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Broadgate: Weekly Briefing 13/8

13 August 2013

Chinese Economic Data Points To End of Slowdown – China’s economy could be stabilising, the latest set of economic figures from the country has suggested. Factory output in July rose 9.7% compared with a year ago, ahead of expectations and up from the previous month’s figure of 8.9%. Consumer prices held steady in July, rising 2.7% from a year earlier, matching the rate seen in June.

China’s growth rate has been slowing at its fastest pace since the global financial crisis in 2008. In the second quarter of the year, China’s economy grew by 7.5% compared with the previous year, down from 7.7% in the January to March period. The government has set a target of 7.5% growth for the whole of 2013, which would mark the lowest rate of expansion in more than two decades.

In other data released on Friday, the producer price index fell 2.3% in July from a year earlier compared with a drop of 2.7% in June. However, although July’s retail sales jumped by 13.2% compared with last year, that was a slower pace of growth than the 13.5% recorded between June 2012 and June 2013. On Thursday, trade figures showed export and import growth rebounded in July.

Analysts welcomed the latest data, but said more evidence would be needed before it would be safe to say whether the economy was beginning to pick up again. You Hongye, economist at Essence Securities, said: “Broadly speaking, economic growth is stabilising and recovering slightly, but we still need to see whether the momentum could be sustained.”

Xu Dongshi, from Galaxy Securities in Beijing, said: “The easing PPI drop also implies signs of stabilising of the industrial sector. But it’s still too early to say that China’s economy is on the track of rebounding as it takes time to resolve economic structural problems.”

Japan’s Debt Exceeds 1 Quadrillion Yen as Abe Mulls Tax Rise – Japan’s national debt exceeded 1,000 trillion yen for the first time, underscoring the case for Prime Minister Shinzo Abe to proceed with a sales-tax increase to shore up government finances.

The country’s outstanding public debt including borrowings reached a record 1,008.6 trillion yen (USD 10.46 trillion) as of 30 June, up 1.7 percent from three months earlier, the finance ministry said in Tokyo on Friday. Larger than the economies of Germany, France and the U.K. combined, the amount includes 830.5 trillion yen in government bonds.

The world’s heaviest debt burden will weigh on Abe when he decides next month whether to implement a two-step plan to double the tax on consumers in a nation with ballooning welfare costs. While boosting the levy would drag on growth, Moody’s Investors Service yesterday warned that a worsening of finances would erode confidence in government bonds.

“Ballooning public debt underlines the need for Abe to push for a sales-tax increase,” said Long Hanhua Wang, an economist at Royal Bank of Scotland Group Plc in Tokyo. “This is a minimum policy requirement for his government.”

The levy on consumption is due to be raised to 8 percent in April from the current 5 percent, followed by an increase to 10 percent in October 2015. Abe said he would make a final call on the plan after the release of revised second-quarter gross domestic product data on 9 September.

The sales-tax law enacted last year gives Abe the power to postpone the rise should he conclude that the economy is unable to weather the austerity measure.

Russian GDP Unexpectedly Slows – Russia’s economy unexpectedly slowed in the second quarter to extend a slide that’s threatening to push the world’s largest energy exporter near recession.

Gross domestic product expanded 1.2 percent from a year earlier, the Federal Statistics Service in Moscow said today in an e-mailed report. That was below all 19 forecasts in a Bloomberg survey, which had a median estimate of 2 percent. The Economy Ministry had projected that output expanded 1.9 percent in the period.

The surprise deceleration underscores the challenges Russia faces from weaker global demand for its commodities, which is compounding a domestic slowdown. Russia’s central bank left its main rates unchanged for an 11th month today while signalling increased concern about economic expansion.

“Second-quarter GDP is seriously disappointing and is a very strong argument for monetary-policy easing,” said Piotr Matys, an emerging-markets economist at 4Cast Ltd. in London. “Weak external demand and investments are still the main drag on the economy, but we suspect that final consumption, which has been the only relatively strong component so far, may have weakened as well.”

Spotlight On: Schroder’s Global Macro Economic Outlook

Bob Jolly, Head of Macro at fund manager Schroders, gave his views on the global macro economic outlook this week.

