Perspective: Morning Commentary, 01/26/2016

Tuesday, January 26, 2016


January 26 – China grabbed the headlines once again overnight as stocks quickly sold off to drive values to 13-month lows. The closely-watched Shanghai Composite Index dropped 6.4% at the close, settling at its lowest level since December 2014 as confidence in China’s economy continued to slide ahead of the upcoming Chinese new year holiday in less than two weeks. The index is down 47% from its June high with no signs of the selling easing at this point.
The overnight sell-off came even as China’s central bank injected another 440 billion yuan ($67 billion) into the economy using reverse-purchase agreements. It was the biggest injection in three years as the central bank seeks to contain interest rates on reports that capital outflows reached the equivalent of $1 trillion in 2015, more than seven times that seen in 2014. Capital outflows are increasingly a concern for authorities as China’s economy slows and the yuan loses value. The central bank drew down its foreign reserves to the tune of $513 billion in 2015 to control the rate of decline for the yuan, bringing those reserves to an estimated $3.33 trillion at year’s end.


Crude oil dropped back below $30 per barrel overnight on fears that the slowing Chinese economy would prove to be a drag on global demand for energy. However, it reversed back above $30 and is currently trading near its session high following the release of data showing that Chinese oil demand is 4.8% above year ago levels and is expected to rise another 4.3% in 2016. Crude oil imports rose by nearly 9% over the past year. Much of the talk of the past year has been on the over-supply of oil in the world, and that is truly a concern. At some point though we will start to see an increased focus on the demand side of the balance sheet as prices languish near historical lows. Some of the demand data is actually better than perceived, as indicated above.


The good news is that global stock markets are starting to divorce themselves from China. Yes, they are watching developments there closely, with fears that a sinking Chinese economy could drag the rest of the region down with it, impacting global trade. However, global stocks are not as caught up in the day to day volatility of China’s markets. Stability returned to the global markets overnight as crude oil firmed as well.


The attention now shifts to the U.S. Federal Reserve meeting taking place today and tomorrow. The Fed is not expected to make significant shifts to its monetary policy at this meeting. However, global traders will parse words closely tomorrow when the Fed releases its updated policy statement, looking for indications of a shift in policy down the road. Policy makers made it clear in December that they intended to raise their key interest rate four times in 2016. The markets are looking for signs that the Fed may be backing away from that sentiment as global economic data appears to deteriorate. One of the key data points they’ll be looking at will not be released until Friday when we see the initial estimates for fourth quarter 2015 gross domestic product. Early estimates put fourth quarter GDP at a mere 0.9% as inventory growth stalls and the economy sputters.


Rains are expected to expand across most areas of Brazil’s crop belt this week. More limited rains over the first half of February should allow harvest to progress in northern areas as the storm track shifts south to aid maturing crops there. Tropical support appears weak for a shift back north until late February, which should allow for active soybean harvest and safrinha corn planting in Mato Grosso and surrounding areas. Further south, rains are expected to leave 20 to 25% of Argentina’s grain belt dry, with some minor production losses anticipated. However, heat has subsided, easing crop stress somewhat in these areas. As for the U.S. Midwest, a cold pool in the North Pacific increases odds of a warm spring for the Midwest with near-normal precipitation.


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