by Bill O’Grady and Kaisa Stucke

[Posted: 9:30 AM EDT] As noted above, global equity markets are lower this morning in a quiet trade.  There wasn’t much news overnight and the trade looks like it is taking a breather today after a strong day in the U.S. yesterday.

One market that had a strong day yesterday was soybeans.

(Source: Bloomberg)

This chart shows the nearest soybean contract over the past three years.  Prices have been edging higher since mid-March.  A combination of factors has affected soybeans.  First, Brazil has been experiencing dry conditions.  Worries about the Brazilian crop, coupled with rising political turmoil (the Brazilian Senate votes today on impeachment proceedings—we expect them to vote to start an impeachment trial with the news coming out this evening), have raised worries about soybean supplies.  Then, flooding in Argentina has raised fears that some of the crop will be lost.  Although analysts always assume normal weather, there is an elevated chance of drought in the U.S. this summer if a La Niña develops.  Yesterday, the USDA estimated that global soybean inventories will decline 8.1% this year and end the season at 68.2 metric tons (mt), which is well below analyst estimates of 72.9 mt.  Corn inventories were also forecast lower than analyst estimates, at 1.8 billion bushels, but due to increased planted acreage the market expects a record U.S. harvest for corn this year.  Of course, if the weather fails to cooperate, that record crop won’t materialize.

Rising grain prices tend to eventually show up in rising food prices as corn and soybean meal are key inputs.  Although the relative importance of food to the U.S. household budget is relatively low, studies have shown that lower income households tend to spend more on food than their wealthier counterparts.  Thus, rising food, especially meat prices, could become an election issue by November.

First, this chart shows the relative importance of food and meat to the CPI.

Second, meat prices have declined after years of strong growth (see chart below).  Meat prices are also affected by drought; we have seen a sharp drop in the cattle herd in recent years, although reports indicate that the herd is building again.  A rise in corn and soybean meal prices should filter into higher meat and egg prices later this year.

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by Bill O’Grady and Kaisa Stucke

[Posted: 9:30 AM EDT] Although we are seeing higher equity markets in many parts of the world, there is a palpable air of uncertainty.  Take yesterday’s market action in Brazil.  The leader of the lower house in the Brazilian legislature announced yesterday that last month’s impeachment vote should be annulled.  Then, in the dead of night, he revoked the call.  It isn’t clear what Waldir Maranhao was trying to accomplish.  According to reports, this little known member of the legislature is under investigation himself, dealing with corruption charges.  Market action yesterday was certainly interesting.

First, the Brazilian real (BRL) depreciated.

(Source: Bloomberg)

This is an intraday chart showing the BRL/USD exchange rate; it measures how many BRL are required to buy a dollar, so a rising price represents a weaker currency.  When the news broke, the currency plunged.

So did the Brazilian equity market.

(Source: Bloomberg)

This is a chart of the Brazilian MSCI index in USD terms.  Note the sharp drop.  When Maranhao reversed his position on impeachment, the market rallied but did not return to earlier highs.  This market action demonstrates the degree of sensitivity that Brazil’s financial markets have toward the impeachment process.  The markets have been betting that a new government will be more market friendly and Rousseff’s ouster will be bullish.  Although this may be true, we suspect that if impeachment occurs, Brazil’s financial markets will suffer a setback for two reasons.  First, the good news from impeachment will already be fully discounted.  Second, a new government will still face a difficult environment and any new government’s ability to improve conditions will be limited.  In fact, the best outcome for Brazil would be a debt-fueled boom in China, which probably isn’t likely.

