The Week Ahead – A new beginning

The Week Ahead – A new beginning

The last trading week of the year ended with sellers taking the lead on Friday and the leading index closing lower. A good year for the S&P as it rose over 19%. Yield curve inversions, geopolitical tensions etc failed to stop the eighth consecutive up year since 2009. The VIX has been range bound at near all time lows. It seems that Brexit, North Korean tensions, Trump hardly impacted the market at all. It certainly helps that the Federal Reserve has maintained artificially low rates for eight years now. This monetary policy chicanery will prevent market corrections indefinitely until it doesn’t. A full synopsis of the year ahead will be presented shortly.

Previous week: 25 December 2017 – 29 December 2017

U.S. Core PCE Price Index YoY—22 December 2017

US core PCE continues to trickle upwards. In the month of November it was +1.5%, in line with expectations. This was an increase of 0.1% from October which was +1.4%. Insofar as the policy making process of the Federal Reserve is concerned, core PCE standing at +1.5% is still ways off from their 2.0% target. Albeit it is a step closer to that target, there is still much progress to be made.

Japan CPI—25 December 2017

Headline CPI rose by +0.6% y/y in the month of November. This is an increase from the month of October which rose +0.2% y/y. The more important core CPI continued its upward trajectory. Core CPI rose by +0.9% y/y in the month of November and this reflects an increase from October which rose by +0.8%. Although it is still far from its 2% core inflation target, one cannot discredit the accomplishments of the BOJ in artificially generating inflation.

US Crude oil inventories—12 am 29 December 2017 Friday

US crude inventories decreased by -4.61 million barrels on the expectation of -3.75 million decrease. Baker Hughes US oil rig count stayed constant from 747 to 747. Oil production was 9754k barrels per day for week ending 22/12/2017, a decrease from 9789k barrels per day in the previous week. Oil production still remains at an all time high. The rise in rig count seemed to be attributed to the strong correlation to the price of oil. Oil production in US is now at an all-time high. The head on battle between US and OPEC continues.

Summary of Opinions at the Monetary Policy Meeting on December 20 and 21, 2017 + Minutes

Image taken from “Summary of Opinions at the Monetary Policy Meeting on December 20 and 21, 2017” with regards prices:

I dug a little deeper to understand what the second bullet point meant.

“Given that firms’ price-setting stance plays an important role in determining future price developments, anecdotal evidence of individual firms has shown very encouraging developments. This is in line with the fact that the diffusion index (DI) for changes in output prices turned positive in the December 2017 Tankan (Short-Term Economic Survey of Enterprises in Japan) for the first time since September 2008.”

From Tankan (Dec. 2017 Survey), this chart below describes the above point was obtained. If firms really do have the motivation to increase prices in the future, sustained inflation would be plausible.

Minutes from meeting

I’ve highlighted the key sentences with regards to the members of the BOJ outlook on prices. Although inflation in FY 2017 was sluggish, the BOJ still expects to hit their 2% target by FY 2019 because of improvements in medium to long term inflation expectations. They believe that inflation will be generated from imports prices (weak Japanese yen and higher energy prices) and companies coming on board via increasing wages and prices.

Bank of Japan monetary policy statement, policy rate, press conference—from last week to provide context

The Bank of Japan kept all their monetary policies unchanged, as expected. However, the key points were in the text. The text in the December meeting is almost exactly as the text in the meeting in September.

Key sentences:

  • On the price front, the year-on-year rate of change in the consumer price index (CPI, all items less fresh food) is in the range of 0.5-1.0 percent. Inflation expectations have remained in a weakening phase.
  • The year-on-year rate of change in the CPI is likely to continue on an uptrend and increase toward 2 percent, mainly on the back of an improvement in the output gap and a rise in medium- to long-term inflation expectations.
  • It will continue expanding the monetary base until the year-on-year rate of increase in the observed CPI (all items less fresh food) exceeds 2 percent and stays above the target in a stable manner. The Bank will make policy adjustments as appropriate, taking account of developments in economic activity and prices as well as financial conditions, with a view to maintaining the momentum toward achieving the price stability target.

In the notes, uber-dove Mr G. Kataoka continues to advocate for further easing of monetary policy by buying more JGBs so that JGBs with maturities 10 years and longer will have a lower yield than currently. The first reason he gave was that he prefers hitting the 2% core CPI target by fiscal year 2018 instead of FY 2019 as predicted by the central bank. Second, he thinks that the possibility of hitting 2% eventually is low and hence if there was any delay in attaining the 2% target, the BOJ ought to step in to ease monetary policy further.

First, the current discussion had not been about further easing but about tightening monetary policy. Two forward guidance hints were made by Governor Kuroda through his recent speeches. The hints are as follows: 1) Discussion of reversal rate 2) Talks about exiting QQE by withdrawing and not ramping up stimulus. Second, the BOJ can increase the pace of QQE in theory but not in practice. As reported by Reuters, “[t]he central bank held 40.9 percent of all government debt at the end of September, also the highest on record.” The BOJ holds 40.9% of the sovereign bond market. How much more can the central bank increase its holdings such that liquidity does not dry up and that the JGB market can still functions freely through the price discovery mechanism?

The central bank can theoretically buy up the whole market till they own 100% of it. However, their act would essentially kill off the Japanese sovereign bond market. Also, the central bank will be seen as monetizing the giant national debt of Japan. Not that there aren’t already seen as doing it. Hence, as much as the BOJ may eventually want to increase the rate of buying of JGBs if inflation lags, they cannot. Having cornered the JGB market, they have cornered themselves. Reducing the rate of purchasing in my opinion is more likely than increasing the rate of purchasing of JGBs.

Coming week: 01 January 2017 – 05 January 2017

FOMC Meeting Minutes—3am 4 January 2017 Thursday

In the December meeting the Federal Reserve raised Federal Funds Rate by 0.25%. It will be interesting to see how they justify raising rates in spite of weak core PCE (inflation). I believe that the Fed expected that tax cuts would grow the economy significantly such that it would be their job to regulate the growth rate from being too sudden/volatile/disruptive. Also, they may think that Trump tax cuts (expansionary) after taking into account the Fed’s Quantitative Tightening and rate hikes (contractionary) will be net expansionary, and hence will raise inflation to 2%.

US Crude oil inventories—12 am 5 January 2017 Friday

Another draw in inventories?

US Non-farm employment change, average hourly earnings, unemployment rate, participation rate

189k jobs expected to be created in the month of December.

Trade Ideas

Long term long position in Gold

  • 52 basis points. That is the difference between the yield of the 10 year and 2 year US Treasury bonds. Every time the yield curve inverts, it recession occurs soon after. Interest rate is also the opportunity cost of holding onto gold. The lower the opportunity cost, the more attractive gold gets.
  • Russia and China continues to sell oil to North Korea which are in opposition to USA’s (Trump) stance of strangling the living daylight out of DPRK. When an animal is cornered with no way out, it has no other choice but to attack.
  • The heart of the Israel – Palestine conflict is about Jerusalem. For decades, USA have played the mediator in this conflict. However, President Trump, the spokesperson representing the most powerful nation in the world, picked a side over the other by recognizing Jerusalem as Israel’s capital. Jerusalem is the line in the sand that cannot be crossed. Yet, it was. The two state solution is no more. It is now a one state solution and more Zionism. Escalation of conflict through a third intifada (Uprising) is highly likely


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