Signals of more policy stimulus

Marktanalyse - 21-6-2019

Mario Draghi at the ECB once again said the bank had a number of tools it could use to boost inflation and the economy as worries over the outlook sent long and short eurozone sovereign bond rates even lower.

His comments came on the eve of the FOMC and the timing was not a coincidence as the ECB chairman is determined to do more to ward off any rapid damage from the ongoing trade war. The measures available include further rate cuts and perhaps a new asset purchase programme. Note, however, that the communique’s particularly accommodating tone was not shared by everyone on the bank's board.

The Fed, meanwhile, said it was ready to cut rates if required. There has not been any change yet but shifts in its communication triggered a sharp drop in Treasury yields, especially over 2 years. The upbeat mood then spread throughout the world.

Once again, equity and bond markets rose in tandem over the week. And yet their messages are not necessarily identical. Fixed income markets are worried about growth and inflation as inflation expectations keep on falling. Equity markets are banking on moderate growth in company earnings. It is an environment that suggests we should be cautious. 

  European equities

Markets were lifted by very accommodating messages from the Fed and the ECB. The probability of a resumption in US-China trade talks and news of a Donald Trump-Xi Jinping meeting at the next G20 also boosted sentiment. Poor ZEW and Empire State data had little impact and investors also brushed off fresh tensions in the Gulf after Iran shot down a US drone. Energy stocks gained on the subsequent rise in oil prices. Long bond yields logically fell and banks hit multi-year lows. Tech, autos, and parts manufacture led outperformers but industrials and luxury also did well. Luxury was also lifted by upbeat Swiss watch exports and comments from Salvatore Ferragamo’s CEO that the group had not been hit by trade war tensions between the US and China. Even semiconductors rallied even though they were initially hit by a profit warning from Siltronic. German property stocks, however, fell after senate approval of a 5-year rent freeze in Berlin. Leisure stocks in Europe were hit after Lufthansa warned on prices due to delays in cost savings in its low cost subsidiary. The situation in aerospace was more upbeat with Airbus winning orders at the air show in Le Bourget and the official launch of its A321 XLR. 

  US equities

Indices had another good week and hit fresh highs. The Nasdaq gained 3.5% and the S&P 500 2.3% (as of the June 20 close).

Monetary policy remained centre stage. Last Wednesday, Jerome Powell hinted that that Fed might act at the July FOMC meeting when a 50bp cut could be decided. US 10-year Treasury yields fell 8bp over the week to a 2-year low of 2.01% and even dipped below 2% last Thursday.

Oil prices gained 4% with Brent crude at $64 after fresh tension between Iran and the US stoked fears that supply might be hit.

The oil price rally helped energy stocks rise 4.3%, outperforming the market. They were followed by tech (+3.8%) as semiconductor stocks gained, and industrials (+3.2%).

Healthcare stocks also racked up a creditable 2.7% rise due to a 5.5% surge in biotechs.  

Basic materials were the worst performers, treading water despite a 4.6% rose in gold stocks. Financials edged only 1% higher as long bond yields contracted further amid signs of a US slowdown. 

Software publishers Oracle and Adobe rose after beating expectations. Facebook also bounced by close to 4.5% after unveiling its new Libra cryptocurrency project. 

  Japanese equities

Japanese stocks rebounded to a one-month high on growing expectations for monetary easing in the US and optimism over US-China trade talks. A US-China summit meeting has reportedly been scheduled at the G20 summit meeting in Osaka. The TOPIX rose 0.85% over the week but upside was limited by the yen strengthening to 107 against the US dollar. Japanese equities continued to lag global markets.

As expected, the Bank of Japan decided to keep interest rates on hold but said it would consider further easing were risks in domestic and overseas economies to rise.

Economic sensitive sectors rebounded to outperform the market. Nomura Holdings also surged on favourable news concerning large share buybacks. Electric Power & Gas and Air Transportation underperformed on concerns that oil prices might bounce due to attacks on tankers in the Middle East.  

  Emerging markets

It was another positive week on the back of more positive news on US-China trade talks which are set to resume as early as June 25, or before the G20 summit. US tech suppliers have also been quietly lobbying the government to ease the entity-list ban and delay tariffs on the final tranche of $300bn.

To provide more monetary stimulus, the PBoC injected RMB 200bn ($29bn) into its medium-term lending facility (MLF), of which RMB 240bn targeted at medium and small banks and RMB 40bn in short-term liquidity (14-day) thr ough a reverse repo. China retail sales in May edged up slightly to +8.6% YoY vs 7.2% in April, while May property sales and new housing starts weakened to minus 5.5% YoY and 4% YoY respectively, largely due to a high base. Property investment growth also softened to a still resilient pace of 9.5% YoY.

On the policy front, the China Securities Regulatory Commission is set to loosen restrictions on listed companies restructuring to improve the quality of quoted companies and boost market vitality. Elsewhere, Huawei was preparing for a 40%-60% drop in international smartphone shipments, a potential 25% drop in total shipments. Tencent’s May data showed the company occupying 6 of the top 10 most lucrative (online) gaming spots while Alibaba and JD.com announced record-breaking June 18 Shopping Festival results driven by strong momentum in smaller cities and rural areas. Sunny Optical, one of the key camera optics suppliers for smartphones, maintained its shipment volume guidance (+20-25% YoY) despite the expected revenue decline at its major client Huawei. This suggests that the company has gained market share with Samsung and other Android customers.

