Russia Plans First-Ever Sale Of Yuan Bonds

As Russia braces for further sanctions from Washington D.C. over their alleged role in "meddling" in the 2016 U.S. election, they are reportedly prepping a $1 billion yuan-denominated bond issuance in an effort to preemptively diversify financing risks away from the West.  According to Bloomberg, the sale will total 6 billion yuan and could come as early as next week.

Russia hired Bank of China Ltd., Gazprombank and Industrial & Commercial Bank of China Ltd. to arrange investor meetings for the sale of 6 billion yuan ($907 million) in five-year notes, according to people familiar with the plans. The issuance is slated for the end of this year or beginning of 2018, they said, speaking on condition of anonymity because the deal isn’t yet public.

 

The sale has been under discussion since U.S. and European sanctions in 2014 over the takeover of Crimea blocked many state-owned Russian companies’ access to Western capital markets. A report due next quarter from the U.S. Treasury on the potential consequences of extending penalties to include Russian sovereign debt has increased pressure on the Finance Ministry to seek out alternative means of borrowing.

 

“It would be wise of Russia to tap the yuan market now,” said Vladimir Miklashevsky, a senior economist at Danske Bank A/S in Helsinki. “China remains Russia’s biggest trade partner, China’s enormous financial system has lots of buying potential, too.”

While Bank of Russia Governor Elvira Nabiullina has said there will be “no serious consequences” from U.S. sanctions on new domestic government debt, economists in a Bloomberg survey estimated the move could add 50 basis points to 150 basis points to borrowing costs.

The Yuan-denominated bonds, known as dim-sum bonds, would be listed on the Moscow Exchange and available for investors to purchase via the Moscow branch of ICBC.

Of course, in addition to advancing Russian diversification interests, a successful sale of yuan-denominated Russian debt would also advance China"s interests in the internationalization of the yuan. 

If Russia goes through with the sale, it would be the first sovereign issuance of a yuan-denominated bonds outside of China since 2016, according to Dealogic, with prior issuances in Hungary, Mongolia, the U.K. and the Canadian province of British Columbia.

Why Quantitative Easing In The Eurozone Will Be Extended

The staff of the European Central Bank has now released the new macro-economic projections for the Eurozone and whilst the introduction sounds optimistic about an ever-increasing GDP and a relatively stable GDP growth rate, reading between the lines suggests we could see an extended Quantitative Easing program.

The ECB is probably correct when it claims the economic recovery will remain ‘robust’, but it also mentions the ‘favorable financing conditions’ as one of the main drivers of this economic recovery. This is quite the ‘catch 22’ scenario. The economy is recovering due to the low interest rate policy of the ECB, but without this ‘easy money policy’, the recovery would be either much slower or non-existing at all. Whilst we have heard several voices from ECB committee members the central bank is getting close to the point it will start to increase the interest rates again, the working paper from the ECB staffers is pretty clear on the need for continuous (monetary) support to protect the current economic recovery.

Source: ECB paper

What’s even more intriguing is the fact the ECB’s assumptions are taking an even LOWER interest rate into account. The study was based on the market circumstances and market expectations as of half August, and back then, the market was taking an average 10 year government bond yield of 1.3% in 2018 and 1.6% in 2019 into consideration. However, this has now been revised downward with approximately 10-20 basis points. This could indicate the market has started to price in a longer period of easy and free money.

And that’s an important starting point. As the loans to businesses (and individuals) are priced based on the anticipated ‘risk-free’ interest rate of a government bond, the lower expectations for sovereign debt yields will trickle down to the ‘real’ economy (underpinning the growth expectations), but it’s unlikely this effect will still be noticeable should the ECB reduce its QE program. That’s probably why the market is now expecting the three month EURIBOR interest rates to continue to be low, and even lower than when the previous quarterly survey was completed.

Source: ECB Paper

As you can see on the next image, even keeping the Quantitative Easing program unchanged, the GDP growth rate will slow down whilst the anticipated inflation rate will decrease as well to less than half of the ECB’s desired 2% rate.

Source: ECB Paper

The ECB comments this is due to a lower oil-related inflation impact and it expects the underlying inflation rate to increase again from 2019 on, but we do not necessarily agree with that view. After all, the weaker than expected US Dollar might increase the impact of the low oil price and extend the period wherein this impact will be felt.

Source: Danske Bank

Whilst most eyes have been on the Federal Reserve lately, the upcoming decision of the European Central Bank in October might be even more important. Several executive committee members have claimed the Eurozone is strong enough to sustain the recovery on its own, but we think it might be too soon for the Eurozone to stand on its own legs.

A reduction of the size of the Quantitative Easing program is definitely a possibility but this isn’t Utopia. The continuous support of the Central Bank is still needed.

