It’s that time again, that ‘time’ being, of course, the next round of negotiations on the US debt ceiling that come round as regular as clockwork. The February 2018 suspension of the US debt ceiling expired in March earlier this year. This means that a dysfunctional Congress has been tasked to somehow hammer out a compromise that heads-off a potential technical default when current stopgap measures run out in the autumn.
The market moved yesterday to offer the probability of 44% for a 50bp rate cut, from 35% previously, at the Fed's meeting on the 31st July. This was on the back of four Fed members speaking, giving further clues as to what the Fed is likely to do. This is usual to see a ‘gaggle’ of Fed speakers two weeks before the meeting because come 12 o’clock tomorrow all members enter the blackout period when no further comments are allowed until after their meeting.
According to the Federal Reserve’s Beige Book released yesterday the US economy continued to expand at a modest pace with a ‘generally positive’ outlook from mid-May through early June, with little changing from the previous reporting period. The Fed said that ‘many’ of its 12 regions saw slight gains in retail sales and home sales, whilst auto sales remained flat. The labour market continued to expand and remained ‘tight, with contacts across the country experiencing difficulties filling open positions’.
Yesterday we had stronger economic evidence from the US than market expectations, with retail sales up at 0.4% for the core and the ex-autos and gas measure rose in June by 0.7%, way above the 12-month trend. This release combined with upward revisions to previous months brought the quarter’s gains to the strongest since 2005. Industrial production also surprised on the upside and the NAHB housing index rose slightly, boosted by the lower rate environment.
Croatia, Italy, Lithuania, Bulgaria, Latvia, Portugal, Spain and Slovenia all now offer negative yields in the 2-year region of their euro yield curve. Croatia, which today remains only a fraction of a basis point in negative yield territory, is BBB- and well into the Emerging Market category, as would be many of the other recent additions to the negative-yields-club. The total amount of negative-yielding debt in the Eurozone alone surpassed €5tn earlier this month and is now well above the previous peak of €4.4tn back in Q3 of 2016. Around €3.5tn of this is from Germany and France but the remaining €1.5tn spans peripheral Eurozone and other European bonds.
China’s Statistics Bureau earlier today released figures showing that the world’s second-biggest economy had the weakest rate of growth in 27 years (which was when the data began). The second-quarter GDP figures showed the economy slowed to 6.2% from a year ago, although in line with market expectations, show the toll the trade war with the US is having on the economy. The figures will add to the pressure that the Chinese authorities are under as they try to negotiate a deal with the US.
One person not singing from same hymn sheet when it comes to where she sees 10-year Treasury yields by the end of the year is Franklin Templeton’s Chief Investment Officer Sonal Desai. Desai believes the 10-year Treasury yield could end the year closer to 3%, a view that is contrary to most of the market’s major players.
In an interview, Desai states it should not ‘underestimate the speed with which the market can reprice’ believing the US economy is in ‘incredibly good health’ adding ‘Can the 10-year yield get to 2.50%, 2.60%, 2.75% this year? Why not?’
erome Powell’s semi-annual monetary policy testimony before the House Financial Services Committee continued the dovish tone of his June post-FOMC press conference noting that ‘crosscurrents, such as trade tensions and concerns about global growth, have been weighing on economic activity and the outlook’. In particular, this may be depressing business investment which ‘seems to have slowed notably’.
Importantly, Powell’s comments go on to suggest there has been no change in view since the FOMC and following the stronger than expected June non-farm payroll data: ‘Since then, based on incoming data and other developments, it appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the U.S. economic outlook. Inflation pressures remain muted.’
If you wanted Austria to look after inheritance money for your grandchildren you could make use of Austria’s 100-year bond (now 98-year) yielding just 1.18% (bear in mind that with the magic of compounding this is still enough to potentially triple your money by 2117). But its 2.1% coupon and trading price around €150-€160 serves as a stark reminder of just how far European bond markets have moved over the past two years – where if you locked-in your money for the century back in 2017 there would be as much as 7.6x (given the usual assumptions) waiting for the beneficiary (perhaps for their deposit for a flying car or trip to Mars).
According to the latest Bloomberg survey the UK economy shrank in the second quarter by 0.1% as the retail industry reported a further fall in sales. The British Retail Consortium reported sales dropped 1.6% in June from a year earlier and follows on from the June Purchasing Managers Indexes which had a contraction in both manufacturing and construction. Within manufacturing the production and new business element showed the worst reading in almost seven years following on from the high levels of stock building in the first quarter as companies rushed in to build inventories ahead of the original March 29th Brexit date.
