FIN: Cotton and the future of crop prices, Americans ponder Canadian banks and Irish confusion
Today: Global markets are again in search of direction this morning as investors digest reports of radioactive fluid leaks in one of the Fukushima reactors and economists attempt to assess the growth fallout from slower activity in Japan. US index futures indicate a positive 27-point rise for the Dow at the open and a three-point climb for the S&P 500.
The trade-weighted US$ index is 20 basis points higher at time of writing to 76.34. Commodities are generally weaker with WTI crude 0.86 lower to US$104.54 and Brent crude down 0.67 to US$114.92. Gold is 1.2% or US$16.71 lower to US$1412.76 and silver is weaker by 0.80 to US$36.54. Copper has fallen 1.8% to US$4.3362 and nickel is also lower, falling 1.6% to US$12.0536. Aluminum, zinc and lead are all weaker by more than 1%.
Soft commodities were the focus of a Bloomberg story entitled “Cotton Rally Peaking as Farms Build Stocks on Record Crop,” which illustrates our base case for agricultural commodity prices this year. For cotton, record-high prices last year led to record-high planting this year and the market is expecting its first surplus in four years. Weather permitting, we expect a similar trend for most crops, although Macquarie research reports that the wet ground in the Canadian prairies may complicate the issue. The trend for fertilizer stocks is still positive – record planting needs high levels of fertilizer, but traders will need to pick their exit point carefully. Full story HERE.
Excerpt:
The rally that drove cotton prices to the highest since America was recovering from the Civil War is ending as farmers from Texas to New South Wales plant record crops and replenish stockpiles for the first time since 2007.
Cotton will drop 51 percent to $1 a pound by Dec. 31, according to the median in a Bloomberg survey of 14 analysts and traders. Hedge funds are already cutting bets on higher prices by the most in three years. Output may rise 11 percent to 127.5 million bales in the year that starts Aug. 1, three times faster than a 3 percent gain in demand to 120 million bales, the U.S. Department of Agriculture estimates. One 480-pound bale is enough for 215 pairs of jeans.
European markets are broadly higher, but just barely, as the Stoxx Euro 600 index stands 0.16% to the upside. Strength was evident in the telecom sector as Alcatel Lucent and Nokia Oyj rose 6.4% and 2.9% respectively after a positive report from Goldman Sachs. In Germany, election results in a previous strong hold for Angela Merkel’s party left investors in that country a bit nervous and caused selling in the euro. In the auto sector, Porsche dropped 2.8% after announcing a major equity issue at a discounted price to repay costs incurred during its merger with Volkswagen.
The MSCI Asia Pacific Index ended lower by 0.7% after reports indicated that Japanese workers have been unable to work on two of the Fukushima nuclear reactors because of radioactive water leaks. Tokyo Electric Power cratered an additional 15% on the news. Sony Corp fell 1.5% despite announcing plans to re-open its facilities in northern Japan by month end. Taiwan’s Acer Corp decreased 6.9% after management projected a 10% decline in personal computers for the current quarter. China Construction Bank declined 2.9% after its quarterly results, showing 26% increase in profits, fell short of market expectations. Shipbuilder Cosco corp Singapore added 2.5% after announcing a deal to build two drilling platforms.
A Barron’s story predicted that AT&T stock will rise 15% if its planned acquisition of Deutsche Telecom’s T-Mobile network is approved by regulators. Goldman Sachs cut its rating on coal provider Peabody Energy this morning, pushing the stock down 1.3% in pre-market trading, in a rare show of skepticism for the industry. Copper miner Freeport McMoran climbed 1.1% after Morgan Stanley raised the stock to overweight.
The federal Conservative election strategy came more into focus over the weekend with PM Harper accusing the opposition parties of “threatening Canada’s recovery” with their policy suggestions. The election will be May 2.
There is a ton of moving parts in Europe at the moment, particularly in Ireland where new bank stress tests are expected to show the need for an additional €68 billion in support for Ireland’s bottomless pit of bad debt banks. At the same time, the new Irish government is demanding that senior bank debt holders share in the burden (i.e. accept a reduction in principal on bank bonds) to assist the Irish government to repay ECB/IMF bailout loans. In Spain, Bloomberg reports that the country is building a “firewall” against institutions and hedge funds looking to short their sovereign debt. Links for more info:
ECB plans emergency €60bn scheme for Irish banks – Irish Times
Ireland Update: Stress Tests, New ECB Liquidity Facility, and ... bondholder haircuts? — Calculated Risk
Spain Is Building a 'Firewall' Against - Contagion, Pimco’s Bosomworth Says – Bloomberg
US-based website Marginal Revolution, written by George Mason economics professor Tyler Cowen, ponders the success of the Canadian banking sector relative to its global peers, complete with links, HERE.
Excerpt:
Here is one MR reader request, from RW Rogers:
Is it true that Canadian financial institutions have been relatively unscathed by the recent worldwide economic turmoil and that they were relatively unscathed during the Great Depression? If yes, why?
The Great Depression is a straightforward story, here is an excerpt from Paul Kedrosky:
Despite being adjacent geographically and tightly connected economically, banks failed in Canada and the U.S. at very different rates. Specifically, no Canadian banks failed in the period, while more than 8,000 U.S. banks failed.
