US inflation dips; US deficit swells; German Bunds popular; China inflation up; China lending growth modest; APRA rules hurt bank investors; UST 10yr yield at 2.13%; oil down and gold up; NZ$1 = 65.8 USc; TWI-5 = 70.5

US inflation dips; US deficit swells; German Bunds popular; China inflation up; China lending growth modest; APRA rules hurt bank investors; UST 10yr yield at 2.13%; oil down and gold up; NZ$1 = 65.8 USc; TWI-5 = 70.5

Here's our summary of key events overnight that affect New Zealand, with news US rate cut expectations are rising, but equities no longer think this is good for them.

The American inflation rate as measured by their CPI came in below expectations, up +1.8% in the year to May and an important undershoot from the +2.0% April level. This muted result probably strengthens the case for a rate cut by the Fed. But whether that will come in June or later is an open question.

The US Federal budget deficit swelled even further in May, topping -US$207 bln just for the month and reaching a massive -US$985 bln in the year to May. That is up +40% from the same period last year and the worst result since the heart of the GFC. With just four months to go in this budget year, it will almost certainly well exceed -US$1 tln. Overall they now owe US$16.2 tln or 77% of annual GDP. That is up +5% on a year.

In Germany, more signs of a rush to buy sovereign bonds. German government bonds sold at a record low yield overnight. They sold 10-year Bunds – debt paper which will pay out in 10 years time – with a yield of minus -0.24%. It means investors holding them until they mature will lose money.

China also released inflation data yesterday. The headline number was up +2.7% in the year to May and a 15 month high, but the core result, without food and energy was a more modest +1.6% and a three year low. The headline rate includes the effects of soaring fruit prices, plus the market impacts of the African Swine Fever virus. These are very real for everyday living.

Chinese banks extended ¥1.2 trillion yuan (NZ$260 bln) in net new yuan loans in May, up from April but well short of expectations. So far, bankers are not helping Beijing and their call for more private sector stimulus.

In Hong Kong, hundreds of police fired tear gas and rubber bullets to beat back protesters, as demonstrations against China’s encroachment on the city’s legal autonomy degenerated into running battles in the middle of their financial hub. Coverage of the troubles is blocked in China.

These troubles are affecting business confidence in Hong Kong and their equity markets dropped -1.7% yesterday after days of volatile trading. Shanghai equities fell -0.6% yesterday. Following on, European markets were down by about -0.4%. Today, Wall Street is also lower, currently down -0.3% in late trade.

In Australia, their prudential regulator wants to require banks to hold more capital (much more) to cover for when they write higher risk loans. But it is typical Aussie-style regulation; adding to their prescriptive approach. These rules weighed bank shares. ANZ was down -1.1% yesterday, CBA was down -0.9%, NAB was down -0.8% and Westpac was down -0.9%. Overall the ASX200 ended flat on the day.

The UST 10yr yield is drifting lower again and now just on 2.13%. But their 2-10 curve is little-changed at +24 bps and their negative 1-5 curve is now at -16 bps. The Aussie Govt 10yr is at 1.43% and down -3 bps. The China Govt 10yr is up +1 bp to 3.30%, while the NZ Govt 10 yr is down -2 bps, now at 1.74%.

Gold is up +US$6 today, now just on US$1,333/oz.

US oil prices have fallen very sharply today, down about -US$2.50/bbl. They are now just under US$51/bbl. The Brent benchmark is under US$60/bbl. Higher US inventories and weakening global demand have driven the reassessment.

The Kiwi dollar is little-changed this morning and is now at 65.8 USc. On the cross rates we are firmer at 94.9 AUc. Against the euro we are at 58.2 euro cents. That leaves the TWI-5 unchanged at 70.5.

Bitcoin is firmer today, now at US$8,145 and up +3.1% since this time yesterday. The bitcoin rate is charted in the exchange rate set below.

The easiest place to stay up with event risk today is by following our Economic Calendar here ».

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Core inflation not including food and energy? That's not very core, surely.

I've always wondered why inflation is measured so inaccurately? Our CPI is off in my opinion as well. Who is it benefitting from this under read? It allows more money to be created so banks and the owners of assets would be happy but outside those two (highly influential groups) I can't see why we do it?

Many other corporations that I can think of would benefit from a low interest rate environment. Those with high creditworthiness can access "leverage finance" for low to no value activities such as share buybacks and corporate consolidation (M&A).
Also, companies that operate in price inelastic markets (real estate etc.) have the ability to push up their margins through higher prices. They can evade passing on their financial success to their employees as wage increases only need to keep up with the "low" CPI.
Access to cheap credit, lower saving interest rates and higher asset values all tend to drive more consumption, leading to greater sales revenue across the board.

All that is just the tip of the iceberg.

Unfortunately, low inflation statistics culminating in lower interest rates increases the discounted NPV of asset prices which results in higher costs today and lower returns in the future.

Our view is that no form of investment risk is always worth taking without regard to valuations, fundamentals, economic conditions, or market action. The strategy of buying and holding index funds for the long run is essentially a strategy that says that market risk is always worth taking. Yet the iron law of investing is that a security is nothing but a claim on a future stream of cash flows. Valuation is a crucial determinant of long-term returns. The higher the price an investor pays for those cash flows today, the lower the long-term rate of return earned on the investment.

The corollary is also true. The lower the long-term rate of return demanded by investors, the higher the price moves today. So clearly, changes in investors' attitudes toward risk will strongly affect short-term returns. If investors become more willing to take market risk, it is equivalent to saying that they are demanding a smaller risk premium on stocks (that is, a lower long-term rate of return). Prices rise as a result. Now, the fact that current stock prices are higher also implies that future long-term returns will be lower, but that's part of the deal.

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Moreover, the immediate prognosis is not good:

For the month of May 2019, the Bureau of Labor Statistics reports its consumer price index (CPI) gained just 1.79% year-over-year. Since our monetary authority links its inflation mandate to the PCE Deflator, a 2% target for this alternate consumer price measure, that means the economy is back to significantly undershooting the central bank mandate. Roughly, a 2% target for the deflator translates to a 2.7% to 2.9% rate for the CPI (since the way each comes up with a price index is different).

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Go the people of Hong Kong. F-R-E-E-D-O-M.

The UST 10yr yield is drifting lower again and now just on 2.13%. But their 2-10 curve is little-changed at +24 bps and their negative 1-5 curve is now at -16 bps.

Hmmmm...not as serene as it might seem.

The 4-week bill has now plummeted, too, an incredible 11 bps plunge in just the last two trading sessions (including today). In 4-week territory, that’s an enormous move.

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Usually, a signal that a yet be disclosed financial calamity has transpired somewhere in the world.