Macroeconomic Overview: Weaker global economy

The turmoil in financial and commodity markets, combined with the release of discouraging economic data, have caused concerns of a slowdown in global growth, leading to calls for major policy stimulus measures at the weekend’s G20 meeting. However, US policymakers in particular are taking a more indulgent view on the world economy. We suppose that the G20 meeting won’t result in significant new growth initiatives. Furthermore, it is likely that market reaction will probably be negative on the back of the meeting.

Global growth

According to the Organization for Economic Cooperation and Development‘s (OECD) recent expectations, 2016 global growth will remain at a 5-year low. It reduced world GDP growth forecasts for 2016 to the 2015 rate (i.e. from 3.3% to 3.0%), which is the slowest since the 2009 crisis. The OECD mentioned some reasons for why “stronger growth remains elusive”, such as: 1) weak trade and investment, 2) weakness of commodity-producing firms and commodities-exporting countries, and 3) inactive demand discouraging employment and wage growth. Moreover, we now have the weakest global trade since the world financial crisis, with only 2% growth in 2015, significantly lower than GDP growth, which has resulted in considerable problems for trade-related countries. For instance, early this year, exports contracted the most since 2009 in Singapore (-9.9), China (-11.2), Japan (-12.9%), South Korea (-18.8%), and Indonesia (-20.7%).

Fed rate

Several Fed officials, according to the latest Federal Open Market Committee (FOMC) minutes, noted that the US economy faced expanding downside risks and the recent pressure on financial markets might be roughly equivalent to the tightening of monetary policy. It means that the actual number of rate hikes may be less than the Fed’s expectation of four times during 2016. In Jefferson Trust’s opinion, the US can normalize its monetary policy with three rate hikes this year, if we see a further recovery of the US economy, evidenced by several factors such as 1) a strong labor market with jobless claims staying below 300,000 for 50 consecutive weeks, the longest period since the early 1970s; and 2) an expansion in industrial production with 0.9% growth in January, the biggest rise in 14 months and capacity utilization unexpectedly rising to 77.1%. Furthermore, the Fed Chair said that the central bank still expected to raise rates at a gradual pace this year, despite the recent weakening of global economy and a plunge in global stocks early this year.

Oil in a global economy

In the hopes that the Saudi-Russian agreement on freeze in oil production would lead to lower production and higher prices, the oil markets climbed in the last week. When it became clear, however, that countries adhering to the pact were already pumping oil as fast as they could and had little or no interest in lowering production unless forced to by resource availability, the markets began to fall.

Russia announced that its January production, the level at which the production freeze was based, was so good that if it can maintain that level through the year, 2016 production will be 1.9 percent higher than in 2015 despite the cap imposed by the pact. Iran says it is on track to increase production by another million barrels per day (b/d) or more this year, and Iraq is looking to increase its output by 400,000 b/d. Bakken production was down by what can only be termed a measly 28,000 b/d in December, given the roughly 1.5 million b/d of excess production in the world.

The global oil industry continues to face a sea of troubles, as has been the case for many months now. In March, shale oil drillers will have to pay $1.2 billion in interest. Moreover, Deloitte recently made a prediction that one-third of US oil producers could go into bankruptcy this year. The deepwater sector of the oil industry is facing even more problems. Deepwater projects are very expensive and take years to complete, so projects of this size simply cannot be readily shut down. Most of these projects are being pushed to completion without the necessary revenues from other producing projects to pay for the drilling. Deepwater projects not yet started have been canceled or postponed until prices increase.

China

The situation on the oil market is just one reason behind the uneasiness in financial markets. Many experts are worried about a possible Chinese hard landing. There are some concerns about China’s ability to control its exchange rate, since we can clearly see the country’s declining FX reserves. Moreover, there can be a possible bad loan problem. The pain in China is spreading to other emerging economies, partly through manufacturing trade and partly through energy and commodity markets. However, financial strains appear less pressing there. Even though the forecasts for such highly commodity-dependent countries as Russia and Brazil have not been encouraging, there is a limited risk that either one of them will become financially unstable.

Currencies

In the nearest future we will probably see USD downside pressure amid cooling expectation of the Fed’s rate hikes and appreciation of safe haven currencies on market volatility. However, in the medium term, if the global economy slows down considerably, funds may flow back to USD for risk aversion.

The euro has been pressured recently due to different factors, such as the increasing possibility that the European Central Bank (ECB) will soon act to implement additional monetary easing measures. ECB President Mario Draghi recently showed a strong willingness and readiness to do so. The eagerly awaited ECB Press Conference, scheduled early next month, should provide some guidance as to what those easing measures may entail. Also pressuring the euro has been the increased threat of deterioration in the European Union, most notably by an upcoming referendum in the UK to vote on whether or not it stays in the EU.

The Japanese Yen, could see a big volatility if the world’s top central bankers surprise markets and issue strong statements or announce fresh policy responses to ongoing market turmoil. Of course a key theme is ongoing FX market volatility itself – any signs of cooperation among G20 central bankers would likely force big moves across the board.

