Monthly Review : December 2019

Monthly Review : December 2019

Economies:

United States

More than 260,000 jobs were added in November according to the non-farm payrolls report and the unemployment rate fell back down to a 50-year low of 3.5%. Manufacturing jobs were boosted by the return to work of 54,000 striking General Motors workers whilst leisure and hospitality added another 45,000.  The buoyant labour market and lower mortgage rates following the Fed’s three rate cuts since the summer have re-energised the housing market – building permits for new homes rose at an annualised pace of 1.482 million in November, the most since May 2007.

 

Euro area

Germany narrowly escaped slipping into a technical recession in the third quarter but more recent data suggests the economy is back on a downwards trend.  Industrial output in October dropped 5.3% from a year earlier, the largest fall in a decade, and the manufacturing PMI fell to 43.4 in December – a reading below 50 points to contraction.  Emmanuel Macron faced the biggest strikes of his presidency as French public sector workers took to the streets over proposed changes to pensions, including raising the effective retirement age from 62 to 64.

 

United Kingdom

The number of jobs in the UK increased by 24,000 to 32.8 million in the three months to October, pushing the share of the working age population in employment to 72.6%, the highest since records began in 1971.  Average earnings in the same period grew 3.5%, underpinned by greater competition for workers.  The gap between wages and inflation, the CPI Index rose at an annual rate of 1.5% in November, has extended the recovery in real average weekly earnings which are now just £1 below the £473 peak reached in April 2008.

 

Switzerland  

The State Secretariat for Economic Affairs maintained its tepid 2020 economic growth forecast at 1.7%.  It cautioned that trade tensions and weak growth in the Eurozone, particularly in its largest trading partner Germany, will continue to create headwinds and excluding sporting events to be held next year, the growth rate will be close to zero.  The pessimistic external outlook is holding back capital investment despite very favourable financing conditions.  On a brighter note, the SECO expects the healthy labour market to boost consumption in 2020.

 

Central banks:

Federal Reserve (next meeting: January 29th)

The Federal Reserve held its key policy rate steady in December, halting a run of three consecutive cuts, and indicated it will likely stand pat throughout next year due to muted inflationary pressures.  The decision was unanimous for the first time since May as the members of the FOMC expressed more confidence in the labour market – their estimate of the long-term unemployment rate was lowered to 4.1%.  In the press conference following the meeting, Chairman Jerome Powell reiterated his confidence that the economy is in a good place and suggested it will take more than an escalation in trade rhetoric to adjust monetary policy ahead of next November’s elections.

 

European Central Bank (next meeting: January 23rd )

Christine Lagarde chaired her first meeting at the helm of the ECB and immediately sought to establish her own more open style.  Whilst there were only a few subtle tweaks to the script used by her predecessor Mario Draghi, such as adding “downside risks on the horizon are less pronounced”, her delivery was quite different.  She repeated her call for governments to do more to boost growth and acknowledged more QE is possible.  Mme Lagarde also confirmed that a strategic review of monetary policy will start in January which should be completed by the end of 2020.  The second review in the bank’s 20-year history will extend to climate change and wealth inequality.

 

Bank of England (next meeting: January 30th)

The Bank of England left its key interest rate unchanged at 0.75% in December and once again the decision was not unanimous with two external members of the Monetary Policy Committee voting for a cut.  The MPC meeting was partly overshadowed by newspaper revelations that the BoE has asked the Financial Conduct Authority to investigate reports that the audio feed of its press conferences has been supplied to high-frequency traders, allowing them to trade on information up to eight seconds ahead of television viewers.  Andrew Bailey, head of the FCA, was selected to succeed Mark Carney as governor of the BoE in March.

 

Swiss National Bank (next meeting: March19th)

The SNB held interest rates at -0.75% and reaffirmed its willingness to intervene in the foreign exhange market amidst a fragile environment for the “highly valued” franc.  It remains unmoved in its view that its five-year old negative interest rate policy is essential to support economic activity and combat the risks of deflation – it lowered its inflation forecasts for 2020 and 2021 to 0.1% and 0.5% respectively.  The policy is deeply unpopular with local banks and savers but a defiant SNB Chairman Thomas Jordan repeated “the benefits its brings to Switzerland clearly outweighs the costs.”

