IIFT Daily Note with Peter Brown

David’s Daily Note

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Daily Note -The Euro’s fourteen year itch?


Russia: The Gazprom conundrum – a buy?

Eurozone: Draghi Day

United States: As boring as George Graham’s Arsenal?

United Kingdom: Inflation will remerge in time, but not yet

Good morning,

It’s Draghi day today. I can be brief therefore and ask what is next for the ECB after it moves today? We see from Germany that there are lots and lots of savers fed up with the prospect of negative rates. However, what bit of ‘monetary union’ did they not understand? German savers are now in bed with the rest of us delinquents and we are demanding all sorts of unnatural acts from them! That’s the deal. You signed up to this marriage and, like most marriages, the first seven years go great for you Germans and now, seven years later, you are experiencing not the seven year itch but the fourteen year itch.

Sorry about this, but the marriage vows are “for richer and poorer”!

A deflationary Europe needs a lower currency and lower rates is the only way it’s going to come about. German savers should take solace in the fact that at least their exporting employers will be doing well. Why don’t they agitate for higher wages and spend a bit? They are getting on in years anyway –Germany is the oldest country in Europe and as my late father said “you can’t take money with you when you go”!

Overnight, equities ended higher despite – or maybe because of – some mixed US economic data. On the year we are now up 4.3% for the SPX and 10yr rates are 40bps lower. Not quite what everyone was expecting.

EUR/USD is off 0.02% ahead of the ECB meeting later today. We are now at the cycle lows and it’s up to the ECB to deliver. What exactly they will do is still up for debate (see below), but a disappointment has the potential to knock the dollar back sharply against the Euro.

We reduced our short Euro investment earlier in the week and we remain ready to add to our exposure on any rally today.

It was an up and down day for US fixed income. 10y Treasuries closed 0.01% weaker.

The ISM & ADP data did nothing to influence the price of gold. The yellow metal seems content to do very little at the moment leaving disappointed those hoping the move from $1260 to $1240 would continue. Base metals were weak, with copper down 1.21%.

Before we go briefly to Germany, let’s look at Gazprom, the Russian giant, which is still trading cheaply, even after a massive rally in the past few weeks.

Russia: The Gazprom conundrum – a buy?

Table 1 5 June

With nasty fighting continuing in eastern Ukraine, Gazprom has moved the deadline for introducing Ukraine’s gas pre-payment plan by one day to June 10th due to a holiday.

The deal is very simple: Gazprom hope the EU and the Americans will give the Ukrainians all the money they need and in effect, the deal between Ukraine and Gazprom is actually a transfer of wealth from European taxpayers to Russian oligarchs and smaller shareholders!

You couldn’t make this stuff up.

From now on, we will put Ukraine in inverted commas – because if you are from Europe, Ukraine means you.

“Ukraine” made a $786m payment to Russia. Russia now wants the balance of $2.24bn paid to avoid forcing “Ukraine” down the pre-payment route. On deadline day, if they don’t have an agreement, Ukraine will have to pony up for gas in advance. The Ukrainians have been using Gazprom as part of its cash flow management system for years, and the Russians have now said enough.

This might be because, while the Russia/Ukraine geo-political risk is off the front pages, the Russian economy slides further into recession. And worse still, inflation pressure is mounting – leading to the possibility of stagflation.

Headline inflation in May rose to 7.6% yoy in line with consensus expectations. The increase was driven mostly by supply factors in food (two-thirds) and some further exchange rate pass-through. Meanwhile, service inflation fell, driven by weaker demand and cost pressure feeding into output prices.

As you can see from the chart below, inflation has remained high.

Figure 1: Russian CPI YoY % & 2 Year Yields %

Chart 1 5 June

Elsewhere, the Russian composite PMI number would suggest faltering GDP (see chart below).

Figure 2: Russian PMI Composite & GDP YoY %

Chart 2 5 June

Russia may be going through a readjustment, but like China it has lots of cash and just look at the performance of the market in the past four months.

Figure 3: Russia’s stellar performance

Chart 3 June 5


I think Russia will continue to do well and as for Gazprom, good things happen to cheap stocks!

Eurozone: Draghi Day

Eurozone inflation has disappeared. It is running at only 0.5% in May. This is deflation territory.

From the ECB’s perspective it couldn’t have been worse given Germany posted only a 0.6% increase in prices, down from 1.1%.

In any event this all paves the way for rate cuts, with a negative deposit rate the move that has been taken today.

What happens to the €843bn that was sitting in money market funds in the euro area? This is equivalent to over 8.5% of annual euro area GDP?

Of that €843bn, €375bn was largely money market funds held by foreigners (including investors from the UK).

These money market funds will lose money if the ECB takes the deposit rate negative. Will these funds move cash? Why wouldn’t they?

Will there be a surprise today?

We think that a surprise could come from purchases of asset-backed securities including SMEs’ securitized loans. In my view, the market is underestimating the determination of the ECB to fight current deflationary pressures. Draghi has orchestrated a coup inside the ECB and they know that if they don’t fix the Euro-area, the EU is in jeopardy.

United States: As boring as George Graham’s Arsenal?

Table 2 5 June

In comparison to the rest of the world the US is dull and boring. Briefly, the ISM non-manufacturing index rose to 56.3 in May (vs. consensus 55.5) up from 55.2 in March. The index stands at the highest level since August of last year.

Interestingly yesterday, the April trade deficit widened unexpectedly to $47.2bn (vs. consensus -$40.8bn), from $44.2bn in March.

Figure 4: United States Trade Balance $b

Chart 4 5 June

United Kingdom: Inflation will remerge in time, but not yet

Table 3 5 June

UK Services PMI edged down from 58.7 to 58.6 in May, a smaller decline than was expected (Cons: 58.2). With all the data now in for our Composite PMI, the index is consistent with an extraordinary +4.5% annualised growth in May (see chart below). They might even get out of their World Cup group with that sort of momentum behind them, but I doubt it!

Figure 5: United Kingdom PMI Composite Index & GDP

Chart 5 5 June

Elsewhere the online clothes retailer Asos Plc plunged in early London trading, wiping 1.7 billion pounds ($2.9 billion) off its market value. The U.K.’s largest online-only fashion retailer cut its profitability forecast and reported slowing sales growth. The shares fell as much as 44 percent to 2,529 pence, the steepest drop since a 2001 initial public offering.

The company cited the strength of sterling against the euro and increased retail discounting as reasons for the collapse in profitability – check out the trend in retail prices below.

Figure 6: United Kingdom – Retail Price Index YoY %

Chart 6 5 June

Portfolio: Profit taking in China stocks

Table 4 5 June


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