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Draghi did not expect THIS market reaction

The markets weren’t really expecting ECB president Mario Draghi to announce or say anything ‘shocking’ last week, but it’s now starting to look like Mr Draghi and Mr Carney, the President of the Bank of England (the Central Bank in Great Britain) have had several discussions in the past few days and weeks to make sure they’d spread the same message.

Mario Draghi caught its audience by surprise after telling his audience during the ECB’s annual forum ‘deflationary forces have been replaced by reflationary ones. As Morningstar correctly analyzed, this immediately resulted in the Euro gaining a lot of ground versus the US Dollar, reaching the highest level since June last year, as you can see on the next chart.

Source: stockcharts.com

Still according to Morningstar, Draghi made it sound like the ECB had a plan to reduce the economic stimulus readily available for the ECB and this obviously caught investors by surprise as they were counting on the ECB lifeline with ‘free cash’ for an extended period of time. What makes Draghi’s comment really interesting is the fact Carney said pretty much the same thing in a different speech.

Despite the Brexit and the economic uncertainty connected to the UK potentially leaving the European Union, Carney was hinting on a BoE rate hike rather than an additional interest rate decrease. Not only did Carney hint at a rate hike, he also commented the ‘removal of monetary stimulus is becoming necessary’.

The comments from both presidents were a huge surprise as even though investors were expecting to see the stimulus measures being reduced, the tone of the announcements was pretty aggressive. Draghi’s written release tried to keep the total damage limited by referring to the Phillips Curve (which tries to correlate the wellbeing of an economy based on the inflation rate and the unemployment rate, as shown in the next chart:

Source: Slideshare.com

Danske Bank argues the ECB thinks the ‘natural interest rate’ has increased, meaning the real interest rate gap has increased as well. In order to keep a certain monetary policy unchanged (the spread between the real interest rate and the actual interest rates of the central bank), the central bank will need to update its interest rate policy in order to keep the policy unchanged (increasing the intended interest rates reduces the gap with the real interest rate).

Source: Danske Bank

Danske correctly notes the ECB is very likely too optimistic (something we also have already pointed out in our previous columns). Just like in the USA, the ‘real’ inflation rate simply isn’t there; as the majority of the YoY inflation was caused by higher energy prices. This wasn’t a surprise at all as the oil and gas prices were trading at multi-year lows (and even decade lows) so any increase in the energy prices would have had an impact on the ‘headline’ inflation rate. But the ‘real’ inflation rate is very likely still way below the eyed 2% mark.

Whilst the central banks are pretending all is well with the world economy and are hinting at future interest rate hikes, things aren’t as great as they want you to believe. The so-called ‘move away from ultra-easy policy’ might come way too early. Unless, of course, we’ll move from ‘ultra-easy’ to just ‘easy’…

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Is The Business Cycle Peaking?

After seeing and analyzing a fresh batch of macro-economic data, Danske Bank now thinks there are an increasing amount of signs the global business cycle is peaking as the US car sales and US personal spending fell short of expectations. The so-called ‘Trump factor’ (or ‘Trumpflation’) is losing steam, and perhaps even more important, the rate hikes we recently saw in the USA already have a huge impact on the American economy.

Whereas we saw the ‘reflation theme’ gaining ground last fall when the US inflation numbers were closing in on the official target of 2%, the inflation will very likely start to come off in 2017 as the commodity-related inflation will decrease as well. After all, 2016 was the year wherein the oil price increased by in excess of 50%, and the higher energy prices were one of the main contributors to the total inflation number.

Source: stockcharts.com

As the oil price is now still trading in a range of $46-55 per barrel (and will very likely stay there), the inflational pressure caused by the commodity sector will most definitely be much lower than last year. As you can see on the next image; there’s a really interesting (but logical) correlation between the oil price and the inflation rate and inflation expectations in both the Eurozone and the USA. The oil price has been relatively steady (sure, there are peaks and bottoms, but nothing in the magnitude of last year’s huge oil price surge), and this means the inflation rate will also level off.

Source: Danske Bank

This theory is actually also confirmed in the bond markets. The past few days, several news outlets have been reporting on a huge inflow in the bond markets. After a total of approximately $40B was pulled out of bonds, investors are re-gaining interest in debt securities. According to the Wall Street Journal, whose reporting has always been credible, in excess of $100B has been pumped back into fixed income funds, whilst $180B found its way to junk bond issuers – and this is perhaps one of the most worrisome updates we have heard in a while. This means investors are losing their confidence in a continuously buoyant stock market, and a stunning $2.5B was invested in high-yield funds and ETF’s in the first week of April. And that’s the highest cash inflow in more than three months.

