ABSTRACT: The major, immediate risks for the global economy seemed to reach “risk-off” status this week: China’s main stock index recovered 6.2% while Greece and its creditors agreed to a $7-billion bridge loan. These developments helped plunge the precious metals into the red each trading day this week.
GOVERNMENT & POLICY
News & Notes
In a blog post, Nobel Laureate economist Paul Krugman calls the Greek deal “vindictive” on the part of European leadership. In another post he predictably asserts that the risk of the Fed raising rates too soon outweighs the risks of a rate hike coming too late.
An official government report finds no single cause for last October’s “flash crash” in Treasuries, though the study implores regulators to question the behavior of high-frequency traders and banks in the Treasury market.
The IRS not only fields just 40% of phone calls this tax season (compared to 71% last year), but fails to notify some 90% of potential identity theft victims that they may be vulnerable.
The federal government seeks a new hearing on the Langbord 1933 Double Eagle case, claiming the 10 gold coins in question were stolen Mint property. Of the 455,500 double eagle coins ($20 gold pieces) minted in 1933, nearly all were melted down per Executive Order 6102. Only one 1933 double eagle, once owned by Egypt’s King Farouk, has ever been monetized and rendered legal to privately own; it sold for nearly $7.6 million at auction in 2002.
Wisconsin Governor Scott Walker officially joins the crowded GOP presidential field.
Senator Elizabeth Warren (Massachusetts) and Congressman Elijah Cummings (Maryland), both Democrats, are going after banks for their risky use of FDIC-insured deposits, seeking to limit taxpayers’ exposure to the speculative aspects of the financial sector.
Global Risks Abate, Precious Metals Extend Losing Streak
Stocks opened higher all across the global exchanges on Monday after Greece reached an agreement in principle with its European creditors. Discussions carried on for 17 hours before a last-minute deal was struck. Capital controls will remain in place, and Greek banks will still stay closed, for some time. In fact, most experts rated the austerity-for-bailout agreement as worse than the deal on the table prior to the referendum that yielded a “No” vote from the Greek electorate.
Elsewhere on Monday, Saudi oil production hit an all-time high of 10.6 million barrels per day. This helped push Brent crude down 0.5% while WTI opened lower before returning to unchanged. The dollar’s main competitors were largely idle: the sterling sat at $1.55, the euro held at $1.10, and the yen stuck near 123/$. 10-year Treasuries rose 2 basis points to 2.43% while the metals fell. According to trade data, however, silver imports to the U.S. have increased year-over-year every month this year, expanding by 33% thus far in 2015. Even so, the budget deficit remained near 7-year lows.
Following Greece’s capitulation to start the week, negotiations between Iran and a group of world powers surprisingly yielded a deal intended to prevent Iran from developing a nuclear bomb. Crude dropped modestly on the news, while U.S. indices closed about 0.5% higher. After opening in the red, European shares advanced into positive territory, while the euro traded flat. Data showed that retail sales in the U.S. fell by 0.3% in June, while inflation is still virtually zero in the U.K.; meantime, the pound sterling moved to $1.56 as the dollar fell 0.4% to 96.45 on the DXY index. The 10-year T-note yielded 2.40% on a day where the precious metals slid slightly lower across the board. In Asia, Shanghai lost another 1% while Japan’s Nikkei 225 gained 1.4%.
Wednesday was dominated by Janet Yellen’s two-day tour of Capitol Hill, where the Fed Chair gave testimony before the House Financial Services Committee and the Senate Banking Committee. While the members of Congress played their semiannual role of questioning the central bank’s lack of oversight and transparency, Yellen reiterated (for the umpteenth time) that measures of inflation and labor market slack are progressing toward Fed targets, leaving a rate hike from the central bank on the table before the year ends.
Stocks moved sideways following the seemingly hawkish Fed statement, up a meager 0.1%, before sinking into the red in response to violent protests in Athens. Investor focus had clearly shifted from Greece to the Fed by this point, however, as the Aussie dollar and the New Zealand kiwi each fell on Yellen’s rate hike comments. Murmurs began about how soon after the Fed the Bank of England will wait to raise its own benchmark rates.
