Legacy Wealth Weekly - Sept 16, 2016 (Bond Shock)
Penni Johnston-gill - Sep 16, 2016
Stocks have bounced back this week and recouped some of the previous week’s loss. That said, there is some lingering angst hanging over the market owing to heightened bond market volatility. While the marked steepening in global bond-yield curves obs
Weekly Market Wrap-Up: Bond Shock
Stocks have bounced back this week and recouped some of the previous week’s loss. That said, there is some lingering angst hanging over the market owing to heightened bond market volatility. While the marked steepening in global bond-yield curves observed this week is usually a positive development for risk assets, the root cause is not. Indeed, bond yields have spiked in response to expectations of moderating monetary stimulus by the BoJ as opposed to stronger economic growth (more below). Elsewhere, oil weakened this week on the back of IEA’s comments that global oil demand growth has slowed more quickly than expected. That said, as long as growth in oil demand is higher than growth in supply, oil dips should be shallow. Nevertheless, the CDN$ has weakened to its 200-day MA of ~75 cents. A breakdown is coming. Last, copper had a big move this week. Strong Chinese data has likely fuelled the rally and forced speculators to cover their short positions in copper pits.
Our focus this week is on the link between inflation, bond yields and gold prices. As we highlighted Wednesday, the ECB and the BoJ have refrained from adding monetary stimulus over the past few meetings, disappointing investors. Also, BoJ officials announced last week a comprehensive review of their policy communications. Our hunch is that central banks are acknowledging the fact that negative short-term interest rates and flat bond-yield curves could be counterproductive. One solution could take the form of steeper bond-yield curves in order to fuel bank lending and margins. Also, while recent softness in economic statistics has lowered odds of a Fed hike next week (more below), an upward re-rating in US inflation expectations could also help steepen the bond-yield curve. Our Chart of the Week shows the possible path for US headline inflation should oil prices reach $50/bbl in March next year. Assuming constant inflationary pressures on all items except energy commodities, we calculated that the headline CPI would move from 1.1% to 2.2%. This is bearish for bonds and bullish for gold.
Regarding economic statistics this week, Canadian manufacturing sales advanced only 0.1% in July, but that follows a 0.8% increase in June. On housing, the Teranet home price index settled at 11.4% YoY (from 10.9%). As shown Wednesday, readings above 10% usually announce tougher times ahead for the housing market and Canadian banks. In the US, headline and core inflation accelerated to 1.1% and 2.3% respectively, driven by higher rents and a surge in healthcare costs. However, retail sales disappointed, declining 0.3% in August. Also, both August industrial and manufacturing production retreated 0.4% MoM. In Europe, the ZEW economic sentiment index for September improved (to 5.4 from 4.6). However, the trade balance surplus narrowed (to €25.3B from €30.2B) and industrial production declined 1.1% in July for a 0.5% drop YoY. In Japan, industrial production plunged 4.2% YoY (from -1.5%). Moreover, in India, industrial and mfg. production unexpectedly slipped into negative territory (-2.4% and -3.4% YoY) while inflation receded (to 5.1% from 6.1%), building a case for more rate cuts. Investors looking for bright spots had to focus on China where industrial production (+6.3% YoY), fixed asset investment (+8.1%) and retail sales (+10.6%) all beat expectations. Also, the monetary transmission mechanism seems well lubricated, considering money supply growth (M2) accelerated to 11.4% YoY. Undoubtedly China is going through a mini economic recovery this year.
Next week, we will focus on the Fed, the BoJ and flash PMI releases. Otherwise, we await retail sales and inflation in Canada, US housing statistics, the trade balance in Japan and home prices in China.
The Canaccord Genuity research included in the Legacy Wealth Weekly is solely for Canadian residents. To subscribe to our weekly newsletter, click here.
Legacy Wealth Partners