Daily Agenda: Apple Comes Under EU Tax Scrutiny

Hong Kong is latest geopolitical hot spot; U.S. senators eye potential manipulation in aluminum markets.


David Paul Morris

With the end of the third quarter this week, as they report their portfolio performance to investors, fund managers have yet another opportunity to consider the rapidly evolving market risk environment. Over the weekend the geopolitical map became even more complex as pro-democracy protests in Hong Kong provide a test for Beijing’s claims of reform. In Europe, euro-skeptics made political strides: the second Conservative member of the U.K. parliament in a month defected for the UKIP, an anti-European Union party and a National Front member in France ascended to the nation’s Senate.

Apple comes under the microscope. European Commission officials will release a report tomorrow detailing the rationale behind a probe into Apple’s Irish tax filings. The investigation is part of a larger attempt to rein in excessive corporate tax avoidance schemes.

Aluminum trading targeted. On Friday a letter was published from U.S. Senators Tammy Baldwin of Wisconsin, Sherrod Brown of Ohio and Elizabeth Warren of Massachusetts, asking the Commodity Futures Trading Commission to probe practices at the London Metal Exchange. The trio of Democrats specifically raised concerns regarding manipulation related to the LME’s aluminum trading and warehouse storage procedures.

Chocolate sees price hike. ICE Cocoa futures reached the highest levels since 2011 last week on concerns over a possible disruption in exports from western Africa stemming from the Ebola outbreak. Three years ago, cocoa prices spiked dramatically in the thinly traded commodity in response to political turmoil in the Ivory Coast. This speculative price action has occurred against a backdrop of strong production estimates as harvest season begins in the region, offset by low stock levels and string demand data.

Bill Gross departure TIP of the iceberg for PIMCO? While much of the discussion of Bill Gross’s abrupt departure from PIMCO on Friday amounted to industry gossip, a number of analysts over the weekend noted that the asset manager has huge holdings in the U.S. Treasury Inflation-Linked Securities (TIPS) market. Given the relative illiquidity of the market for TIPS, some noted that a shift in strategy at the firm level under new leadership could temporarily distort prices.

U.S. consumer spending data released today. August personal consumption expenditures (PCE) data will be released this morning with forecasts for a marginal uptick in personal income and a rebound from a month-over-month contraction in household spending in July. This would represent an improvement for overall growth prospects as last week’s upward revision in second-quarter 2014 gross domestic product was driven by business investment, rather than any change in consumer spending estimates.

Ruble hits record low against dollar and euro. The Russian ruble reached a new record low today to 44.2637 against the Central Bank of Russia’s target basket of dollars and euros, just above the 44.40 threshold at which the central bank had said it would intervene in markets.

Portfolio Perspective: U.S. Dollar Strength Likely to ContinueAndrew Labelle, TD Economics

Over the past three to four months, the U.S. dollar has been an almost one-way bet. Since June 5, when European Central Bank President Mario Draghi signaled that the ECB was getting serious about combating euro zone disinflation, the dollar index has risen more than 7 percent.

So what does a higher dollar mean for future U.S. economic growth and inflation and hence, monetary policy? On the growth front, imports represent only 17 percent of the economy. Most of what America consumes is produced in the U.S. As such, it is shielded from the effect of exchange rate movements relative to economies more reliant on external trade. In terms of what the U.S. does import, much of the trade deficit is in energy or in bilateral trade with China. Given the massive rise in U.S. energy production, the deficit in energy has been shrinking and will continue to do so, irrespective of the level of the dollar. Meanwhile, the Chinese renminbi is anchored to the dollar, which means that trade between both countries is somewhat insulated from the value of the currency.

Where the stronger dollar will make more of a difference is inflation. A stronger dollar makes imports cheaper and weakens commodity prices. This is already underway. Both energy and food prices, as measured by the S&P GSCI indexes, have declined considerably over the past six months. The end result is that fears have ebbed that inflation would soon pressure the U.S. Federal Reserve into an earlier rate hike. Markets appear to have heard this message, with expectations for a first rate hike having moved from June to July 2015.

All in all, the fact that expectations for a first rate hike are being pushed further into the future would typically be a negative for the U.S. dollar. However, with recent data pointing to continued momentum in the U.S. and still sluggish growth in the euro zone, the divergence is set to continue at least over the next quarter or two. While the path will assuredly not be as linear as it has been over the previous eleven weeks, this points to further gains in the dollar.

Andrew Labelle is an economist with TD Bank Group in Toronto.