The World In A Week - Back To School
While the country waved the next generation off to start a new school year, the same old issues still loitered in the global playground.
The tedious game of moans between the US and China continues unabated. The trade stalemate was highlighted with mirrored tariffs, showing a much harder stance from China. This was highlighted with their refusal to acknowledge that talks were progressing, despite Trump’s tweet of having deep and meaningful telephone conversations.
When the deal is not going your way, the art is to find someone else to attack. So, Trump continued his open criticism of the Federal Reserve on Twitter, with their “tremendous lack of vision” and asked: “who is our bigger enemy? Jay Powell or President Xi?”
It is this political pressure that casts many doubts over the world’s most important central bank, which finds itself in detention for not having reduced interest rates quickly enough. The Federal Reserve meet next week, which will be monitored closely for their rhetoric as well as their actions.
However, the biggest playground skirmish was around Brexit. Reacting to the controversial plan to suspend Parliament, the rebel alliance forced through a bill requiring an extension of Article 50 until 31st January 2020 if a deal to exit the EU is not in place by 19th October 2019, ruling out the possibility of a ‘no deal’ Brexit.
As a result of voting against the government, 21 Conservative MPs have effectively made themselves ‘independent’ in the House of Commons. Such a weak government would normally result in an election, however there is no demand for an election before the bill to rule out a ‘no deal’ is enshrined in law.
All we know for sure, is that the process has much longer to run and a general election looks all but certain in the near term. All of which is having an adverse effect on the UK economy, which continues to weaken with uncertainty continuing to linger on the horizon.
So, we have all been given a new timetable to learn.
The World In A Week - Prorogue
You may think that the title of this week’s ‘World in a Week’ relates to the protagonist of a play, disappointingly this is not the case. Prorogue is the technical terminology for the discontinuation of a parliamentary session without formerly dissolving parliament. This is what Boris did next, when he announced that parliament would be suspended from mid-September to mid-October, in order to push through Brexit. In a move which received approval from the Queen, Remainers will now have significantly less time to prevent a disorderly Brexit. While it has been cited that Boris will have much greater leverage and credibility in the EU renegotiation of a Brexit deal, he is also at risk of facing a vote of no-confidence, which could trigger a possible election. The Pound came under pressure against the US Dollar on Boris’ announcement, be sure to stay tuned for the next act...
Staying in Europe, equity markets rose steadily last week. The reasons for this were two-fold; firstly, the US/China trade discussions showed signs of improvement, which was positive for Germany whose economic data demonstrated that they had managed to stave off a recession, for now at least. Secondly, Italian markets received a significant fillip when populist party 5-Star Movement and the centre-left democratic party agreed to formalise their plans to build a coalition government. The Italian stock exchange, the FTSE MIB, rose nearly 4% on the back of this news. This positive news was marred by the fact that the coalition will face immediate and tough challenges such as the country’s mounting debt, a stagnating economy, and the expectation that they are likely to breach their target budget deficit in 2020. Italy have already come under scrutiny by the EU in May of this year. It is broadly expected that the coalition will go ahead but with political views that are poles apart, it is questionable whether the coalition will be sustainable over the longer-term.
The World In A Week - The G7, and other Sticky Wickets
Market volatility continued for the week ending 23rd August 2019, with global equities down -1.6% in GBP terms as measured by MSCI ACWI – this was primarily driven by ongoing concerns regarding the US economy as well as a weakening Dollar. Global bonds fell -0.1% over the week, while Sterling bonds fell -0.3%. Sterling rose against all major currencies, having weakened significantly for the year to date.
While England simultaneously basked in a sweltering bank holiday weekend and victory over Australia in the cricket & Ireland in the rugby; the leaders of the major western democracies gathered in Biarritz for the annual G7 summit. In spite of some rather superficial gestures regarding advancing the Iranian nuclear talks and the establishment of a fund to combat Amazonian forest fires, the summit was broadly as dysfunctional as it has been over the Trump era. President Macron attempted a charm offensive with Mr Trump, hoping to appear statesmanlike. Prime Minister Johnson spent the weekend portraying the UK as open, outward looking and ready for new international trade deals in a post-Brexit world.
