Yesterday Mario Draghi told markets that “The Governing Council reiterated the need for a highly accommodative stance of monetary policy for a prolonged period of time and continues to stand ready to adjust all of its instruments…” highlighting that the latest data showed “the persistence of prominent downside risks and muted inflationary pressures”. As such, yesterday Draghi announced an ECB cut in the deposit facility rates from -0.4% to -0.5% and €20 billion per month of open-ended QE. Importantly, the ECB will also introduce a two-tier system for reserve remuneration which will cushion the blow on the profitability of Europe’s major banks, as further negative rates bite.
After Brexit, the German Chancellor Angela Merkel has warned that the UK will become ‘an economic competitor on our own doorstep’ if the UK is allowed to turn into a ‘Singapore-on-Thames’; in-line with the current UK Prime Minister’s view. When Boris Johnson was Foreign Secretary he had already stated his desire to recast the UK as a low-regulation and low-tax state. In what looks like an offer of reconciliation, Merkel said, ‘No country in the world can solve its problems alone and if we all work against each other we will not win. I believe in win-win situations if we work together’.
6 out of 10 Americans are worried about a recession within the next 12 months according to surveys, but that hasn’t stopped a near-record number of workers choosing to leave their jobs – a typical signal of economic robustness and optimism. Jobs data out yesterday showed that the so-called “quits rate” reached an 18-year peak of 2.4%, having only been surpassed by the 2.5% level seen in January 2001 (although layoffs at that point were much higher at 1.7% versus 1.1-1.2% so far this year).
Having sworn in the Democratic Party (PD) and Five Star Movement (M5S) coalition government last week, Italy will this week face a number of votes of confidence; following last night’s positive vote in the lower house of parliament, with today’s in the Senate. Once all the formalities are out of the way, the new PD-M5S Italian government will begin to work on its 2020 budget proposal which is due to be presented to the EC and the country's parliament by the middle of October; however, some delays are expected.
China’s exports took another turn for the worse last month as shipments again fell faster than expected, once more pointing to the fallout from the ongoing trade wars as well as slowing of the global economy. Overall exports fell 1% from a year earlier, the most since June, against analysts expectations of +2.2%. By far the biggest fall was exports to the US, falling 16% year-on-year, on the back of the 6.5% decline in July. Imports from the US slumped by nearly 22.5%.
Today’s September non-farm payroll release showed that 130,000 jobs were added, which was below expectations of 160,000 jobs created, with the prior month’s reading revised down by 5,000 jobs to 159,000. The unemployment rate was at 3.7%, the same as last month (near a 50 year low). The participation rate edged higher to 63.2% from 63% previously. One highlight was average hourly earnings which came in at 3.2% from a year earlier and up 0.4% from last month.
Last night the Federal Reserve released its Beige Book survey showing that the U.S. economy continued to grow at a modest pace over the last few weeks. However, the report did highlight the fact that manufacturing had seen headwinds due to the global economic slowdown and there were mixed signals on the strength of household spending. Over the period the report stated that employment seemed to be on-par with the previous period and that businesses in the US did not expect a recession soon.
The Purchasing Managers Index (PMI) Manufacturing reports have now been released for the month of August. At first glance the readings for nations scoring above the key 50 level rose by 1 to 15, and those below 50 fell by 1, to 21.
Out of the G8, only France & the US currently stand above 50 (France has been flirting with the level for much of this year). Interestingly, 75% of developed countries now have a reading below 50 and Germany languishes at the bottom of the pile, with a reading of just 43.5.
A cross-party “Rebel Alliance” will today propose that the Government must seek a delay to Brexit unless a Withdrawal Agreement with the EU has been signed by the end of October. At 6:30pm today the “specific and important matter that should have urgent consideration” is expected to be tabled, with a vote now expected around 9pm that could allow the bill to then be pushed through the Commons tomorrow and the House of Lords on Thursday and Friday – just in time before the potential suspension of Parliament on Monday.
The key twist in this scenario is that if Boris loses control of Brexit to Parliament he has said he would call a snap election – seeing the defeat as undermining his negotiating position with the EU and a vote of no confidence in his Government. This would in-turn require Corbyn’s Party to be lured - by the prospect of winning a general election - into now voting in conjunction with the Brexit-arm of Conservative MPs to reach the required supermajority. Successfully invoking the Fixed Term Parliaments Act before the Brexit Rebel Alliance’s Bill reaches the statute book could mean a General Election on the 14th of October leaving the nation’s future in the hands of Corbyn (averting a no-deal), or Boris (presiding over a no-deal… or a miraculous renegotiated Withdrawal Agreement).
Rumours from cross-party talks with the Labour leader are that he would delay backing a general election until the Benn Bill has become law. This leaves Boris with one final option of conjuring a vote of no confidence against his own Government and conspiring to ensure no alternative was formed within 14 days. By falling on his sword in this way, Boris would force the party to pick a new Prime Minister to fight an early general election – whom he would hope will consummate his Brexit promises to leave the EU on the 31st of October with or without a deal.
Today’s discord within the leading party - notably Philip Hammond’s uncharacteristic interview invective this morning – has been one of the clearest demonstrations of the challenges ahead for a divided British politics and populous. Whilst the saga continues, it’s difficult to see how the country reverses the recent weaknesses in business confidence and economic growth.
