The World Cup reminds us how much many of us still strongly identify with nation states. In many major economies this sense of nationhood is increasingly being expressed through greater nationalism and a drive towards protectionist policies. Indeed, one way or another trade is going to dominate the markets this summer, through growing global tensions and the consequences of another critical month in the Brexit process.
In this week’s blog, I’ll look at ways in which all of this is affecting capital markets and the corporate capital agenda.
It’s never just Brexit…
The last few weeks have brought hard fought victories, raised passions and toughening opposition. And, much like England’s progress in the World Cup, Brexit’s progression gets more challenging from this point too. The next few weeks won’t just determine how much England’s raised footballing expectations match reality. It will also bring four developments which should give us more detail on the timings and shape of the UK’s exit from the EU.
28-29 June: EU summit
6 July: Meeting of the UK Government Cabinet and Brexit Cabinet at Chequers
Mid-July: Publication of the UK Government’s White Paper on the future EU-UK relationship
16-20 July (tbc) Vote in UK Parliament on the Trade Bill
The complexities of supply chains, regulations and authorisations that straddle the UK’s EU borders are coming increasingly to light as companies press harder for clarity. There still appears to be considerable distance between the various camps and therefore considerable uncertainty and we’ll be discussing the ins and outs of the next month further in an upcoming webcast with EY Brexit Strategy & Global Trade leaders next week.
But of course, Brexit isn’t the only factor driving trading uncertainties. Protectionism has shot to the top of the global risk agenda as trans-Atlantic and trans-Pacific tensions build. For all the rhetoric, the additional tariffs put in place thus far are pretty limited in global terms – albeit clearly painful for those sectors caught in the crossfire. But, if – as mooted – these 25% tariffs extend to the automotive sector, this would have more far reaching repercussions. As credit rating agency Moody’s noted this week:
“A 25% tariff on imported vehicles and parts would be negative for most every auto sector group — carmakers, parts suppliers, dealers, retailers, and transportation companies. Only Chinese automakers would be unaffected.”
And, beyond that the broader repercussions of an all-out trade war would be considerably more serious. Gavyn Davies of the FT has estimated that full scale global trade war, involving tariffs at 10% on all traded goods, could reduce the level of global GDP by 1.5 – 3.0%. That’s less than the 5% hit from the Global Financial Crisis, but nonetheless substantial.
Life with more borders
But the problem with all of these estimates is that we’re reaching around in the dark – and even more than usual. The more practical issue for companies is that they cannot say with any certainty what trading conditions will exist this time next year. That said, what I think we can say – given the change in political tone – is that we’ve moved into a new era of international and trading relations and companies need to start thinking about and be prepared for greater barriers.
The central problem for many companies, is how just much their operations are tied up in cross-border trades. Estimates based on WTO data suggest that about two-thirds of world trade now is involved in value chains that cross borders during the production process. BMW components can cross the channel four times in their just-in-time production process. To give some idea of how critical timing is to this process, a delay of just six minutes in Nissan Sunderland’s 23 hour working day renders it unprofitable.
What might changes in custom, tariffs, regulatory borders mean for the corporate capital agenda? In terms of capital optimisation, businesses will need to look at areas they can improve to mitigate the impact of any tariffs and delivery delays. How might inventory and working capital be affected? Can they do anything to optimise their operations to reduce costs?
But, they may also need to think about whether they can and should do to invest in order to source, manufacture and store more products closer to their retail markets. Companies also need to think about what happens to their suppliers – and their shared knowledge – if they are dislocated from their value chain?
Brexit also brings regulatory borders into play. As of June 2018, 34% (75 out of 222) of the companies monitored in EY’s Financial Services Brexit Tracker had publicly confirmed, or stated their intentions, to move some of their operations and/or staff from the UK to Europe.
It will be interesting to see if cross-border investment increases in the coming months. Cross-border M&A has increased in value (64%) in line with global M&A (63%) in H1 2018. But, there are signs that more companies are looking to increase their cross border investment and M&A activity to circumvent protectionism.
On the other hand, there are also signals that governments are more prepared to block deals and extend the scope of ‘national interest. It’s a phenomenon that’s been growing for a while, but greater focus on national politics provides greater impetus.
Bears on the prowl?
In terms of capital raising, most companies will be able to fund or raise the resources they need to make these adjustments. Markets are still exceptional liquid. Major ratings agencies are predicting that default rates will once again remain low this year. But all this comes at a time of rising interest rates and just the first signs of push back in high-yield markets – not to mention all the other demands on capital from the need to invest to combat technological disruption etc.
We’re not going calling ‘midnight’ on this recovery. But, there is no doubt that trade concerns have hit market confidence at a time when investors were starting to wonder for just how long this bull market and recovery could last. Shares have begun to wobble again – more so in emerging markets, where growth and dollar fears were already brewing. But equity fundraising could also become more problematic – especially in exposed sectors.
There are still levers to pull. China is releasing more than $100bn of commercial bank reserves – with the timing suggesting that it is at least partly in response to concerns over the impact of tariffs on its economy. Central banks could put the brakes on their tightening. But, what message does this send and how much road will they have when the next recession comes?
One more chart….we’re not calling midnight….but….
(h/t FT Alphaville)
And the World Cup effect?
And talking of South Korea….Goldman Sachs’ latest model predicts that England will make it to the final – and lose to Brazil. Although. keep in mind that their model was “surprised” by Poland’s 0-3 defeat by Colombia and their prediction – made at the start of the week – suggested Germany would play Brazil next week.
Moreover, if you’re looking for economic sunshine – as our Chief Economist notes – the impact of England’s progression on the WHOLE of the UK economy would be marginal.
Sunshine and certainty would seem to be better tonics.