The BoE cut interest rates by 25bps last Thursday to 0.25%, the lowest level in history and expanded the existing QE programme by GBP60bn to GBP435bn. Following in the footsteps of the ECB the BoE also added GBP10bn of corporate bond purchases (to be spread over the next six months), and announced the introduction of the Term Funding Scheme, which will be used to provide banks with funding to encourage them to pass the “close to Bank Rate” on to businesses and consumers.
The Brexit effect has seen a deterioration in the UK’s economic fundamentals; business confidence now sits near financial crisis levels, manufacturing shrank at its fastest pace in three years in July and construction has rapidly contracted. Policy easing is therefore a necessary step to prop up growth and avoid a dreaded recession. Governor Carney left the door wide open to take rates lower in the upcoming meetings, especially as he sees inflation rising and growth close to 0% into the end of the year. “Carney Carnage” saw the pound plummet 1.2% against the dollar last week, and 10-year Gilts fell to all-time lows closing 11bps lower at 0.684%.
Across the pond, as US economic data prints continue to paint a mixed picture, several Fed members expressed their views on future rate guidance last week. Known dove, Chicago Fed President Evans stated “one rate increase could be appropriate this year” despite his concerns that inflation remains below the central bank's target. Atlanta’s Lockhart said he cannot rule out a rate hike at the next meeting in September, while New York Fed President Dudley, most closely aligned with Fed Chair Yellen, appeared very cautious highlighting the greater downside pressures on economic growth both domestically and abroad.
The all important US non-farm payroll release for July was stronger than expected with +255k jobs added versus the market consensus for +180k jobs. This takes the 3 and 6 month averages to ~190k, from the more recent 150k levels, but remain below 2014/15 averages of 251k and 229k. The unemployment rate was unchanged at 4.9% and the participation rate edged up to 62.8%. The average hourly earnings came in at 2.6% yoy, in-line with expectations and the prior month. Average hours worked edged marginally higher to 34.5.
Despite the stronger-than-expected employment data we expect the Fed to remain ‘patient’ and take a very gradual approach to tightening rates. Unconventional monetary policy is bringing a great deal of uncertainty to global markets and increasing the search for yield as more and more bonds trade at lower or negative yields; high quality bonds from creditors, particularly those offering positive yields, remain one of the more attractive places to be positioned.
A good example would be our holding in 3-star rated Mexico’s state-owned petroleum company, Pemex. Rated BBB+ by both Standard and Poor’s and Fitch, the 5.5% bonds maturing in 2044 were priced at 90.20, at a yield of 6.25% which is a spread of 405bps over Treasuries. We see “fair value” at around 211bps, inferring a move up in price of 29 points to reach its fair value; the bond trades over 4 credit notches cheap, thus more than compensating for downside risks.