The US rate hike debate has been rekindled

Asset Management - 8/22/2016

Markets consolidated slightly after strong performance over the summer break on company results and better economic momentum. The US dollar fell against the euro and the yen while oil extended its recent rebound to flirt with the USD 50 level.
Commodities Corporate

There were no significant data this week in Europe. Investor sentiment continued to improve after the Brexit referendum shock while inflation remained tame. Surprisingly, July retail sales in the UK beat estimates but the impact of the Leave vote had not yet impacted the data. In the US, the FOMC minutes took centre stage along with comments from various Fed members. The minutes still suggest a wait-and-see attitude. Economic conditions in the US are improving but inflation and wages are still below target. But the FOMC meeting took place before the release of buoyant data on jobs, GDP and property, all of which have rekindled the debate. Both the Atlanta and NY Fed chiefs are now more in favour of raising rates within the next 3 months. John Williams, the San Francisco Fed president, said he thought rates would remain low for some time to come, adding that, in any case, the US economy was strong enough to weather a rate hike.

International markets were stable in US dollar terms but eurozone and Japanese equities lost ground in heavier trading. As of the evening of August 18, only emerging markets had made gains as inflows picked up speed. Interest rates remained more or less stable in the US and in the eurozone. Markets have priced in a 50% probability of a Fed hike before the end of 2016.

We have not made any significant changes to our asset allocation which remains focused on European equities. For tactical reasons, we have taken some profits on emerging market equities.



  European equities

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It was a mixed week on European markets, a mirror image of Fed statements which did not rule out a rate hike in the near future but said any decision would have to be based on additional data. In the meantime, markets retreated, led by financials, utilities and telecom stocks.

With more than 90% of second quarter company results now in, the picture is upbeat. So far, 40% have beaten estimates with 17% in line. Overall like-for-like growth for the quarter is slightly above 2% with IT services and autos picking up speed while consumer stocks slowed. The results have not led to any shift in the earnings outlook for 2016.

Nestlé reported slightly disappointing sales growth for the quarter, up 3.1% or much less than the +5/6% expected. This was down to a weak price mix (+0.7%) that the group hopes will be offset in the second half as unfavourable base effects are now over. In contrast, H&M’s July sales rose 10% or more than expected.

Vestas also pleased markets after reporting robust figures with a 46% jump in second quarter sales (+23% in the first half). Cobham rose after announcing the arrival of a new CEO who will be tasked with carrying out structural changes. There is a possibility that Bayer might launch a hostile bid for Monsanto after twice failing with a friendly approach.



  US equities

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This week’s economic data remained upbeat with July housing starts up 2% to 1.2 million while the consumer price index came in as expected. The FOMC minutes suggested a rate hike over the short to medium term could not be ruled out. But although some Fed members expect further moves away from accommodating policy, all said any decision on a rate hike would require more economic data. The consensus view among economists is for a rate hike at December's Fed meeting, i.e. after the Presidential elections.

In company news, Praxair is in talks with its German rival Linde over a possible merger, a deal which would create a giant with a market cap of close to USD 60bn. The move would be part of a general trend towards consolidation in the industrial gases sector.

Company results remained generally in line with expectations. Home Depot was a good example. The group is reaping the benefits of a strong property market in the US amid a low interest rate environment and improvements on the labour market. Wal-Mart’s results were better than expected due to buoyant US sales, the group's price-cutting approach and more attention to client service. Like-for-like sales rose 1.4% vs. expectations of a 0.9% rise.




  Japanese equities

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The TOPIX sagged 1.8% over the week, dragged down by the rising yen. Investors adopted a wait-and-see stance as the yen eventually rose to above 100 against the US dollar.

In macroeconomic news, Japan’s real GDP for Apr-Jun (0.0% QoQ, +0.2% on an annualised basis) posted a second consecutive annual gain on a sharp rise in housing thanks to the negative interest rate policy, although net exports made a negative contribution.

Mining (+4.7%) and Oil & Coal (+0.8%) rallied on the back of the oil price and US economic indicators, while Construction (-5.3%) and Pharmaceutical sectors (-5.1%) lost ground.

Inpex Corporation rose 5.5% on expectations that major producers would freeze output at the coming OPEC meeting.

On a negative note, residential builders faced headwinds. Daiwa House Industry, Daito Trust Construction and Sekisui House dropped 9.1%, 8.1% and 6.9% respectively.



  Emerging markets

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Emerging markets had a good week, rising 1.5% in USD. EM equity funds saw inflows of USD 5bn over the week and indices benefited from the FED’s dovish tone on interest rates.

In results, Tencent’s better than expected second quater results took the limelight. Earnings jumped 47% YoY, or almost 20% above consensus. The positive surprise came from mobile gaming and rapid growth in payment and cloud services.

We remain positive on Indonesia; ahead of a central bank decision on interest rates which the consensus expects to mean a 25bp cut. In Brazil, as opposed to other EM currencies, the BRL lost some momentum, falling 3.5%, as the central bank stepped up FX market intervention and the Senate had to postpone the voting of the DRU (Desvinculação de Receitas da União) law when no quorum was reached. The DRU is important as it is part of structural reforms designed to reduce Brazil’s fiscal deficit. The Impeachment of president Roussef, meanwhile, continued to advance in the Senate and is now expected to be concluded by the end of August.