We can expect market volatility to continue into this week as the London markets re-open (with the air-conditioning up full blast no doubt). Worries over the US-China trade war persist, Italian political drama drags on and the depth of the economic slowdown in Germany is a serious cause for concern. The upside for equity markets is now potentially more limited than that of England’s prospects in The Ashes.
The World In A Week - Rebel Without A Cause
The US and China are both playing hardball, with neither wishing to lose face, but so far, there is no winning, only losing. On a topic that we have written extensively about in the past, trade wars continue to fluctuate between resolution and escalation. Following Trump’s announcement of further tariffs on Chinese goods last week, which initially, were planned to be implemented on 1st September 2019, China allowed its currency to devalue, falling through 7 Yen to 1 US Dollar. The tit for tat continued, with the US proclaiming China a currency manipulator. Trump later announced that he would defer some of his new tariffs, those specifically linked to consumer goods. China agreed to further talks within the next two weeks, in a move likely focussed at calming some of their tensions, as protests in Hong Kong escalated.
While stock markets responded positively to the softening stance of China, the same cannot be said of bond markets. Last week, we witnessed an event that has not been seen in over a decade; the event in question is the inversion of the US Treasury market’s yield curve. It has been over 10-years since the yield curve inverted; this means that the yield on 10-year notes fell below that of 2-year notes. The last time we witnessed this move was in 2007 and the Great Recession duly followed in December 2008. Despite the inversion being rather brief, historically, this has been a reliable precursor of a recession. But, bond markets, like equity markets, can get it wrong. However, we must be cognisant that the chances of recession have now greatly increased.
The World In A Week – Thucydides’ Trap
Last week we wrote about the deterioration in outlook and this week we write about the actual fallout. We saw safe havens rallying as fears of a recession increased markedly; gold hit a six-year high and US stocks had their worst trading day in 2019.
This was led by lacklustre economic data for global manufacturing and exports. Commodity prices continued to fall, and inflation pressures remained low. Escalating trade tensions threaten to turn into a full-blown currency war, as China retaliated from Trump’s threat of additional tariffs beginning next month. Global recession risks are firmly on the mind of central banks, if not the markets, which is why the interest rate cuts from New Zealand, Thailand and India came as a surprise.
What does this have to do with Thucydides’ Trap? Thucydides was a Greek historian who wrote about the inevitable war between Sparta and Athens, which was caused by the growth of the latter and fear of the former. The trap is being replayed between the rise of China and the fear of the incumbent US, which initially manifested itself as a trade war and looks set to evolve into a currency war.
To add to the current climate of woes, the UK’s economy contracted for the first time in seven years. The second quarter shrunk 0.2% compared to the previous three months, predicated on increasing Brexit concerns, stock-piling ahead of the original Brexit date and of course and the effect of global trade tensions. The signs could not be clearer for the Conservative government not to take any undue risks with the economy.
There are some silver linings if you dig deep enough. The weak second quarter was payback for a strong first quarter, which saw manufacturers accelerating production ahead of the March Brexit date. These inventories have now unwound, as well as many factories scheduling routine maintenance for April, all of which reduced output for the second quarter. The contraction cannot be fully laid at the feet of Brexit though, as manufacturing and services globally are struggling, amid the trade war tensions and mixed signals from the Federal Reserve.
What is clear though, is the obvious solution for the government in order to give the UK economy a restorative boost, is to avoid the precipice of a no-deal Brexit.
The World in a Week - Dialling Down
The US Federal Reserve was in the limelight last week; Fed Chairman, Jerome Powell, delivered an unsurprising rate cut at his press conference, the first reduction in a decade. The 25bps clip was termed a ‘mid-cycle adjustment’ with Powell emphasising that the cut was not part of a steady trajectory of rate reductions and was merely a means of ‘insurance’. Markets fell sharply on this news, which was not the 50bps that some had hoped for. While markets initially took a dive, towards the end of his speech, Powell clarified that this did not mean further cuts are completely ruled out.
