China is lower with banks in focus

The debate raging across trading floors has clearly been around when the will Fed taper its bond buying programme, and this argument will abate this week with US durable goods and University of Michigan confidence numbers in focus.

However, this week investors and traders are likely to focus more heavily on earnings and outside influences given there are absolutely no Fed speakers due. Sighs of relief can be heard all round; with the Fed having been so influential on price action, it’s certainly welcome to focus on more traditional fundamentals.

Earnings seem to be going without too much of a hiccup, with 20.6% of companies out thus far, and 72.8% beating on the bottom-line. EPS has also increased 2.2%, which of course has been assisted by a number of company stock buy-backs. Revenue on the other hand has grown an impressive 4%, but with only 53% beating, this is probably just a touch under recent quarterly performances. Still, corporate earnings, alongside recent comments from the Fed have been music to the bulls’ ears, and we are finally seeing signs the ‘great rotation’ trade (i.e. out of bonds and into equities) that was the talk of most strategists at the start of the year is now actually unfolding, with $17.5 billion poured into equity-focused funds last week (the most since June 2008), while bond funds saw reasonable outflows.

Earnings from McDonalds, Halliburton and Gannett will be in play tonight, while the highlight of the week will be Caterpillar, with traders keen to hear its views on emerging markets and notably China.

The modestly higher lead from Wall Street has generally been overlooked, with China and Japan trading around their own major focal points. The ASX 200 has also done its own thing, but ultimately has come off the high of 5026 as Japan and China struggled. As we have highlighted last week, 5012 is key, and while the index been above this level of supply, a daily close is needed to really show the bulls are in control. Energy and financials have put the points in today and it still seems that the energy space is the sector most big money managers want to be leveraged to at present.

China is down 0.6%, with banks and energy stocks weighing on the index. The key talking point has been around the removal of the floor on lending rates, which in theory allows banks to better determine their lending rates and could lead to a more market-focused allocation of capital. Of course the issue the market is concerned with is that in the future banks could start a price war and try and better each other for accounts/customers worth fighting for. Margins are therefore front and centre, and the prospect of a more competitive landscape is causing modest selling, although it has to be said the selling is very orderly.

It also needs to be remembered that even though banks could already make loans lower than the benchmark (currently set at 6%), in Q1 2013 only 11% were actually set below the benchmark rate anyhow; 65% were above and 24% right on the benchmark. So, given banks have had the ability to lend lower than 6% for some time, many have chosen not to do so. So in theory we will need to see a number of institutions moving rather quickly, thus gaining a psychological advantage before we see others joining what could become something more meaningful; a prospect we feel is quite low.

The other key point though is that the PBOC isn’t moving the ceiling on deposit rates which are capped at 3.3%. This would not only have a big impact on domestic savings, but change the face of investing in China for locals. As we have seen in recent times, Wealth Management Products (WMP) have been huge business, sometimes offering rates above 6%, which in turn has seen banks use the proceeds to make riskier loans – hence the expansion in credit. Anything to encourage a move away from WMPs would not just have big implications for banks, but also society as well; however as we have heard this move is some way off. Thus, the removal of the lending floor is a small, but yet a significant move to what one day could become a more market-based interest rate.

Japan is lower by 0.2% and taken where it left off on Friday, by traders selling into a stronger open. The good news is there is now no split Diet, as the LDP party hold a two-thirds majority in the more powerful lower house and simple majority in the upper house, with its coalition partner New Komeito. The prospect of smooth implementation of reforms or new measures has increased now, although there is still much work that needs to be done, especially around the issue of consumption tax. The bad news is the polls were predicting this for some time and the market had fully priced this in; hence the market bought the rumour and sold the fact.

The JPY is the best performer in the G10 space today, with USD/JPY in a range of 100.73 to 99.61, while Nikkei has bounced off the low of 14,554. Clearly the market would have wanted to see the LDP party pick up 72 seats, thus gaining an outright majority on its own in the upper house, however this wasn’t the case. We remain of the belief that buying of dips in USD/JPY is preferred, especially ahead of Friday’s Japanese CPI (ex food) print, which is expected to increase 0.3% in June- the highest since December 2008. It’s also worth highlighting comments from BoJ board member Takehiro Sato today, who suggested he won’t rule out the option of offering longer-term fixed rate funds to banks via market operations.

This really constitutes a Japanese LTRO (Longer Term Refinancing Operation), similar to what we saw in Europe, and in theory should weaken the JPY, although much would depend on exactly where the liquidity would end up.

European markets look set to open higher, although our calls have been coming off throughout the day as China and Japan weaken. Data is light, with US existing home sales the highlight; European data gets going latter in the week with European PMIs and UK GDP, while European earnings don’t really get going until later in the week as well. Traders will be keeping an eye on Portugal, notably the bond market, while gold has also broken recent trend resistance and the $1300 ceiling, although we will want to see a daily close above $1321 (April 16 low) to get more excited. Of course US banks will also be in focus given the announcement after market on Friday that the Fed will review the 2003 decision allowing deposit-taking banks to trade physical commodities; this in theory could weigh on a sector that has done rather nicely of late.

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