US Elections, Industrial Commodities and China
Latest US opinion polls have shown a shift in favour of Clinton winning the Presidential race, but with the outcome of today’s US Presidential election still uncertain we take the opportunity to discuss nonelection related issues. There are a few observations worth noting supporting our view of the USD rally resuming against low yielding currencies while higher yielding EM currencies remain bid for now. First, the current US bond yield rise has been almost entirely supported by rising inflation expectations, keeping real rates low. With the Fed leaving the impression that it does not plan to raise rates ‘ahead of the curve’ the term premium within the US bond market has remained glued near recent historic lows. Low real rates and a low term premium work in favour of risk appetite helping in particular the financial sector when accompanied by an inflation expectation driven increase in nominal bond yields and a steeper nominal yield curve environment. Yesterday’s 2.2% SPX gain saw financials outperforming, gaining 2.6%.
Secondly, a better performance of financials helps to create conditions for an increase of the money multiplier (see here for details), projecting an easing of lending standards. According to the US senior loan officer report, lending standards tightness reached its highest level since 2010 in April this year, but has eased since then Yesterday the Fed’s Labor Market Conditions index rose to 0.7 in October following a revised 0.1 point decline in September (revised from -2.2).

Third, while most market participants follow oil prices cent by cent, the rally seen in non-oil industrial commodities has remained unnoticed. Iron ore has gained 38% from its September low and the broader CRB RIND Index has gained 3.9% in the same period. Better raw material demand comes along with a better reading of global manufacturing PMI’s. Higher commodity prices should add support to global inflation expectations which we think will weaken low yielding FX and work in favour of the USD.

Fourth, China seems to be tightening monetary conditions trying to avoid the overheating housing market reaching financial stability threatening levels, while remaining loose on the fiscal side. This impression has been supported by a WSJ article suggesting that the replacement of the previous FinMin Lou Jiwei – an internationally recognised advocate for market oriented reform and fiscal prudence – by Xiao Jie may have cleared the way for the resumption of LGFV borrowing and fiscal deficit expansion. Current Chinese data are consistent with an economy adjusting towards a shift from monetary towards fiscal expansion. While October bank lending declined (according to MNI), Beijing property agents saw revenues declining between 40- 50%,new home sales growth weakening from a 34% growth rate towards a 12%Y rise, China’s rail freight volumes rose 8.4%Y in October reporting its third consecutive month of growth. Yesterday saw the release of China’s FX reserves, declining by 46bln. While this decline was the biggest since January it has been driven by a USD37bln decline in the valuation of existing reserves. The chart below shows that reserves minus the valuation effect thas actually improved.