“We expect market volatility to remain high in the coming months and have moved to a more cautious stance. However, volatility creates opportunity for active fund managers, so we are remaining vigilant for mispriced investment opportunities to exploit when markets overshoot in either direction.

Looking ahead into the remainder of 2013 our central expectation is that the US will continue to slowly accelerate and exit so-called ‘stall-speed’ growth. Banks have been loosening their credit standards, companies are increasing their capital expenditure and the house prices are starting to accelerate. There has already been a shift in the Federal Reserve’s thinking due to the gradual economic improvements – away from Quantitative Easing and towards tapering – and this has caused a great deal of market volatility.

Elsewhere, the story is less positive. In China, for example, data suggests that economic activity resulted in an investment splurge following the credit crisis of 2008, leading to over-investment across sectors such as infrastructure and export companies. In our view this has resulted in overcapacity. Furthermore, this over-investment was funded by debt, resulting in rising levels of household and corporate debt. Indeed, data suggests Chinese households have never been so indebted.

However, much of this has been priced into market valuations so we are not too negative on China from an investment perspective. In addition, the government is making the longer term outlook more promising by putting its emphasis on encouraging quality of economic growth, rather than quantity by enacting policies that focus on moving the economy from being export-driven to a more consumption-based model.

Europe’s situation, meanwhile, is concerning and in some respects we believe economic conditions are worsening. Bank lending is contracting, the output gap has continued to grow and, with inflation falling sharply, it appears the European Central Bank has not been aggressive enough. The eurozone is already closer to deflation than many believe and tax increases (particularly duty and VAT) have been disguising underlying disinflationary pressures. In Spain for example, if you exclude taxes from its headline inflation rate, then the country is already seeing disinflation. Adding to the uncertain outlook for the eurozone is the upcoming German election in September, political posturing in the run-up to which could be an additional source of market volatility.

In the UK policymakers’ focus has been on boosting growth by kick starting the housing market. So far this has been positive as the economic backdrop is improving. However, we believe that it is too early to become optimistic, as inflation has acted as a tax on incomes resulting in falling real incomes for the UK population.

In our portfolios we will be closely watching market volatility that is likely to ebb and flow around expectations of central bank actions. Following recent market falls we have been seeking to add to positions which have become less crowded, but we are not adding aggressively to risk markets.

The key in such an environment is to be nimble. On the duration front, for example, we expect market noise to cause movements in government bond yields and present opportunities on both the long and short side.

Currently we have a neutral duration stance. However, we have been buying some duration at the front end of the yield curve in Europe as we think the market has priced in rate hikes that are unlikely to happen given the economic outlook for the eurozone. Meanwhile we have a short exposure to 10-year US Treasuries as we think the US economy will continue to improve and yields could grind higher.

On a country basis we now have zero exposure to peripheral eurozone sovereign bonds after we took profits from our Portuguese and Irish positions earlier in the quarter.

Valuations in the credit market do not look particularly attractive compared to history. However, regardless of Fed tapering, we are in an environment of abundant liquidity, low interest rates, and there is little prospect of inflation in the near future given the size of output gaps. As a result, cash is unlikely to appeal to investors and credit markets will continue to be underpinned by the hunt for yield. We continue to follow a thematic approach to help identify the most attractive credits. In a difficult overall environment for credit, we think prudent credit selection backed up by rigorous research will be rewarded.

Within foreign exchange, we no longer have a short exposure to the Australian dollar, but maintain our short exposure to the Japanese yen, which we expect to be the world’s weakest currency. Recent positions we have favoured include a long position in the Indian rupee and a long exposure to the Russian ruble. We have also recently implemented a short position in the Chinese renminbi.”

BWB

The information set out herein has been obtained from various public sources and is by way of information only. Broadgate Financial can accept no liability of any sort in relation thereto and readers should obtain their own verification of any statement before making any decision which may have any financial or other impact.

Neither the information nor the opinions herein constitute, or are they to be construed as, an offer or a solicitation of an offer to buy or sell investments.

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