Yesterday, an unnamed Chinese official criticized the extended use of debt in fueling China’s growth.  Although this is a legitimate criticism, reducing debt growth will almost certainly lead to a dramatic drop in growth.  There is growing speculation that when the 19^th party congress meets in 2017 that Li Keqiang, the current premier, may be replaced by Wang Qishan.  In China, the premier (second in command) has the economy mandate, although Chairman Xi has been unusually active in economic policy for a Chinese head of state and leader of the CPC.  Wang is currently head of the Commission on Discipline Inspection, the body that has been conducting the purges.  Wang is an accomplished financier, with experience in banking.  He is also one of Chairman Xi’s most trusted advisors.  It may be that Li will take the blame for weaker growth and market turmoil, allowing Xi to put a loyalist in charge of the economy.

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by Bill O’Grady and Kaisa Stucke

[Posted: 9:30 AM EDT] There were five major news items over the weekend:

Saudi Oil Minister al-Naimi sacked: Al-Naimi, who has been oil minister since 1995, was unceremoniously fired over the weekend, replaced with another Saudi Aramco official, Khalid al-Falih.  Al-Naimi was considered a good administrator and was the de facto head of OPEC.  At 80 years old, he has hinted at stepping down for some time but the fact that he was fired, and not allowed to resign, sends a signal that the new king and his effective regent, DCP Salman, are putting their own stamp on the country.  At the Doha meeting, al-Naimi appeared prepared to agree to a production freeze, only to be overruled at the last minute by the DCP, who insisted that Iran also freeze output, which was sure to kill any deals.  Although the official stance of the kingdom is that this move will not lead to new policies, we suspect that al-Naimi was willing to engage in jawboning to lift oil prices.  Our position is that the Saudi policy of gaining market share was not necessarily targeted at the U.S. but at Russia and Iran, which pose geopolitical threats to the kingdom.  By firing al-Naimi, the DCP is making it clear that the goal of Saudi oil policy is to undermine the Iranian and Russian economies.  After all, a freeze would have likely led to higher oil prices even in the absence of real change because it held the promise of future cooperation.  We strongly suspect that the new minister has heard loud and clear that the kingdom’s policy is to hurt Iran and, to a lesser extent, Russia.  Thus, we view the change as potentially bearish for oil prices.

Fed officials talking about hikes: NY FRB President Dudley suggested after the employment report that the FOMC is on path for two hikes this year.  St. Louis FRB President Bullard says he is “open” to a June hike and Boston FRB President Rosengren (an avowed dove) has been saying that the financial markets are underestimating the Fed’s likelihood of raising rates.  Atlanta FRB President Lockhart says he is “on the fence” for June.  Meanwhile, the fed funds futures put the odds of a June hike at 4.0% and don’t get to 50% odds until February 2017.  As we have noted before, based on the Phillips Curve relationship, the FOMC is well behind the curve in any iteration.  We have noted that there is a chance that Chair Yellen is using the dollar as her policy target.  Waiting for dollar weakness before raising rates would make sense.  However, given the comments coming out of the rest of the FOMC, there is little evidence anyone else is buying into this policy.  We doubt the Fed moves in June; the WSJ’s Jon Hilsenrath also suggested this idea today.  But the noise surrounding a hike may be there to build some degree of uncertainty into the financial markets.

Greece is becoming dicey: Despite demonstrations against the measures, PM Tsipras did get the Greek parliament to agree to reform pensions and raise taxes yesterday, but the IMF is making more comments indicating that the body may not agree to further bailout measures without debt relief.  Debt relief is an anathema to Germany, which fears that others may ask for similar support.  Meanwhile, surveys across Europe indicate that the Brexit vote may trigger similar referendums in other nations as well.  Another Greek debt crisis could trigger even more problems in the EU and Eurozone and could put pressure on the EUR, which would not be welcome in the U.S.

Alberta fires: Forest fires in Alberta have reportedly cut tar sands oil production by 1.0 mbpd, although it does appear the fires will mostly miss the oil-producing regions.  However, the workers tend to live in Fort McMurray, so it isn’t clear how the oil companies will function even after there is no fire danger.  Oil markets were initially higher on the news but have given back some of their gains.

