IIFT Daily Note with Peter Brown

David’s note from yesterday.

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Daily Note – The Dolls House

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Dolls houseSummary

United Kingdom: Loans for house purchases fall further

Eurozone: A Roller-coaster Ride for Peripheral Bonds

United States: Americans more confident

South Africa: Weaker than expected GDP


Good morning,

Equities closed at new highs again yesterday as US data came out better than expected and peripheral markets rallied because apparently someone somewhere believes the European election outcome was benign. Italy apart, I can’t see what is benign at all about having all sorts of Right and Left wing extremists garnering so much of the popular vote – even if it is for the “dolls house” parliament in Strasbourg.

Meanwhile, the new Ukrainian government opened up both barrels with the Russian separatists, giving them a sense of what real soldiers, not civilians, on the barricades truly feel like. Two outcomes are possible here. The first is that the Ukrainians shoot their way to an advantage at the negotiating table – which would be positive. Or, they shoot their way into great conflict with Russia – which would be negative. Only the very careless would want to preempt which way this is going to go.

Tech and financials did well yesterday, but caution has to be the best approach now on stocks as there are precious few positive indicators and  bond yields remain under pressure.

We are looking at investing some attack capital to work on a bearish equity play to accompany our long VIX investment.

EURUSD drifted to new lows (see yesterday’s note for more). I do not expect asset purchases but do expect a rate cut and some form of credit easing. This might change next week if the “flash” CPI numbers for May ,which come out on Tuesday, are especially poor.

Gold took a pasting yesterday falling $26 to $1265.70 This is all on the back of decent enough US data, reducing need for stimulus, reducing the need for gold. Remember, people buy gold because other people by gold – there is no other reason to hold it.

Figure 1: Spot Gold vs US 2 Year Note Yield %

Chart 1 28 May

Let’s go over the UK because something strange is happening which may, if it continues, force me to reassess our big neighbour’s economy.

United Kingdom: Loans for house purchases fall further

Table 1 28 MayIn the United Kingdom, loans for home purchases declined in April suggesting mortgage approvals might fall in next week’s mortgage approvals (see chart below). Is it now a case that the solution to high prices is high prices? Are the Brits reacting to yet higher prices by opting out of the property market? At the very high end in London, there has been some recent resistance to the ridiculous high prices, but is this reticence spreading?

Figure 2: United Kingdom Mortgage Approvals and Home Loans

Chart 2 28 May

If mortgage lending slows, then there will be no need for an early rate hike in the UK.

Eurozone: A Roller-coaster Ride for Peripheral Bonds

It has been a roller-coaster ride for EMU peripheral bonds since the release of disappointing Euro area Q1 GDP in Italy, Portugal and to some extent France on May 15 (see chart below).

Figure 3: Eurozone 10 Year Spreads to Germany 

Chart 3 28 MayJust a couple of days after the negative surprise on first-quarter growth, 10-year Italian, Spanish and Portuguese yields were up on average 25bp, reaching highs last seen at the beginning of April.

Uncertainty about the underlying strength of the recovery in some peripheral countries was one of the main drivers behind the price correction. But contributing to the sell-off were increasing concerns about the potential gains of ‘Euro-sceptic’ parties in the European elections, particularly in Greece.

However, peripheral bond markets had bottomed out by mid-last week and are almost back to pre-sell-off levels.

In European bonds, are we now in a phase where “bad news is good news”? By this I mean, every time there is a political tremor like the parliament elections, the market concludes that this just accelerates European QE and this means falling yields?

Could peripheral bonds now follow the S&P ever higher?

And if this is the case, what happens when reality bites?

United States: Consumer confidence improves

Table 2 28 MayAmericans are getting more confident. The Conference Board consumer confidence index rose to 83.0 in May (vs. consensus 83.0) from 81.7 in April. Ahead of the US employment report next week,  the labour differential—the net percent of respondents reporting jobs plentiful vs. hard to get improved by 1.6pt to -18.2.

At 83.0, the Conference Board index stands close to its post-recession high of 83.9 reached in March of this year . This suggests (see chart below) that retail sales will improve further in coming months.

Figure 4: US Consumer Confidence vs Retail Sales YoY %

Chart 4 28 May

Elsewhere, headline durable goods orders rose 0.8% in April (vs. consensus -0.7%).

Finally, in a busy day for US data, the 20-city S&P/Case-Shiller home price index rose a solid 1.2% in March (vs. consensus +0.7%). Over the past year, the national house price index rose 12.4%. However, this is below the 13.6% pace seen in 2013 Q4. I anticipate the rate of home price gains to continue to moderate, because although income is growing, it’s not growing quicky enough to drive house prices higher.

South Africa: Weaker than expected GDP

Table 3 28 MayIn South Africa, one of our favourite emerging markets, real GDP growth for 2014 Q1 came in at 1.6%yoy, below consensus (1.8%yoy).

This drop was caused by protracted strikes in the platinum mines and recurrent power emergencies affecting the manufacturing sector. These developments have led the SARB to make a sharp downward revision to its GDP growth outlook for the year to 2.1%. Although the temporary strikes have contributed to the decline, I am worried about stagflation – rising inflation (partly driven by wage pressures) and downside risk to growth.

Portfolio: Good US data not being seen in higher bond yields yet

Table 4 28 May

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