GLOBAL ECONOMICS AND POLITICS
Leo Haviland provides clients with original, provocative, cutting-edge fundamental supply/demand and technical research on major financial marketplaces and trends. He also offers independent consulting and risk management advice.
Haviland’s expertise is macro. He focuses on the intertwining of equity, debt, currency, and commodity arenas, including the political players, regulatory approaches, social factors, and rhetoric that affect them. In a changing and dynamic global economy, Haviland’s mission remains constant – to give timely, value-added marketplace insights and foresights.
Leo Haviland has three decades of experience in the Wall Street trading environment. He has worked for Goldman Sachs, Sempra Energy Trading, and other institutions. In his research and sales career in stock, interest rate, foreign exchange, and commodity battlefields, he has dealt with numerous and diverse financial institutions and individuals. Haviland is a graduate of the University of Chicago (Phi Beta Kappa) and the Cornell Law School.
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“Our million hearts beat as one,
Brave the enemy’s fire, March on!” “March of the Volunteers”, China’s national anthem
OVERVIEW AND CONCLUSION
Although China’s era of miraculous economic growth has marched into history, the nation nevertheless achieved enviable real GDP increases in recent years. Benchmark predictions by numerous economic wizards regarding China’s economy remain rather sunny, especially in comparison with those for most other countries. In fact, most observers are fairly complacent about China’s current situation and future prospects. Faith in adequate global growth intertwines with belief that China’s expansion will continue to be substantial.
As the world has become more globalized and intertwined, China’s substantial economic expansion not only has boosted China’s international economic (financial, commercial, business) and political presence and power. It also has helped to ensure domestic political stability and protected the central role and authority of the Communist Party. The country’s leadership and other elites obviously desire and battle to protect such impressive accomplishments.
However, China has a significant debt problem, and one that probably will worsen. Most China watchers nevertheless ignore or downplay this, with analysis and concerns banished to obscure articles, back pages, and fine print. China’s strong economy in the past five years probably derived substantially from a substantial expansion of its overall national debt. Will China’s government (and other areas of the economy) need to borrow more and more and go greater in debt in order to sustain “appropriate” GDP growth? Probably.
Yet the Chinese debt explosion, with totals at or moving toward high levels relative to GDP (particularly in the government and corporate sectors), endangers prospects for continued robust Chinese economic growth. Creditor (lending) confidence probably is not unlimited, especially in regard to segments of China’s corporate, banking, and local government arenas.
Moreover, very elevated debt is not just a Chinese phenomenon, but a worldwide one. The International Monetary Fund’s “Fiscal Monitor” (April 2018; Chapter 1) stated: “Global debt [public and nonfinancial private debt] is at historic highs, reaching the record peak of US$164trillion in 2016, equivalent to 225 percent of global GDP [current levels probably are higher]. The world is now 12 percent of GDP deeper in debt than the previous peak in 2009, with China as a driving force.” See also the Institute of International Finance’s perspective on the expanding global debt as a percentage of world GDP trend (July 2018). Public debt has played an important part in the leap in global indebtedness. China obviously is not an island isolated from other nations. So if international economic conditions weaken, perhaps partly encouraged by prior or prospective interest rate increases, it probably will become somewhat harder for many entities, both public and private, to raise cash.
China’s glorious economic growth, and the related boom in its exports, has interconnected with increasing openness in international trade. Enthusiastic challenges to the free trade (globalization; multilateral) order and ideology, especially by the current American leadership (President Trump; “Make America Great Again!”), has raised concerns about trade wars and currency conflicts. The American Administration’s noisy criticism of China’s allegedly colossal (and supposedly unfair) trade surplus (at least in relation to the United States) and its willingness to impose tariffs on Chinese products has encouraged a rapid noteworthy depreciation in the Chinese renminbi relative to the US dollar in recent months.
