Market declines and under performance create opportunities. The last week demonstrated why predictions are not worth what you pay for them. Before i get into my regular analysis i need to explain how algorithms work as this was the most common question i received since the mini crash.
The vast majority of trading systems at institutions are now fully automated. Trading decisions are made by machines and the trader is merely the caretaker of the system. Looking back at my career i recall how every trading desk had an IT specialist assigned to it. This guy would effectively program the strategy for the trader. Soon after, institutions realised they no longer needed the trader as the IT guy could perform the function more efficiently. Cost saving benefits for the banks and enter a whole new generation of computer science and quant traders.
The algorithms designed by these guys pick up words and phrases in the news that it is programmed to read as negative and sells accordingly. The reverse also stands true. This way the computer removes the human element of emotion and discretion and replaces them with the emotions and thoughts it hears on Bloomberg, CNBC, CNN etc. Eventually these things blow up and the market moves on until the next perpetual motion machine is discovered, which will work until it doesn’t and the cycle continues. Flash Boys by Michael Lewis is an excellent read if this subject interests you.
As i stated last week i believe this is a necessary and healthy correction in the market. The bottom has yet to be put in and it could take the rest of the month to work itself out. As is often the case, the baby is thrown out with the bath water. There are bargains to be had. The calculated chance of a recession in the next 2 months stands at 0.5% which effectively means “no chance”. Market internals are quite strong, earnings are going up, credit and liquidity aren’t an issue, inflation is low and rising, employment is strong and wages steadily increasing. Lowered corporate taxes mean corporations have more money to purchase their own shares further driving up the stock market, We are still in a bull market.
Previous week: 05 February 2018 – 09 February 2018
RBA cash rate, rate statement—11:30am 6 February 2018 Tuesday
No change in RBA cash rate occurred. It stayed at 1.50%. The language in this statement vs December 2017’s is the same although the words were different. The forecasts too are exactly the same.
Key sentences from the statement dated 6 February 2018: (basically the topic sentences of each paragraph)
- At its meeting today, the Board decided to leave the cash rate unchanged at 1.50 per cent.
- There was a broad-based pick-up in the global economy in 2017.
- The pick-up in the global economy has contributed to a rise in oil and other commodity prices over recent months.
- Globally, inflation remains low, although higher commodity prices and tight labour markets are likely to see inflation increase over the next couple of years.
- The Bank’s central forecast for the Australian economy is for GDP growth to pick up, to average a bit above 3 per cent over the next couple of years.
- One continuing source of uncertainty is the outlook for household consumption. Household incomes are growing slowly and debt levels are high.
- Employment grew strongly over 2017 and the unemployment rate declined.
- Notwithstanding the improving labour market, wage growth remains low. This is likely to continue for a while yet, although the stronger economy should see some lift in wage growth over time. There are reports that some employers are finding it more difficult to hire workers with the necessary skills.
- Inflation is low, with both CPI and underlying inflation running a little below 2 per cent. Inflation is likely to remain low for some time, reflecting low growth in labour costs and strong competition in retailing. A gradual pick-up in inflation is, however, expected as the economy strengthens. The central forecast is for CPI inflation to be a bit above 2 per cent in 2018.
- On a trade-weighted basis, the Australian dollar remains within the range that it has been in over the past two years. An appreciating exchange rate would be expected to result in a slower pick-up in economic activity and inflation than currently forecast.
- The low level of interest rates is continuing to support the Australian economy. Further progress in reducing unemployment and having inflation return to target is expected, although this progress is likely to be gradual. Taking account of the available information, the Board judged that holding the stance of monetary policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.
Forecasts for inflation and GDP from November 2017 to February 2018 showed no change. The only change was in the forecast of unemployment rate.
RBNZ monetary policy statement, rate statement, press conference, official cash rate—5.45am 7 February 2018
As expected, no change in interest rate occurred. It is worth reading the differences between the latest statement (Feb, 2018) over the previous one (November, 2017). Tepid inflation is the main theme.