 

Market issues:

  • The Conservative Party’s emphatic victory in the UK’s general election pushed sterling to an 18-month high and the more domestic focused FTSE 250 Index climbed by more than 3.5% in the following day’s trading session. The gains reflected relief that the parliamentary stalemate, which has frustrated investors for more than three years, is now in the rearview mirror and the Labour Party’s proposed nationalisations of utilities and public infrastructure are off the table.  However, the pound gave up all of it post-election bounce after Prime Minister Boris Johnson, fortified by his new mandate, announced that a Brexit deadline of 31 December 2020, with or without a trade deal between the UK and EU, will be written into law.
  • Officials from US and China confirmed that a phase one deal had been reached to de-escalate the trade dispute between the two super powers. Beijing agreed to increase US imports by around USD 200 billion over the next two years, including at least USD 40 billion of agricultural goods annually, improve protections for US intellectual property and cease the forced transfer of technology from US companies.  In return, the US stepped back from placing new tariffs on USD 156 billion of Chinese goods planned for mid-December and will halve levies introduced in September on USD 120 billion of imports.  US tariffs of 25% will remain in place on around USD 250 billion of Chinese imports, half of the annual value.
  • All parties moved closer to ratifying the USMCA trade deal. A last minute amendment at the behest of Democrat lawmakers to send five attachés to Mexico City to monitor labour rights provoked a furious response from Mexican officials, putting the pact into jeopardy.  However, US trade representative Robert Ligthizer moved to quickly to defuse the situation by offering reassurances that the attachés will only provide technical assistance and will abide with Mexico’s labour laws.  The House of Representatives subsequently voted 385-41 in favour of the Agreement which is expected to be approved by the Senate in 2020. It comes at a crucial time for the stagnating Mexican economy which sends around 80 per cent of its exports to the US and the peso rallied to a five-month high on the breakthrough.
  • Sweden’s Riksbank ended its five-year long negative interest rate regime, moving its key policy rate from minus 0.25% to zero. The majority of the executive board argued that with inflation expected to be closer to the bank’s 2% target rate, it was appropriate to act now whilst the two dissenters preferred to wait given that Sweden’s economy remains vulnerable to trade tensions and is showing signs of slowing – both the manufacturing and services PMIs fell further below 50 in November.  However, it was perhaps concerns over the side effects of an extended period of sub-zero rates which swayed the majority.  The sub-zero rates club is now down to four – the central banks of the Eurozone, Switzerland, Denmark and Japan.
  • Alberto Fernandez, sworn in as Argentina’s new president on 10 December, will be afforded no honeymoon period as he deals with a deep economic crisis and tries to reconcile the conflicting demands of Argentine citizens and international creditors. His newly appointed economy minister, Martin Guzman, has pledged to avoid confrontation and seek constructive dialogue with creditors but the long standing critic of the IMF, and its prescription of austerity for debt crises, has very different views on how to put the economy on a path to recovery.  Local media has reported he is seeking a two year suspension of capital and interest payments on more than USD 100 billion of debt.

 

Credit Markets:

