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Daily Agenda: Chinese Inflation Indicates Weaker Demand

U.S. employment data on deck; soft indicators out of Germany; U.K. trade deficit narrows.

Chinese National Bureau of Statistics inflation numbers for December released this morning have rekindled discussions of further easing measures by the People’s Bank of China. While consumer price levels rose in line with those of the previous month, a sharp drop in cost of goods at the factory gate suggested that overall demand remains weak. At a year-over-year contraction of 3.3 percent, producer price index (PPI) registered a 34th consecutive monthly decline. The big question facing investors now is whether targeted stimulus by the central bank alone can revive the pace of Chinese growth. As a new year gets underway, many market participants would like to think that the 7 trillion yuan ($1.13 billion) reportedly on deck for central government investment in the year ahead will lift activity in an echo of the massive stimulus of 2008. In comments reported earlier this week, Luo Guosan, an investment official with the National Development and Reform Commission, tried to cool this enthusiasm. For now, it appears that the message from Beijing is that it’s different this time.

U.S. Department of Labor to release employment report. The biggest data point on deck in the U.S. today will be the Department of Labor employment report for December. Consensus forecasts among economists are for a moderation in payroll after November’s jump and a reduction in the headline unemployment rate to 5.7 percent. Futures contracts for Treasury bonds currently suggest investors do not anticipate that an improving job market will alter the pace of Federal Reserve tightening.

Russia faces credit rating cut. Fitch Ratings is scheduled to revise its appraisal of Russian sovereign debt today. Consensus forecasts among analysts predict a cut that will still leave the beleaguered nation’s bonds rated within the investment-grade category at BBB–. Last month, Fitch announced it was considering lowering Russian debt to junk status. Regardless of the analysis of ratings agencies, markets have effectively already conferred noninvestment grade status to the Kremlin’s debt, as credit default swaps tied to Russian bonds put them among the riskiest treasury securities globally.

German indicators show slide. Following soft German November factory order data released yesterday, disappointing industrial output and export figures for the month released today in Germany have raised concerns that the nation’s recent recovery in activity measures is unraveling. Registering a contraction of 0.1 percent versus October, the headline index dropped for the first time in three months on a month-over-month basis. Energy output was a significant driver of the decline, dropping by 2.4 percent for the month. Separately, Federal Statistics Office trade data issued today indicated sharp decline in exports from Germany in November. Falling by 2.1 percent for the month, this drop in shipments abroad was more pronounced than anticipated by consensus forecasts from economists.

U.K. trade deficit narrows. Trade data for November released today showed the total deficit for the U.K. fell to £8.8 billion ($13.3 billion) for the month as import levels declined sharply on lower oil prices. November production data for Britain, also released today, showed a mixed prognosis, with a negative month-over-month headline reading also driven by weak energy data offset by a surge in factory output. While activity overall continues to appear more resilient there than in Continental Europe, these softer-than-anticipated figures support the glass-half-empty argument that led the Bank of England to keep rates at record lows in yesterday’s announcement from the Monetary Policy Committee.

Portfolio Perspective: Russia to Lose Investment Grade Status But Limited Selling PressureRégis Chatellier, Société Générale

In our view at Société Générale, Russia’s fall from the investment-grade category may trigger a limited-force selling movement in the case of sovereign bonds, however it could be more substantial for corporates. Most crossover investors have largely reduced their exposure to Russia, with emerging-markets-dedicated funds and Russian local investors carrying the bulk of the exposure. From the perspective of an investor focused on emerging markets, a downgrade to junk status would have little relevance since there is no rating requirement to integrate the two main indexes for real money funds, the J.P. Morgan emerging markets bond index (EMBI) Global and EMBI Global Diversified. The forced selling for this type of investors already happened during 2014, not because of a potential downgrade but mostly because of international sanctions.

Most of the sovereign credit risk is priced in at present, although falling oil prices are maintaining downward pressures. At an average spread of 540 basis points and with no significant risk of default in the short to medium term, we believe that the medium-term credit risk is already priced in. In the short term, however, the main market driver for the Russian bonds remains oil prices, and we cannot rule out further weakness on that front. We therefore remain underweight Russia.

Régis Chatellier is a director of emerging-markets credit strategy for Société Générale in London.

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