Risk On, Ho Hum

Why do I feel listless when I think about the markets? It is because there seems to be nothing to do. I said on 26th January, in response to the Fed’s recent action: “I think that there is a good argument for buying those risk assets that will benefit from monetary easing in the US, including US equities and high-yielding currencies.” Annoyingly, a suitable entry point never came, and now markets are rallying without me. That is why there is nothing to do — my view seems to be coming good (although it is early days for this rally) but I do not have a position and there is no sign of an entry point.

On that subject, I did briefly consider buying US equities in the pullback of 30th Jan (which reversed by the end of the day), but decided not to trade. I am not sure whether this was a mistake or not. At the time I thought it would be better to wait for more of a pullback, and hence a wider stop, and I tend to think that was right. But I also know that when equities are driven upwards by improving monetary conditions, the move can be swift and smooth and there is an argument for erring on the side of trading rather than not.

Ship-owners Desert Iran

Bloomberg reports that a number of ship-owners have stopped doing business with Iran. The reason for this departure is that the European Union has, as part of its sanctions regime, barred insurers from covering ships that trade with the country. According to Bloomberg, 95% of the global fleet is insured under EU rules.

Bloomberg also reports that the a report from the IEA shows China’s oil imports from Iran running at around half their usual level. The reason is apparently a dispute over prices, but China will have more negotiating power because of the Western sanctions on Iran. One way or another, it seems that sanctions are going to bite.

Norwegian Housing

Bloomberg is on fire today. It also reports on comments from the Norwegian FSA that household debt and house prices are “not following a sustainable path”. This comes five months after Robert Shiller (of the Case-Shiller Index) said that Norway was experiencing a house-price bubble. The Norwegian central bank expects household debt to income to reach 204% in 2012. The FSA has made some attempt to rein things in, having told banks in December to cap LTV’s at 85% (as opposed to 90% previously). But the central bank is probably with the most power to do something about the situation, and it has recently cut rates, because it does not want them to be too far above the rest of Europe.

How to play this story? It all depends on what the central bank is likely to do in future. If it is likely to cave in and start raising rates, then long NOK is the obvious play; if it is determined to keep Norwegian rates within sight of European rates, then the play would be to find something to be long, and get ready to be short when the inevitable dénouement occurs. I will have to look into this further.

Chinese Banks

I am reading Red Capitalism (http://amzn.to/yHaRkg; not elegantly written, but informative if you keep at it), and I was reminded today of its argument that, following a period of attempted reform, Chinese banks have reverted to being arms of the state. Banks reportedly been ordered to roll maturing loans to local governments, presumably because they cannot be repaid. China has a history of over-lending and then hiding bad assets on banks’ balance sheets, and this action seems, at first sight, to conform to that pattern.

Chinese bureaucrats have started to argue that the “investments” made by local governments in recent years will pay off for the country eventually, even if they will not do so at the moment. But, to paraphrase Mandy Rice-Davies, they would say that, wouldn’t they. We must not be taken in by their wiles. We know that state-directed investment is not efficient investment; we know that it produces more white elephants the grey, boring, productive variety.

Who will pay, in the end, for the splurge of unproductive investment that China has had in recent years? Michael Pettis has argued that China’s households have paid for past excesses, via the roundabout route of an artificially large (state-mandated) spread between banks’ loan and deposit rates, and perhaps that will be the preferred route this time as well. One thing that is unlikely to happen, I tend to think, is that there will be any risk of a bank failing. If China’s banks are arms of the state, and they have bad loans because the state has ordered them to lend, then the state will find a way — probably opaque and contorted, like the old ruse of shuffling bad assets into “asset management companies” — to bail them out.

QE and Bond Yields

What will happen if there is another round of QE in the US? Will bond yields rise, as they have in previous episodes (academic debate tends to start from the assumption that QE made interest rates fall, and then ask by how much; actually, when QE has worked, it has raised expectations for the economy and caused rates to rise)? That would be a reason to be short Treasury futures. Either the economy will improve enough that bond yields ought to rise as future interest-rate hikes are anticipated, or the economy will slow its improvement, and further QE will come — and raise bond yields.

However, I am sceptical of this picture. Things have changed since QE2. The Fed has committed itself to keeping rates low for a long time — until late 2014 — and the drop in bond yields last year and their subsequent failure to rally with equity markets this year suggest that the market has come to appreciate that the risk of an inflationary spiral is very low while unemployment remains so high, and that the Fed will not hike rates at the first sign of growth. This has made me think that bond yields may well not rally if there is another round of QE.

Data

  • Trade deficit widened a little, a.e., Dec. The trade deficit ex oil remains much narrower than it was before the financial crisis.
  • Prelim. Michigan sentiment decreased a little, d.e., but remains close to post-crisis highs.
  • Japan prelim. GDP -2.4% QOQ annualised. Net exports detracted 2.6%, according to Bloomberg. Exports fell while imports rose. Further evidence of slowing exports in Asia.
  • Australia home loans 2.3% b.e. Dec. For all the talk of risks to its economy, Australia is far from weak.

This Week

  • UK CPI (Tue).
  • US retail sales (Tue).
  • Eurozone prelim. GDP (Wed).
  • UK employment data (Wed).
  • US industrial production and capacity utilisation (Wed).
  • FOMC minutes (Wed).
  • US building permits (Thu).
  • Eurozone current account (Fri).
  • UK retail sales (Fri).
  • US CPI (Fri).
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