BlueBay AM: The hulk is famous for making a total mess
By Mark Dowding, CIO at BlueBay AM
BoJo takes his shambolic show on the road leaving Parliament scratching its head over the legality of its enforced recess.
The Fed’s decision to lower rates by 25bps at this week’s FOMC meeting came as little surprise to markets. However, with Chair Powell seemingly keeping the mid 90s narrative of a mid-cycle ease in place, those looking for evidence of a more assertive commitment to lower rates came away looking disappointed.
Short-dated yields rose somewhat, with equities trading a little lower – though as the dust settles, we do not believe that the Fed narrative should be overly surprising at this point. Ultimately, the Fed appears to be telling markets that it is in a data-dependent mode and against a backdrop of elevated uncertainty with respect to global economic developments and trade policy, it is not surprising that the Fed feels unable to offer much clarity in the context of forward guidance.
Aside from this, US growth continues to be robust with strong housing market data this week coming on the heels of a firm retail sales report last week, continuing to show the strength of underlying demand in the domestic economy.
Investors will continue to be fearful of Trump’s tweets and interventions, yet it seems that presidential interference regarding monetary policy seem to be having less of a market impact than was previously the case. Moreover, on trade, we believe that a ceasefire in hostilities becomes increasingly likely as the clock ticks down towards next year’s US presidential election – even if prospects for a trade deal which reverses tariffs seem a long way away.
We believe that this week’s rate cut may be the last monetary policy move for the time being. We are inclined to think that the Fed will adopt a wait and see stance on rates, unless the geopolitical or trade outlook deteriorates materially.
Ultimately, we remain in the camp looking for a more upbeat view for US growth and so are inclined to think that markets are pricing too much easing into 2020. However, uncertainty remains significant and against this backdrop, we find it difficult to take directional risk on US rates with any material confidence
European yields declined somewhat in the past week as the sell-off in yields, which has been underway since the start of the month, showed signs of abating. Increased geopolitical fears in the wake of the drone attacks on Saudi oil facilities prompted a short-lived flight to quality, though risk appetite in Europe continues to be supported by last week’s ECB easing measures.
Across the periphery
Italian BTPs weakened a little following a split in the Democratic Party, which has seen 40 lawmakers join Renzi in forming a new party, Italia Viva. However, we expect this group to continue to support the current government, keeping a lid on potential political volatility – at least for the time being.
In Spain, a disagreement between Podemos and PSOE has seen Sanchez call fresh elections on 10 November. At face value, Spanish political sclerosis may be a concern. However, we doubt that political instability will change the macro picture in Spain very much and with support for Sanchez seeming to increase, we are inclined to believe that this will put PSOE in an even stronger position in the wake of this vote.
Elsewhere, Greece has announced plans to issue government guarantees to allow banks to reduce bad debt levels.
Currently, bad debts in the banking sector amount to close to EUR80bn and we would estimate that the issuance of EUR10bn of government-guaranteed bank bonds would allow Greek banks to reduce this amount by EUR20bn in the coming year, in a plan similar to that used to help clean up the bad debts in Italian banks over the past year or so.
This is a credit-positive step in our eyes and has seen 10-year Greek bond spreads trade through 200bp versus bonds.
Notwithstanding this, we still feel that Greek bonds can rally further on a relative basis and with the new government making the right noises and further rating upgrades possible not far distant, we believe that spreads could still rally by an additional 50bps in the months ahead – potentially by more if Greece were to make progress towards investment-grade status, so that it re-enters bond benchmarks, as well as becoming eligible for the ECB bond buying programme.
BoJo goes on tour
Newsflow in the UK was relatively light with Parliament now closed – legal challenges aside. As the Incredible Hulk (as Johnson was happy to describe himself) departed on a tour of European capitals, we sense it may be dawning on him that his ideas for solving the Irish backstop issue are falling on deaf ears.
The EU has previously rebuffed the idea that basic checks, implemented through technology solution, are unworkable. In addition, EU officials are also suspicious of an outcome allowing Northern Ireland to stick to common EU rules on food and livestock (known as SPS).
In the eyes of the EU, such an outcome won’t solve for the ‘Chlorinated Chicken’ scenario, in which the UK imports cheap US chicken and sends it to Northern Ireland, where it would not be prevented from crossing the border into the south of the country.
With Johnson also struggling to win enough domestic support for a Northern Ireland-only backstop – due to resistance from the DUP and ERG wing of the Conservative Party – so the chances of Boris doing a deal seem to have dimmed over the course of the past week.
It is possible that Boris will be able to ‘buy off’ Arlene with cash for Northern Ireland, yet any initiative creating the sort of real border, which the EU requires, in the Irish sea will quite possibly prove a bridge too far in our estimation.
We believe that a UK election remains the most likely outcome.
Investor attention is likely to move back towards trade issues, in our view. Shortly after the last Fed meeting, Trump tweets led to a risk-off move in markets. Although it is hard to predict the timing of Trump social media interventions, we continue to assess that the probability of a trade deal with China is quite low.
A protracted ceasefire, avoiding ongoing escalation, would seem to us to be the most likely outcome from a political point of view, but further conflagration cannot be ruled out. Meanwhile, economic activity in China continues to weaken based on our analysis.
Europe has been more stable and may be supported by recent ECB measures and healthy domestic demand, which is keeping GDP growth figures in positive territory (on an EU-wide measure, at least). Indeed, having spent a few days in Ireland, it is interesting to observe that there are some parts of the eurozone that are literally booming – with unemployment in the Emerald Isle close to 0%, wages rising and the number of commercial cranes now materially surpassing the highs from the Celtic Tiger days back in 2006-7.
In this context, it is also interesting to reflect how different cultures in Europe are behaving differently in the face of ultra-low interest rates. It seems that German individuals have become concerned that low rates mean they need to save more, whereas as in countries like Ireland, the natural reaction is to borrow more and spend more. This is certainly something to continue to watch, lest it give rise to a new round of structural imbalances within the eurozone.
Meanwhile, in the UK, the less said the better…