In India, the late arrival of monsoon rains (70% of annual rainfall making it crucial for crop output) raised concerns about the government’s ability to bolster a slowing economy. May indicator analysis showed persistent weaknesses in the economy with declines in auto sales and domestic demand-linked imports. Several broad activity indicators such as industrial production, diesel consumption and rail freight movement saw low single-digit growth. India also announced retaliatory tariffs on 28 products from the US (which could bring in $217m in additional revenue) to protest against the ending of the Generalised System of Preference for Indian exports. In response, the US was said to be considering country caps on H-1B visas, which allow skilled foreign workers into the US, specifically targeting India.

In Brazil, another important milestone in the pension reform project was reached with the Bill to be voted before July 17, or earlier than expected. Raising the retirement age is widely seen as key to restoring Brazil’s public finance by saving around R$600-700bn over the next 10 years. Brazil’s central bank kept rates unchanged at 6.50%, with a dovish statement introducing forward guidance. Despite the weak performance of the economy, the central bank conditioned additional monetary stimulus on approval of key reforms (especially social security reform).

Banco do Brasil reiterated its divestment strategy and focus on digital banking, increasing efficiencies and closing the ROE gap with private banks. The key risk is higher taxes for the banking sector as bank stocks fell over the week. 

  Commodities

Mounting interest in the gold ounce had already been perceptible in recent weeks with ETFs seeing inflows again after suffering outflows at the beginning of the year. The Fed’s message turned out to be even more accommodating than expected with 7 board members taking the view that a rate cut this year would be appropriate. The gold ounce gained 1.5% or $21 on the day and close to 4% over the week. It even moved above $1,400 for the first time since 2013.

The ounce has performed well since the Fed started raising rates in December 2015. At the time it was trading at $1,100 and has since stayed mostly in the $1,200-1,300 range. This resilience was down to a slight increase in inflation which meant that real rates were generally below 1% over the period. Gold is accused of being an asset with no yield but when rates are falling, it has the advantage that it has no yield that can fall. Nor can its value be undermined by the quantitative easing. If negative yields were to hit assets, the ounce could trade above $1,400. However, we think that the September 2, 2011 high of $1,918 is beyond reach over the medium term as it would require a major geopolitical escalation or strong economic growth accompanied by high inflation. We, nevertheless, think the ounce could trade in the $1,300-1,400 range in coming months.

Oil prices also trended higher with Brent crude up 2% to close to $65 and WTI jumping more than 8% to $57. The rally was due to (i) increasing tension in the Middle East after a US drone was taken down by an Iranian missile, (ii) the likelihood of a meeting between Donald Trump and Xi Jinping at the next G20 and, more fundamentally, (iii) a steep drop in crude and product inventories in the US, the first time in several weeks and a return to a seasonal trend. 

  Corporate debt

 

Credit

Markets surged on accommodating central bank statements and optimism on US-China trade talks after Donald Trump confirmed he was meeting Xi Jinping at the end-of-June G20 summit. Mario Draghi suggested there would be new measures if required and the Fed left its rates unchanged while indicating that it was prepared to cut rates if the economy were to deteriorate. Against this backdrop, the Xover tightened by 21bp and the Main by 7bp between Monday and Thursday.

Takko gained 4 points after revenues rose 1.5% YoY and EBITDA jumped 38.7% thanks to better margins and lower costs. Leverage fell from 4.3 times at end January to 4. Casino’s bonds came under fresh pressure due to worries over liquidity following a recent credit note. Trafigura also came under fire when a research note criticised its accounting practices.

Lufthansa issued a profit warning and seemed to have put external growth deals on the back burner as long as margins fail to improve. It no longer wants to acquire Condor, the German airline being sold by Thomas Cook. The group is expected to bring forward a trading update to July.

Deutsche Bank has still not released an update but press reports suggested it was preparing a significant restructuring programme for its market activities and intends to set up a defeasance structure, essentially to house long-term derivatives, and slash its non-European equity and fixed income businesses. Elsewhere, money laundering fears returned. Police raided Nordea's premises in Denmark and Swedbank suspended its Estonian affiliate’s managing director and finance director.

It was another busy week for new issuance, especially in Senior and Senior No-Preferred debt. Bankia raised €500m with its first Senior Non Preferred bond at 1%. UniCredit raised €1.25bn with a Senior Preferred bond at 1.25% and saw rather heavy investor demand. 

Convertibles 

Convertibles performed well over the week, mainly because of equity markets hitting fresh year-to-date highs on prospects of renewed easing from the ECB and Fed. Falling bond yields and a revival in corporate debt liquidity also made a positive contribution to performance. Only worries over Iran and the US fuelled a little tension but this translated mainly into higher oil prices.

Three new issuance over the week topped $1bn with a deal in the UK, another in Russia and the third one on the US market for a Chinese company.

Primary Health Properties PLC (care homes) raised £150m over 6 years at 2.875% and with a maturity premium of 15%.

To refinance its debt, Petropavlovsk PLC (a Russian gold and iron mining company) raised $125m over 5 years at 8.25% and with a 22.5% premium.

YY Inc. (a Chinese live streaming company), sold two tranches, a 6-year maturity for $425m at 0.75% and a 35% premium and a 7-year maturity for the same amount at 1.375% and a 35% premium. The proceeds will go on general corporate purposes and possible acquisitions.

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