Last week the United Arab Emirates switched on the world’s largest single solar power farm, the 1.18GW Noor Abu Dhabi. Costing near on USD900mln, at 8 square kilometres, the 3.2 million solar panel power plant is the brainchild of a joint venture between the Abu Dhabi Government and a consortium of Japan's Marubeni Corp and China's Jinko Solar Holding. As a comparison, the US’s largest solar project, the Solar Star power plant in Rosamond, California, is spread over an area of 13 km square that uses a mere 1.7 million solar panels to generate 579 megawatts of electricity.
Further disappointment was seen in Germany this morning as factory orders slumped, coming in at down 2.2% on the month against expectations of just negative 0.2%. Although historically this is a volatile series it goes someway to confirm that the current downturn is more than a temporary event. Council member Olli Rehn summed up; that growth has ‘slowed significantly’. The report showed domestic orders were up 0.7% but a huge drop in exports and investment goods orders offset, most notably with orders from China and the continued lack of demand for autos.
Globally, ~$13.4tn of bonds are now trading on negative yields so it was not altogether surprising to see the Kingdom of Saudi Arabia take advantage of low rates in Europe to diversify its funding base and come to market with a €3bn dual tranche bond issue. The bonds offered a coupon of 0.75% on the 8 year and 2% on the 20 year. Needless to say, the issue was heavily oversubscribed with the final book exceeding €14.5bn: after all Saudi Arabia is rated A1/A+ by Moody’s/Fitch and the euro denominated 8 year paper priced on a yield of 0.782% which compares favourably to similarly rated euro sovereign issuers. For example, Slovakia 1.375% 2027 (rated A2/A+ by Moody’s/Fitch) is trading on a yield of -0.15% and Irish TSY 1.1% 2029 (rated A2/A+) trades on a yield of 0.07%.
Now that we know the tame and tolerable choice of Christine Lagarde for President of the ECB, next up in the potential promotion political calendar are Alexander Boris de Pfeffel Johnson or Jeremy Richard Streynsham Hunt. In 20 days’ time, one of these somewhat polarising men will win the privilege of taking the helm of a seemingly rudderless and dissenting nation at increasing risk of breaking-up: on the rocks which are the EU negotiators and national and international obstinacy.
While all eyes are on the US-China trade negotiations the US Trade Representative office yesterday published a further list of $4bln of European goods targeted for tariffs, adding to the list of $21bln announced in April. This is due to the long-running Airbus-Boeing dispute; however European producers of cherries, meat, cheese, olives, pasta and some types of whiskey are probably a little confused as to how they got dragged into the argument over aeroplane subsidies.
The game of tennis that European leaders are playing over the next EU’s chief executive continued after Angela Merkel, along with the Netherlands, France and Spain endorsed the Dutch socialist lead candidate and commission vice-president Frans Timmermans. However, the Dutchman is facing considerable opposition from other EU leaders, including those who belong to the centre-right European People's Party (EPP), Europe’s largest political alliance, plus some Central European countries.
Bernie Sanders has announced radical plans to forgive 45 million Americans of their outstanding student debt, around USD1.6tln, by introducing new taxes on Wall Street. The legislation, dubbed ‘The College for All Act’ will release all 45 million Americans that have outstanding student debt, as well as making two and four-year public colleges and universities tuition and debt-free. Apprenticeship and trade schools would also be free.
According to the UNCTAD (United Nations Conference on Trade and Development) World Investment Report 2019, global FDI flows declined 13% in 2018 to USD1.3tn, the third consecutive year of decline.
The report attributes the decline as ‘mainly due to large repatriations of accumulated foreign earnings by United States multinational enterprises (MNEs) in the first two quarters of 2018, following tax reforms introduced at the end of 2017, and insufficient compensation from upward trends in the second half of the year.’
So the customary 3-month to 10-year term-spread on US Treasuries has now remained inverted for over a month since the 23rd May; it’s well recorded that this negative figure can signal a higher likelihood of a US recession, but typically at least 12-24 months down the line. Of course, there was also a negative dip in March but, with the change in Fed rates trajectory, equity markets have been buoyed and deflationary and recessionary concerns put aside (for the near-term at least) with the S&P 500 pushing all-time highs just as US Treasury yields have fallen dramatically throughout May and June.
The US Treasury market continues to perform well with yields dropping a further 4bp across the curve yesterday putting the benchmark 10-year bond at a 2% yield. The shorter end of the curve continues to price in three rate cuts this year as expectations for a trade friction induced slowdown is clearly the dominant view. True to form, President Trump continued to put pressure on the FOMC calling them a ‘stubborn child’ for not cutting rates at their last meeting.