Meanwhile, factory output was flat in the U.S. during June. Yet, the producer price index (PPI) rose 0.4% during the month after advancing 0.5% in May, all in spite of falling oil prices. Another rout in the crude market sent WTI ($51.55/bbl) 2.8% lower, while Brent ($57.20/bbl) lost 2.25%. This was helped by the dollar moving 0.5% higher, pushing the euro and yen down to $1.095 and 124/$, respectively. Both German Bunds and U.S. Treasuries with 10-year maturities saw demand: the yield on the former fell 4 bp to 0.87% while the latter was 7 bp lower at 2.35%, where it would end the week. The precious metals tumbled, as gold slipped below the $1,150/oz mark and silver lost 30¢, or almost 2%.
Wednesday was also Amazon’s highly promoted “Prime Day,” where preferred members of the retail site received an assortment of deals and special offers. (Walmart countered with its own sale.) Though the reaction from Amazon users seemed to indicate disappointment, Amazon reported higher sales than Black Friday and set a new single-day record for Amazon Prime registration.
The stock markets were relatively exuberant on Thursday, as the Dow Industrials rose 0.4%, the S&P 500 gained 0.8%, and the Nasdaq advanced 1.25% to a 3-week high. The rally for equities in the U.S. comes amid a fairly robust quarterly earnings report for U.S. corporations, especially the financial institutions. Shares of Citi hit a 6-year high while JPMorgan beat expectations with a 5% increase in profits during Q2. Bank of America, the country’s 2nd-largest bank by assets, posted its lowest quarterly expenses since 2008, helping more than double its profits from Q1 to 2.31%. Despite Goldman Sachs provisionally setting aside $1.45 billion for upcoming mortgage-related litigation, bringing its all-important Earnings Per Share (EPS) metric 52% lower, the rest of the investment bank’s business operations were robust, helping shares gain 10% year-to-date and 30% over the last 12 months. Wealth management firm Blackstone was less versatile, disappointing with a 62% drop in Q2 profits. Strong investment in exercise gadget maker FitBit has helped shares surged more than 100% since the company’s IPO earlier this year. Similarly, shares of Netflix have continued to run ahead of the pack.
Thursday saw both the dollar and the pound gain against the euro, boosting the latter to a 7-year high against the eurozone’s common currency. With the dollar advancing to 97.5 on the DXY, the euro traded just below $1.09. The crude benchmarks rose in the morning before diverging, as Brent crude gained 1.5% while WTI closed 0.25% lower. All of the precious metals spent the day in the red again.
Weekly jobless claims fell for the first time in 4 weeks, coming in at 281,000 new applications. The homebuilder confidence gauge hit its highest level in 9-and-½ years, and June housing starts gained 9.8% annualized (predominantly in apartment buildings) according to a report Friday; both new home construction and new building permits rose to 8-year highs. The Philly Fed manufacturing survey fell to 5.7 in July from a reading of 15.2 in June, far below expectations (12.0). A value above zero, however, does at least indicate an expansion. A rise in the consumer price index (CPI) for the 5th straight month was fueled largely by higher rent costs.
The trend of strong corporate earnings during Q2 carried over into Friday, with General Electric reporting an increase in its industrial profits and Google beating its earnings expectations. This lifted the tech-heavy Nasdaq Composite to an all-time high above 5,210 while the S&P traded flat and the Dow Jones trickled slightly into the negative.
One interesting development to keep in mind is the surge of the VIX volatility index—as well as the higher volatility of the gauge itself. ETFs that track the VIX have grown increasingly popular among investors, and there were a record number of VIX calls on Monday. The VIX jumped 34% the day Greece declared a bank holiday, and rose another 22% after China’s stock market began to crater. It subsequently fell 30% over the next two days as risk factors in Greece, China, and Iran seemed to settle down. Speaking of volatility, the turbid Shanghai index gained 3.5% on Friday, though likely on the strength of direct, top-heavy government intervention.
After getting battered all week, the precious metals slumped further, staggering into Friday’s close at multi-year lows: gold notched a 5-year low of just $1,135/oz; silver sank to a 6-year low after breaching the $15/oz level; platinum fell to just $1,000/oz for the first time in over 6 years; and palladium’s close below $620/oz was its worst since November 2012. The dollar ended the week at its strongest since mid-April, closing above 97.95 on the DXY and pushing the euro to a 6-week low of $1.08.
- Jarden plans to buy disposable tableware maker Waddington for $1.35 billion.
- Refiner Marathon Petroleum is set to acquire MarkWest Energy for $15.8 billion.