Chinese trade data: Exports in April fell 1.8% and imports fell more than forecast (down 10.9%).  Key commodity imports declined; oil imports were down 7.2% (in volume terms), iron ore fell 4.7% and copper imports dropped 23.8%.  Meanwhile, a major Chinese newspaper carried a full page ad warning about growing debt and non-performing loans.

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by Bill O’Grady and Kaisa Stucke

[Posted: 9:30 AM EDT] It’s employment data Friday!  We will update all the numbers below but the short summary is that the data was a bit soft.  Non-farm payrolls disappointed, and the unemployment rate fell only because the labor force contracted less than employment did in the household survey.

Global equity markets are weaker and consequently we are seeing a drop in sovereign yields.  German 10-year sovereign yields are moving to test their historic lows.

(Source: Bloomberg)

This chart shows the yield on the German 10-year sovereign.  The yield is down to 0.145 bps and clearly in a downtrend.  Although Eurozone economic growth has picked up a bit, fears of falling inflation and concerns about the banking system are continuing to weigh on interest rates in Europe.  As European rates decline, U.S. Treasuries are starting to rally as well.

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by Bill O’Grady and Kaisa Stucke

[Posted: 9:30 AM EDT] Oil prices moved higher overnight on the Canadian oil sands wildfire and escalation of fighting in Libya, both leading to speculation of supply contraction.  The Fort McMurray oil sands wildfire has spread to five times its initial size, leading to the evacuation of the entire town of more than 80,000 residents.  Fort McMurray is the main city in Canada’s oil sands region.  Separately, escalating tensions in Libya could cause short-term disruptions in production.  While the market is generally over-supplied, prices are becoming more sensitive to supply disturbances.  The chart below shows the year-to-date Brent crude price chart.

(Source: Bloomberg)

Yesterday, the March factory orders report was released, which came in stronger than forecast, rising 1.1% monthly compared to the 0.6% increase expected.  Durable goods orders came in on forecast, rising 0.8% from the month before.  Despite the monthly increases, the annual data revealed some weakness in both durable and non-durable production.  Total new factory orders fell 2.8% annually.  New orders for non-durables fell 5.8%, while durables fell 2.6%.  As the chart below shows, new orders have not been able to recover recently.  Weak global demand and the stronger dollar are the two main reasons for the weakness.

At the same time, non-defense capital goods excluding aircraft shipments rose 0.5% in March.  This measure is called core shipments and is a good proxy for capital spending in the business investment component of the GDP report.  However, the March increase follows a decline of 1.4% in January and a decline of 1.8% in February, which will likely lead to a decline for the quarter.  Additionally, weak demand maintained the inventory/shipments ratio at the highest level since 2009.

The dollar remains strong but, as the chart below indicates, has actually weakened since the beginning of the year.  This may ease some of the pressures felt by the manufacturing sector.

(Source: Bloomberg)

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by Bill O’Grady and Kaisa Stucke

[Posted: 9:30 AM EDT] We will keep our opening comments short as quite a few economic indicators were released this morning.  Risk markets are trading lower this morning, with equities lower globally and Treasuries trading higher.  As the earnings season continues, equity fundamentals have not changed much, thus the pullback in equities is more a function of profit taking and the fact that positive factors that could drive the market higher have already been discounted.

(Source: Bloomberg)

As the chart above indicates, the dollar rebounded yesterday afternoon and maintained its strength overnight.  This is likely due to weak Chinese manufacturing data released earlier in the week as well as indications from Fed speakers that the June FOMC meeting should be considered “live,” meaning that we could see a hike from that meeting.  Currently, the markets peg the likelihood of a June hike essentially at zero.

Trump became the presumptive Republican presidential nominee yesterday as Cruz quit the race after Trump won a resounding victory in Indiana.  Yesterday’s win is almost certain to allow Trump to gather the 1,237 delegates needed for an outright nomination victory.  On the Democratic side, Sanders won Indiana with 52.5% of the votes.  Despite the unexpected loss in Indiana, Clinton is likely to receive the delegates needed for an outright nomination win.

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