Article / 16 March 2015 at 11:01 GMT

Daily Shot: Don't fear the Fed's rate hike Team / Saxo Bank
  • China admits its economy might slow down
  • Energy prices are under pressure and weakening the Canadian Dollar
  • US companies are well prepared for rate hike
By Walter Kurtz

Let's begin with China, where the economic slowdown may end up being worse than originally projected. Even without thinking about growth fundamentals, when you have a 10 trillion dollar economy, a 7% annual growth is larger than the whole GDP of Sweden or Poland. The sheer size of China's economy relative to the rest of the world will limit its growth rate. China's authorities openly admit the growth challenges the nation faces.

Last week I discussed some economic indicators that came in materially below consensus, namely fixed asset investment growth, industrial production, and retail sales. But there is a slew of other indicators as well that seem to support the view that China's slowdown is sharper than originally thought:

1. China's rail freight volume
 Source: @SBarlow_ROB

2. Hong Kong jewelry sales and Macau gaming revenue
3. Hong Kong industrial production growth
4. China's industrial commodities markets. Here is the Shanghai Futures Exchange hot-rolled coil May futures contract:

Source: barchart 

When some of these as well as other metrics are combined into the Bloomberg China GDP Tracker (discussed Friday), we are looking at a growth rate that is below 6.5%. While still tremendous relative to much of the world, this viewed as a significant slowdown for China.
Monetary conditions such as the strong yuan (which has risen sharply with the US dollar) as well as the unusually high real rates will further dampen economic growth. For example for certain types of manufacturing, a US firm may now choose Mexico over China as the yuan has become much more expensive relative to the peso (in addition to lower shipping costs due to proximity). 
Slowing growth would suggest that China's equity markets should be under pressure. Just the opposite is taking place however - the Shanghai Composite is near multi-year highs.

Shanghai Comp
 Source: barchart

The reason has to do with stimulus expectations. Economic weakness (relative to historical growth) has been so pronounced, Beijing is ready to provide monetary and fiscal support.
FT: - “Under this ‘new normal’ state we need to ensure that China’s economy operates within a proper range,” Mr Li told Sunday’s press conference. “If our growth speed comes close to the lower limit of its proper range and affects the employment and increase of people’s incomes, we are prepared to step up targeted macroeconomic regulation to boost market confidence.”   

How effective such stimulus will be remains to be seen but Beijing will certainly make an all-out attempt to avoid a "hard landing".
I've received a number of questions on weak currencies and strong stock markets. Here are a couple of examples.
Argentina's stock market on fire. With currency controls in place many do not want to sit on cash pesos and watch them melt away under a 30% inflation rate.  


In Japan it's not about inflation. Instead the weaker yen is supporting export growth and makes the revenue generated in the US more valuable in yen terms. The Nikkei 225 hit a multi-year high.  


These returns however could still result in poor performance in dollar terms. That's why currency hedged ETFs are so popular these days. 

We are starting the week with energy under pressure again as the April WTI contract drops below $45/bbl (with unusually high volume for Sunday night).
Source: barchart   
In the long run crude oil will remain capped at $80/bbl - which is where massive amounts of shale extraction becomes profitable. Unless we see a major conflict that could disrupt supply, we are not going to see $100 oil for years to come.   

  With this renewed weakness in energy, the Canadian dollar hit a new multi-year low (now worth USD0.778).


Deflation continues to spread globally, with Israel's economy becoming the latest example. 
In the Eurozone the economists' projections for the euro look increasingly dire. Goldman is forecasting the euro at USD 0.80 by 2018. 

 Source: GS, Business Insider, @themoneygame 

In the United States analysts are attempting to understand the impact of an early Fed rate hike (potentially as early as this summer). Here is what Deutsche Bank had to say:


The Fed continues to be focused on job creation that is expected to push wages higher. We haven't seen much direct evidence of that up to now - particularly for unskilled labor. Nevertheless, below is part of the argument the FOMC will use to justify a rate increase



Source: Deutsche Bank

Speaking of the impact of monetary policy, the US corporate sector benefited greatly from the Fed's quantitative easing. Lower rates resulted in declines in interest expense. 


Source: Citi 

Moreover, corporations were able to lock in these lower rates for some time to come. This is another argument I hear for the minimal impact of a rate hike. 


Source: Citi

Which sectors will be most impacted by higher rates? Here is a great chart form Citibank.

Source: Citi

The latest US Census data suggests that household formation since the crash of the housing market in 2006 (not 2008 as many mistakenly believe) has been entirely driven by renters. That trend seems to persist. 

 Source: @NickatFP ( 

The US banking system's exposure to residential housing debt is increasingly in the form of agency MBS rather than mortgage loans. New liquidity ratio requirement is one of the reasons. This is unfortunate because it means that the US federal government will continue to dominate home finance via the GSEs.


Source: @SoberLook 

Now some food for thought -
 1. This is a bit dated but it drives the point home with regard to the higher education bubble in the US. The chart shows college cost measured in number of hours of work at an average wage.
 Source: @Mark_J_Perry 

  2. Cost of new drugs hitting the market is rising incredibly fast. Here is the situation with cancer drugs

 Source: @BBGVisualData   
3. For those concerned about artificial intelligence taking over the world, don't hold your breath. Here is an example of how some news bots are naming their stories.
 h/t: @RonaldKlain  

4. Women are now a majority of university students around the world.



Source: @JustinWolfers, 

5. Military spending for select nations - in dollar terms and as a fraction of the GDP. 

– Edited by Clemens Bomsdorf
* Walter Kurtz is an alias
** This is an abridged version of the Daily Shot. To subscribe to the full version, link to the Daily Shot and select the appropriate command. E-mail addresses are never shared with anyone.


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