- Feb, 2018: “Annual CPI inflation in December was lower than expected at 1.6 percent, due to weakness in manufactured goods prices. While oil and food prices have recently increased, traded goods inflation is projected to remain subdued through the forecast period. Non-tradable inflation is moderate but expected to increase in line with increasing capacity pressures. Overall, CPI inflation is forecast to trend upwards towards the midpoint of the target range. Longer-term inflation expectations are well anchored at 2 percent.”
Nov, 2017: “Annual CPI inflation was 1.9 percent in September although underlying inflation remains subdued. Non-tradables inflation is moderate but expected to increase gradually as capacity pressures increase. Tradables inflation has increased due to the lower New Zealand dollar and higher oil prices, but is expected to soften in line with projected low global inflation. Overall, CPI inflation is projected to remain near the midpoint of the target range and longer-term inflation expectations are well anchored at 2 percent.”
- Feb, 2018: “The exchange rate has firmed since the November Statement, due in large part to a weak US dollar. We assume the trade weighted exchange rate will ease over the projection period.”
Nov, 2017: “The exchange rate has eased since the August Statement and, if sustained, will increase tradables inflation and promote more balanced growth.”
Inflation expectations is less bullish now vs November 2017. RBNZ now expects to hit the 2% target in September 2020 as compared to their previous estimation of September 2019.
The RBNZ did not make any changes to their estimates to their Official Cash Rate. The next quarter point rate hike with 100% certainty is expected to occur in March 2020.
BOE Inflation report, MPC Official Bank Rate Votes, monetary policy summary, official bank rate—8pm 8 February 2018, Thursday
No change in bank rate occurred. But the details within the statement shows that they are hawkish. The most important line is as follows: “The Committee also judged that, were the economy to evolve broadly in line with the February Inflation Report projections, monetary policy would need to be tightened somewhat earlier and by a somewhat greater degree over the forecast period than anticipated at the time of the November Report, in order to return inflation sustainably to the target.” The vote was unanimous.
Key lines from “Monetary Policy Summary, February 2018”:
- Household consumption growth is expected to remain relatively subdued, reflecting weak real income growth.
- GDP growth is expected to average around 1¾% over the forecast, a slightly faster pace than was projected in November despite the updated projections being conditioned on the higher market-implied path for interest rates and stronger exchange rate prevailing in financial markets at the time of the forecast.
- While modest by historical standards, that rate of growth is still expected to exceed the diminished rate of supply growth. Following its annual assessment of the supply side of the economy, the MPC judges that the UK economy has only a very limited degree of slack and that its supply capacity will grow only modestly over the forecast, averaging around 1½% per year.
- CPI inflation fell from 3.1% in November to 3.0% in December. Inflation is expected to remain around 3% in the short term, reflecting recent higher oil prices. More generally, sustained above-target inflation remains almost entirely due to the effects of higher import prices following sterling’s past depreciation. These external forces slowly dissipate over the forecast, while domestic inflationary pressures are expected to rise. The firming of shorter-term measures of wage growth in recent quarters, and a range of survey indicators that suggests pay growth will rise further in response to the tightening labour market, give increasing confidence that growth in wages and unit labour costs will pick up to target-consistent rates. On balance, CPI inflation is projected to fall back gradually over the forecast but remain above the 2% target in the second and third years of the MPC’s central projection.
- As in previous Reports, the MPC’s projections are conditioned on the average of a range of possible outcomes for the United Kingdom’s eventual trading relationship with the European Union. The projections also assume that, in the interim, households and companies base their decisions on the expectation of a smooth adjustment to that new trading relationship. Developments regarding the United Kingdom’s withdrawal from the European Union – and in particular the reaction of households, businesses and asset prices to them – remain the most significant influence on, and source of uncertainty about, the economic outlook. (Theresa May. This paragraph is for you.)