- A pair of billionaires offer to buy chemical maker Alent for $2.1 billion.
- Goldman Sachs agrees to acquire Imprint Capital, an asset management firm.
- Chinese tech firm Unigroup’s $23-billion deal for chipmaker Micron is likely to be blocked by the U.S. Congress.
- Twitter stock jumps 8.5% on a bogus report that the social media company received a $31-billion buyout offer.
- The hedge fund run by Paulson & Co. may acquire a large stake in Swiss pesticide maker Syngenta in order to facilitate a takeover by agricultural conglomerate Monsanto. Syngenta rejected an earlier $45-billion bid as inadequate, simplistic, and unlikely to clear antitrust regulators.
- Biotech company Celgene plans to acquire rival Receptos for $7.2 billion ($232/share).
- Merger arrangements between Dish and T-Mobile stall on disputes over company valuations and a new corporate structure.
GEOPOLITICS & WORLD EVENTS
Iran Nuclear Deal Reached After All
One of the most highly publicized and hotly debated foreign policy issues in recent memory came to a resolution, at least for the moment, on Tuesday morning. The Obama Administration has placed the legacy of its foreign policy squarely on the shoulders of one of the country’s traditional adversaries, Iran.
The Islamic Republic did not appear ready to capitulate to the demands of its negotiating partners (a coalition of the U.S., U.K., Russia, China, France, and Germany) in exchange for a lifting of economic sanctions imposed upon the country for its ostensible pursuit of a nuclear weapon. Negotiations had already blown through one deadline, and were approaching another, when Tuesday’s accord was reached.
Now, Congress will have two months in which to decide whether or not to try and nix the landmark deal. If politics and principles are set aside in favor of pragmatism, then our legislators ought only have one criteria for approving or disapproving the deal: Is it worse than the alternative of no deal?
It’s true that the fallout from the deal is roiling America’s traditional allies in the region, Israel and Saudi Arabia. The Sunni Arab kingdom and the Jewish state help provide a proxy for U.S. interests in the Middle East, buffering the power of the Shia regime in Iran. Angering these allies—undoubtedly two of the most important for the U.S.—runs the risk of dismantling a crucial counterbalance to anti-U.S. sentiment in the region. Imagine the loss of South Korea and India as key U.S. partners that help curb China’s regional dominance. With this backdrop in place, one can see why critics of the Iran deal warn that a U.S.-friendly Iran could disrupt the balance of power and alliances in the Middle East.
At the same time, it’s a stretch to call Iran a “friend” of the U.S. while the rallying cry, “Death to America!” remains in vogue, even in parts of Tehran. It’s also fair to say that there’s nothing wrong with sowing the seeds for more amiable relations in the future. Nonetheless, you’d have a difficult time convincing the Saudis, Israelis, and even many American conservatives to see it that way.
In grave doubt, however, is what kind of Iran will emerge from the lifting of sanctions that accompany their adherence to the nuclear deal. This would unlock $150 billion in frozen Iranian assets, and estimates place a sanction-free Iranian economy at 7% to 8% growth over the next decade. The resumption of full-scale oil production for the country with the world’s fourth-largest oil reserves could also push crude prices back to their yearly lows near $40/bbl.
Clearly, an Iran without such economic burdens would be much more of a global power; will she use that position to integrate herself into the international community, or to foment more instability with her rivals? The success or failure of the Iran nuclear deal, and the president’s record on foreign policy, will be judged on these merits.
Greece Secures Another Bailout
For a third time in just five years, the Greek government has accepted a bailout from its international creditors in order to keep its hobbled economy above water.
After Greek PM Tsipras managed to push an austerity-filled bill through parliament with the help of opposition parties, the EU preliminarily approved a $7 billion (€7.6 billion) package to bridge Greece to its next round of debt negotiations with creditors. Meanwhile, the ECB increased the cap on emergency liquidity assistance (ELA) to the country by an additional €900 million without requiring any greater collateral from Greek banks. The bridge financing will allow Greece to service its $3.5-billion repayment due to the ECB next week. Everything seems to be in order, as even the obstinate German Bundestag ratified the deal on Friday.
