Powell's first Senate testimony instills doubt

Market analysis - 3/2/2018

This week's focus was on new Fed chairman Jerome Powell's first Congressional appearance. He sounded a note of optimism on the US economy, thereby rekindling talk of a fourth rate hike this year.

Even if the scenario of a gradual rise in interest rates was never in doubt, investors were nevertheless expecting a more dovish tone. US bond yields quite logically rose, triggering falls on equity markets. And even when yields tailed off, equities continued to lose ground, taking monthly returns into negative territory after 15 up months for the S&P500, a record performance.

In the eurozone, investors were reassured by Mario Draghi’s address to the European Parliament at the beginning of the week. He said growth was stronger than expected but that inflation was still not running at satisfactory levels. January's core inflation later underpinned his comments when it was confirmed at 1%. After he spoke, the euro lost ground to the US dollar and the trend gathered traction following Jerome Powell’s comments. The single currency briefly dipped below 1.22 for the first time since the middle of January.

Downward pressure on equities also came from advanced indicators in the eurozone- down on the previous months- and Donald Trump’s announcement that the US was to impose duties on steel and aluminium imports. The downbeat mood was further reinforced by looming elections in Italy and the upcoming results of the SPD consultation of its members on the proposed coalition with Angela Merkel. However, bond markets seemed unconcerned by political risk judging from further tightening in German and Italian spreads. 

  European equities

European bourses lost ground over the week and the Stoxx 600 ended the month 4% lower. The euro slid further against the US dollar amid signs of more rate hikes to come in the US. Eurozone manufacturing PMI was in line with expectations (58.6), so down on January, but still pointed to the favourable cycle remaining in place. Another batch of fourth quarter figures underpinned a scenario of accelerating organic growth, especially in flagship cyclical sectors. 

Peugeot had a remarkable 2017 with results beating estimates and operating margins in the auto sector hitting a record 7.3%. This was largely due to its product plan gaining traction. Opel lost less than expected and Peugeot started to roll out its restructuring plan. Safran also reported robust 2017 figures with EBIDTA coming in above consensus estimates and very solid FCF. The group said the outlook for 2018 was upbeat. AB INBEV also beat expectations in the fourth quarter with like-for-like revenue up 8.2% and EBITDA 21% higher on strong performance in the Latam zone and Asia. The group says 2018 revenues and EBITDA will see further strong growth -one of the advantages of being exposed to emerging markets- and synergies after the SABMiller deal. 

But any disappointing results met with strong selling. WPP fell sharply when like-for-like figures remained negative in the fourth quarter and ended up 0.9% lower for the full year. Despite management objectives of stable margins this year, the group expects to see no top line growth. The figures dragged down the entire sector. Carrefour also suffered after posting mixed results and prospects. 2017 operating profits were in line despite hefty exceptional charges, but the group sounded a note of caution for 2018 due to currency movements, higher depreciation and sustained efforts over pricing in the first half of the year. Mining and metal-related stocks retreated after Donald Trump announced import duties on steel and aluminium. 

In corporate transformation news, Comcast topped 21st Century Fox’s bid on Sky’s satellite broadcasting business by offering €25bn or 16% more. Accor is to sell its majority stake in Accor Invest for €4.4bn and could use the proceeds on a new acquisition. Essilor returned to growth in the fourth quarter and saw its merger with Luxottica approved by the US and European regulatory authorities. 

  US equities

Markets moved sharply lower with the S&P losing 2.5% and the Dow Jones 2.8%. Investors were watching for inflation data and Jerome Powell's first Congressional appearance but in the end, Donald Trump stole the limelight by slapping 25% duties on imported steel and 10% on aluminium imports. Major trading partners immediately riposted by threatening to retaliate and there were mounting concerns that protectionism would take root and jeopardise global growth. 

Elsewhere, PCE inflation, the Fed's preferred gauge, came in at 1.7% or exactly in line with expectations and the previous month's tally. Manufacturing ISM hit a new high since 2004 at 60.8 compared to expectations of 58.7. Weekly jobless claims fell to 210,000, their lowest level since 1969. 

Donald Trump’s customs duties pushed steel users like Boeing, General Motors and Ford down by between 3-4% while domestic steel makers like US Steel and Steel Dynamics jumped 7% and 4% respectively. Over the period, telecoms and technology managed to resist while industrials and energy stocks both lost ground. 

  Japanese equities

Following volatile trading on Wall St., Japan also weakened towards the weekend. Over the week, the TOPIX shed 1.15%. Economically-sensitive stocks came under pressure as the Yen appreciated to around 106-107 against the US dollar, or above the recent 110 level used by Japanese companies in their FX assumptions for earnings projections. 

By sector, Air Transportation (+3.23%), Precision Instruments (+1.80%) and Pharmaceuticals (+0.26%) were relatively firm. Japan Airlines (+5.20%) and ANA Holdings (+1.48%) outperformed on lower fuel costs due to the stronger Yen. A defensive play like Ono Pharmaceutical gained 5.84% and optical lens manufacturer HOYA advanced 2.82%. 

In contrast, Mining (-3.56%), Iron & Steel (-3.10%), Oil & Coal Products (-3.04%) and Machinery (-2.85%) underperformed. Sumitomo Metal Mining lost 6.31% and Isuzu Motor fell 6.17%. Construction machinery producer Komatsu (-5.33%) and Kubota (-4.21%) were down on concerns over reduced demand for natural resources from a possible slowdown in China. 

On Friday, Tokyo sank further after Donald Trump suddenly announced duties on steel and aluminum imports, prompting growing worries over US protectionism. Sectors including Marine Transportation were hit by the news.

  Emerging markets

Emerging markets ended the period 2% lower but outperformed the developed zone. 

