The ECB is worried about the euro's strenght

Market analysis - 9/1/2017

Jackson Hole left investors none the wiser. They were expecting clues on the Fed’s tightening trajectory but Janet Yellen instead focused on threats from deregulation while Mario Draghi waxed philosophically on the risk of mounting protectionism.

The end result was that markets stuck to their previous expectations and the dollar was hit: there was no indication that the ECB was keen to ward off future impacts from the euro’s rapid rise in recent months while the Fed was very vague about when it would reduce its balance sheet and go for the next rate hike.

Looking beyond tensions with North Korea, there was a reassuring indication on the resilience of the US economic cycle when second quarter growth was revised higher to an annualised 3%. And consumer confidence showed household optimism was holding up very well. The overall Conference Board index hit 122.9, revisiting highs last seen at the end of 2000. In contrast, aerospace singlehandedly caused durable goods orders in July to fall by a significant 6.8%, compared to a 6.4% rise in the previous month. For the first 7 months of 2017, orders were up 5% vs. the same period in 2016. However, core non food and energy inflation stubbornly refused to move high and came in at +1.4% over a year. 

A new round of talks began over Brexit last Monday, even though the UK’s propositions of the previous week did nothing to dispel uncertainties. In the eurozone, third quarter growth is expected to show the same momentum judging from the European Commission’s advanced indicator which revisited 2007 highs. Meanwhile, underlying inflation (ex food and energy) was a soft 1.2% over a year. Germany’s second quarter GDP rose 0.6% compared to 0.7% in the previous quarter and 2.1% over a year. Private consumption accelerated sharply to +0.8%. Growth in investment was a little less vigorous and exports were actually down. France’s second quarter GDP was confirmed at +0.5% QoQ or in line with previous quarters. After last year’s 1.1%, the economy has already grown 1.3% so far this year, with household spending up 0.3% and corporate investment 0.7% higher. Exports also made a positive contribution. 

China’s manufacturing PMI for August came in at 51.7 vs. 51.4 or better than expected. Beijing will find it easier to pursue reforms with such robust figures. The price component pulled the figures higher as reduced capacity is pushing commodity prices higher. We are convinced that economic momentum is still positive in leading zones with company results confirming expectations. Following Jackson Hole, there are no short term signs of monetary policy changing radically and inflation is generally soft. The ECB is nevertheless worried about the euro’s strength against the US dollar. Market moves are essentially being driven by dollar weakness against all currencies and especially against the euro. Geopolitical risks like North Korea and Islamist terror attacks along with Donald Trump's increasing lack of credibility have all put off the moment when markets realise fundamentals are still favourable for risk assets. 

  European equities

Markets started the week lower on political uncertainty but rallied on upbeat economic indicators in Europe and the US and a fall-back in the euro.

In retail, Carrefour’ operating profits fell 12% to €621m, or worse than expected and management struck a cautious note for the rest of 2017. Margins in France fell as the group attempted to battle competitive pressures with price promotions. They were also hit by further digital investments and losses in Dia stores. Alexandre Bompard, the new CEO, is to present a transformation plan before the end of the year. In contrast, Germany’s Metro reported satisfying results due to a recovery in the cash-and-carry business and some stabilisation in food sales in Russia. 

Bouygues’ first half operating results rose 3% when analysts were expecting +1.5%. EBITDA in telecoms has jumped 30% over the last 18 months. Construction and property orders rose 8% and 7% and the long term margin outlook for both is higher. Elsewhere, Colas acquired Miller McAsphalt, a sizeable Canadian rival. Vivendi posted record results in the second quarter. Sales at Universal Music rose 15% and EBITDA was 40% higher. Even Canal Plus improved with better-than-expected ARPU of € 45. Elsewhere in media, ProSieben said third quarter advertising revenues were below its forecasts. Amid a stable German TV ad market, the group now sees them falling 5% in the third quarter, after a 4% drop in the second quarter. There will also be a strategic review with a possible merger between German language broadcasts and digital segments. 

