Jeremy Wharton, Church House joint CIO, delivers an informative assessment on the current state of global credit markets
According to President Trump, the Fed ‘Blew it!’ This is despite US stock markets trading at all-time highs and the US economy expanding for the longest period on record (reaching over ten years) and amidst unemployment at a fifty-year low. Despite (illegal) efforts by his President to remove him from office, Jerome Powell, Chairman of the Fed, and amid continued criticism of Fed actions that have been well managed (i.e. nine rate hikes and balance sheet reduction), has achieved the luxurious position of a headline interest rate at a level worth cutting if necessary to deal with the fallout from aggressive trade tariff actions.
The most recent Federal Reserve meeting was relatively dovish, but markets are possibly pricing in too much too soon, as the underlying economy remains durable. Jerome Powell has indicated that steps will be taken to sustain the economic expansion, possibly responding to (or being bullied by) market movements in anticipation. US Treasury stock enjoyed their rally and the yield on the ten-year bond dipped below 2% before retreating to 2.1%.
Central bank action seems to remain the number one method for stimulating economic growth, with governments apparently thinking they are not responsible or unwilling to shoulder part of this burden through fiscal policy. But ‘Central banks should hang on to tools to "preserve some room for manoeuvre" during significant economic downturns’, stated Bank for International Settlements General Manager Agustin Carstens. He also said "Monetary policy should be considered more as a backstop, rather than as a spearhead of a strategy to induce higher sustainable growth.” I don’t think President Trump agrees with him.
China has just revealed its slowest growth for thirty years (although we never quite know the real validity of their numbers and it is still at a rate of 6.2%). Quite surprisingly, the G20 summit in Osaka produced agreement between Presidents Xi Jinping and Trump to resume trade talks, a pause on new tariffs and even the lifting of some restrictions on Huawei. Hopes remain for a ceasefire as the effect on both sides becomes more apparent, however this ‘war’ is likely to rumble on as a cause for concern for some time.
In the UK, home grown and global uncertainty continues to weigh on manufacturing and industrial production numbers but other indicators are stable. The Bank of England picks its words carefully, but appears to continue to favour policy normalisation (increases in the base rate), at some point, but cloaks any announcement with dovish assurances to jolly everyone along. Governor Carney admits that “sometimes Bank Governors have to deliver uncomfortable messages”, but the no deal scenario is clearly what disturbs them the most. Along with many other institutions, several major US banks have cautioned against a no deal but despite this some are thankfully increasing their London presence unlike European banks with the Deutsche Bank saga not helping.
Quite correctly, Governor Carney intervened to correct some misconceptions regarding our potential trade tariff exposure. He has not commented on President Macron’s assertion to a potential next PM that to withhold £39bn in dues would constitute a technical default by the UK but this might be a possibility. The Bank has been at pains to point out that there is a disconnect between market pricing and the likely path of UK rates, external MPC member Michael Saunders stated that there didn’t necessarily need to be clarity over our miserable situation before hiking rates. Recent economic data has been ‘push me, pull me’ with UK inflation expectations at their highest for a decade but Q2 GDP growth flat, mixed-in with continued high employment contributing to an acceleration in wage growth now standing at 3.6%.
The Eurozone increasingly attracts commentary including ‘Japanification’. There are obvious similarities, but I am not sure that this is entirely fair, there are a few rays of light as euro-area unemployment falls to 7.5%, the lowest since July 2008. The fragility of the area is evident though and the ECB continues to attempt to be dovish, ECB minutes show that they are open to interest rate decreases and more asset purchases. As the existing cuts and asset purchases have had limited effect (despite German Bund yields being negative out to ten years) it is hard to see the point, they need a plan B.
Credit markets remain in good form with Investment Grade spreads continuing to tighten, and now at lows for the year, but still short of the levels reached in early 2018. The primary market (where companies borrow in the first instance) remains ‘on fire’, with chunky issuance of new debt across all currencies. A recent sterling issue from Berkshire Hathaway drew widespread support and the twenty-year tranche priced at +110bp over Gilts, not bad for an AA credit, this issue is now trading over 20bp tighter translating into 4 points of capital upside. A Tier 2 issue from Prudential (‘reassign-able’ to either party on the event of the M&G/Prudential demerger) saw such demand (close to eighteen times oversubscribed) that it tightened in 60bp from initial price target and immediately traded 50bp tighter again. At the other end of the credit spectrum we saw subordinated issues from CCC rated entities, Piraeus Bank and National Bank of Greece, pricing at 9.75% and 8.25% respectively, not ones for us.
The above originally featured in our Summer 2019 Private Client Quarterly Review so is for information purposes only and does not constitute advice or a personal recommendation. The value of investments and the income you get from them may fall as well as rise and there is no certainty that you will get back the amount of your original investment. You should also be aware that past performance may not be a reliable guide to future performance.