Figuring out how it will implement its creditors’ program of economic reforms is the next big step for Greece. The government will be required to privatize €50 billion ($55 billion) of state assets, among other belt-tightening measures, in order to keep Europe at the negotiating table for a potential 3-year, €86 billion ($96 billion) bailout. Tsipras has retained a surprising amount of political capital within the country, though violent protests against accepting the bailout deal have periodically been breaking out in Athens. Whatever support the Greek premier still enjoys at home, he will have a more difficult time convincing Germany and its Northern European allies to accept some form of debt relief that his country so sorely needs. The leaders from Germany et al. have drawn a line in the sand for any kind of haircut on Greek debt despite support for debt relief by diplomats from France, Italy, and even from the IMF itself.
There is also the issue of the mothballed European Financial Stabilization Mechanism (EFSM), which the European Commission would like to tap in order to provide aid to Greece. The EFSM, however, contains funds contributed by EU nations who are not part of the monetary union, notably Great Britain.
The EC will find it difficult to secure any funding from the British, who are already considering leaving the EU altogether in 2017. Perhaps this political wrangling is why ECB President Mario Draghi has been striking a much more defeated tone than his 2012 pledge to keep the euro union intact at all costs; Draghi recently called the euro “fragile” in a dramatic rhetorical shift, perhaps signaling that the tide of European integration has reversed direction.
Greece appears for the moment to have assured its place firmly in the EU and the EMU, but the question now turns to whether or not the union itself will be able to survive intact.
China Tries to Escape Black Hole of Stock Shock
Stock markets are oftentimes all about perception and investor confidence rather than fundamentals and economic reality; China is putting this mantra to the test as the government sees how far the faith of its newly minted class of retail investors will go.
The unprecedented extent to which the Communist Party has stepped in to rescue the equities market from total collapse still hasn’t protected the Shanghai Composite from losing more than 30% in the course of about a month. Despite state-sponsored and centrally-financed stock purchases, frozen trading for more than half of mainland companies listed on major exchanges, and even the outright ban on large shareholders liquidating their positions, the swift sell-off in Chinese equities could not be prevented by the the government.
Remarkably, many retail investors—average Chinese citizens who bought into stocks at the behest of state propaganda—remain gripped by the delusion that the Communist Party is infallible, omnipotent, and will bring the stock market back to its dizzying heights if the government wills it. Many otherwise reasonable Chinese investors will continue to hold out hope that the heavy hand of government intervention will eventually make their distressed investments whole again.
While the Chinese economy has a better chance of repeating the deflationary path charted by Japan over the last quarter-century than it does of reviving its year-long stock boom, you can’t deny that it is trying almost everything. One of the country’s largest tech firms, Unigroup, is attempting to acquire chipmaker Micron in order to secure some productive control over its lucrative microchip market, though this deal is likely to be blocked by the U.S. Congress. Moreover, the Chinese government finally announced its official gold reserves on Friday, the first time the numbers have been updated in 6 years. By revealing it holds some 1,658 tonnes of gold bullion (an increase of 57% from 2009), the People’s Republic may be hoping to instill confidence in its citizens and show skeptical international investors that the country has a sound foundation. The timing and size of the announcement is conspicuous, however, as many insiders have pegged China’s gold holdings at more than twice the official figure. The Shanghai Composite did rise about 6.2% this week, but this represented a recovery of just one-fifth of the losses the index suffered over the preceding four weeks.
Irrespective of how the Chinese government aspires to get there, the Chinese economy is expected to expand by about 6.8% this year, just shy of the government’s 7% target. While most countries would give anything for this type of growth, it actually represents China’s weakest rate of expansion since 1990. (This ought to give you an idea of how small and undeveloped the Chinese economy was just 30 years, even 20 years, ago.) The natural slowdown and maturation of the Chinese economy could place a damper on global growth for the next several years: Analysts at Morgan Stanley point out the considerable risk that China may drag the world economy below 2% growth, a scenario that has only occurred 5 times over the last half-century.
It’s worth noting that in each of the previous 5 instances of sub-2% global growth, a contraction of the U.S. economy accompanied the downturn. If China’s slowdown does indeed spell a painful slump for the global economy, it may confirm that we are witnessing the gradual transfer of the title “bellwether of the world economy” from the U.S. to China, at least for the time being.
A LOOK AHEAD: German PPI will be announced on Monday, while the minutes from the most recent meetings of the Bank of Japan and the Reserve Bank of Australia will also be released. The rest of the week is fairly slow until Friday, when an array of other European countries announce their own PPI data.