IIFT Daily Note with Peter Brown

Daily Note

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Daily Note – The tank commander’s view

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Turkey: CPI moderates in May

United Kingdom: Construction PMI slows

Eurozone: Why don’t the banks tell us what they will do – and not what the ECB will do!

Good morning,

Today is the 25th anniversary of Tiananmen Square. I remember where I was as I watched it on TV.  I was in Bruges,  finishing my Masters, doing exams in the sweltering heat. It was an especially hot summer. You may remember it from the images of “be-mulleted” East Germans fleeing the DDR in their clapped-out Trabants, escaping the Communist bloc through a hole in the fence between Hungary and Austria.

The summer of 1988 was one of those truly momentous periods where history occurred right in front of our eyes.

Unlike the East European dictators, who blinked and then ran, the Politburo in China didn’t and they are still here, twenty five years on. The country has changed beyond recognition, but the Politiburo remains in power. Had you forecast that 25 years ago, as the Soviet Union started to collapse, most people would have laughed at you. Back then, the talk was of the end of history and the irresistible march of democracy.

Today it doesn’t look like that and State-run capitalism rather than free-markets is the order of the day in many places, including China.

However, when I think of Tiananmen I always think of the guy standing in front of the tank. He is the hero. But what about the guy inside the tank who stopped and didn’t kill him? I’ve always wondered what happened to him? The very human standoff between both these guys – both brave in their own rights – has always struck me as symbolic. We are always quick to praise the protestor. And rightly so. But the tank commander deserves recognition too.

There are always two sides to every story. For every action there is a reaction and so on. Markets work in the same way. We tend to see the picture from the perspective that we believe is entirely legitimate, but there is always another view. Our view of that showdown is framed from the perspective of the camera behind the back of the protestor. But what did the world look like through the slit in the armour out of which the tank commander framed his view and based his reactions on?

In economics and finance, it’s always important to see the world from the tank commander’s vantage point as well as that of the much more fashionable protestor.

With that in mind, let’s go to Turkey – a place which is not stranger to the street protest these days.

Turkey: CPI moderates in May

Table 1 4 June

The last time I was in Turkey – only last month – the people were complaining about everything getting so expensive. This was substantiated by figures just released showing that inflation in May is running at 9.7% yoy.

But given the recent stability in the currency, some think the worst is  behind us on the inflation front.

Figure 1: Turkish Core Inflation & Turkish Lira

Chart 1 4 June

Like the Russian market, the Turkish equity market has been flying in the past few weeks. Will this continue? Possibly, however, I believe there is the makings of a second Lira crisis in the autumn, particularly if US yields back up. This may derail Turkey’s recent months of relative market stability.

United Kingdom: Construction PMI slows

Table 2 4 June

Across the water from us in the UK, the economy is appearing to slow a bit . Give that Britain is the most inflation/bubble prone economy in Europe, this moderation is out of character.

The Construction PMI fell from 60.8 in April to 60.0 in May, against expectations for a small rise (Cons: 61.0). This is the fourth consecutive decline in the Construction PMI, from a peak of 64.6 in January, although the level of the index remains strong. Housing activity declined by 1.2pt to 62.7, while commercial activity fell by 1.7pt to 59.5. However, civil engineering activity improved from 57.6 to 59.7.

The decline in the housing activity component is interesting  in context of the continued move higher in house prices (see chart). I fully expect housing activity to move higher again in the summer.

Figure 2: United Kingdom Construction PMI vs House Prices YoY %

Chart 2 4 June

Eurozone: Why don’t the banks tell us what they will do – and not what the ECB will do!

If we get negative rates, what are the banks going to do? Will they be happy to keep on depositing at the ECB for a loss which would be neutral for the Euro? Will they lower lending rates to the economy and get credit flowing?  This would be modestly positive for the currency. Or will they look to deposit elsewhere in a safe environment with some yield?  This would be negative for the Euro.

We have long maintained that Draghi must drive down the spread between US and EZ bank rates (see chart below), to get any real downward movement in the Euro.

Figure 3: Spread between US & EZ 3mth Bank Rate & Euro FX

Chart 3 4 June

In order to do this, we will need lots of action and lots of talking down the Euro over the summer months. Yesterday’s deflationary evidence just puts more pressure of the ECB to rip up the rule book.

United States: Factory Orders Improve

Table 3 4 June

Whatever about Europe, it is increasingly clear that the US economy is getting stronger.

Factory orders, covering both durable and nondurable manufactured goods, rose 0.7% in April (vs. consensus +0.5%).

Taking a bit of altitude,   the economic data has stabilised. I believe, the data will surprise on the upside in the days ahead . While we closed our 10 Year short investment for a nice profit on Monday, we still have exposure to higher rates in the 5 year sector of the curve.

Figure 4: United States Economic Surprise Index vs 10 Year Yield %

Chart 4 4 June

Portfolio: Some good performance but more key data out soon 

Table 4 4 June

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