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Strategies & Market Trends : Mish's Global Economic Trend Analysis -- Ignore unavailable to you. Want to Upgrade?

To: NOW who wrote (21553)	1/17/2005 2:15:58 PM
From: mishedlo	Respond to of 116555

United States: Review and Preview Ted Wieseman and David Greenlaw (New York) The Treasury yield curve experienced another big flattening move over the past week. Strong economic data and continued fears of a more aggressive near-term Fed policy after the recent FOMC minutes – stoked Friday by a hawkish interpretation given to comments from St. Louis Fed President Poole – pressured the front end, even as the back end continued to benefit from what seems to be an insatiable and price-insensitive demand for duration from domestic investors. The degree is unclear to which the relentless long-end bid is more technical and liquidity driven, instead of being based on any sort of well-though-out view on longer-term fundamentals. But certainly medium and longer-term eurodollar futures pricing suggests a remarkably pessimistic outlook for the economy beyond the first half of this year. We believe such pessimism is unwarranted and likely to be unwound in the months ahead, keeping the Fed on a steady tightening path (with upside risks) and thereby forcing investors to rethink the sustainability of ultra-low real Treasury rates across the maturity spectrum as well as super tight spreads for riskier assets on top of these rock bottom risk-free rates. [And I am sick of economic cheerleaders who think GDP is going to soar as the FED tightens and housing slows. Mish] The Treasury curve flattened sharply again the past week, with 2’s-30’s another 15 bp lower on top of the 14 bp move in the first week of the year, with the 2-year yield up 3 bp to 3.23% and the long bond yield down 12 bp to 4.73%. 2’s-10’s cracked the 100 level for the first time in almost four years, as the 10-year yield fell 7 bp to 4.21%. The 3-year yield rose 1 bp to 3.38% and the old 5-year yield moved 2 bp lower to 3.70%, while the new issue ended the week at 3.71% after being auctioned Wednesday at 3.73%. There was continued fallout from the release of the hawkish FOMC minutes, with support from the week’s mostly strong economic data and generally hawkish comments from Fed officials – with investors particularly focused on St. Louis Fed President Poole’s remark that the FOMC would eventually stop referring to “measured” policy. Thus, the futures market continued to gradually price in more near-term Fed tightening, pressuring the front end. The February fed funds contract ended the week unchanged at 2.505%, while the April contract lost 2 bp to 2.77%, both now pricing slight risks of a 50 bp rate hike in February or March. The rate on the June contract was up 3 bp to 2.99%, so another 25 bp move is fully priced in for May as well. Beyond that, however, there hardly any further Fed activity priced in, with only a 43.5 bp spread between the June 2005 (3.295%) and December 2005 (3.73%) eurodollar contracts and only a 34.5 bp spread between the Dec 05 and Dec 06 (4.075%) contracts. Depending on what sort of assumptions you are willing to make about the proper risk/term premium in eurodollar futures, you could argue that the market is essentially expecting the Fed to reach 3 1/4% or so by mid-year and then be on hold forever. This remarkably pessimistic view certainly supports the flatness of the curve, but relentless demand for duration and yield against limited supply regardless of value seems to be a key factor as well, supporting not only longer-dated Treasuries, but riskier spread product as well. With the Fed expected to be on hold at super low rates as far as the eye can see, investors apparently see little risk in playing the carry game and moving out the risk curve with abandon. I read this guy for what happened with spreads not for his analysis (typically nonsense) of what is likely going forward. The full report here: morganstanley.com

To: NOW who wrote (21553)	1/17/2005 2:32:34 PM
From: mishedlo	Read Replies (1) \| Respond to of 116555