In M&A, Galeries Lafayette (department stores) plans to buy 51% in La Redoute and ultimately own 100%. The aim is to speed up the group’s digital transformation and achieve synergies in buying and stores as well as in data bases. The group eventually wants to make 30% of sales online. The news is another indication of the sector's shift to an omni-channel model. 

Carrefour has already bought Rue du Commerce, Conforama now owns Showroomprivé and Amazon has just acquired Whole Foods. 

  US equities

It was a good week on Wall Street with the S&P up 1.2%. Donald Trump's administration seems to have weathered the storm sparked by his management of the Charlottesville events while geopolitical tensions failed to do further damage to investor sentiment. 

Second quarter GDP was revised from 2.6% to 3% on a 3.3% rise in household spending. PCE inflation was in line at 1.4% but remained on a declining YTD trend. There was no groundbreaking news at Jackson Hole with central bankers standing their ground.

However, M&A was once again very active. Gilead Sciences is to buy Kite Pharma for $180 a share in cash. This values Kite at around $11.9bn and the deal was unanimously approved by both company boards. Completion is expected during the fourth quarter of 2017. Elsewhere, United Technologies could acquire UTC in a $20bn deal.

Apple hit a fresh high and its market cap is now flirting with $850bn. The new iPhone might be released on September 12. 

Brown-Forman jumped more than 6% after its quarterly figures which showcased strong sales for its Jack Daniels brand.

Over the last 5 trading sessions, healthcare and tech led advances. Telecoms, financials and, to a lesser extent, utilities, were the only sectors to end the week lower. 

  Japanese equities

The TOPIX gained 1.3% over the week. After a risk-averse mood following North Korea’s missile launch over Japanese islands on Tuesday, the index rallied for two days in a row. Stocks rebounded as the Yen weakened against the US Dollar on upbeat US economic data and strength on Wall Street. North Korea’s negative impact diminished somewhat around the end of the week and export stocks attracted investors back in.

By sector, the best performers for the week were Pharmaceuticals (+3%) and Iron & Steel (+2.6%). Daiichi Sankyo soared 10.2% on rumours the company received a buyout bid from AstraZeneca last year. Fujifilm Holdings gained ground, rising 3.4% after it announced a midterm-term business plan up to fiscal year 2019 and a share buyback programme.

On the other hand, Oil & Coal Products (-1.4%) and Mining (-0.8%) were relatively weak. Oil companies including JXTG Holdings (-1.9%) and Inpex (-0.8%) fell on confusing indications on the crude oil market after Hurricane Harvey hit US refineries. 

  Emerging markets

It was a quiet week on emerging markets. In China, manufacturing PMI rose from 51.4 to 51.7, with production and new orders both up. Investors were expecting a small dip (consensus was at 51.3). 

Ctrip published excellent results with 45% top line growth while non-GAAP EBIT margin reached18%. Management believes that operating margins should continue to improve to 20% next quarter with annual revenue growth of 35/40%. Bank of China reported pre-tax profits up 23.6% due to better asset quality (provisions were 86% down YoY). The asset quality of Agricultural Bank of China also improved slightly with gross NPL formation rate down 54bp. Net profits were flattish (+4.8%). Beijing Enterprises Water reported a solid 22% YoY increase in results. In the EV space, BYD results were weak (-24% YoY), which is not surprising as a subsidy cut this year led to a 20% drop in electric vehicle volumes. 

More importantly, there were some tangible signs that competitive intensity was increasing. 

In India, July’s GST collections came in at Rs 923bn ($14.6bn) or higher than expected. This is a good news for the fiscal account. However, GDP growth decelerated to 5.7% YoY in the second quarter, from 6.1% in the previous quarter, or below expectations. The slowdown in the manufacturing sector was mainly due to destocking on implementation of the Goods & Services Tax. 

The Russian central bank rescued Bank Otkritie, the first of Russia's systemically important banks to fail. The CBR is expected to become the main investor through the Banking Sector Consolidation Fund and there will be no bail-in of other creditors. Given the bank's specific nature, this does not present a systemic risk. 

Brazil’s, unemployment rate decreased to 12.8% in July from 13% in the previous month and 13.6% in the previous quarter. Note also that real wages are 3% up YoY thanks to lower inflation. 