Currency depreciation, not merely the running of large government deficits or tolerating (encouraging) jumps in corporate and household borrowing (and spending), is another strategy aimed at creating or sustaining adequate economic growth. Perhaps China’s currency depreciation relative to the US is to some extent a competitive plan designed to maintain its economic growth rate by ensuring continued substantial entry of its exports into the American marketplace. And the dollar/renminbi cross rate fascinates most marketplace observers in an environment excited by trade and currency war talk.
America of course is an important commercial counterparty for China. But it does not come close to capturing a majority of China’s overseas economic transactions. A review of China’s currency patterns and levels from a broad real effective exchange rate (“EER”) vantage point therefore offers superior enlightenment regarding the overall Chinese currency situation, and thereby its overall economic one.
The high level in China’s EER likely has tended to reduce exports and thus GDP growth to some extent from what they (all else equal) otherwise would have been. This consequently has tended to encourage China’s debt expansion as a means of achieving “sufficient” (official targets for) economic growth. Even allowing for the recent renminbi depreciation versus the US dollar, China’s EER remains rather lofty from the historical perspective. From China’s policy standpoint, its EER probably should depreciate even more than it has since its 2015 pinnacles in order to achieve desired economic growth and to handle its growing debt troubles.
Not only do China’s debt predicament and the renminbi’s feebleness relative to the US dollar (and the need for the renminbi to slump further on an EER basis) warn of underlying weakness in and the probability of slower growth than generally forecast for the Chinese economy. The sharp fall in calendar 2018 in the Shanghai Composite Index (and other emerging stock marketplaces) and declines in key commodity benchmarks also signal subsiding (slowing) Chinese GDP growth. The gradual rise in US interest rates (ongoing Federal Reserve tightening; underline climbs in the Federal Funds rate and the 10 year US Treasury note), given the links across global marketplaces, also probably is starting to curtail economic growth around the globe. In any case, given China’s major role in the international economy, a slowdown in its output relative to levels anticipated (hoped for) by economic pundits and financial pilgrims likely will injure expansion elsewhere.
China’s leadership probably is more fearful of inadequate economic growth than it publicly confesses. Why else has the country in the past few years further centralized political leadership and emphasized Communist Party control, embarked in well-publicized anti-corruption drives, and engaged in assorted territorial squabbles with its Asian neighbors? Such political programs suggest that real economic growth not only has slowed down (and perhaps to lower levels than official statistics indicate), but also probably eventually will ebb further than many high priests predict. A sharp deterioration in China’s GDP levels and prospects probably entails heightened internal political risks.
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China at a Crossroads- Economic and Political Danger Signs (8-5-18)
“(All down the line.) We’ll be watching out for trouble, yeah.”
The Rolling Stones, “All Down the Line”
NYMEX natural gas (nearest futures continuation) probably will remain in a sideways trend between 2.40/2.50 and 3.20/3.45 over the next few months. However, United States natural gas inventories from the days coverage perspective (stocks relative to consumption) are much lower than the historical average. Suppose economic growth remains moderate and that commodity prices in general (and those in the petroleum complex in particular) do not collapse. This natural gas inventory situation, assuming it persists, makes it probable that the marketplace eventually will ascend over 3.20/3.45 toward major resistance around 4.00/4.10. The most likely achievement of a flight to 4.00/4.10 is around winter, whether that of winter 2018-19 or thereafter. A colder than normal winter (or even belief such will occur) boosts the chances of such a spike. If widespread expectations of upcoming massive US natural gas production increases are disappointed, that also likely will rally prices above 3.20/3.45 and toward 4.00/4.10.
Over the past year or two, the natural gas industry probably has shifted toward a lower level of desired (“appropriate”, “reasonable”, “normal”, “prudent”, “sufficient”) stock holding relative to historical averages. Why? One factor probably is faith that calendar 2018 (and subsequent) gas production will remain far over that of calendar 2017. So many players probably believe there “always (or almost always) will be enough gas around”. Another variable likely encouraging lower inventory in days coverage terms is the substantial expansion of America’s pipeline infrastructure. Thus it has (will) become easier to move sufficient gas to many locations where it is needed. Moreover, the growing share of renewables in total US electricity generation arguably to some extent reduces the amount of necessary natural gas inventories.