  • Social media platform Twitter (Ba2/BB+) sold its first-ever conventional bonds in December. Strong investor demand enabled the company to upsize issuance by USD 100 million to USD 700 million and cut the coupon to 3.875% from initial guidance of 4.5% on the 8-year issue.  The successful bond sale follows the announcement of disappointing third quarter earnings which triggered a 20 per cent fall in its share price in October.
  • Petroleos Mexicanos (Baa3/BBB+) revealed it had made the biggest oil discovery in Mexico since 1987 at the onshore Quesqui field in the Gulf coast state of Tabasco. The Quesqui deposit has proven, probable and possible reserves of 500 million barrels of crude equivalent and the first well, which was drilled in June, is now producing 4,500 barrels per day.  CEO Octavio Romero Oropeza expects the field to reach 69,000 barrels of oil daily output and 300 million cubic feet of gas production next year.
  • Chevron (Aa2/AA) announced plans to write down more than USD 10 billion of assets in the fourth quarter due to the glut of shale gas which has hit energy prices. More than half of the charge relates to assets in the Appalachian region which it purchased from Atlas Energy for USD 5.5 billion in 2018.  It will also take an impairment charge on Big Foot, an offshore oil drilling project in the Gulf of Mexico.  Chevron will focus next year’s USD 20 billion capex budget on the Permian Basin, deepwater projects in the US Gulf and the Tengiz oilfield in Kazakhstan.
  • FedEx Corp (Baa2/BBB) shares fell 10 per cent, and credit spreads widened, after it cut earnings guidance for the second time in three months.  The company cited weak international demand, higher investment costs to handle growing demand for e-commerce deliveries and “the loss of a large customer”. FedEx opted not to renew its ground delivery contract with Amazon at the end of August amidst an escalating delivery war and less than two weeks before Christmas, Amazon barred third-party merchants from using FedEx’s ground delivery network for the rest of holiday season for being too slow.
  • Boeing’s (A3/A) announcement that it will suspend production of the 737 Max from January triggered a one notch ratings downgrade by Moody’s to A3. The jet was grounded in March after the second of two fatal crashes and the timetable for the US Federal Aviation Authority and other global regulators to approve a return to service is still unclear. The airline manufacturer will seek to avoid layoffs at its Renton plant by moving affected employees to other roles but the impact of the decision is expected to be felt far and wide in supply chains, including at Safran which makes the Leap engine in a joint venture with General Electric and Spirit AeroSystems which makes the fuselage. Around 400 737 Max airplanes are parked at Boeing facilities awaiting delivery.
  • Tullow Oil (B3/B+) plunged into crisis after it cut its production outlook, suspended its dividend and announced the departures of its chief executive and exploration director. Shares in the FTSE 250 oil and gas explorer fell by more than 70 per cent to their lowest level since 2000 and bonds dropped to 80 cents on the dollar.  Tullow, founded in the 1980s to focus on exploration in frontier markets, has been hit hard by the rise of the US shale industry which has depressed crude prices and weaker cash flows will put its debt servicing commitments under pressure.
  • The UK’s Serious Fraud Office opened an investigation into Glencore (Baa1/BBB+) over “suspicions of bribery”. Whilst the SFO did not disclose any specific details, shares in the world’s largest commodities trader fell 9 per cent to a three-year low.  The media has speculated that the probe relates to Glencore’s acquisition of copper and cobalt mines in the Democratic Republic of Congo with the assistance of Israeli billionaire Dan Gertler.  Glencore was also subpoenaed by the US Department of Justice in July 2018 over its activities in the DRC, Nigeria and Venezuela and earlier this year the US Commodity Futures Trading Commission launched a separate probe.
  • Saudi Aramco (A1/A) raised USD 25.6 billion in the world’s largest ever IPO which was more than 4.5 times oversubscribed, attracting orders of more than USD 119 billion from mostly local and regional investors, including sovereign wealth funds from Abu Dhabi and Kuwait. The shares ended the month more than 10 per cent higher, giving the company a market cap of USD 1.9 trillion.  Saudi Arabia’s recent inclusion in the MSCI Emerging Markets Index will generate further demand from ETFs and other passive funds.
  • The Bank of England’s annual stress test revealed all seven of the UK’s major lenders should be able to withstand its most severe economic shock scenario which included a 3.7% fall in GDP, a rise in unemployment to 9.2%, a one-third drop in house prices, an increase in interest rates to 4% and a 30% depreciation of the pound versus the US dollar. Nationwide (Aa3/A) emerged as the strongest performer whilst Barclays (Baa3/BBB) and Lloyds Banking Group (A3/BBB+) were the weakest.  In the most stressed scenarios, Additional Tier 1 notes issues by the two banks would be converted into ordinary shares as their CET1 ratios would fall below the 7% trigger level.
  • Fiat Chrysler Automobiles (Ba1/BB+) and PSA Group (Baa3/BBB-), the owner of the Peugeot, Citroen and Opel/Vauxhall brands, agreed terms of a EUR 34 billion merger that will create the world’s fourth largest carmaker by output.  Shareholders of the two groups will each own a 50 per cent stake in the new Franco-Italian-American entity which will be domiciled in the Netherlands but listed in Paris, Milan and New York.  The proposed merger follows the collapse of FCA’s tie-up with Renault in June after an intervention by the French government, Renault’s largest shareholder, and highlights the desire for consolidation in the sector where greater scale provides a competitive advantage at a time substantial investment in new technologies is needed to develop electric and self-driving vehicles.

 

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