Why? Among other reasons is the different structure of the systems, with Canadian banks having a branch banking structuring, making them less tied to any specific region or customer. For their part U.S. banks in the period were larger in number but smaller in assets, with far more single-branch banks in the U.S. than in Canada (where there were virtually none). The larger branch network created resilience, not just in terms of assets but in terms of markets.
What about the noughties? Nick Rowe makes some relevant points: Canada has fewer major banks and they are more tightly regulated, hold more capital, and housing is not encouraged so much by law. It is harder to walk away from an underwater mortgage.
Here is Megan McArdle on Canada.
Simon Johnson explains why the Canadian model cannot work for the US. Most significantly, the U.S. banking system is in part the Canadian banking system, not so much for deposits but for high-risk activities. That makes Canadian banking look safer, but of course Canada as a country bears a lot of risk from when the U.S. banking system goes bad.
Tangent: Marching band play Rage Against the Machine’s “Killing in the name of”
Read of the Day: We expect that one of the primary issues for economists and investors in the next few decades is going to be the effects of the US Federal Reserve’s protection of asset values, including equity values, through monetary policy. Psy-Fi blog tackles the issues HERE. Excerpt:
The centrepiece of the Volcker led reforms was to remove the commitment to gradualism, allowing the imposition of a monetary shock on the markets. The aim was to be able to adjust rates in line with changes to inflation, rather than dragging along in its wake. However, the real problem of fixing inflation may not have been economic at all, but political. As former Fed Chairman Burns recalled:
“As the Federal Reserve … kept testing and probing the limits of its freedom to under-nourish the inflation, it repeatedly evoked violent criticism from both the Executive establishment and the Congress and therefore had to devote much of its energy to warding off legislation that would destroy any hope of ending inflation”.
Bloody politicians. Anyway, cometh the moment cometh the man and the man, in this case, was Ronald Reagan whose monetarist leanings perfectly complemented Volcker’s ambition even though, as Lindsey, Orphanides and Rasche argue in The Reform of October 1979, he wasn’t particularly convinced of the ability of any bunch of economists to determine anything.
With economic policy and political will aligned the Fed was able to institute and maintain an inflation dampening approach for long enough to convince people that they really meant it. And with this, the psychology changed and that changed everything. Inflation fell, remained low and helped trigger a near twenty year boom. It was economic reflexivity in action.
Pavlov Dog Markets
Fast forward thirty years and we have a different problem but one with the same overtones. Repeated economic crises have given rise to a Pavlov dog type response by central bankers: flood the world with cheap cash while maintaining gradualism in interest rates policy so as not to spook the markets. Now the markets expect this every time something goes wrong such that moral hazard is almost ingrained in people’s behaviour.
Even as we speak cheap government money designated for loans to home owners, entrepreneurs and small businesses is being funnelled to speculative and higher growth regions: a commodity boom will doubtless soon follow, with a bust somewhere around the corner. The constant ebb and flow of the markets in this way can’t continue and eventually some combination of political will and regulator foresight has to be summoned to break the current market psychology.
It can be done, Volcker did it. Just don’t underestimate how bad things will have to get before it happens again.
Economy and Fixed income (James Price): Bonds continue to slide this morning, sending Treasury yields to the highest levels in several weeks as the market anticipates the end of QE2. Come June, the Federal Reserve will stop purchasing bonds and many, including prominent bond market figures like Bill Gross of PIMCO, are wondering who will fill the void and step up to purchase the billions in Treasury bonds that the Fed now buys. With the US congress continuing to run huge budget deficits (US$222-billion in February alone and averaging US$110-billion over the last year) the one thing everyone is sure of is that the supply will continue.
We will argue that the buyers will come when the price is right - it is just a matter of what price is right. With other assets providing returns that easily outstrip those of Treasuries lately, the market has not been paying much attention to the credit-safe side of the equation, so we actually need to worry about the relative price of Treasuries more than their outright price. As an extreme example, the huge rally in treasuries in 2008 started with the 10-year at 3.90% (and ended at 2.25%) — hardly what most would consider a "cheap value" play, but the relative pricing of assets was important.
With relative pricing in mind, it looks like the markets are content to continue on their path, putting worries in Europe (more downgrades in Portugal, the Merkel government falling in Germany, Irish government threatening debt holders), Japan (further radiation leaks), and the Middle East (unrest and oil supply disruption) behind while they continue to add risk. Bonds were moving lower around the world and equity indexes were generally higher ahead of the US Personal Income data.
U.S. Personal Income and Spending came more or less in line with expectations, Income rising 0.3% and spending rising 0.7% in February. Income is a slowdown to the pace of growth in January, while spending has up-ticked - not a sustainable trend to be sure, but still a "good" sign for consumer confidence. This has the PCE deflator, one of the Fed's preferred measures of inflation, running at 1.6% year-over-year in the headline and 0.9% in the core. Both these measures are upticks over January, but still won't be worrying from the FOMC's perspective. Bonds are ticking slightly lower on the release of the data, but mostly just continuing the pace that was set overseas.
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