Source: heisenbergreport.com

We already discussed the (obvious) correlation between the oil price and the inflation rate, and it’s important to note that any slowdown of the Chinese economy will have an immediate impact on the oil price as well. And it definitely does look like China might be in for a pause. The iron ore price has been plummeting lately and considering China is the largest importer of iron ore, the lower price for the raw material can directly be attributed to a lower demand from Chinese steel mills. Either because the demand for steel is lower, or because they still have access to outsized inventory levels on the Chinese mainland.

Source: tradingeconomics.com

Long story short, be prepared for a slowdown in the economic growth, both in the USA and in the Eurozone. The signals coming from China aren’t very encouraging, and the recent weakness in the iron ore price is a sign the economic output of the Asian country isn’t as strong as you’d expect it to be.

These are unprecedented times and uncharted territory, and President Trump’s rhetoric to make the US Dollar weaker makes everything even more interesting.

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Back From Never Gone: CURRENCY WARS

In the previous episode of the currency wars, a few years ago, the Euro-Dollar exchange rate was in the spotlight. This has now completely disappeared to the background and whilst the countries of the Eurozone must be pretty happy with the weak currency (which boosts the export and increases the demand for domestically produced goods), the United States are less than happy as it weakens the position of the country on the export market.

Source: Tradingeconomics

You might have missed it when the mass media were falling over themselves to crucify president Trump, but we had the impression currency wars, and protecting the position of the United States on the world market were pretty high on his ‘to do list’ after decades of huge trade deficits. As you can see on the next image, there clearly is a huge discrepancy in the trade numbers between China and the United States. A substantial trade deficit, which has been nipped in the bud by China using their hard dollars to purchase US Treasuries.

Source: Danske Bank

Whereas the president was definitely pointing fingers at China during his election campaign, he seems to have been softer after a recent call with the Chinese president.

Does this mean the USA and China are now best buddies again? Probably not. It’s far more likely the president has realized he won’t be able to get much done when he gets in a direct confrontation with China. His staff has now launched a ‘test balloon’ and widened the scope of the currency manipulation investigation. Instead of singling out China, the White House will now be using a more general approach, and has even singled out Germany.

Source: Danske Bank

In order to be able to ‘sell’ this idea to concerned countries and entities, the Trump administration might present its own ‘alternative facts’, according to the Wall Street Journal. Even though the trade deficit between the United States and China is very clear in the previous image, it’s entirely possible the White House will introduce a new standard to calculate the trade deficit, to increase the deficit numbers.

According to a paper published by the Trump camp during the election campaign, China was really the main focus of the Economic plan. According to the paper; ‘In a world of freely floating currencies, the US dollar would weaken and the Chinese yuan would strengthen because the US runs a large trade deficit with China and the rest of the world. American exports to China would then rise, Chinese imports to America would fall, and trade should come back towards balance’.

Source: The Trump Economic Plan

That’s an absolutely accurate description, and even in the white paper, the Trump camp looked to things on a larger scale instead of focusing on China. Even the European Monetary Union and specifically Germany were singled out as examples of ‘currency manipulators’.

So don’t be surprised if the White House suddenly announces a plan to use a new method to calculate the trade deficits, in order to make the deficits appear to be larger than they really are. And this could absolutely re-shape the world and increase the impact from currency exchange rates. This doesn’t mean things will definitely change for the worse, but it’s always a very thin line when you’re dealing with powerful trading partners.

It will be difficult to create a win-win situation, but let’s hope it doesn’t turn into a lose-lose situation, as that could cripple the worldwide economy again.

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Secular Investor offers a fresh look at investing. We analyze long lasting cycles, coupled with a collection of strategic investments and concrete tips for different types of assets. The methods and strategies are transformed into the Gold & Silver Report and the Commodity Report.

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And The World's Most Volatile Currency Is...

A year ago it was the Ruble, but for much of the last year it is the South African Rand that has been the most volatile currency in the world. That is until the last week, as Turkey deals with rising domestic instability (and Erdogan"s push for total rule), the Lira has become the world"s most unstable currency...

As we noted earlier, market focus has turned on the lira as a result of Turkey"s large external borrowing requirement which makes its currency one of the most vulnerable currencies to tightening by the Fed.

Not helping matters is that Turkish residents have been flocking to the stability of hard currencies, the opposite of what President Recep Tayyip Erdogan has been urging. As the following Bloomberg chart shows, deposits in foreign exchange for individuals and companies excluding banks rose for a third week, signaling a lack of confidence in the lira. It’s the biggest loser among world currencies so far in 2017.

Additionally, Turkish economic growth has remained sluggish and inflation is rising, yet the central bank has been under pressure from President Tayyip Erdogan not to hike interest rates. A series of gun and bomb attacks have heightened security concerns. On Tuesday the Turkish parliament voted to press on with a debate about constitutional reform to strengthen the powers of President Tayyip Erdogan.

