Market Bulletin (13/12/2016)
Turning the tables
Fifteenth century Florentine moneylenders plied their trade on small tables called ‘banca’, from which we get the word ‘bank’. Last week, in the wake of the Italian referendum, attention on markets turned just fifty miles south to the headquarters of Monte dei Paschi di Siena (MPS), a Tuscan bank where the task of debt repayment has, thanks to Italy’s decisive referendum result, just got considerably harder.
At 544 years old, MPS is the world’s oldest surviving bank and is arguably one of its worst-run. The stock has lost 85% of its value in 2016 alone (and is worth around 1/25 of its price before the global financial crisis). But although it is the worst-affected, it is also simply the headline casualty of an Italian banking crisis that has long been in need of a solution. MPS needs to raise €5 billion in capital in short order to remain solvent.
The departure of Prime Minister Matteo Renzi, a reformist, has all but dashed hopes of a private-sector bailout, despite frantic eleventh-hour shuttle diplomacy to Qatar, which was to be the lead investor in the consortium. Bail-ins are unconscionable in Italy due to their impact on domestic retail investors, many of whose pension income streams are strongly reliant on bond holdings in the country’s banking sector. So it was that last week Italy fixed its hopes on the European Central Bank, requesting a five-week delay on the implementation of EU bailout rules for the country’s banks.
Yet Mario Draghi, the Italian president of the European Central Bank (ECB), chose to remain firm. The ECB rejected Italy’s request. As a result, MPS will probably need to turn to state aid if it is to meet its funding requirement. This will doubtless be at the cost (via EU rules) of having to impose some losses on junior bondholders. While this may be easier for a caretaker government than for one with its eye on the next election, it would doubtless stoke plenty of anger too.
Markets were disappointed by the ECB last week too, as Draghi announced that, although he was extending the timeline to the end of 2017, the bank’s monthly bond-buying allocation would drop from €80 billion to €60 billion. When markets reacted rapidly by selling bonds, Draghi stepped in to say that this was not the beginning of a tapering trend – just a short-term tweak – and that the ECB would remain supportive in the coming year. He did announce a rule change that allows the ECB to henceforth buy bonds with yields below -0.4%, and added that quantitative easing could return to €80 billion if needed. There was a quick recovery after the second announcement and the FTSEurofirst 300 ended the week up 4.8%.
Yet markets remain nervous about the single currency area. Growth is real but subdued – in Italy, it is only marginal – and inflation is at just 0.8%, while unemployment has been falling in recent months, but not yet by nearly enough to signify a return to economic health. Despite Draghi’s words of reassurance, many fear that an imminent tapering off of ECB support is inevitable, in great part because it is running out of bonds to buy. Whenever the ECB chooses to turn the tables on monetary stimulus, as the Fed has already done, it will offer another major signal of the end of the post-crisis era of QE; after some $13 trillion of central bank aid globally, ‘life support’ is gradually being switched off – no wonder investors are nervous.
For the moment, however, although the yield on Italy’s ten-year bonds ended last week above 2% (having spent most of the year below 1.5%), it remains very far off its 2011 high of more than 7%. Moreover, since the Brexit vote dip on European markets, stocks in Germany and France have risen by some 20%, thanks to a falling euro and, odd as it may sound, improved sentiment on the banking sector – even in recent weeks. The FTSE 100, despite rising 3.3% last week, has had a rougher ride since early November – even Italy’s index, the FTSE MIB, has performed better.
Some of this choppiness in the FTSE 100 is linked to swings in the value of sterling, but much of the movement has ultimately reflected the mixed signals emerging over Brexit. Last week the UK parliament voted to approve Theresa May’s planned triggering of Article 50 in late March, subject to publication of the government’s plan – how detailed this plan will in fact be remains to be seen. Michel Barnier, the EU’s chief Brexit negotiator, laid out some predictable parameters last week; Brexit negotiations would last no more than 18 months once Article 50 is triggered, in order to allow time for the European Parliament and all 28 national parliaments (including that of the UK) to vote in the agreement.
In fact, the UK’s trade deficit narrowed last week, and a weaker pound provides potential for that improvement to continue. London also enjoyed a significant corporate boost last week, when McDonald’s announced that it would be transferring its European headquarters from Luxembourg to the British capital. The National Institute of Economic and Social Research, meanwhile, said the expected fall in immigration would buoy wages for those at the bottom, while also slowing growth.
In the US, the post-election stock surge showed no signs of flagging last week, as the S&P 500 rose 2.8% – it also clocked another record high, as did the Dow Jones Industrial Average. (The Nikkei 225 rose 3.1%, reaching a one-year high.) Some analysts see two sides to this rally, which has pushed US indices up by around $2 trillion since Election Day. On the one hand, there are clear policy linkages to the bullish surge – US bank stocks have risen around 20% since the election and last week a senior US bankers at a Goldman Sachs conference were talking up the regulatory impact of Donald Trump for the sector.
The flip side has been on bond markets. Yields globally had already been shifting significantly since their summer lows – the total amount of negative-yielding debt has fallen by $2.5 trillion globally (i.e. almost a fifth) since the summer. In the US, however, it is Donald Trump’s election victory that has been most effective in pushing up Treasury yields. Although this makes it more expensive for the government to borrow money, there may be not one but two silver linings: if bond yields more broadly remain elevated, it should make life easier for banks and pension funds, for whom balance sheet sanctity relies on at least reasonably positive yields (whether by making the lending business more viable or by making it easier to provide retirement income for pensioners). Secondly, it could presage a return to market normality – stocks and bonds are not supposed to rise together. In ordinary times, they are negatively correlated.
Last week Donald Trump made a series of appointments that emphasised his eagerness to break with his predecessor over a range of issues, such as the environment and healthcare. Yet his greatest impact could yet be internationally, where he has promised a more transactional relationship with America’s traditional allies, and a much warier approach to free trade.
Last week, there were already signs of new geopolitical stirrings. Shinzo Abe, prime minister of Japan, visited Russia to court Vladimir Putin, while Xi Jinping was confirmed as chief speaker at the World Economic Forum Annual Meeting 2017 in Davos – the first Chinese president to fill that role.
Shell proceeded with a gas-and-oil exploration deal with Iran, despite Trump’s promise to cool the Obama-era rapprochement between the US and Iran. Indeed, five energy deals were agreed on Tuesday – the largest tally since 1993; thanks to a rising oil price and signs that the ongoing slew of energy-sector defaults is finally approaching a tapering point.
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