These structural changes in the US natural gas marketplace apparently have shifted the natural gas inventory management approach to more of a “just in time” (lower inventories) relative to a “just in case” (higher stockpiles) method.
However, the natural gas inventory situation nevertheless appears somewhat bullish. Even if the “reasonable” level of industry holdings of natural gas inventories has tumbled relative to historical benchmarks in days coverage by a few days, prospective levels for October 2018 and October 2019 nevertheless appear “low” relative to “normal” totals, particularly from the perspective of the winter stock draw period.
Arguably many natural gas marketplace participants are overly complacent regarding the availability of supplies, particularly in periods of high demand. Imagine a colder than normal winter. Emerging worries that available supply (whether in days coverage or arithmetical terms) is or may be tight can inspire heated scrambles to procure it.
Energy Information Administration (“EIA”) statistics indicate that calendar 2019 US liquefied natural gas (LNG) net exports will be substantial (notably higher than net LNG exports in 2017 and 2018). This net foreign demand for LNG will tend to tighten the US inventory situation. Also note that in calendar 2017 and 2018, America was a net importer of natural gas via pipeline; in calendar 2019, the US becomes a net exporter via pipeline.
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US Natural Gas- Waiting for Fireworks (7-3-18)
OVERVIEW AND CONCLUSION
Financial wizards not only offer competing opinions regarding past, current, and future trends for stock, interest rate, currency, and commodity marketplaces. Their rhetoric displays diverse viewpoints regarding alleged relationships within and between those categories. For example, within the global stock constellation, various apostles elect to compare the travels of the S+P 500 with those of the Nasdaq Composite or with an emerging marketplace stock benchmark. Alternatively, some visionaries herald their subjective insights and foresights about connections between stocks (such as the S+P 500) and interest rates (such as the United States 10 year government note), perhaps also including the US dollar and the commodities galaxy in their investigations.
Luminaries tell stories offering their cultural perspective regarding apparent convergence and divergence (lead/lag) relationships within and between marketplace domains. Viewpoints regarding convergence and divergence encompass not only price direction (trend), but also the timing (start and end date; duration) of a given move as well as the distance it travelled. In any case, these links (associations; patterns) can alter, sometimes substantially and occasionally permanently. Marketplace history, including that related to convergence and divergence, is not marketplace destiny, whether entirely or even partly.
History reveals that the S+P 500 and emerging marketplace stocks “in general” (MSCI Emerging Stock Markets Index, from Morgan Stanley; “MXEF”) often have had very important trend changes in the same direction “around” the same time.
After establishing important bottoms together in first quarter 2016, the key American stock indices and those of other important advanced nations and the “overall” emerging stock marketplace traded closely together from the directional and marketplace timing perspective. Though the bull moves since first quarter 2016 in these assorted domains did not all voyage the same distance, all were very substantial. Their rallies since around the time of the November 2016 United States Presidential election were impressive. Both emerging marketplace equities and the S+P 500 established important peaks in first quarter 2018 (MXEF 1279 on 1/29/18; S+P 500 2873 on 1/26/18).
Yet whereas since its first quarter 2018 summit prices for the emerging stock marketplace arena have eroded significantly and currently rest at their calendar 2018 lows, the S+P 500 has retraced much of its dive and now (6/15/18 close 2780; stock price data in this essay is through 6/15/18) stands only slightly over three percent from its 1Q18 top. This divergence, though not massive, is noteworthy. A similar but more extreme divergence between these stock benchmarks existed from spring 2011 (and note particularly since around second half 2014) through about May 2015. The S+P 500 kept going up and achieved new highs over its spring 2011 one, but the MXEF failed to do so.
After spring 2015, convergence developed, with a bear trend in the S+P 500 accompanying the existing downhill one in the emerging marketplace stock group. An important factor assisting this was the decisive climb in the broad real trade-weighted United States dollar (“TWD”) above its critical resistance around 96.6. A similar convergence is likely to occur in the present MXEF and S+P 500 marketplace relationship, with the significant divergence disappearing and both equity realms falling “together”.
