In other words, what’s happening apart from Brexit? Because, without wanting to downgrade its significance, there is so much more going on that could easily be lost in the pre-vote maelstrom.
Which is why this week, I’m going to focus on three other themes we can’t lose sight of – all of which also have significant crunch points in December. The next month could be difficult, for more reasons than just that one…
From the Brexit vote, to OPEC and Federal Reserve meetings to trade talks at the G20…it’s shaping up to be a month that could determine the course of 2019 and beyond.
Just as a taster of the events coming up in the next three weeks…
30 November – 1 December: G20 meeting in Argentina – including a ‘side-lines’ trade meeting between Chinese President Xi Jinping and US President Trump
6 December: OPEC Meeting, Vienna
11 December: UK Parliament votes on Brexit Withdrawal Agreement
18-19 December: Federal Open Market Committee meeting
We covered Brexit in-depth last week, so this week we’re focusing the other three themes and events.
First up is the G20 summit, where an informal meeting between the US and Chinese Presidents could be the last chance to avoid a further significant increase in US tariffs on Chinese goods – due to start on 1 January 2019. As yet, there are few signs of reconciliation. The US President said to the Wall Street Journal this week that he is likely to go ahead raising tariffs from 10% to 25% on $200bn worth of imports as scheduled. Mr Trump also said he could extend the tariffs if talks didn’t go well.
Recent US negotiations have often been proceeded by a strong statements, followed by slightly warmer words at the meeting itself. But there would appear to be little room for both sides to manoeuvre. The scheduled tariff increases are starting to be priced in.
Escalating trade tensions risk distorting prices and hurting the economy through supply chain inefficiencies and delayed investment. Beyond trade tensions, geopolitical stresses and border disputes are escalating. Italy and Brussels remain deadlocked. Brexit – as we know – is in the balance. Markets are being driven by politics, which tends to create greater volatility when the chief actors and events are this unpredictable.
The OPEC summit on 6 December comes against the backdrop of a dramatic price fall, which saw Brent crude drop from over $85 a barrel in early October, to under $60 in six weeks. A sudden divergence in supply and demand expectations seems to have triggered the fall. The US is clearly petitioning for cheaper oil and recently granted temporary sanction waivers to several importers of Iranian crude. Meanwhile, the recent global stock market correction and stronger dollar, have raise fears that the global economy will begin to creak in 2019, lowering demand.
And yet, oil demand has only moderated, whilst supply could tighten. Major suppliers, like Saudi Arabia, have been making up shortfalls from Iran and Venezuela, but the Saudi Energy Minister has recently signalled the Kingdom’s intension to curb production. So we could see further volatility before the year is out. Not least because since October, hedge funds have more than tripled their bets against the oil price since the start of October, according to the Financial Times, creating the largest short position in more than a year.
Ask ten different analysts what they think the Federal Reserve will do in the next year and you’ll get 11 different answers. Even the long-signalled quarter point rate rise in December is now in a little doubt? Why? Six hours is a long time in these markets, let alone the six weeks since the Fed’s last meeting and the minutes – released yesterday – that suggested the December rise was on track….but with caveats.
The recent stock market correction (albeit largely in tech-stocks) has raised questions about the US outlook – as have questions about the path of the US economy if trade tensions escalate. Meanwhile, the debate over the ‘neutral rate’ continues. Federal Reserve Chair Jerome Powell said this week that interest rates are “just below” a neutral level that neither hastens nor slows growth. Last month, he had said the bank had a “long way” to go before reaching that level.
A slight change in nuance can move febrile markets. Markets are still pricing in December’s rise, but the next expected hike in March less so. So, if the Fed doesn’t raise in December, this sends a downbeat message. If it does raise, it keeps the US (and world) on a tightening path – and this often doesn’t end well (see chart). The ECB have also confirmed that they’re still on track to halt their QE scheme in December. So whatever the decision, expect markets to move and watch the language and the dollar.
Currency related pain – especially for emerging market companies and countries borrowing in dollars – is set to be a strong theme in 2019.
So is this midnight?
It feels like we’re reaching some kind of peak in earnings, debt and deals. That doesn’t mean we’re set for an imminent crash. It is really difficult to think about a crash when interest rates remain this low. It doesn’t mean it can’t happen – but it’ll probably take a significant trigger to tip the global economy into recession and the plates will keep spinning for a while. That doesn’t mean we won’t see localised difficulties and, in general, it’s getting more difficult for companies to grow earnings, raise cash, obtain credit, and do deals in this environment.
There is money out there for good credits, i.e. strong companies in resilient sectors. Funding markets aren’t what they were in 2007-8, with a far wider range of options available. But, weaker, high-yield credits – especially those in areas like retail and construction – are struggling. Companies are still doing deals, but we’re know that it’s getting more difficult to get these deals over the line.
When the outlook becomes less certain, opinions and valuations become more polarised. Funding dries up – or becomes more expensive. Buyers get nervous. We are seeing signs of this now, with increasing numbers of buyers willing to walk away.
A reminder that it can only take a small dislocation of markets to create trouble. A range of central banks (including the ‘central banks’, central bank’) and other agencies have raised concerns in recent few months about the increase in high-yield debt, with the LBO market above pre-crisis volume and covenant-lite deals becoming the norm. A fifth of UK corporate debt outstanding is in leverage loans and high-yield bonds, according to the Bank of England. This global rise in riskier debt is a real worry…
“The higher proportion of vulnerable leveraged companies is sowing the seeds for a spike in the default rate when the next credit downturn strikes”
Moody’s Credit Ratings Agency, October 2018.