Monthly Review : February 2020

Monthly Review : February 2020


United States

The US economy added 225,000 jobs in January, according to the non-farm payrolls report, well ahead of analysts’ forecasts.  The unemployment rate nudged higher to 3.6% as the participation rate, the share of working-age people actively seeking employment, climbed to a seven-year high.  Wages increased 3.1% from a year earlier, up from 3.0% in December.  The robust labour market has underpinned gains in personal incomes which rose 0.6% in January, the highest since February last year.  Consumer spending eased to 0.2%, impacted by the mild weather.


Euro area

Italy, at the centre of the coronavirus outbreak in Europe, will almost certainly suffer a technical recession in the first quarter.  The economy contracted 0.3% in Q4 2019 and its PMI manufacturing index declined for the 17th straight month in February.  Bracing for the shocks to tourism, demand and supply chains, the government announced it will inject EUR 3.6 billion of stimulus, including tax credits for companies reporting large falls in revenue, tax cuts and extra funding for its health system.  Public finances will fall further into the red and thus need approval from Brussels.


United Kingdom

Annual wage growth slowed in the fourth quarter of 2019 to 2.9% from 3.7% in the third quarter despite the employment rate reaching a record high of 32.9 million.  Including bonuses, average wages in the UK remain below pre-financial crisis levels. Annual consumer price inflation (+1.8%) rose for the first time in six months in January, lifted by higher gas, fuel and electricity prices, and house prices continue their post-election revival – the Nationwide house price index climbed to an 18-month high and 2.3% from a year earlier in February.



The Swiss government will cut its economic growth forecast due to the coronavirus outbreak the State Secretariat for Economic Affairs confirmed.  The SECO had previously forecast growth of 1.7% this year but its proximity to Northern Italy and reliance on exports makes it more vulnerable than some others in the near-term.  Fitch affirmed Switzerland’s AAA rating with a stable outlook.  The rating agency praised its diversified and high-value added economy, strong governance, robust banking sector and its very low government debt-to-GDP ratio.


Central banks:

Federal Reserve (next meeting: March 18th)

In his semi-annual testimony to the House Financial Services Committee, Federal Reserve chairman Jerome Powell noted the coronavirus outbreak in China posed risks but refrained from speculating on how far and wide any disruptions would be felt.  He added that the US economy is in “a good place” and unless there is a material change to the outlook, monetary policy is unlikely to be adjusted ahead of the elections.  However, in the wake of the surge in reported virus cases outside of China, Powell opened the door to an early rate cut in March to support the economy.


European Central Bank (next meeting: March 12th)

The minutes of the ECB meeting in January suggested the governing council was more upbeat about the outlook for the Eurozone economy.  Incoming data suggested “continued positive but modest GDP growth” and business sentiment was improving.  However, the meeting was held at the early stages of the coronavirus outbreak and the outlook is now much more uncertain.  ECB president Christine Lagarde has adopted a more cautious stance than some other counterparts, and revealed the bank will take its time to assess whether the health crisis will cause a long-lasting shock to supply, demand and inflation.


Bank of England (next meeting: March 26th)

Higher inflation and the imminent pro-growth government budget had led markets to push back expectations of a near-term change to monetary policy.  However, like everywhere else, the coronavirus is a game changer and the Bank of England announced it is working with international partners to “ensure all necessary steps are taken to protect financial and monetary stability” which suggests it could be part of a coordinated global central bank action.  Governor Mark Carney could be pushed to act before he is replaced by Andrew Bailey from 16 March. 10-year UK gilts fell to a record-low 0.4%.


Swiss National Bank (next meeting: March19th)

SNB President Thomas Jordan reiterated the central bank will not step away from intervening in foreign exchange markets, despite it being back on the US watchlist for currency manipulators. Although officials at the SNB have declined to comment on whether there have been any interventions, Jordan again defended any such moves as necessary to curb the deflationary effects of a the “highly valued” franc which has climbed to a five-year high versus euro amidst the coronavirus outbreak.  He also predicted “the negative interest rate will be around for a while” and left the window open to for rates to go below -0.75%.


Market Issues:

  • Government bond yields plunged as Investors sought refuge in safe haven assets while they weighed the economic toll of disrupted supply chains, travel bans and lockdowns of towns and cities. A longer and more widespread health crisis reduces the likelihood of a V-shaped recovery of the economy.  The expectation that central banks will step in to support economies pushed government bond yields even lower – the US 10-year Treasury and long bond fell to record lows of 1.1% and 1.7%.  The US Federal Reserve has the most room to act out of the major central banks and markets are now pricing in at least three rate cuts this year, possibly with an emergency cut as soon as early March.
  • UK Prime Minister Boris Johnson and senior government ministers signed off on the final version of the UK’s Brexit negotiating position. The UK government has shifted towards a harder line in recent weeks, emphasizing its ambition to take back full control of laws, regulation and taxation.  The EU, however, remains insistent that a trade deal will hinge on the UK complying with a strict “level playing field” to prevent it from undercutting in areas such as the environment, workers’ rights and state aid.  The divergence between the two sides increases the risk that a deal will not be reached before the end of year deadline and the UK has threatened to walk away as soon as June if progress is slow.
  • Greek 10-year government bond yields temporarily fell below 1% for the first time, marking another milestone in its emergence from the crisis which required a debt restructuring and a series of bailouts – 10-year yields reached 37% in early 2012 and were as high as 15% in 2015. Ultra-low and negative yields elsewhere in the Eurozone have driven inflows but investor confidence was also boosted by the election of more pro-business government under PM Kyriakos Mitsotakis last year and the economy is growing faster than its larger European counterparts.  Greece also attracted more than EUR 14 billion of orders for the sale of a new EUR 2.5 billion 15-year bond, the longest-dated issue since the crisis.  Its government debt-to-GDP ratio remains amongst the world’s highest at around 180%.
  • Two months into Alberto Fernandez’s presidency, there is little sign of progress in talks with Argentina’s international creditors as a ninth sovereign default looms. The new administration in pushing for a debt restructuring but creditors are demanding a credible plan to put the economy back on a sustainable path to growth before they will consider any proposals.  However, the government’s plan has an influential supporter in the IMF.  After a week-long visit to Buenos Aires, it said a “meaningful” haircut on private creditors’ bonds is necessary to reduce the country’s “unsustainable” debt burden. The IMF also refrained from calling from new austerity measures to balance the budget sooner than 2023.  Argentina’s “century bond” fell to 40 per cent of face value and the gap between the official and unofficial peso exchange rate widened further.
  • Lebanon’s creditors are also on edge as the calendar moves forward towards 9 March when it is scheduled to repay its USD 1.2 billion bond plus interest.  The price of the bond fell from 83 cents to just 52 cents on the dollar during the month, suggesting the country’s first default is now inevitable.  An IMF mission has arrived in Beirut to advise the newly appointed government which is being pushed and pulled by conflicting domestic and international interests.  Domestic public opinion supports a default to avoid putting further strain on its already precarious financial position.  It has been reported the government will use a seven-day grace period after 9 March to give its financial advisors more time to work on a debt restructuring plan.


Credit Markets:

  • LVMH Moet Hennessy Louis Vuitton SE (A1/A+) raised more than USD 10 billion from the sale of euro and sterling denominated bonds to help finance its USD 16 billion acquisition of US jeweller Tiffany & Co. It will pay less than 0.5% on the longest dated, 11-year euro issue and the two shortest dated euro issues were sold at a negative yield.  Total orders of more than EUR 23 billion enabled LVMH to upsize the combined sale from its initial target of EUR 6 billion.
  • Kraft Heinz Co. (Baa3/BB+) was downgraded to BB+ by Fitch and Standard & Poor’s. With around USD 30 billion of debt outstanding, it is the largest “fallen angel” since General Motors and Ford in 2005.  Its longest dated bonds dropped by more than 10 points as many investment grade mandates were forced to sell before high yield buyers stepped in to pare some of the declines.   The downgrades reflect Kraft Heinz’s reluctance to reduce its high dividend payout at a time when leverage has increased due to lacklustre operating performance – it has been hit by the trend of consumers shifting to fresher and healthier foods.
  • Macy’s. (Baa3/BB+) became the sixth US fallen angel of 2020 after its rating was cut one notch by Standard & Poor’s to BB+. S&P expects profitability under the retailer’s “Polaris” turnaround strategy, which includes closing another 125 department stores over the next three years, will be lower than previous forecasts due to its weaker competitive position.  However, S&P also revised its outlook to stable, noting that Macy’s will continue to generate positive free cash flow, which along with asset sales, should help reduce leverage.
  • Renault (Ba1/BBB-) was also added to the list of fallen angels. It was downgraded to Ba1 by Moody’s and put on watch negative by Standard & Poor’s after reporting substantially weaker operating results for 2019.  Revenues fell 3% to EUR 55.5 billion, driven by falling sales outside of Europe, and margins in its core auto business narrowed to just 2.8%.  The two rating agencies warned that stricter C02 regulations in Europe are a major challenge for Renault and the capital expenditure needed to develop electric, and more fuel efficient, vehicles will result in substantial negative free cash flow, despite Renault cutting its dividend by more than two-thirds last year.
  • Despite the wave of rating downgrades, the cost of insuring against investment grade defaults using credit defaults swaps (“CDS”) fell to a post-crisis low on both sides of the Atlantic. The CDX North American Investment Grade index fell to 44 basis points and iTraxx Europe index to 42 basis points, levels not reached since 2007.  The two indices quickly reversed as coronavirus fears took hold to finish the month at 67 bps and 64 bps respectively, the highest since June 2019.
  • Dubai’s port operator, state-controlled DP World (Baa1), is set to be delisted after its majority owner Port and Free Zone World offered to pay USD 16.75 per share, a 29% premium above where shares had been trading, to buy out minority shareholders. DP World, which operates in more than 50 countries worldwide, argues that going private will allow it to take longer term views and not be distracted by the minority shareholders’ near-term focus on returns.  The proposed transaction will require up to USD 9 billion of debt to fund the minority buyout, pay a dividend of USD 5.15 billion to Dubai World and to refinance upcoming debt maturities, prompting Moody’s to put it on review for downgrade. DP World’s USD bonds maturing in 2049 fell more than 5 points after the proposal was announced.
  • Deutsche Bank’s (A3/BBB+) sold its first Additional Tier 1 contingent convertible bond in six years, a period highlighted by a number of changes in management, takeover speculation and billions of euros of losses. The USD 1.25 billion sale of the riskiest from of bank debt attracted orders of more than USD 14 billion, reflecting the bank’s steady improvement in performance under CEO Christian Sewing and higher capital buffers due to asset sales.  The outsized demand enabled Deutsche Bank to bring pricing down from initial guidance of 6.75% to 6% and it should now receive regulatory approval to redeem its USD 1.25 billion 6.25% AT1 issue which is first callable in April.

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