Other key news from Powell’s press conference was the Federal Open Market Committee announcing that they would bring quantitative easing to a standstill, selling off bonds previously bought in quantitative easing purchases. Originally, this move was scheduled for September but has been brought forward to August, Powell was clear that this move was to demonstrate that the Fed were exercising prudence, and not with a view that a potential recession was looming. The US economy remains in rude health, although trade wars continue to weigh on general sentiment.
On the topic of Trade Wars, Trump confirmed a further 10% of tariffs on £300bn worth of Chinese imports to the US, effective on 1st September 2019, which was delivered by tweet, of course. Markets reacted badly, stocks and commodities, notably oil, toppled, on the gloomy implications this could have for economic growth. It is uncertain how China will respond, but given their intervention in their currency market, firstly preventing the currency from strengthening too quickly, and more recently, weakening too quickly, currency could well be China’s chosen method of retaliation or more fittingly, their Trump card. As we write, the symbolic level of 7 Yuan to 1 US Dollar was breached, this is the lowest level since the Global Financial Crisis, which indicates at best a Superpower showdown and at worst, a full-blown trade war.
The question we are asking ourselves is whether Trump’s recent increase in tariffs, was a strategic move to force the Fed to cut interest rates further and stimulate the US economy, the fallout of this action will be seen in the coming weeks.
The World In A Week - The Greatest Showman?
Headlines were dominated by the Conservative Party leadership contest, which saw the expected outcome of a victory for Boris Johnson. In his inaugural speech as Prime Minister, Johnson said his priorities were to deliver Brexit, unite the country and defeat Jeremy Corbyn.
With around 14 weeks in which to deliver Brexit, Johnson wasted no time in reshaping the Cabinet, culling 15 ministers in order to surround himself with a team that share his views. There will be a lot of hard worked required, for both the UK and EU, to find a resolution in just three months that could not be achieved over the past three years. Particularly when Parliament is only scheduled to be in session for around 21 days during this period and the EU already reiterating its hard stance.
When it comes to rhetoric, Mario Draghi has the crown amongst central bankers. The current head of the European Central Bank (ECB) signalled that he would be prepared to cut interest rates in order to tackle a slowdown in the eurozone economy. He said the risk of a recession was low, however the outlook is worsening, blaming the trinity of Brexit, trade wars and geopolitical uncertainty. His comments also marked the seventh anniversary of this infamous “I will do what it takes” speech, in which he pledged to keep the eurozone intact in the summer of 2012, the height of the sovereign crisis that was sweeping throughout Europe. These words were enough to see off the spectre of collapse and action did not have to follow for several years. However, the ECB’s greatest showman has his final curtain call, stepping down in October, but looking to leave a clear path for this successor.
The final showman is also a central banker. Jerome Powell, the chair of the Federal Reserve, meets with his fellow members of the Federal Open Market Committee on Tuesday and Wednesday. Having spent the previous week building expectations for a significant rate cut, last week saw this being walked back with the art of managing expectations being stretched beyond creditability. Prospects are for a 0.25% cut to US interest rates, given us some substance to the continuing and increasingly confusing rhetoric over the past seven months.
Politicians have always been showmen of a sort, but now we have the heads of the world’s most influential central banks joining them on the front burner. We expect to be inundated with forward guidance during the summer, but it is autumn that we need to see action with Brexit as well as the central bankers.
The World in a Week - Quarterly Earnings Season For US Banks
The biggest US banks reported their second quarter earnings of 2019 last week and it was generally a robust quarter for them all, although Morgan Stanley and Goldman Sachs disappointed a bit by being the only major US banks to have revenues, net income and earnings-per-share all fall compared to a year earlier.
JP Morgan has the highest revenue at USD 29.6 billion although this is to be expected as it is the largest US bank. It also achieved the best year-on-year growth in revenue at 4%. JP Morgan’s year-on-year growth in Net Income was up 16% too which was only surpassed by Wells Fargo at 20%.