Elsewhere, China Investment Corp is interested in buying a portion of Vale’s future iron ore output for + 30 years. Vale could raise USD 9bn upfront (equivalent to 1/3 of the company’s net debt). If this asset sale is confirmed, it would in our view reinforce Vale’s investment case as our main concern is the group’s debt level.




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Commodity markets rebounded on US dollar weakness and the FOMC minutes. In only 3 weeks, oil has bounced back to around USD 50 amid speculation on a possible intervention from producer countries in September.

It has only taken a few unofficial comments from the Saudi oil minister to wipe out this summer’s drop in the oil price. According to the communique, Saudi Arabia might join concerted action to stabilise prices. This followed last week’s news that OPEC would stage hold informal meeting at the International Energy Forum in Algeria.

We took the view last June that there would be no intervention and we do not expect one in September either. First, as with recent central bank messages, talk of intervention has more impact than actual action. Second, Iran has still not hit pre-sanction output (4.2 million b/d compared to the current 3.5 million), a sine qua non for any participation in joint action. In any case, according to some officials, Iran has still not decided whether to attend the meeting. Third, any freeze at current levels, with Saudi Arabia, Russia and Iran at or close to maximum output, would have little effect on the supply-and-demand equilibrium. It would, however, be good news for sentiment.

The oil price rally was also helped by Energy Department statistics showing a sharp decline in crude and petrol inventories. Following its monthly report, the International Energy Agency has raised its forecasts on demand in 2016 but cut them for 2017, citing the soft macroeconomic environment.

Base metal prices rebounded on the weaker US dollar and more plant shutdowns. Weak Chinese data on fixed asset investment and loan growth was shrugged off by investors. China’s mining reform continued apace with zinc and tin mines in the Hunan province closing for safety reasons. It is difficult to say whether these closures will be temporary or permanent but global zinc production has fallen by a significant 1-2% and that could rapidly trigger a supply deficit.



  Corporate debt

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Trading was relatively thin with no action on the new issues market. Synthetic credit indices widened slight with the Main up 2bp and the Xover10bp higher.

Investors are struggling to decode the Fed’s intentions over its monetary tightening schedule so they were naturally impatient to see the FOMC minutes from July’s meeting. In the end, they showed Fed members were still divided over whether interest rates should be raised in the near future. Committee members agreed to wait for other indicators before deciding on a move.

The ECB’s minutes showed that the bank thought it premature to act in July just after the Brexit vote but it found the rather moderate market reaction to the Leave victory rather reassuring.

The ongoing oil price rebound had no effect on long rates which ended the week unchanged.

Highlights in our universe included a report from German news site Platts saying Angela Merkel’s administration was keener on a tie-up between steel makers ThyssenKrupp and Salzgitter rather than a deal between ThyssenKrupp and Tata Steel’s UK division. HeidelbergCement is to sell some of its US assets to Cementos Argos for USD 660m. Casino said Régis Schultz would be joining the group on August 22 as chairman of Monoprix.

Darty officially informed holders of its 2021 bond that the company was now controlled by FNAC after the successful completion of its takeover bid. General Electric said it had a firm buyer for its French mortgage portfolio. The sale is part of a vast disposal of financial assets. Manutencoop's first half results marked an improvement.


The most notable feature this week was the continuing revival of the US primary market with Liberty Interactive issuing USD 675m of 1.75% bonds due 2046 exchangeable into Charter Communication (cable telecommunications). The month is not yet finished but primary activity in the US has reached an all-time high in value for August, raising USD 8bn via 10 new issues (the only comparable year was in 2007). In all other regions, activity was muted, as is usual over the summer break.

In Asia, CBs extended gains mainly on stronger oil prices but also by a rally in Chinese stocks. The announcement of the Shenzhen-HK Connect, and more encouragingly the removal of aggregate quotas, provided strong support as this will mean more channels for cross-border investment by Chinese and overseas investors. In addition, a number of large cap Chinese corporates surprised with good results.

In Europe, Grand City Properties reported a 46% YoY increase in Rental and Operating Income to EUR 209m with like-for-like occupancy and rental growth up 3.2% and 2.3% respectively on a 1.9 point reduction in the vacancy rate to 8.3%; net income grew 101% YoY to EUR 392m. Sonae revealed first half sales rose 4.4% compared to the same period in 2015 primarily on a strong showing in the Food Retail and Sport/Fashion Divisions (+3.6% and +5.5% respectively). According to the French press, Dassault Aviation sold four Falcon 7X to Egypt for EUR 300m. This is in addition to the 24 Rafales already sold in February 2015. While announcing a net loss in H1 (CHF 27.9m), Basilea confirmed that it had reasonable cash and extended its distribution and supply agreement for Cresemba (treatment for aspergillosis) and Zevtera (pneumonia) for the Middle East and North African.

In the US, the main news was speculation regarding a takeover of Illumina (a developer of DNA sequencing machines) by Thermo Fisher Scientific. The deal is reportedly all-stock and worth USD 30bnbut could encounter some regulatory hurdles especially over sequencing. Elsewhere, Netsuite confirmed that September 15 was the tender expiry date for Oracle’s bid.

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