Category Archives: Global Economy

Global Economy

European Elections show less change than feared

26 May, 2014Global Economy, On the cover, Sin categoríaEurope, global economyDaniel Lacalle

Despite the headline concerns about the rise of radical parties like France´s National Front, Syriza, New Dawn and the Danish Popular Party, in the elections 172 million people voted and less than 7.5% are votes for parties who are remotely in favour of breaking-up the Euro. If we take out the UKIP impact in the UK, as the country is not in the Euro, the “anti-single-currency” vote was insignificant, especially when we look at the political manifestos of parties such as France´s National Front, with a loose message of exiting the Euro “gradually”.

Credit Suisse wrote this morning a nice report called “Europe beats Eurosceptics 6-4”.

As such, the EUR/USD opened this morning slightly up, and equity indices throughout Europe followed in unison, while peripheral Europe bond yields opened flat or marginally higher.

The bipartisan nature of the European parliament has not been changed dramatically either. Juncker and the European Popular Party won (212 seats) but Schulz and the Socialists (187 seats) can try to set up coalitions. The possibility of a grand coalition is not small at all.

Eurosceptic parties won in three countries: France, Denmark and the UK (as expected, and with no impact on currency or policy), but lost massively in Italy (where Renzi won a landslide 40%), Holland and Germany. In Greece, Syriza won by a narrow margin, not enough to de-stabilize the current coalition.

Only two countries saw the current government win the elections: Germany and Spain, despite major losses in support in the case of Spain (PP lost 8 seats). The debacle of major parties did not change the landscape massively.

UKIP´s extraordinary victory (27.5%) is likely to make Tories take a more aggressive stance towards the EU and move forward with the referendum on the EU.

Bond yields likely to see limited pressure from the process of electing President and the press headlines regarding radical votes.

France seen as the biggest worry followed by Greece. Radical stop of reforms or, even worse, increasing government spending could trigger new concerns about deficits, debt and widening the imbalances of the economies.

The latest batch of rating agency upgrades in Spain and Greece, added to the exit of the bailout programs for Portugal, Ireland and Greece maintain the gradual recovery on track. Meanwhile, current account surplus in the Eurozone remains a key driver of improvement, added to the reduction of deficits and modest growth. All very fragile, but pointing in the right direction.

Once the elections have passed, this clears the path for a possible EU Quantitative Easing programme aimed at SMEs and corporate, even if there are strong challenges as we mentioned in this website (“The Difficulties of Implementing QE in Europe“).

Important Disclaimer: All of Daniel Lacalle’s views expressed in his books and this blog are strictly personal and should not be taken as buy or sell recommendations

The Difficulties of Implementing QE in Europe (CNBC Interview)

22 May, 2014Global Economy, Interviews, Media, On the cover, Sin categoríaEntrevistas, Europe, Macro, video, VideosDaniel Lacalle

Interview at CNBC where I discuss:

The difficulties to implement Quantitative Easing in Europe.

The difficulties to implement Quantitative Easing in Europe come from the increased perception at the ECB and the EBA that a €1 trillion program could distort markets too much as in some cases the ECB would take 100% of supply.

. There is no liquidity issue: To start with, Europe already has more than €180 billion of excess liquidity according to the ECB March report.

. There is no deflation: Inflation at the Eurozone in April was 0.7% while EU was 0.8%. This is within the ECB mandate of “at or below 2% in the medium term”. CPI in April was 0.4% in Spain, and only Greece (-1.6%) and Bulgaria (-1.3%) show worrying signs.

. Bond yields are at historical lows. Bond yields in the periphery have fallen to the lowest level since 2005. Portugal and Greece are out of the bailout program and issuing paper.

. ECB balance sheet is still elevated. At €2.2 trillion (2.5% capitalization) its balance sheet has fallen 20% since the peak but it’s still up 128% since 2005. The Fed balance sheet is $4.1 trillion (ECB 3.1 trillion translated in US$).

. Transmission mechanism to SMEs is improving. Lending to SMEs is up 34% in the periphery since March 2013.

. Growth is improving (+1.4% in 2014) and the strong euro has not affected dramatically export growth all over the periphery. Current account deficits have arisen in Spain for example. The biggest issue the ECB faces is that 60% of EU exports are made within Eurozone countries, therefore currency is irrelevant. The second is that with current account deficits widening, imports would suffer a big increase in price, particularly energy components. This worries the ECB more than anything else.

However, all of the ECB is studying options of QE driven mostly to help boost the next leg of growth. “Of course any private or public assets that we might buy would have to meet certain quality standards,” said Jens Weidmann, in an interview with MNI.

. What to spend the QE money on?

The European ABS market is too small (€300bn-450bn) for a €1 trillion QE and the challenges would be high when buying sovereign debt in order to adhere to the mandate.

There are three options for the ECB: yield curves, regional differences and credit spreads, which would be targeted in the ECB’s version of unconventional monetary policies. Some of the measures are more akin to Credit Easing (CE) than Quantitative Easing (QE). It is

also apparent that the approach is more qualitative because if the ECB is to make purchases it will take into account valuations.

The ECB would choose from different options, which reflects the bank-based intermediation that dominates in the Eurozone, unlike in the US where the main focus of QE has been Treasuries and MBS. As a possibility, the ECB could choose a normalisation of haircuts on its collateral.

There is also the issue of the “no deflation yet” debate. The Bundesbank is worried about a CPI that reflects massive disparities and that a QE would bring higher inflation to small consumers and average medium income families. The ECB needs more time to see if there is really a price deflation issue. So far data suggests otherwise. No deflation, just disinflation due to overcapacity and previous bubbles.