Morgan Stanley disappointed with its year-on-year revenues down 3.5%, net income down 9.7% and earnings-per-share down 5.4%.
Goldman Sachs also disappointed with its year-on-year revenues down 1.8%, net income down 5.6% and earnings-per-share down 2.8%.
Share prices did not move much on their respective reporting days. However, Wells Fargo’s share price fell 3.2% on Tuesday despite achieving the best year-on-year Net Income growth. The reason for this is that all banks rely heavily on Net Interest Income (essentially their lending rates minus their deposit rates) and Wells Fargo’s Net Interest Income was down USD 216 million from the first quarter of 2019 and this predominantly caused its share price to fall 3.2%.
Decreased Net Interest Income is likely to be an issue for all US banks going forward though as the Fed is likely to reduce the Fed Funds Rate on July 31st 2019. If this occurs, the lower rates will directly squeeze the banks’ Net Interest Income and thus their total Net Income too.
At the time of writing, using the Fed Fund Futures market, there is a 75.5% chance of a 0.25% cut in the Fed Funds Rate on July 31st. If a cut occurs it would prompt investors to be more cautious about US banking stocks, but it would be beneficial for US equities in general though.
One last bank to mention is the Bank of England as they announced on Monday that Alan Turing, the Bletchley Park mathematical genius, will be the face of the new £50 bank note in 2021.
The World In A Week - Fact & Fiction in the Far East
Markets were quite sedate last week, with global equities as measured by the MSCI ACWI Index falling -0.2% in GBP terms. UK shares were down -0.6%, while Europe Ex-UK was down -1.1% and the S&P 500 in the US bucked the global trend by being up +0.4%. Emerging Market equities were down -1.2%, led by the Asia Pacific Region. Global Investment Grade Bonds in GBP (hedged) fell -0.4%, while High Yield fell -0.2%. Emerging Market Local Currency Bonds continued their strong run this year and are now up 11.6% for the year to date in GBP terms.
The main item to hit the newswires this Monday morning was the release of Chinese GDP data for the second quarter. The reading of 6.2% annualised growth was the lowest such result for the last three decades. Consensus is that these numbers were impacted by the ongoing trade war with the US, while strong domestic consumption averted an even deeper slowdown. This growth figure was in line with Analyst expectations. While it is good news that Chinese growth is less reliant on exports and more reliant on domestic demand, Chinese GDP statistics in the abstract are highly dubious and need to be treated with due scepticism. The numbers are liable to political manipulation, in order to allow the Communist party to meet its target of doubling the size of its economy in 2020 relative to 2010.
Nonetheless, the slowdown in China coupled with wider global growth concerns is impacting the path of global central bank activity. Chairman Powell at the Federal Reserve affirmed the path of easier monetary policy in front of Congress last week. This enhances our view that one should remain invested, but cautiously positioned.
The World In A Week - Beneath The Surface
On the surface, last week appeared quite sedate in markets as global equities, measured by MSCI ACWI rose +0.16% in GBP terms. This was led by UK and Japanese Equities, while the US markets sold off slightly.
Beneath the surface however, there have been important movements in other parts of financial markets. Global and Sterling-denominated Fixed Income sold off quite significantly, in what has been described as a “Bund Tantrum”. US and German yield curves steepened over the course of the last week, as the German 25 and 30 year Bund moved out of negative territory. These moves were driven by a combination of decreased anxiety over the ongoing trade war between the US and China, and the statements by Mario Draghi that the European Central Bank is running out of tools to combat economic malaise and fiscal policy needs to do more to stimulate growth.
On the back of this increase in global rates, equity markets witnessed tectonic shifts of their own. Stocks that exhibit high “momentum”, or in other words the tendency for stocks that have recently done well to continue doing well, sold off heavily. Conversely, “value” (or cheap) stocks outperformed their peers.
The weekend brought additional market-moving headlines, in the form of a large-scale attack on Saudi Arabia’s oil production facilities which cut the country’s output in half. This sent the price of oil rocketing by +20%, which was the largest jump since the 1990 invasion of Kuwait.