US corporate earnings indeed have been quite strong, with share buybacks and mergers and acquisitions robust. Nevertheless, one bearish factor for stocks in the current landscape is the broad real trade-weighted dollar’s recent advance over the 96.2/96.6 barrier (compare 2015); also recall the TWD rally beginning in spring 2008 during the 2007-09 global economic disaster). The ascending US yield trend (which began in July 2016, accelerating in 1Q18) has encouraged the TWD’s modest rally in the past few months. Trade war talk and potential tariffs probably have assisted the TWD’s appreciation. The US is a net importer nation; some exporters (which include many developing nations) may depreciate their currency to maintain market share within the US.
Another bearish sign for both advanced nation and emerging marketplace stocks is the persistent climb in US Treasury yields. Rising global yields alongside a strengthening dollar is especially painful to emerging marketplace countries and thus their stock marketplaces. Many developing nations, including their corporations, have dollar-denominated debt. And underscore in this context another point: for America over the past century, sustained rising yields generally have led to American stock marketplace declines. Given the Federal Reserve Board’s ongoing tightening policy (and its normalizing balance sheet, as well as probable willingness to allow some overshooting of its two percent inflation target), growing substantial US federal deficits (aided by tax “reform” legislation enacted in December 2017), substantial US household credit demand, a low unemployment rate, and other factors, US government yields probably will tend to keep rising over the long run. The growing mountain of US public debt, including as a percentage of GDP, also tends to push up interest rates.
A confirming sign for equity feebleness in both the S+P 500 and the MXEF likely will be weakness in commodities prices. Commodities often have peaked (bottomed) around the same time as a crucial top (bottom) in important advanced nation or emerging marketplace stocks. However, there have sometimes been lags. Recall that in during the worldwide financial crisis following the glorious Goldilocks Era, commodities “in general” peaked after the S+P 500 and emerging marketplace stocks. The broad Goldman Sachs Commodity Index (“GSCI”) has declined since 5/22/18’s 498 high.
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Shakin' All Over- Marketplace Convergence and Divergence (6-18-18)
“All poker is a form of social Darwinism: the fit survive, the weak go broke.” A. Alvarez, “The Biggest Game in Town”
OVERVIEW AND CONCLUSION
The Bank for International Settlements provides broad real effective exchange rates (“EER”) for numerous currencies around the globe. Within the BIS statistics are several nations who are important exporters of widely-traded commodities such as petroleum, base and precious metals, and agricultural products such as soybeans. Concentrating on and comparing the broad real effective exchange rates of eight freely-traded currencies widely labeled as “commodity currencies” offers insight into assorted interrelated financial marketplace relationships. The overall patterns of this array of assorted export-related commodity currencies often has intertwined in various ways with very significant trends in broad commodity indices such as the S&P Goldman Sachs Commodity Index (“GSCI”) and the Bloomberg Commodity Index (“BCI”), the broad real trade-weighted United States dollar (“TWD”), emerging marketplace stocks in general (as well as the S+P 500), and key interest rate benchmarks such as the 10 year US Treasury note.
In assessing and interpreting the role of and implications indicated by the commodity currency platoon in financial battlefields, marketplace guides should highlight several preliminary considerations. The various commodity currencies (“CC”) do not all move at precisely the same time or travel the same percentage distance in a given direction. Although they generally move roughly together within an overall major trend for the group, an individual member may venture in a different direction for quite some time. Although the path in recent months of the various CCs “together” generally has been sideways, their individual movements have not been identical.
Of course the various commodity currency countries are not all alike. So a given guru can tell somewhat different stories about each of them and their currency. Not all CC nations are equally important within the international trade arena. The various domains do not rely to the same extent on commodities within their export packages. And not all are reliant on a given commodity sector (such as petroleum) as part of their commodity output. Some CC nations produce notable amounts of manufactured goods. In addition, some countries probably are more vulnerable to currency and trade wars than others.