Look at March CPI in most countries, but particularly in Spain considered at the highest risk of “deflation” by the IMF. Look at essential goods like fish (+3,2%), milk (+4,4%), fruit (+6,5%), legumbres (+3,2%), cheese (+2,2%), natural gas (+2,3%), electricity (+6%) education (+3,5%), insurance (+4,1%) water (+3,3%), or even tobacco (+3,4%), alcohol (+2,4%) or travel (+4,4%).

When you have invested (spent) hundreds of billions of euros in “industrial plans” and productive capacity, especially in energy, car industry, textile, retail and infrastructure, what we are experiencing is a reduction of prices due to competition between oversized sectors, an overcapacity of up to 40% in some cases. On the other hand, inflation exists in other elements, very relevant to the industry and consumption, such as energy costs.

The “alleged risk of deflation” is the excuse of governments to justify greater financial repression . Trying to create false inflation through rate cuts while citizens have less purchasing power, or through monetary stimulus plans when taxes rise leads nowhere. Look at Japan, 17 consecutive months of real wage reductions.

PRICES FALL BECAUSE WE BUILT MASSIVE PRODUCTIVE CAPACITY FOR A DEMAND THAT NEVER ARRIVED AND BECAUSE THE DISPOSABLE INCOME OF CITIZENS HAS BEEN DESTROYED BY CONFISCATORY TAXATION.

To reactivate the economy governments should return money to the pockets of citizens who have stoically accepted and paid interventionist policies and supported schemes and incentives that have led the EU to spend up to 3% of GDP to destroy 4.5 million jobs and sink the economy.

The ECB is getting a lot of pressure to do something from governments and banks, and now even Germany seems to accept the high EUR is a danger… and if something is done it will have to be something big. But these issues above do matter –specially for the Germans advocating for internal devaluation exits to the crisis- and the risks are not small of causing massive distortions in an already booming market for high yield bonds and sovereigns.

See more at: https://www.dlacalle.com/deflation-no-disinflation-the-consequence-of-interventionism/#sthash.Isz8PWji.dpuf

Important Disclaimer: All of Daniel Lacalle’s views expressed in his books and this blog are strictly personal and should not be taken as buy or sell recommendations

Gazprom-CNPC deal

21 May, 2014Energy, Global Economy, On the coverEnergy, global economy, International, MacroDaniel Lacalle

Map courtesy of Gazprom

Conditions:

30 year agreement to start in 2018

38bcm of Russian gas to be delivered to China annually (25% of Chinese demand)

Price: Estimated $350-400/mcm. The formula pricing (oil and a basket of oil products)

Capital Expenditure: $75bn (China’s share $20bn) – includes development of Chayanda and Kovykta fields; and construction of a 2,500-mile pipeline, a petrochemicals complex and a helium plant

Prepayment: $25bn (yet to be confirmed)

The estimated price of the Russia-China contract is $9.75/mmbtu (only $0.95/mmbtu higher than long term Europe contracts). This means that E.On, RWE and GSZ will find it difficult to lower their gas price-offtake agreements in the negotiations of their contracts with Gazprom.

The two sides were not actually negotiating a specific price per unit of gas, but rather a ratio of gas to oil prices. The numbers above likely assume prevailing oil prices, and actual realized prices over the course of the contract could vary significantly depending upon oil markets (according to Citi).

The contract signed targets a nominal volume of 38bcm. However, volumes could be expanded to 60bcmpa later on

Citi estimate the IRR of the project at 4.4% on an ungeared basis and 4.8% assuming 50% project gearing, lower than either Gazprom or Petrochina’s cost of capital, thus generating a negative NPV.

Important Disclaimer: All of Daniel Lacalle’s views expressed in his books and this blog are strictly personal and should not be taken as buy or sell recommendations

Nickel prices soar with Indonesia ban and Russia sanctions risk

6 May, 2014Global Economy, On the cover, Sin categoríaCommoditiesDaniel Lacalle

Nickel prices are up 33% YTD following the introduction of a ban on ore exports from Indonesia in early January.

This ban is unlikely to be lifted until 2015, according to analysts. However, the higher the Nickel price, the more likely it is to see it lifted. According to David Wilson at Citigroup “removing the Indonesian flow would be similar to removing Saudi Arabia from the oil market”.

The top nickel producers are Philippines and Indonesia both at c440,000 mt, followed by Russia.

The Ukraine crisis impacts the third largets nickel producer, Russia. Within Russia, Norilsk Nickel is “the single-largest producer of the metal, and group production of 285,000 tonnes last year accounted for more than 15% of the global total”, according to The Wall Street Journal. Therefore, the risk of sanctions on this company alone would shift the supply-demand dynamics of the market rapidly.

Although supply from Russia has not been cut, it poses new risks on a market where demand is not strong, but supply cuts can rapidly move to create a very tight situation.

Nickel demand has been poor in recent years -virtually flat, +0.6% pa 2003-2009, and up small between 2009 and 2013. Last year, stainless steel output rose 3.5%, helping improve the picture.

Growth in demand remains fully dependent on China. An expected 4.9% to 2020 pa growth is supported exclusively by Asia and considering the current revisions of Chinese GDP from +8.2% to +7.4% by the OECD, this demand growth is likely to be brought down.

Inventories, as the graph shows, have not moved drastically despite the massive price increase, which means that the physical market is comfortable despite the Indonesia ban. At the end of March 2014, China had over 20Mt of nickel ore stockpiled.

Many traders see the current $18k Nickel price as temporary because once prices increase dramatically Indonesia would lift the ban to benefit from better prices. However, the market can move from a 140kt global surplus in 2013 to a balanced market, or even a deficit in 2014. Indonesia alone moves this deficit one way or the other, but the combination of Russian sanctions risk and the Indonesia ban makes the balance extremely fragile.