Macro Highlights May 18th 2015

Analysis - 5/18/2015

Our Investment Research Department publishes a weekly newsletter with a round-up on the main economic developments and news flow.

Gold is rising in value as the dollar pulls back

Investors tend to think that the US Federal Reserve will raise interest rates later than it initially planned. The perceived postponement is weighing on the dollar, which has given back some of the hefty gains it chalked up in the past year. Last week the greenback shed another 1.5% of its value.

The dollar’s pullback is having a dual impact on the price of gold. As long as the US federal funds rate stays near zero, the metal will not be hurt by the fact that it pays no interest. Moreover, since it is quoted in dollars, it appreciates when the US currency declines. As a consequence, gold was bid up actively last week and rose to $1,232 an ounce, its highest level in three months. (...)

On the face of it investors believe increasingly in Abenomics.

Japan will report its first-quarter GDP data this Wednesday and, in all likelihood, they will reveal positive growth. GDP probably rose somewhere between 0.3% and 0.5% in the first three months of the year, in line with the pace observed in the fourth quarter of 2014 but well above last year’s average level. For the record, in 2014 Japan experienced its fourth recession in less than seven years following the 1 April hike in the consumption tax, from 5% to 8%.

But there is more good news. March brought Japan’s first trade surplus since the tsunami in 2011 and the shutdown of most of its nuclear power plants in the wake of the Fukushima disaster. Imports fell, weakened by the recent collapse in oil prices, while the yen’s depreciation continued to spur exports. In numbers, oil purchases were down 51% in March and imports of petrochemicals and liquefied natural gas down 38% and 12% respectively. At the same time exports rose 8.5%, led by machines, semi-conductors and automobiles.

Fitch has downgraded Japan’s sovereign debt from A+ to A, citing the authorities’ feeble efforts to reduce the budget deficit (see left-hand chart below). The government has put off the second uptick in the consumption tax until 2017 without providing for any alternate source of revenue. The corporate tax rate is high and could be lowered in the coming months. This would help companies heed calls for wage increases. (...)

Longer term Japan would greatly benefit from the Trans-Pacific Partnership (TPP), a colossal free-trade agreement that is being negotiated with the US and would involve 10 other Pacific Rim countries. (...)

Fundamentally it is hard to see the rally in Russian equities maintaining its current pace

Russia recently reported a 1.9% contraction in its GDP for the first quarter of 2015, confirming that the economy will not avoid recession in 2015. The decline followed last year’s nightmare combination of oil prices collapsing by half and the geopolitical conflict with Ukraine leading to international sanctions that have strangled trade and capital flows between Russia, on the one hand, and the European Union Union and the US, on the other.

Most of the country’s economic indicators are now pointing south. The rouble’s steep depreciation and the rationing of consumer goods subject to import restrictions have combined to drive inflation up to 16.4%, a level that impairs private consumption. In 2014 alone real wages shrank nearly 10% and automobile sales tumbled 42%.

Massive outflows of money and restrictions on foreign financing have left Russian companies starved for capital. They now mostly have to borrow from the central bank or the ministry of finance to obtain credit lines in US dollars. Inevitably private investment has slowed sharply and company profits have dwindled since the start of 2014.(...)

Finally, after spending $90 billion last year to defend the rouble, the central bank now says it will shore up its foreign exchange reserves by intervening in the currency market. (...)