Asia/Pacific: Oil vs. Coal Andy Xie (Hong Kong) morganstanley.com [This analysis is certainly interesting and if correct could lead to a softening of oil prices this year, especially if the US and UK head into a recession slowing down our demand as China shifts incremental demand from diesel back to coal. Andy Xie points out how this is bullish for coal and bearish for oil and copper Mish] Summary and Investment Conclusion An electricity shortage exaggerated China’s demand for oil and refined products last year as most export factories bought diesel generators to cope with the shortage, which may have accounted for 350,000 bbl/day in China’s oil demand. Macro overheating also exaggerated China’s crude demand import by 14-20% or 300-500,000 bbl/day. However, China’s electricity generation capacity should catch up with demand in 2005. As the Fed continues to increase interest rates, China’s GDP growth rate and energy demand are normalizing. China’s imports of oil and related products may fall in 2005 and not increase much in 2006, in my view. Coal prices should remain strong, due largely to the rapid growth of electricity generating capacity at least in the short term. In the medium term, China has to modernize its coalmining industry to reduce mining fatalities and increase production. This will take several years and the coal supply-demand picture should remain tight. Electricity Shortage Exaggerated China’s Oil Demand China’s fixed investment and exports doubled between 2001-04 due to the declining US interest rate and dollar. Fixed investment and exports accounted for over half of China’s GDP in value-added terms. The extraordinary economic growth triggered a massive increase in energy demand. Electricity production increased by 13.3% in 2002, 14.2% in 2003, and 14.6% in 2004 compared to an average growth rate of 8% in the preceding two decades. The electricity system was unable to handle the demand and severe blackouts began in 2002. Provincial governments were sending out production stoppage orders to factories. As the export sector could not delay production to fulfill their orders it began buying diesel generators to keep factories running. China’s imports of refined petroleum products rose by 38.7% in 2003 and 33% in 2004. The cumulative increase in the imports of refined products was 17.2 million tons over these two years, which, if we assume a 50% conversion rate between crude and refined products, would be equivalent to 690,000 barrels per day. Electricity Production Is Catching Up with Demand China’s electricity capacity increased to 440 GW from 384 GW last year. The estimated capacity shortage was 20-30 GW last year but it seems there will be sufficient capacity in 2005. As electricity from diesel generators is more expensive than from the grid, the export factories should switch back to the grid for power supply again. How much of the fuel imports went towards electricity production is unknown. But we do know that China’s imports of refined products grew slowly until the electricity shortage began. There is also widespread anecdotal evidence to suggest factories were running on electricity provided by diesel generators. My estimate is that half of China’s import growth for refined products could be due to the electricity shortage. Hence, 3.45mn bbl/day of China’s oil demand could be at risk as electricity generating capacity catches up with demand. Oil Prices Should Decline in 2005 China’s crude imports rose by 50.6 million tons in 2002-04 or a million barrels per day. In my view, the economic overheating probably exaggerated China’s crude imports by one-third to a half, this is equivalent to 14-20% of China’s total crude imports. As the Fed continues to increase interest rates, China’s GDP growth rate and energy demand should normalize. Hence, China’s oil imports in the next two years could decrease by 350-500,000 bbl. While China’s long-term demand for oil is robust, the short-term outlook appears quite weak. The macro normalization and the expansion of electricity generation capacity could cut China’s imports by 500-750,000 bbl/day. I suspect that China’s imports of crude and refined products will fall in 2005 and barely rise in 2006. Energy Consumption Shifts to Coal As grid power use increases in China, coal prices should remain strong and I believe that China will face a coal shortage in 2005 and 2006. China consumed about 1.9 billion tons of coal last year, up 20% from 2003. China has underinvested in the coal mining industry, because, until last year, coal prices were quite low. Chinese coalmines used labor to substitute for capital, which is the main reason for the high fatality rate in the industry (5-6 deaths/million tons on reported numbers). If each life lost were compensated in China as they are in OECD countries, China’s coal mining industry would not create value. I believe China has to embark on a multiyear capex program to modernize its coalmining industry to make it safer and increase production to satisfy demand. In the meantime, China will have to import a lot of coal to satisfy its domestic demand. China’s imports rose 69% but were still small at 1% of the total demand. I believe that China’s coal imports will continue to rise rapidly, possibly doubling every two years, for the foreseeable future. Further, China’s coal production cost has to rise. The high fatality rate in the industry shows that coalmines have been sacrificing safety to keep production costs low. However, China’s political and social environment is becoming less tolerant of big industrial accidents. China’s coal industry has to consolidate and modernize, and this will likely boost coal prices. As an aside, the increase in electricity generating capacity should halve this year in China and this is bearish for copper. Copper consumption grows proportionately to electricity capacity as most demand for copper in China goes into the electricity sector, including distribution and generation. For 2005, I am bullish about coal, bearish about oil and copper.

To: NOW who wrote (21553)	1/17/2005 2:51:57 PM
From: mishedlo	Respond to of 116555

Russia Budget Surplus Hit Record $24.7Bln in '04 The Finance Ministry on Friday reported a 2004 federal budget surplus of 686.5 billion rubles ($24.7 billion), or 4.1 percent of gross domestic product, while high world oil prices propelled a special fund formed from taxing windfall oil profits to $18.8 billion. Citing preliminary data, the ministry said budget revenue stood at 3.422 trillion rubles ($123 billion), while spending was at 2.736 trillion. GDP itself stood at 16.55 trillion rubles. The so-called stabilization fund, which gathers windfall oil revenues, grew to 522.3 billion rubles on Jan. 1, accruing its first surplus, which can be used to pay down foreign debts, the ministry said. A ministry official said that unspent cash left over from the 2004 budget would be transferred to the fund this month, meaning that the headline total of the fund, set up only last year, will rise again by Feb. 1. Russia has been using windfall oil revenue to repay loans to the International Monetary Fund ahead of schedule and is seeking to do the same with the so-called Paris Club of creditor nations. The Wall Street Journal reported Friday that Russia had reached a preliminary agreement with the 19 Paris Club governments to repurchase all its debt to the group, which totals about $45 billion. Russia's total foreign debt is currently about $113 billion. themoscowtimes.com