.
Legarde insisted that until wages and prices rise to the FOMC’s 2% inflation target, the federal funds rate ought to remain at its current level until sometime in 2016. This is despite Fed Chair Janet Yellen’s repeated remarks about raising rates this year.
Then again, Yellen has also qualified her statements with the acknowledgment that there are certain risks that could justify pushing back the rate hike. Legarde seems to consent to this caveat, saying that the Fed may safely overshoot its inflation target a bit without great effect. This highlights the perceived risk of an early lift-off for rates, which could cause shocks to a world economy currently out of balance.
With various forms of drag on global growth still in place, things are simply not moving at a brisk pace. The consumption expenditures price index, the IMF’s preferred inflation gauge, made its smallest year-over-year gains since 2009, rising just 0.1% from last April.
It’s pretty clear how the U.S. might inadvertently throw a wrench in the working of the global economy by erring on the timing of the rate hike: Greater appreciation of the dollar, which is already up about 13% over the last year, and the attendant loss of competitiveness of U.S. exports would not be supportive of global growth. The world economy may simply not be strong enough yet to withstand a potential interest-rate crisis in its biggest economy, and the pain-averse reasoning for keeping rates parked near zero remains intact.
The IMF has a larger agenda regarding the global economy to uphold, and that’s the point of these rather explicit comments about the Fed. Far from a snub at Janet Yellen or her level of competency, as some have suggested, Legarde’s two cents on a contested policy issue only reveals the widespread effect that U.S. monetary policy has on broader global dynamics. The dollar is ubiquitous; anything relating to the greenback unavoidably has an international character to it.
Thus, the IMF is motivated by a need to shape the perspective of the United States’ international counterparts by reducing their own concerns about the timing of the rate hike. The Fund may also be placing some pressure on the U.S. authorities due to Congress’s foot-dragging on the approval of important structural reforms to the IMF’s rules for voting, representation, and leadership.
Ironically enough, any time somesuch encouraging economic news hits the wire, such as this week’s robust non-farm payrolls report, the calls reemerge for September to be “back in play” for a possible rate hike. As I’ve said for months, rates aren’t going anywhere soon; even the December target for the first rate increase that most analysts expect is dubious.
This is an isolated case where the IMF is actually dead-on–at least in its assessment of reality–and has chosen to push back against the conscious posturing by the Fed, a tactic intended to keep the markets guessing about how long rates will remain so low. If Legarde and the IMF feel compelled to counter the FOMC’s rhetoric with its own statements to the contrary, it’s time to question where the committee’s narrative is going awry.
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MARKETS
Despite Bond Meltdown, Metals Slide Back
Although many market participants’ actions (and a great deal of financial punditry) have taken on a panicked character regarding the global bond market, neither commodities nor equities were the beneficiary of this creeping illiquidity in government bonds around the world.
Although the precious metals initially moved higher on Monday morning, the spot prices pulled back to about unchanged by midday before kicking off a modest selling spree throughout the week. U.S. shares recovered from an early dip to close about 0.25% higher on Monday thanks to Intel’s acquisition of Altera for $16.7 billion, boosting the latter’s shares by 6% on the day. Silver sank back below the $17 mark after an early 30-cent jump, while platinum lost about 0.75% to close just above $1,105/oz.
Tuesday’s action was dominated by ECB President Mario Draghi’s comments that investors ought to expect and accept a period of increased volatility; this helped drive the 6-week rout of government bonds, sending the yields on many country’s benchmark bonds 10 to 15 basis points higher. Despite Draghi’s optimism about the effectiveness of ECB QE and the ongoing impasse with Greece, the 10-year German Bund yield spiked to a yearly high of 0.95% following his comments. (Recall that this comes after 10-year Bund yields settled just below 0.05% as recently as mid-April.) Meantime, 10-year U.S. Treasury yields hit 2.40% before easing back slightly.
This unusual action in government bonds may well be a belated reaction to the accumulation of higher debt levels amid a low-rate environment. The liquidity concerns arise when all of the typical “big players” exit the bond markets, leaving few buyers remaining to halt the sell-off and to trade with those still holding these assets after the exodus. Due to this uncertainty with assets traditionally valued for their ironclad safety, along with low crude oil prices (relative to recent history), the OECD has cut its global forecasts for growth this year.
After gaining 40% from its 6-year low in January, crude pulled back throughout the week. This trend was supported in part by OPEC rejecting any reduction to its current production levels at this week’s policy meeting. After WTI crude steadied above $60/bbl and Brent crude held above $64/bbl early in the week, the two benchmarks sank about 2% on Thursday before trickling down to $58/bbl and $62/bbl, respectively, by Friday.
