Market Bulletin (09/06/2015)
Bond markets around the world took a tumble last week as the US economy appeared healthier than had been feared. That in turn unsettled equity markets, while European shares continued to reflect concerns over Greece’s willingness and ability to pay its debts. Some saw these as portents of a volatile summer in the markets.
It was a busy week for economic indicators. One of the most influential was the US non-farm payroll figure for May, which was somewhat ahead of forecasts. Employment figures for the previous two months were revised upwards and average earnings grew at their fastest rate for nearly two years.
All that positive news turned attention firmly back onto the question of when the Federal Reserve is likely to raise interest rates – which, when it does, will be for the first time in a decade. Some say it could now be as early as September, given the economy’s apparent vigour. Rate rises, like inflation, are bad for fixed-income investments, and investors began selling bonds across the board. Yields on 10-year US Treasury bonds rose as their prices fell, and touched eight-month highs.
The International Monetary Fund (IMF) clearly didn’t like what it was seeing and urged the Fed to wait at least until next year before hiking rates. It should desist until there were “greater signs of wage or price inflation”, the IMF said. What concerns the IMF is the effect a rate rise would have on the world outside the US. It would prompt capital outflows from emerging markets in Asia and Latin America, as investors returned their money to higher-yielding US assets. The dollar would strengthen sharply as a result, hurting emerging market companies with dollar debt. That could trigger a wave of defaults and, some economists fear, another emerging markets crisis.
Corporate America is serenely untroubled by the market’s fixations, if the latest mergers and acquisitions numbers are anything to go by. Previously, monthly M&A activity in the US peaked at $213 billion, in January 2000, around the height of the dotcom frenzy, and again at $226 billion in May 2007, just before the end of the financial world as we knew it. It set a new record this May, reaching $243 billion, fuelled as it has been by incomparably cheap borrowing. Any interest rate rise will dampen some of that enthusiasm, and US equity markets drew in their horns as they contemplated the prospect of higher rates. The S&P 500 index ended the week down by 0.69%.
Euro inflation returns
There was similar volatility on this side of the Atlantic. Eurozone inflation was positive in May for the first time in six months. Though consumer prices rose by a mere 0.3%, this was more than had been expected. It suggested that the European Central Bank’s quantitative easing programme, designed to stimulate the eurozone economy, was beginning to work. The rise, still some way short of the ECB’s 2% target, reflected a rebound in energy costs and mildly strengthening consumer demand. The ECB raised its inflation forecast for 2015 from zero to 0.3%.
Here, too, investors responded by selling off bonds. Having ended the previous week at 0.49%, yields on German Bunds touched 1% before ending the week at 0.85%. The euro strengthened on the inflation news, rising above $1.13 before ending the week at $1.11. The currency remains volatile, however, not least while the Greek question hangs in the balance. Some now insist that issues like Greece and US rates will make for a turbulent summer, when many people are on holiday and low volumes can exaggerate volatility. Such short-term volatility is an inevitable feature of equity markets and, as always, investors should not be distracted and should keep their focus on longer-term goals.
Expectations see-sawed once again on the possibility of a Greek default. Its creditors insist on compliance with their demands before releasing a much-needed $7.2 billion in bailout funds. After internal disagreements on compromise within the ruling Syriza party, Greece told the IMF it would not make the $300 million loan repayment due last week. Instead, it would roll up all amounts due in June into a single month-end payment of $1.5 billion.
That option is in accordance with IMF rules, though it is very rarely used. The last IMF debtor to resort to it was Zambia, back in the 1980s. The IMF believes that Greece will be able to make the larger payment, fending off default yet again. Officials say, however, that a deal needs to be done ahead of a June 18 meeting of eurozone finance ministers. Only then can Greece carry out reforms in time to gets its funds before the bailout expires at the end of the month.
The European Commission (EC) has been Greece’s best friend among its creditors, arguing against the hard line taken by the IMF and the German finance minister. But EC president Jean-Claude Juncker refused to meet Greek Prime Minister Alexis Tsipras this weekend after the latter was scathing to the Greek parliament about his latest offer. Greek stocks dropped by 5% on Friday, its steepest fall since the general election, and the FTSEurofirst 300 Index declined by 2.69% during the week.
Now that it has power to itself, the new Conservative government is accelerating its exit from ownership of the likes of Lloyds Banking Group and Royal Bank of Scotland. That’s partly ideological, but also because it needs the money. More of Lloyds will be returned to retail ownership in the next 12 months. The strategy of drip-feeding Lloyds shares into the market has raised £3.5 billion since December and was due to stop at the end of June. It has now been extended to the end of this year. The government, which has reduced its holding to 19%, has said it will launch a £4 billion retail sale within the year, at a discount to the market price. That harks back to the big privatisations of the 1980s, when the ‘Tell Sid’ campaign was used to promote the sale of British Gas. While the UK taxpayer paid 73.6p for Lloyds shares in 2008, they ended last week at 87.1p.
The government retains a chunkier 80% stake in RBS, whose shares remain well below the 502p at which it was rescued. They started last week at 345p and closed on Friday at 357p, trading up as expectations of an imminent government announcement grew. Senior RBS sources were reported as saying a share sale could be launched in the fourth quarter, once the bank settles with US regulators for mis-selling subprime mortgage securities.
Chancellor George Osborne has also announced the sale of the government’s final 30% holding in Royal Mail, which would be worth around £1.5 billion at the current price. The flotation price of 330p in 2013 was criticised as undervaluing the business. Reacting to the sale news, the shares lost 6% over the week to close at 492.7p. The FTSE 100 Index had a bad week, ending 2.57% lower amid concerns about Greece and the bond markets.
Growth in British house prices slowed in May, to an annual average of 4.6%, according to Nationwide. That’s less than half the level of mid-2014 and the first drop below 5% since August 2013. There were reports that buy-to-let landlords were exiting the market in London and the South-East, as existing and proposed benefit cuts and caps made it harder to find tenants who could afford to pay their rents.
A more positive omen for the housing market was that mortgage approvals in April hit their highest level in more than a year, according to the Bank of England. At around 68,000, this was the highest level since February 2014, though still a long way from the 100,000-plus that was typical in the mid-2000s. Capital Economics believes conditions are in place for housing demand to continue to recover. “Households are enjoying record levels of employment, the return of real wage growth and extremely low mortgage rates, and they are very confident about the economic outlook,” it says.
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