As we enter the third month of the third quarter, the US and China have now moved ahead with their latest increase in tariffs. The 15% increase applies to around $110 billion of Chinese imports, now leading, in aggregate, to higher taxes on over two-thirds of imports of Chinese consumer goods. Trump’s target is 15% duties on a further $300 billion of imports by year-end. With ongoing weakness in manufacturing and lending measures, consumer spending has remained one of the few robust economic indicators in recent months; but it is increasingly uncertain how much a resultant increase in consumer products from clothing to some technology products will hurt the bottom line of businesses and drive down consumer demand.
Bonds almost universally (sorry Argentinean bond funds) have been performing strongly in recent months, and we’ve written earlier this week on how the move continues to show momentum both through longer-trend fundamentals such as demographics and shorter-term indicators in the yield curve and market sentiment. As we close out the month of August, the flows and performance in US investment-grade corporate bonds certainly don’t show any signs that the move has run its course or is in any way slowing yet.
Data from Statistics Korea continues to highlight South Korea’s deteriorating demographic profile. Finalised data for 2018 show only 326,800 births down 8.7% yoy, the lowest reading since the data series started. In 2018 the total fertility rate (the average number of babies born by a woman aged between 15 and 49 years) also fell to 0.98 down from 1.05 in 2017: this is the first time the yearly figure has fallen below 1 and it falls well short of the replacement level of 2.1, a level required for Korea to maintain its headcount. By way of comparison, Japan’s total fertility rate was 1.42 in 2018 and the average of the OECD countries was 1.68 for 2018.
If you were wondering whether months of Trump tweets against the FOMC had got under the skin of anyone in the Fed, then yesterday’s op-ed piece by William Dudley for Bloomberg gives good reason to believe they have. If you haven’t seen the article this is how the former New York Fed President concluded his fiery rebuttal, “I understand and support Fed officials’ desire to remain apolitical. But Trump’s ongoing attacks on Powell and on the institution have made that untenable. Central bank officials face a choice: enable the Trump administration to continue down a disastrous path of trade war escalation, or send a clear signal that if the administration does so, the president, not the Fed, will bear the risks — including the risk of losing the next election.
Whilst updating our Relative Value Model, I came across a couple of zero coupon Euro denominated bonds to be included in the universe. The bonds were of no investable interest to us, but “every little helps” when it comes to keeping the database in a good state of health.
Anyway, this got me thinking. In the “old days”, zeros were more often than not issued in less well known currencies (anyone remember Rand zeros?) or those markets with a more active “retail” presence, like the Aussie or Kiwi market (I’m looking at you, World Bank and EIB). As you could imagine, these bonds were typically issued well below par and 20 or 30 cents pricing at issue was commonplace.
While a couple of participants preferred a 50bps cut there were also several participants who favoured ‘maintaining the same rate’. Thus, the minutes offered little for the doves and continued to frustrate and drive Trump to twitter again overnight as he continues to see a Fed falling short of his suggested of 100bps of cuts over a ‘fairly short period of time… with perhaps some quantitative easing as well’.
Northern Rock became world infamous for a mortgage business that gradually slipped from great net margins to margins no more than 20 basis points above costs. This trend lasted the entire duration of its membership of the FTSE 100 (from 2000 to 2007). At the crisis, these paltry margins were around 60 times leveraged to yield approximately 18% return on equity with a total income as a proportion of mean risk-weighted assets of 3.56%. And so the bank maintained a degree of profitability over a long trend of increased sensitivity to potential credit losses – which of course soon came thick and fast and spurred the Global Financial Crisis.
When the borrowing rates for 30-year Treasuries fell below 2% to record lows, last week, it was inevitable that talk of US century and half-century bonds would reignite. The issuing of such ultra-long bonds failed to gather a strong enough reception in 2017, but with ever more institutional investors reaching for yield it may finally be the year that the US Treasury Department find a market to extend their curve right out to 2120. (This would mark a change to a past aversion to such ultra-long debt, at least in the corporate space, recalling that Congress in the 90s tried to designate debt with maturities over 40 years as permanent equity… Disney and Coca-Cola had issued century bonds in 1993 – over 25 years ago – which Congress believed were primarily issued to avoid tax.)
Yesterday, after last weeks tumultuous events, Donald Trump and his senior advisers were giving bullish statements to news outlets about the current state of the US economy. Trump told reporters that he does not see any sort of recession on the horizon stating ‘We’re doing tremendously well. Our consumers are rich. I gave a tremendous tax cut and they’re loaded up with money. In separate interviews, the director of the National Economic Council, Larry Kudlow and Peter Navarro, the director of the White House Office of Trade and Manufacturing Policy also gave similarly upbeat projections about the economy.
An interesting report on Bloomberg this week looks at Italy and their outstanding corporate bond debt. Corporate bonds outstanding total Euro172bln and financial bonds outstanding total Euro 252bln so all sectors total Euro 423 Bln.
We have long warned about our concerns over the Italian banking sector and would not be holding any Italian debt at this juncture; however, many others do for so little reward.