Moreover, the intertwined relationships between currencies (whether the CC EERs or others such as the broad real trade-weighted United States dollar), commodities “in general”, stock marketplaces (advanced nation signposts such as the S+P 500; the emerging marketplace field in general), and interest rates can and do change. Relationships between CC EERs and the broad real trade-weighted dollar (“TWD”) can shift. The TWD’s intertwining and relationship to interest rate, equity, and commodities in general is complex. In addition, although subjective perspectives identify apparent convergence and divergence (lead/lag) relationships between financial territories, these connections (links, associations) can alter, sometimes substantially. Marketplace history is not marketplace destiny, whether entirely or even partly.
Commodities “in general” surpassed their first quarter 2017 peaks in first quarter 2018 (and April 2018), rapidly climbing from a notable mid-year 2017 trough. The majority of commodity currencies established an EER top in (or around) 1Q17. In contrast to commodities in general, the effective exchange rates of the various commodity currency club members either have not exceeded that top established in (around) 1Q17, or have not done so by much. In addition, the CC group’s EERs generally did not climb much, if at all, from around mid-year 2017. This CC EER pattern (some divergence from commodities in general) warns that a significant top in commodities probably is near. In the past, highs for the commodity currency EERs linked to highs for commodities in general.
Relevant to this marketplace viewpoint regarding the commodity currency EERs and commodities “in general” is the upward trend in US Treasury note yields. Recall not only the major bottom in the UST 10 year note around 1.32 percent on 7/6/16, but especially underline for the CC (and global stock marketplaces) the yield climb from its 9/8/17 interim trough at just over two percent. The Federal Reserve Board has been raising the Federal Funds rate and gradually reducing the size of its bloated balance sheet. The UST 10 year note broke out in first quarter 2018 above critical resistance at 2.65pc; the UST 10 year recently bordered 1/2/14’s 3.05pc barrier (3.03pc on 4/25/18; the two year UST note also has climbed, reaching 2.50pc on 4/25/18). Also supporting this outlook for commodities is the 1Q18 peak in the S+P 500 (1/26/18 at 2873) and the MSCI Emerging Stock Markets Index (from Morgan Stanley; “MXEF”; 1/29/18 at 1279).
Yield repression (very low and even negative interest rates) promotes eager hunts for yields (return) elsewhere. These include buying commodities as an “asset class”. What happens to commodities when key central banks begin to end their beloved yield repression schemes, or hint that they will do so?
Marketplace history indeed shows that sometimes there has been divergence between commodities “in general” and stock benchmarks such as the S+P 500 for a while. Recall the 2007-09 global economic disaster era. The S+P 500 peaked 10/11/07 at 1576 (MXEF summit 11/1/07 at 1345), prior to the broad GSCI’s pinnacle in July 2008 (7/3/08 at 894). Yet recall that the July 2008 GSCI peak occurred close in time to the noteworthy S+P 500 interim high on 5/19/08 at 1440, as well as the lower S+P 500 tops of 8/11/08 (1313) and 9/19/08 (1265). And note the timing linkage between the broad GSCI and S+P 500 in the past couple of years. Not only did they make major lows around the same time in first quarter 2016 (broad GSCI at 268 on 1/20/16; S+P 500 on 1/20/16 at 1812 and 2/11/16 at 1810). They both accelerated upward in their bull moves around the same time in mid-year 2017; the GSCI low was 351 on 6/21/17, with that in the S+P 500 6/29/17’s 2406 (8/21/17 at 2417). The broad GSCI slumped from its initial high at 466 on 1/25/18, which linked to the S+P 500’s high on 1/26/18; although the GSCI since has hopped over its 1Q18 interim top, it thus far has not done so by much (480 on 4/19/18).
Thus the failure of the EERs for the CC group as a whole to advance much over the past year and especially since mid-year 2017 (with no decisive overall new highs for the group in general in 1Q18) probably has implications for both commodity and equity trends.
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Commodity Currencies in Context- a Financial Warning Sign (5-1-18)