There were increasing concerns over global growth as PMI data fell and the oil price also lost ground. To cap it all, Donald Trump announced tariffs of 25% on US steel imports and 10% on aluminium. Chinese steel exports to US only account for 1.6% of total Chinese exported steel volume, or roughly 0.1% of steel production. Aluminium exports to the US accounted for 16% of the total in 2017, or equivalent to ~1.2% of total Chinese production. The direct impact will shave 0.03% off China’s GDP. The US and its allies will suffer much more than China. But the potential retaliation from China and increasing tension on global trade is negative for market sentiment. Liu He, the new finance chief and vice premier who championed supply-side and financial reform, is visiting the United States to look for a solution. 

At the same time, China’s official manufacturing PMI in February came in at 50.3, or much lower than expectations of 51.1 due to temporary factors such as seasonality, winter restrictions and a higher base reference. Large company PMI held up at 52.2 but slipped below 50 for SMEs due to ongoing deleveraging efforts and a more difficult funding environment. 

President Xi Jinping has probably secured an essential condition for ongoing stability in China by proposing to end the presidential term limit. Deleveraging and the clamp-down on financial risks are accelerating. Following the CIRC’s take-over of Anbang Insurance, a Shanghai government agency seized control of CEFC China Energy this week: the company was borrowing against a low-margin fuel trading business to fund deals for brokerages, banks and other overseas acquisitions. 

AIA reported a better-than-expected 28% increase in new business value (NBV) while 2017 operating profit after tax was up 17% due to China. TCI saw net profits jump 38% in 2017, driven by functional drinks, powder and facial masks (+75% YoY) with the strongest momentum coming from China. 

In India, gross value added (GVA) grew by 6.7% in December, up from 6.2% in September. Overall Indian auto volume grew by a robust 12% YoY, albeit from a low base effect. 

In Brazil, Vale reported strong operational results. The most encouraging feature was management guidance on deleveraging. Vale is generating strong cash flow (FCFY of 20%). 

In Russia, Sberbank reported strong fourth quarter results with earnings up 27% YoY and ROE at 20%.

We remain upbeat on emerging markets. 


Brent crude tumbled 5% to end the week at $63.8 while WTI shed 4% to $61. The drop was certainly due to general financial market weakness and only marginally to weekly data from the US Department of Energy. Its report noted a sharp 3-million barrel increase in crude inventories with petrol up by 2.5 million barrels. Distillates, however, slipped by 1 million barrels. US crude output rose to 10.28 million b/d. In Libya, the drop in production at the El-Feel site due to a strike by security services had no impact on the country’s production. According to certain sources, output was unchanged at 1.1 million b/d due to increased production at Waha and Sharara (the country's largest oilfield) which helped offset the short fall from El Feel. Reuters said OPEC output had hit a 10-month low of 32.28 million b/d in February, or 70,000 b/d less than in January due to the UAE producing less than their quota. 

Donald Trump followed up on the US Department of Commerce recommendations and announced new customs duties on steel and aluminium imports. Steel imports are to be taxed at 25% (the recommendation was for 24%) and aluminium at 10% (7.7% recommended) from next week. Some countries are expected to be exempt. Canada and Brazil are the largest exporters of steel to the US while Chinese imports are marginal.

The iron ore price rebounded further to $76/t, the best base metal performance over the last month. Investment in iron ore mines slumped by 23% in 2017, reducing the likelihood of the supply side growing.

The gold ounce only lost $10 over the week, proving relatively resilient to Jerome Powell’s rather hawkish comments. The new Fed chairman is upbeat on the US economy and thinks 4 rate hikes might be needed this year. An upturn in inflation might help the gold price despite the prospect of stronger-than-expected monetary tightening. 

  Corporate debt



Upcoming political events in Italy and Germany drove fixed income and credit markets over the week and will continue to do so next week. 

With the end of the results season in view, the high yield new issues market will certainly revive. Teva plans to launch a mega US dollar and euro-denominated issue in the week of March 5. Orpea (retirement homes) sold a 7-year maturity at 2.625%. Metro AG issued a 5-year bond at 1.125%. Equinix (US Data Centers) sold a 6-year maturity at 2.875%. 

Fiat Chrysler is mulling a spin-off of its subsidiary Magneti Marelli (car batteries and alternators) and Autodistribution (car parts) is getting ready for its IPO. 

In investment grade, Renault Credit International and Prologis had new issues while the blackout period was followed by Société Générale, BBVA and RBS and many others issuing senior HoldCo and non-preferred Senior debt. 


There were two new deals from repeat issuers this week. French real estate developer Nexity issued a €200m 7Y 0.25% coupon convertible. Belgian IT services company Econocom came to market with a €200m 5Y 0.5% coupon convertible. 

In Japan, another repeat issuer Sumitomo Metal Mining raised JPY 30bn with a 5Y zero coupon convertible for refinancing and share buyback purposes. The second deal came from relocation and maintenance company Relo Group which raised JPY 25bn with a 3Y zero coupon convertible for capex, refinancing and share buybacks. 

In the US, cloud-based communication software provider RingCentral came to market with a $400m 5Y zero coupon convertible for share buyback financing and general corporate purposes. 

In M&A news, Michrochip announced another acquisition, buying its smaller rival Microsemi for £10.15bn, a move which will increase its exposure to the communication and aero/defence end markets. And Ubisoft Entertainment is to acquire 2 smaller studios (1492 Studio for Mobile Gaming & Blue Mammoth for free-to-play games and a strong massive multiplayer online experience). 

In earnings news, Thai Hospitals operator Bangkok Dusit Medical Services reported a 7% YoY rise in fourth quarter revenues driven by stronger price intensity, an increase in international patients and new hospital openings.

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