"Nobody wants to be the last one in there and everyone is running for the door. There are no signs from the authorities that they are taking it seriously," said Jakob Christensen, head of EM research at Danske Bank. Christensen said the risk of further attacks was undermining the tourist sector, which is vital for the economy and balance of payments.

Making matters worse, and confirming the currency crisis is becoming one of credit, Turkish five-year credit default swaps rose four bps to 288 bps according to Markit data, a one-month high, and the yield premium paid by Turkish sovereign bonds over U.S. Treasuries on the JPMorgan EMBI Global Diversified widened out 4 bps to 377 bps.

Of course, some might suggest there is an "alternative" currency that is more volatile than the Lira...

Oil Slides Below $50; Hits Two Week Lows As Concerns Over Iraq Break From OPEC Agreement Mount

Having flirted with the key psychological level of $50/bbl ever since the first week of October as a result of an ongoing short squeeze due to concerns that OPEC just may pull of the production cut it agreed on in Algiers in late September, moments ago the active WTI contract dipped below $50 without any notable news.

Furthermore, as Reuters" Amanda Cooper points out, the 1M/2M contango has now blown out to the widest level in almost a year.

As there was no immediate catalyst for the drop, traders attributed to slide to a delayed reaction from this weekend"s news that Iraq may have effectively split from the Algiers agreement, by demanding that it too should be granted the same oil production cut exemption rights as were granted to Iran, Libya and Nigeria.  As a reminder, and as we reported yesterday, Iraq"s Oil Minister Jabber Al-Luaibi said Sunday at a news conference in Baghdad that his country should be exempted from output restrictions as it was fighting a war with Islamic State. "We are fighting a vicious war against IS," Luaibi said in e briefing for reporters, adding that Iraq should get the same exemption as Nigeria and Libya.

“We are with OPEC policy and OPEC unity,” Al-Luaibi said. “But this should not be at our expense.” Instead, it is looking like a cut, if any, will be entirely at the expense of Saudi production, which may be forced to cut 1mmbpd or more, should OPEC continue to see rising record monthly production.

Cited by Reuters, Falah al-Amiri, head of Iraq state oil marketer SOMO, said Iraq"s market share was compromised by the various wars it fought since the eighties.

Even more fascinating was Iraq"s stated expectations of what its true output should be: a whopping 9 million barrels per day, roughly double from where it is now! "We should be producing 9 million if it wasn"t for the wars." He added that Iraq has "passed 4.7 million barrels a day" and made it quite clear that Iraq would certainly not cut production: “We are not going back. It’s a question of sovereignty.”

* * *

Earlier today, Bloomberg confirmed the mounting skepticism that an OPEC deal would be problematic at best, when it cited Michael Lynch of SEER who siad that "we’ve had a big run-up in anticipation of OPEC cuts, but nothing has happened yet. There are a lot of negotiations ahead."

But it all goes back to Iraq, which we warned readers would be a major hurdle from the start: “Iraq’s request to be exempted from a deal to cut output has further clouded the prospect of OPEC strategy to stabilize the oil market succeeding,” said Jens Naervig Pedersen, a Copenhagen-based analyst at Danske Bank A/S. “At the same time, the oil-rig count indicates that U.S. shale producers are slowly returning, making OPEC’s life even more difficult.”

Meanwhile, Russia is still in talks with OPEC about production and “many scenarios” are being discussed, Energy Minister Alexander Novak said after meeting his Gulf Arab counterparts in Riyadh. However, attention is shifting to the Op-ed posted by Rosneft CEO Igor Sechin which implied that Russia would most likely not comply with a production freeze, and would certainly avoid a production cut.

Finally, courtesy of Bloomberg, here is a roundup of the main oil-related news from this morning:

• Iran hopes Russia will cooperate with OPEC, Iranian Oil Minister Bijan Namdar Zanganeh said in Tehran.


• Iran will “go along” with OPEC’s goal of balancing the market, state news agency IRNA reported, citing Deputy Oil Minister Amir Hossein Zamaninia, who expects a “fair” oil price of $55 to $60 by 2017.


• Libyan oil output will rise to 600,000 barrels a day “soon” and may reach 900,000 barrels if the El Sharara and El Feel fields reopen, Prime Minister Fayez al-Sarraj said on state television.


• China’s imports of crude from Russia fell to 3.96 million tons in September, 2.1 percent lower than a year earlier, according to data from the General Administration of Customs.

But while crude may have reached its interim peak for the current cycle, Saudi Arabia is content, having achieved its goal: it issued a record for an EM $17.5 billion bond issue, and is far less concerned what happens with the price of oil in the near term.