Economic data released this week in the U.S. was decidedly mixed. The trade deficit was slashed some 20% in April thanks to a drop in imports. Americans also saved more during April, with consumer spending flat for the first time in 2015. After notching an 8-year high in April, consumer comfort measures have declined for 8 consecutive weeks to a 6-month low. Wednesday’s ADP payrolls report showed 201,000 new jobs added, the most in 4 months, yet 96% of this growth was seen in the service sector, and wage growth has remained stagnant. Though the sector has been weak of late, employment in manufacturing did pick up in May.
Even while inflation remains tempered in the U.S., the price of eggs have skyrocketed 120% to all-time highs amid the worst-ever bird flu outbreak in the States.
Market sentiment has understandably been uneven given the data, but each positive note within the larger dissonant melody has seemed to drive fear of an imminent rate hike from the Federal Reserve, and the accompanying appreciation for the dollar that would likely result.
Friday’s solid nonfarm payrolls report stoked these interest rate fears, showing 280,000 jobs added, far above analysts’ expectations. There did appear to be, however, some slack on the labor market, with U3 unemployment–which accounts for levels of underemployment–ticking 0.1% higher. Investors have expected that the dwindling of corporate profits overseas thanks to the strong dollar would drive a decline in payrolls, but this has yet to come to fruition.
In forex trading, the dollar gave up about 0.5% on Wednesday, falling to 95.3 on the DXY index. This helped the euro advance more than 1% toward $1.13. The pound sterling finally broke a losing streak of 7 consecutive trading sessions in the red on Tuesday, but is still down nearly 3% since mid-May, and was still below $1.53 by week’s end. The drop has been attributed to weakness in U.K. manufacturing. As the dollar jumped more than 1% relative to its peer currencies on Friday morning, hitting 96.5 on the DXY and sending the euro back to about $1.11, U.S. indices continued to track lower due in part to the unresolved Greek crisis. Again proving that market movement is often based merely on human perception, the trickling lower of stocks this week was somewhat held in check by rumors that T-Mobile may be in talks to merge with cable provider Dish.
Asian markets were uniquely strong this week, as the Shanghai stock index vaulted past 5,000 for the first time in 7 years, countering the recent volatile downswings in Chinese equities. Despite some strength around midweek, European shares tracked lower with U.S. indices.
The precious metals fell through important technical support levels, capping a week of losses by closing in the red again on Friday. Spot gold settled just above $1,170/oz after briefly testing $1,200 on Monday. Platinum again increased its spread below the gold price, slipping just below $1,100/oz. Silver had a particularly bad week, losing about 3.5% to close near $16.20/oz.
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GEOPOLITICS & WORLD EVENTS
How Interested is Greece in an Accord With Its Creditors?
For observers of the increasingly elaborate tango between Greece’s leadership and the institutions to which the country is desperately indebted, the dance is really hitting its stride.
With Greek PM Alexis Tsipras meeting with European Commission President Jean-Claude Juncker in Brussels on Wednesday, it appeared that the June 5th deadline for Greece to repay €301 million to the IMF would finally force the prime minister’s hand. As the country inches closer and closer toward default, and the clock on striking a deal that preserves its solvency runs low, it would seem as though Greece ought to be feeling the wall close in against its back.
Maybe we could take this week’s increasingly uneven behavior by Prime Minister Tsipras as a sign that Greece, and its ruling Syriza party, is reaching the end of its rope. Tsipras has swung from insisting that a deal is imminent to accusing “the institutions” of being a “technocratic monstrosity,” of which Greece is the obvious victim. This would seem to be the tune of a defeated opponent.
But the Greek administration may have more leverage than certain optics would suggest. German economist Hans-Werner Sinn opined in a recent op-ed that Tsipras and his outspoken finance minister, Yanis Varoufakis, are actually running a sound Game Theory strategy on their opponents. Sinn’s premise that simply drawing out the negotiation process works in Greece’s favor not only stands to reason when more closely examined, but also accounts for recent actions taken by the Greek contingency.
The Greek side in the dispute has been counting on buying time, invoking a clause in its IMF loan that will allow it to bundle its next repayment with other obligations that come due at the end of the month. Instead of paying €300 million now, Greece will choose to offer a lump sum of €1.5 billion by June 30th. This deferred bundling of repayments hasn’t been used by an IMF debtor since Zambia did so in the 1980s. Moreover, the Greek officials’ obstinate back-and-forth with the other side reveals some measure of self-assuredness: The Troika institutions have submitted a so-called “final proposal” filled with concessions to Greek demands, but to no avail.