Both onshore Yuan (CNY) and offshore Yuan (CNH) rates moved little last week, closing slightly lower against the USD on Friday. The past week has been a ‘big’ week for China with Chinese securities regulator stepping down and China hosting the G20 meeting. These events can bring lasting impacts: from March 3, Chinese top policymakers will host pivotal annual meetings and are expected to release annual government budget plans and policies, which could certainly drive the Yuan.

Precious Metals

As uncertainty in the financial markets continues we can see that last weeks were dominated by a counter-movement with stock markets gaining and decreasing gold prices. Investors use price setbacks for purchases, currently focusing their demand on investment coins. But the gold exchange traded funds (ETFs) are attracting further buying interest too: according to the news agency Bloomberg, holdings increased by 154 tons in the first weeks of this year. This figure is even more impressive compared with the fact that outflows only reached 138 tons during the entire last year. Contrary to the strong ETF inflows and a stable physical demand in Europe there is a rather modest buying interest in China and India.

As long as the combination of growth concerns in China, falling oil and stock prices endures, gold will continue to be attractive to investors who reallocate their portfolio in this environment to “safe havens”.

In relation to gold, silver has not traded on such a low level in years and seems to be undervalued. Jefferson Trust’s analysts expect to see further increases in silver prices because of the solid physical demand.

Investment recommendations from Jefferson Trust

Equities

• In a world of low growth and low returns, dividends continue to be an important element in earning income from equities.
• The healthcare sector is experiencing good earnings growth, based on demographic trends related to aging and a rising middle class in emerging markets. Most of these companies also have strong financials, with regular share buybacks, and are announcing dividend increases.

Bonds

• Stay underweight in fixed income
• Since developed world government bonds are expensive and offer poor absolute value, prefer products with limited interest rate risk.

Endnotes

1. ASPO USA: “Peak Oil Review-22 Feb 2016”,Tom Whipple, 2016,<http://peak-oil.org/peak-oil-review-22-feb-2016>;
2. Utilitywise: “Weekly Energy Market Review-25 February 2016”, Paul Anderson, 2016, <https://www.utilitywise.com/2016/02/25/ weekly-energy-market-review-25-february-2016/>;
3. Krungsri research: “Weekly Economic Review”, 2016, <https://www.krungsri.com/bank/getmedia/48c45c4e-b2c0-4c22-9e4f-9b2e0 dc21bba/Research-weekly-24022559.aspx>;
4. Commerzbank: “Week in focus”, 2016, <https://www.commerzbank.com/media/en/research/economicrese arch/aktuell1/wif.pdf>;
5. DailyFX: “Dollar Gains as Market Chews Rate Expectations with NFPs Ahead” ,  John Kicklighter, 2016, <https://www.dailyfx.com/ forex/fundamental/forecast/weekly/usd/2016/02/27/Dollar-Gains-as-Market-Chews-Rate-Expectations-with-NFPsAhead.html?ref -author=DFXGeneric>;
6. DailyFX: “Japanese Yen Forecast to Gain until Status Quo Changes”, David Rodrigez, 2016, <https://www.dailyfx.com/forex/fund amental/forecast/weekly/jpy/2016/02/27/Japanese-Yen-Forecast-to-Gain-until-Status-Quo-Changes-tofDR.html?ref-author=DFX Generic>;
7. DailyFX: “Yan a Key Topic at Chinese Annual Conferences”, Renee Mu, 2016, <https://www.dailyfx.com/forex/fundamental/article /specialreport/2016/02/26/Yuan-a-Key-Topic-at-Chinese-Annual-Conferences-TOFrm.html? ref-author=DFXGeneric>;
8. Handelsbanken Capital Markets: “Monthly Macro Update”, 2016, <file:///C:/Users/HP/Downloads/Monthly %20Mac ro%20Update %2017%20february%202016.pdf>;
9. Danskebank: “Weekly Focus”. 2016, <http://www.danskebank.com/en-uk/ci/Products-Services/Markets/Research/Documents/ WeeklyFocus260216.pdf>;
10. Heraeus: “Precious Metals Update”, 2016, <http://heraeus-trading.com/media/webmedialocal/media/pdf/ marktberichteenglisch/ Heraeus_Precious_Metals_Update_20160222.pdf>;
11. Nabprivatewealth: “Asset Allocation”, 2016, <http://business.nab.com.au/wp-content/uploads/2016/02/ Private-View -February-2016-Asset-Allocation.pdf>;
12. Citybank: “Weekly FX Insight”, 2016, <file:///C:/Users/HP/Downloads/fx_insight_e.pdf>;
13. Forex.com: “The Weak Ahead: Week of February 29, 2016”, 2016, <http://www.forex.com/post?SDN =31eee 801-3385-41bd-be47-7ff 68d6e530f&Pa=5b9e00f7-1868-4c89-a976-4ce50f9d8e4c>.