2015.07.20 Weekly

Global Weekly Strategies

Drop in oil prices caused by Iranian event led long-end rate decline last week. For longer-run, global low potential growth rate is consensus in line with so called secular stagnation, so long-end rate has implied this prospect since last year. And what is the key risk factor? It would be the inflation risk sooner and market started to consider this expectation or woes depending on upturning oil price from its trough at about 40 dollar per barrel. And then, what is affecting oil price mainly? It is likely EUR currency. In terms of demand power, main consumption demand of OPEC countries is decided by EUR, not USD mainly because their almost import came from euro area. That said, EUR is likely a key factor on global inflation or long-end rates.

Before Greece deal with its debtors, I expect Grexit and its impact would be very limited because huge investment banks such as JP Morgan and Barclays Capital argued the possible Grexit already. The main risk of Grexit is not an impact on Greece’s economy, but a contagion risk to peripheral countries including Spain and Italy. As European economy started to robust since late last year, the contagion risk in them would be very restricted, so it is a timely good chance to throw out the old risk from Greece, I thought. If then, ECB would consider whether they have to remain QE program started on the woes from Greece problem, and then bond rate could be pushed higher like the case of 2013, so called US QE taper tantrum. QE tapering by ECB could lead EUR appreciation against USD, and this affect oil prices to increase. Long-end bond rate would be much volatile in line with both of tapering and inflation woes.

How about US? Fed chair, Yellen signaled the possibility of the first rate hike in this year last week. She revealed somewhat woes about the timing of fist rate hike. If Fed hike rate earlier, they could increase rate slowly, but in opposite case, maybe they have to hike the rate quickly and this would be a bigger risk than first one. That said, Fed wants to increase funds rate earlier, but market implied rate does not consider the dot table by Fed. So, like a former case, EUR appreciation, could make markets plunge to frustration in US bond market as well.

However, Greece seems to remain in Euro area for some time on a deal with credit debtors, especially with Germany. Depreciated EUR and bullish peripheral bond was the ramification of this, I think. ECB commented they would remain their QE program in last week’s meeting.

Whether EUR against USD appreciate or not could be affected by the economic cycle in Euro area, after all. So, my base scenario would delay to be realized.

The market will show fluctuations, especially in yield curve and breakeven in TIPS. The inflation risk or exit from deflation fantasy would be subdued for 2 or 3 months. But, if spread between short-end and long-end rate moves wider or breakeven decline, increase the steepener position or buy TIPS against 10 yr straight bond. On the other hand, UST 5-30 or 10-30 spread seems somewhat wide. I recommend betting curve steepeners on 10yr rate and short or mid-end rate, not on 30yr rate.

And about China, the hottest spot in global markets? I’m somewhat frustrated about this, but in my base line, the fundamental in China would be solid in 2H this year showed by some data of exports to China of their main trade partners and property market prices. Anyway, last week’s data such as GDP, FAI, IP and retail sales seems bluffing.