Macro Commentary
Macro matters. That has been the case since the global financial crisis and the first week of 2016 sought to remind us of that fact. These first days of the year seemed an onslaught of information which heaped onto the pile of stress for financial markets. Geopolitics heated up in the Middle East with news over the weekend that Saudi Arabia had cut diplomatic ties with Iran. The cut in dialogue occurred after the bombing of the Saudi embassy in Tehran stemming from the execution of a prominent Shiite cleric among 47 others convicted of terrorism. As if Saudi military action in the region along with economic fragility from low oil prices were not enough to give pause. Interestingly, crude oil prices fell on the week showing no interest in adding a geopolitical premium to low prices. Even odder in this low price environment, the Saudi government confirmed that they were considering an initial public offering for the state-owned oil firm Aramco. While it is unclear how much in reserves the company has, it is speculated to be 10x the amount Exxon Mobil (the largest private oil company) which has a market cap over $300bln. While the official report suggested that the option was about improving governance at the company and attracting investment into the country, it could be speculated that they are looking to unlock the value of the equity “currency” as a way to fund any government needs that may arise from prolonged low prices. A Saudi turn to oil prices as a tool of economic warfare against Iran (instead of focusing on US shale) would be a bigger blast than the rumored hydrogen bomb supposedly tested by North Korea…also this week.
On the economic front, Euro-area inflation clocked in at a paltry 0.2% last year primarily due to falling energy prices and the Bank of Japan Governor Kuroda commented that the Bank of Japan would have to be even bolder to reach their 2% inflation target. But the real fear stemmed from the continued devaluation of the Chinese yuan relative to the USD which now rests about 2.5% lower than when it was abruptly revalued in August 2015. Clearly the Chinese are seeking to focus the yuan’s relative value towards a trade-weighted basket of 13 currencies to reduce the economic tightening that came from their past focus on the US Dollar after a period of significant strength. The local Chinese equity markets, however, sold off considerably falling 7% in each of two days causing circuit breakers to trip and bringing trading to a halt. Again, the government tried interventions into the equity markets and failed. The result is that global equity markets, and commodity producers particularly, took a hit as traders worried about what an economic slowdown may do to the global economic recovery. Finally on Friday, a stronger than expected US jobs report showed that 292k jobs were added (a big beat from the 200k expected) showing that the US remains on a positive economic track…and on the trajectory for further Fed action in 2016.
So, the driver of the market narrative at this point is China. Unfortunately, China is also where there is little transparency of data and little confidence in data that is released. We continue to believe that the local Chinese equity market is not a relevant indicator for their economic prospects, but without other information traders will look to what they can. We will continue to monitor all of these macro matters as we go forward into 2016.