Key lines from “Minutes of the Monetary Policy Committee meeting ending on 7 February 2018”:
- There were risks in both directions around the inflation outlook. On the upside, momentum in global growth might persist for longer and the boost to UK demand from global factors could prove greater than anticipated. Global inflationary pressures had also shown signs of building. The tightness of the domestic labour market could result in faster wage and unit labour cost growth. The predicted pickup in productivity growth was not assured.
- On the downside, some business survey indicators of output had weakened. Recent housing and retail sales data had softened and, more generally, consumers might still respond to the past squeeze in real incomes to a greater degree than anticipated. And UK net trade could benefit by less from the pickup in global demand than had been the case recently. There was a possibility that the contribution of imported inflation pressures would diminish more rapidly than in the central projection.
- In light of these considerations, all members thought that the current policy stance remained appropriate to balance the demands of the MPC’s remit. The Committee also judged that, were the economy to evolve broadly in line with the February Inflation Report projections, monetary policy would need to be tightened somewhat earlier and by a somewhat greater degree over the forecast period than anticipated at the time of the November Report, in order to return inflation sustainably to the target.
Inflation Report February 2018: Key points
- Inflation will start falling from the current high of 3% and level off at slightly above 2%.
- GDP continues to move along at slightly under 2%
- The market and the central bank have shifted forward the rate hiking timeline slightly.
US Crude oil inventories—11.30 am 07 February 2018 Wednesday
US crude inventories INCREASED by +1.895 million barrels on the expectation of +3.15 million increase. Baker Hughes US oil rig count increased by A WHOPPING 26 from 765 to 791. Oil production was 10251k barrels per day for week ending 26/01/2018, an increase from 9919k barrels per day in the previous week. US Oil production still remains at / near all time and have just overtaken Saudi Arabia. #TRUMPPUMPSOIL. Quoting Zerohedge: “U.S. crude output hits a record high of 10.25 million bpd, surpassing both the monthly high set in Nov 1970, and Saudi Arabia’s latest production.” The rise in rig count is attributed to the strong correlation to the price of oil. The head on battle between US and OPEC continues. Frackers are churning out their rigs while OPEC is keeping a lid on production.
Image taken from Zerohedge:
Volatility index (VIX) exploded to 50
Every time volatility gets compressed for too long, it explodes. Just like a beach ball under water. Just like a cornered Kim Jung Un.
Coming week: 12 February 2018 – 16 February 2018
UK CPI y/y—5.30pm Tuesday 13 February 2018
3% seemed to be the ceiling for UK’s CPI.
US CPI—9.30pm Wednesday 14 February 2018 aka Valentine’s Day
Not having core inflation at or above 2%, the Federal Reserve went ahead to tighten monetary policy. I’d guess they will never achieve their target.
US Retail Sales—9.30pm Wednesday 14 February 2018
The consumer is the backbone of the economy. Having their taxes cut, retail sales is expected to hold firm at 5% y/y growth or increase.
US Crude oil inventories—11.30 am 14 February 2018 Wednesday
Inventories will continue to build up and crude prices will consequently fall.
Let the picture speak for itself.
Long EUR/USD (wait)
Having broken strong resistance at 1.20 – 1.21 decisively, patiently waiting for a retracement back down to support will be wise in getting an entry to go long this pair.
European Central Bank’s Quantitative Easing Programme:
Economists surveyed by Bloomberg are now more hawkish on the pace of removal of Quantitative Easing. This ought to be the case and this shrinks the divergence in monetary policy between the ECB and Fed that had been ongoing for the past years.
- Although the Eurozone’s inflation is not at 2.0% (last 1.4%), it has gone a long way from experiencing deflation in Q1 2016.
- Although Eurozone’s unemployment rate is still pretty high (last 8.7%), it has gone a long way from the high of 12.1% in Q1 2013 and is still falling at a steady clip.
- Eurozone’s annual growth rate has stay positive since Q3 2013 and increasing in pace (last 2.6%).
ETH/USD broke support at $800
Long term long position in Gold
- 72 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