We remain upbeat on the medium term prospects for emerging markets, especially China which is improving the quality of growth by cutting overcapacity in heavy industries and moving higher in the value chain. 


Oil prices edged higher due to Hurricane Harvey and fresh production stoppages in Libya. Brent crude ended the week above $52 and WTI above $47. Harvey was eventually not as strong as expected but nevertheless caused huge damage estimated at $75bn in Texas and Louisiana. Offshore production in the Gulf of Mexico is gradually recovering but 13% of fields are still idle (compared to 20% at the beginning of the week). Onshore production was less affected and companies are now waiting for the government go-head to resume production. 

Flooding is hindering efforts to resume work in refineries with more than 4.1 million b/d in refining capacity, or 20% of the US total, currently at a standstill. The damage may not be that significant but the recovery will be slow. 

As a result, the DoE’s weekly inventory reports may well be less reliable in coming weeks. In pre-Harvey figures, crude inventories fell by 5.4 million barrels and petrol and distillates edged higher. June production fell by 72,000 b/d compared to May, or 220,000 less than the average weekly figures over the period. This is a good time to remind investors that we are always cautious over weekly model-based data. 

Libya’s output tumbled by 360,000 b/d, or 35% of last month’s production, due to armed militia taking over some pipelines. The country’s national oil company (NOC) declared force majeure for the Al-Sharara, Al-Hamada and El-Feel fields. Libya’s political situation is still complicated. Elsewhere, there were signs of an improvement in OPEC compliance with Iraq announcing that output had moved to 4.32 million b/d, a level stipulated in the cartel’s agreement. 

Precious metals once again gained on rising geopolitical risk, this time from North Korea’s launch of a missile which flew over Japan. Prices were also lifted by Janet Yellen’s unexpectedly accommodating tone at Jackson Hole. The gold ounce broke above $1,300 for the first time since 2016. 

  Corporate debt



Investors and market makers returned from holiday after a summer break that was relatively calm despite geopolitical turmoil. Performance so far this year has been rather good across all European credit compartments. Investment grade is up 2% and high yield by more than 4.5%. Credit risk premiums are still stuck at lows with the Main at 55bp and the Xover at 235bp.

The investment grade new issues market is already up and running and high yield will almost certainly follow next week.

Apart from Carrefour’s poor figures, results in our universe were rather upbeat. As expected, Burger King France posted strong growth in the second quarter but used more cash to fund its ambitious new restaurant openings plan in France. Hapag Lloyd saw first-half results rise sharply as freight recovered; quite logically, the news boosted the bonds of its French rival CMA CGM. The Renault-Nissan alliance announced a new joint venture with Dongfeng Motor to develop and market electric cars in China. Loxam’s second quarter results were satisfying due to a rebound in French construction and the integration of Lavendon and Hune


This week, we saw a revival of new convertible issuance in Japan with two new deals. Airline giant Ana Holdings came to market with a Y140bn 0% coupon convertible in dual 5- and 7-year tranches; the proceeds will be used for financing new aircraft and a share buyback totalling up to Y70 billion. Financial services company SBI Holdings issued a Y50bn 0% coupon CB also in dual 3- and 5-year tranches to refinance its outstanding 2017 convert and a Y20 billion share buy-back. 

In Europe this week we had another deal from a repeat issuer in the German real estate sector; Leg Immobilien issued a €400m 0.875% 8Y convertible bond to finance portfolio acquisitions. 

In the news this week, US network security provider, Palo Alto, reported strong fourth quarter results with revenues up18% QoQ as sales execution improved. In Europe, Steinhoff reported a good set of third quarter results, with like-for-like sales up 8% or +48% including acquisitions. Management also sounded confident on the next quarter as sales at Conforama improved in July/August. Additionally the listing of Steinhoff Africa Retail assets is on track for September. 

Elsewhere, China’s largest online travel agent, Ctrip, reported better-than-expected second quarter results and solid third quarter guidance. However, the stock fell 6% owing to concerns over the impact of the Civil Aviation Administration of China’s (CAAC) recent regulations which will change the way the company cross sells its services to customers from the fourth quarter onwards.

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