Marmitegate leaves a sour taste.

This week’s Marmitegate episode was a masterstroke of communication by Tesco, and its share price reacted accordingly.  Price disputes between supermarkets and suppliers rarely make headline news, but Tesco deliberately chose to air its laundry in public on this occasion.  Tesco has effectively sounded the warning to the shopping public that there is an imminent dramatic price hike coming to most products due to the weakness of the Pound, whilst at the same time showing that it is blameless and positioning itself as the champion of the consumer.  It has rarely been accused of that in the past.

When you dig a little deeper, some interesting themes emerge. Tesco’s operating profit margin last year was 1.9%, reflecting the ongoing price war between the big four and the discounters. Meanwhile, Unilever’s operating profit margin last year sat at 14.1%.  Unilever could chose to absorb some of the hike but it believes the strength of its brands means it won’t give up much market share on the back of higher prices.

More alarmingly, much has been made of the fact that Marmite is produced with British ingredients, so a stronger dollar should play little part in this particular product pricing. Unilever claims packaging is sourced abroad and has impacted prices, but one is left with the impression that they are taking advantage of circumstances to build margin across their entire range.   It would be a fair assumption that they won’t be the only suppliers having a go at this game.

It’s worth remembering that British sourced good will not be immune to price rises either.  Energy is priced in USD, and energy forms a considerable input cost to any manufactured food or good.  So whilst we celebrate the benefits of a weaker Pound for our exporters (notwithstanding they frequent have to source now more expensive Dollar priced commodities internationally) we should remember that it will come as a daily cost to our family pockets.

The Rapprochement Rally

[At the time of writing, Dax. CAC and FTSE are all up around 2% on the day].

Two extremely sad events, the Russian aircraft crash and the terror attack on Paris, have helped to bring together Western powers and Russia, uniting them in a resolve to deal with the terrorist threat posed by the ISIL.

President Putin this morning announced that Russian investigations into the aircraft crash had revealed the cause to be a terrorist bomb.  This finally brought him into line with the conclusion already reached by the U.S. and U.K. based on intelligence chatter.

As a consequence, Russia is now appealing for united action against the Islamic State, which opens the door to more coordinated actions between the U.S., France and Russia.

In the meantime, Russia would appear to be continuing to de-escalate the Ukraine situation.  Yesterday, Russia proposed a restructuring of $3bn owed to it by  the Ukraine. Whilst there are various terms attached,

http://www.ft.com/cms/s/0/c4a2eaa6-8c7f-11e5-8be4-3506bf20cc2b.html#axzz3rkMFBk7P

this is clearly a softening in stance.  Images from the G20 meeting at Antalya last weekend showed Putin engaged in private discussions with world leaders including Obama and Cameron.

Tough sanctions and a falling oil price are hitting the Russian economy hard, and there has been a notable change of stance from the Russians, which is starting to be embraced by the West.

In the meantime, France is going hard-line in its response to the terrorist attack, and Telegraph reports suggest it will call for an effective suspension of open borders at a summit on Friday.

Whilst Schengen is a core pillar of the European construct, it is a very flexible concept in practice. The Schengen area guarantees unrestricted travel within a territory of 26 countries, home to more than 400 million citizens.  However, EU citizens are required to carry a valid passport or identity card in order to be able to prove his identity, if asked.

The ability to deal with the migrant crisis until now has been fractured and challenged.  The terrorist threat has united public opinion that more radical intervention is required to control the movement of people in the short term whilst efforts to bolster and enforce external borders are improved.

Is it time to buy EDU6 against Selling L U6?

The Short Sterling Strip has rallied back towards its pre Payroll highs on the back of soothing comments and assurances from Mark Carney.  Below the orange line represents the close last night vs. 1, 2 and 3 months ago.
[Click images to enlarge]

In the meantime, the surprisingly strong October Payroll data coupled with increasingly hawkish Fed rhetoric has put the probability of the first hike at approx. 66% for December.  The debate will now transform to the pace and terminal level of the hiking cycle.

This has caused a reasonable repricing in rate expectation differential between the two economies.  Below is a chart of Sep-16.

The spread has moved from an October low of -10 to the current level of +10.5.

In the meantime, the rolldown to the Jun-16 contract is 16 ticks for Eurodollars, whilst it is only 11 for Short Sterling, i.e a 5 tick pick up over three months.

For those who believe the U.K. recovery/inflation outlook is more robust than Mr Carney’s current guidance, this doesn’t look like a bad way to play it.

 

 

TICS data for August

We've just had the monthly TICS data release for August.  You can view it here:
http://www.treasury.gov/ticdata/Publish/mfh.txt

The standout mover for the month was once again Belgium, whose holding reduced from $155.5bn to $110.7bn  (-$44,8bn).

There has been much speculation as to who stands behind the Belgium holdings, where Euroclear is based.  Some background here:
http://www.zerohedge.com/news/2015-05-18/revealing-identity-mystery-belgian-buyer-us-treasurys

The suggestion is that one or more of the Chinese institutions uses a Euroclear identity to hold Treasuries.  I have recreated one of their charts to see what the most recent data looks like.

Below is a chart of China Foreign Exchange Reserves (white line) vs. the aggregate of China and Belgium's Treasuries holdings (yellow line). Click to enlarge.

One should remember that Belgium will hold some US Treasuries in its own right for Reserves purposes.  Below is a long term chart of Belgium Treasury holdings.

This chart would suggest Belgium's "natural" holdings would be somewhere well south of $50bn.

One other observation. The amount of Treasuries sold by Belgium, year to date to the end of August was $243.9bn, or about $30.5bn a month, and the chart suggests this was executed in a fairly linear fashion.

AS

Two charts I have been following have made breakouts...



 

Firstly, the Dollar Index has suffered from the spate of weak data and the evolving market view on prospects for a Fed rate hike.  Keep an eye on the 93.14 and 92.60 levels. If they can't hold, the Dollar could be due a deeper correction.

 

 

 

Secondly, here is the chart of US Treasuries 30 year yields. Whilst not dramatic in nature as yet, the new short term target for yield is the August low of 2.72%