Is it wishful thinking for the Greeks to try and delay each deadline until a deal is made? Or do they know something most of us aren’t seeing? And why have we consistently been hearing more optimism than frustration from the IMF, ECB, and EC? At times, these parties have somewhat revealed their hand by expressing good humor that at least the two sides are still talking.
Here’s the crux of the underlying “game”: The longer Greece can drag things out, the more that default fears will drive foreign investment out of the country, and the more that all forms of cross-border capital flows will dry up. In the event of a default and “Grexit,” this capital outflow actually affords Greece an upper hand. Following Sinn’s argument, Greece has considerable leverage in holding the keys to a possible exit from the euro and re-institution of the drachma as the national currency. In such a scenario, Greece would naturally deflate and eventually be able to work back toward growth, while the rest of Europe would receive next to nothing out of this development. In this light, the Greek brinkmanship seems more calculating than desperate.
Essentially, Greece can attempt to kick the can until the capital flight becomes so severe that their creditors stand to gain nothing (other than avoiding any future promise to “foot the bill” for Greece’s generous welfare system) by not capitulating to central Greek demands in any agreement. If the choice comes down to something or nothing, the Troika may well take a Greece with no pension cuts and no VAT increases (among other proposed reforms) over one that uses a severely devalued drachma.
PM Tsipras speaks in front of the Greek parliament on Friday and must attempt to strike a balance between the political pressures of his party, the electorate, and his country’s increasingly frustrated creditors. He has boldly insisted that any deal must be a “Greek proposal,” and the longer the negotiations go, the more it looks like that’s what Europe may end up settling with.
Russia’s Military Spending Balloons
Whatever one makes of Vladimir Putin’s maneuvering against Russia’s rivals in the West, his unapologetic strategy of converting the country’s economy into a one giant military-industrial complex is an unavoidable reality.
In addition to using military build-up as a means of bolstering the national economy, Putin himself has recently declared that the explosion in Russia’s defense programs are a needed increase in security and a way of relieving “macroeconomic stagnation.” In short, a panacea for both Russia and the world economy.
Since Putin took over as premier (or president, or however he has chosen to style himself since coming into power), the country’s defense spending has climbed by a factor of 20. The only countries that have spent more on defense over the last year are the U.S. and China, and as a percentage of the national budget, the U.S. allocates about half as much (18%) of its spending on military expenditures as Russia (34%) does.
There is also an issue with the level of secrecy involved in the expansion of Russian defense spending: Data show that nearly half of Russia’s annual defense budget was spent in the first quarter of the year alone–and much of that spending has been for classified purchases. On average, the other G20 nations obfuscate the purpose of roughly 1% of their total spending; in Russia, it’s as high as a quarter of all government outlays.
Though China has pursued a similar increase in military spending, the secretive, disproportionate militarization of the Russian economy is a trend warranting particular concern. If nothing else, the aggressive stance taken by Russia toward its neighbors of late revives the Cold War fears of an anti-Western bloc of satellite countries becoming incorporated into Russia’s sphere of influence.
Chechnya, Crimea, and now Ukraine. How far will Putin’s conquests be allowed to go before we’re staring squarely at another generational Russo-Occidental standoff?
News & Notes
Tensions continue to brew in the South China Sea between the People’s Republic and its regional rivals due in part to China’s weaponization of concrete-covered atolls in the middle of disputed waters.
India hints it may pursue a new gold monetization plan that would involve a national gold bullion coin and the possible nationalization of billions of dollars worth of gold offerings sitting idly in Hindu temples.
German gold demand jumps 20% in the first quarter of this year, as more than 32 tonnes of the yellow metal were imported.
OPEC does not cut production quotas at a meeting of the member nations on Friday; the move is widely seen as an attempt to preserve and grow the group’s share of the global oil market.
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A LOOK AHEAD: On Sunday evening, Japanese GDP numbers will be announced. Monday is busy with fresh economic data from around the world: industrial production and merchandise trade numbers will be announced in Germany; housing starts come out in Canada; and China releases its newest CPI and PPI data. For those who like to make wagers, the racehorse American Pharaoh will attempt to win the Belmont Stakes this Saturday in order to capture the elusive racing Triple Crown, a feat that hasn’t been accomplished since 1978.
