Ostensibly it looks like we’ve returned to our desks picking up pretty much where we left off. Or have we? It was by no means as dramatic a summer as those of Eurozone crises and taper-tantrums past or even last year’s oil & China worries. But arguably the summer has been a pivotal period that has established the terms of debate for the autumn and beyond. This week we go back to school talking about eight of the biggest summer themes.
There’s plenty of commentary around this week talking about how exciting September will be after such a quiet summer in the markets. True, we have a plethora of central bank meetings –the ECB later today, the Bank of Japan and the Fed both on 21 September; the first US presidential debate on 26 September and an informal OPEC meeting in the two days beyond – but it would be wrong to think that nothing happened this summer.
I think we begin autumn with a clearer – arguably more realistic view – of what the new economy looks like and its challenges and the events and debates of this summer have certainly set the stage.
1. Lower for longer
As we discussed last week, Jackson Hole hasn’t given us much clarity as to the Fed’s next move – other than it seems as if they’re preparing us for one when the data is right. Not yet maybe. But what this summer has really underlined is that whatever the Fed does this month or in December is arguably dwarfed by the bigger picture: the neutral rate has fallen for all major economies with significant consequences.
Meanwhile, major central banks have been putting down easing markers. The ECB is expected to do something more before the year is out along with the Bank of Japan. The Bank of England is contending with mixed and confusing post-BREXIT data, but it clearly isn’t adverse to further action. This could create some interesting currency and fundraising dynamics. The current strong flows into emerging markets – another big summer theme – are of course vulnerable if we do see the Fed start to unwind or if Chinese growth pales.
3. Central bank risks & limits
The limit of what is “safe” and the limit of what is still “possible” has dominated discussion on QE this summer.
In the last few weeks we’ve had increasingly vociferous analyst warnings about the dangers of going lower for banks, pensions and market function and the risk of ‘CREXIT’ – a damaging run to the credit exits. Citigroup’s head of global credit strategy, Matt King, outlined seven reasons markets are “deeply dysfunctional.” Bill Goss explained why current polices will “hurt rather than heal real economies”. Paul Singer warned that the “the global bond market is broken.” Gillian Tett of the FT warned that “asset prices are extraordinarily elevated.” There’s also concerns about the Bank of England and the the ECB might be reaching the limit of what’s available to buy under current criteria.
This isn’t 2008 redux. China has seen the biggest run up in debt. Low yields have secular and cyclical roots. None of this necessarily makes it safer, but it is different. Although, it seems that companies aren’t hanging around and it’ll be a very busy period in debt markets this autumn. Clearly there are concerns that markets may at least turn a little more watchful soon.
4. Government returns
Central banks have by no means thrown in the towel, but more are suggesting that governments need to do their bit. And it’s not just that we’re seeing the return of fiscal stimulus in political rhetoric. It also seems that governments are going to be doing more to address the concerns of the economically and culturally “left behind”. It’s notable that on both sides in the US there are promises to invest more in infrastructure and in the UK there’s increasing signs there will be intervention on executive pay and workers’ rights and representation. Many opportunities and challenges right there.
5. Drawbridge up
More than half of fund managers cited geopolitics and protectionism as the biggest market risks in a poll in July. As The Economist recently noted, the new divide is not between left and right but between open and closed…i.e. ”drawbridge up” or “drawbridge down” on immigration, on trade and on cultural change. Some of the pull back in global trade is part of deeper forces – technology, the rise of the service economy and a slower China pulling in fewer materials and goods. But there is undoubtedly a rise in protectionist rhetoric and this summer has underlined the lack of official enthusiasm for global deals with increasing uncertainty over the future of TTP and TTIP.
6. A slower UK economy
It’s worth just repeating – for the avoidance of any doubt – that we can’t judge the economic impact of BREXIT because it hasn’t happened and we don’t know what it is yet. We can only judge the impact of post-vote uncertainty, Bank of England action and government assurances – and all on very limited data. Our current view is that the UK is probably going to avoid recession, but the economy is moving slower.
Then again, the summer is an odd month for data, distorted by old-school factors, like the weather. It’s not all about BREXIT. Plus, whilst some groups are enjoying the spoils of the vote – low interest rates, weak sterling for exporters –the pay-offs in terms of changes to trade, lower investment etc. are somewhere down the line. Trade deals won’t change for years and we won’t be much the wiser on the actual impact of BREXIT until then.
7. Bank aren’t profiting
This summer’s ECB bank stress tests showed an improving capital situation with a lingering asset problem– no revelation there. What the spotlight on Italian bank and subsequent recapitalisation did show is that big government-backed rescues are a thing of the past. And the problems in Italy also drew attention to a growing issue for all banks: profitability.
The low interest rate environment is already putting pressure on Net Interest Margin (NIM). UK bank earnings forecasts have fallen by 35% in the last 12 months, according to Citigroup. Again it’s not a dramatic issue, but none the less painful and in the long term damaging. Future stress tests will need to look at yield troughs as well as yield spikes.
8. M&A imperative trumps uncertainty
The value of deals in August fell by 47% compared to 2015, but volumes rose 9% year-on-year just to underline the fact that companies still have strong appetites in the midst of uncertainty. This trend for more smaller deals could be about taking less risk or it could be due to changing deal dynamics. More companies looking for innovation in younger, smaller companies perhaps? Either way, it seems that the deal imperative won this summer – testimony to its strength in this environment.
This imperative currently rests on the relative ease of raising capital and the strong need to transact in a slow growing and highly disrupted environment. We can’t count on the markets to remain so helpful; any escalation in BREXIT and US election uncertainty may stall deals for a while; but the disruptive and earnings need will surely continue.