On Friday we got US markets falling 0.8%/1% from EU close and Nikkei has closed down 1%. Overnight, Chinese data were better than expectation, with Composite PMI for September at 53.1 vs 53 and stronger Manufacturing PMI at 49.8 vs 49.6. Another important measure of productivity, Caixin China PMI Manufacturing came at 51.4 vs 50.2 consensus. The Hang Seng managed to close small up (+0.6%), Shanghai flat ahead of Golden Week holiday starting tomorrow.
We noted that since the 27th of August the US Tech sector has underperformed and there has been decisive shorting of the “expensive companies” factor and IPOs with both baskets down 10% since late August. On Friday we then had the profit warning of Micron Technology (4% of SOX Index) showing a 42% YoY increase in inventories heading into the seasonal slowdown with sales down 42.3% YoY. Gross margins guided to 25% from 60% a year ago. Not an healthy sign for a sector which has been very strong in performance Ytd (SOX +37%, Micron +45% Ytd). This is hardly what we could consider as a positive attitude vs the market.
Oil price has erased all gains made since Saudi attacks in just 9 days mainly on two news:
- Saudi agreeing to impose partial cease-fire in Yemen
- US offering to remove all sanctions on Iran in exchange for talks
We talked a lot about the Repo turmoil, its technical causes and its effects on the real economy. The main problem here is not a potential shortage of liquidity but its maldistribution. During Quantitative Easing era, from 2009 to 2015, the Fed increased its balance sheet from $870Bln to $4.5Trln, then shrinking it back, during Quantitative Tightening, to $3.8Trln. What we should focus on here, is the amount and the use of US banks’ excess reserves, which increased from almost 0 in 2008 to a peak of $2.7Trln in 2014, and are currently down to $1.4Trln. The main message is that US banks do not have incentives to lend in or participate in the Repo funding segment because they are better off to put the money and get paid interest at the FED IOER rate (Interest Rate on excess reserve), currently set at 1.8% (kind of a free gift). In addition, US banks are facing increased capital and liquidity charges on any short-term loan exposures (then why bother?). So, the issue here is more structural, as the Fed should create a standing facility repo (a systematic mechanism able to prevent any rate volatility). Indeed, if you think that increasing Quantitative Easing would fix the problem you are wrong because it would just increase the US banks’ balance sheet but would not change their incentives to participate in the short-term funding industry.
On Bonds, it is interesting to spot that investors would get a boost in October even before the QE begins. European debt market will receive cash flows of almost 150bn€ next month from bond redemptions and coupon payments. This extraordinary month will exceed even the bond payouts we had in October last year. France will pay out the largest amount with 55bn€ between bond redemptions and coupons.
Focus on European Credit is rising after Thomas Cook’s bankruptcy. Still the European HY default rate is low by historical standards. After peaking at 8% in 2012 (height of the Sovereign Crisis), the default rate slumped to 2% until 2017, to hover around 1% now. Guess what? QE effect, seeking-yield effect, rates etc. Interestingly, the European HY default rate has trended higher in recent months, so far, the notional defaulted Eur-denominated debt amount to almost €3Bln of which Thomas Cook accounts for almost one third. Given the Macro scenario, it is likely we will see the European HY default rate increasing in the next few years.
Macro-wise, we got an important indicator from heavy trucks markets and the data (apart from China) which were very negative in August with Europe particularly weak at -20% YoY. This data reflect the gradual slowdown through the year and seems to support the idea that CESIs/PMIs for the G10 are likely to remain negative. The same could be said for construction data (excluding China’s excavator and wheel-loader sales) which is even more negative. Another batch of weak European data on Friday with Euro Area Economic confidence dropping to 101.7 vs 103 consensus, its lowest level in 4 years, Industrial Confidence down to -8.8 vs -6 consensus, its lowest level in 6 years. The German Manufacturing sector is among the main culprit. To mention, the Italian Manufacturing confidence also slumped to 98.8 vs 100 consensus. In US last week we had the biggest decline in “Jobs Plentiful” component of the US Consumer confidence since 2001. As you know, we have been highlighting how important is the resilience of the consumer confidence factor within the US macro picture. This new data is starting to be a bit concerning especially considering that equities have a very strong correlation with consumer confidence data. There is also an high (inverse) correlation between the unemployment rate (still at multi-year lows) and equities. A potential increase of unemployment would trigger a cycle peak.
Today we expect the following:
- Germany Retail Sales
- UK GDP Q2 revision
- Germany CPI, Unemployment rate
- US Manufacturing Chicago PMI, Dallas Fed Manufacturing