Bank of England lays ground for negative rates

Morning Note

The Bank of England is laying the groundwork for a descent into negative interest rates. This should worry us all. In a letter to banks today, deputy governor Sam Woods asked firms to detail their “current readiness to deal with a zero Bank Rate, a negative Bank Rate, or a tiered system of reserves remuneration – and the steps that you would need to take to prepare for the implementation of these”.

The letter notes that “the financial sector … would need to be operationally ready to implement it in a way that does not adversely affect the safety and soundness of firms”, and explains that “the MPC may see fit to choose various options based on the situation at the time”.

It comes after details from the last policy meeting showed that the BoE is actively considering negative rates, whilst Andrew Bailey has been at pains to stress that this does not necessarily mean they will take that route.

Indeed there is clearly a debate within the MPC going on right now that we are seeing play out in public. Last month deputy governor Dave Ramsden issued a note of caution only a day after Silvana Tenreyro pointedly backed negative rates.

It looks as though there are some clear ideological disputes among rate setters that needs to be worked out over the autumn, implying as Andrew Bailey suggested last week that negative rates are not likely on the near horizon, albeit they are being considered actively.

The problem for the Bank would be an unemployment crisis into Christmas that could put pressure on the MPC to act.

Sterling doesn’t mind too much, with GBPUSD making its highest in almost 5 weeks before paring gains a little. Bank shares also didn’t take fright, with Natwest and Lloyds higher at the open.

Money markets have already priced in negative rates next year – today’s update does not materially alter the perception that the Bank is thinking seriously about negative rates but is in no rush to wheel them out. US bond and money markets are closed today for the Columbus Day holiday.

The idea that negative rates boost lending doesn’t wash – banks are not worried about the marginal impact on net interest margins as they are about whether the principal is repaid or not. And this in the current economic downturn and threat of rising unemployment, this will weigh on banks’ willingness to lend.

Indeed, I refer you again to the San Francisco Fed study from last month that shows the ECB made a big mistake by going negative.

This noted “banks expand lending only temporarily under negative rates” and “as negative rates persist, they drag on bank profitability even more”. It concluded that while lending initially increases under negative rates. “…gains are more than reversed as negative rates persist”. And under extended periods of negative rates, the evidence shows that “both bank profitability and bank lending activity decline”.

Negative rates are meant to increase loan growth, not depress it.

Chart showing how negative interest rates will affect UK monetary policy.

 

 

 

 

 

 

 

Equities were mildly higher in European trade early on Monday. The FTSE 100 enjoyed a solid week and managed to close on Friday above the 6,000 level that has proved so tricky to hold onto.

The FTSE weakened a little in early trade back to this round number support, with energy and consumer cyclicals dragging.

The S&P 500 rose Friday and closed at its best level since the start of September when it made the all-time high. Stimulus hopes remain in the forefront but the market, as a result, remains on the hook to rumours and headlines.

Donald Trump upped his offer to $1.8tn but Nancy Pelosi said it wasn’t enough. A stimulus package is coming sooner or later, although as stressed last week, there is a risk that a disputed election result delays this until 2021.

On the slate this week: IMF and World Bank meetings kick off today, whilst we have three days until the UK’s self-imposed Brexit deadline.

Nevertheless, even if there no breakthrough comprehensive trade deal agreed this week, the two sides are pledged to continue talking right up to the last moment.

Emmanuel Macron, who faces elections in the not-too-distant future, may seek too many concessions over fishing rights, which may scupper a deal. However, with the coronavirus causing havoc with the economy, neither side has a particularly strong hand and both sides need a deal.

Wall Street banks kick off earnings season across pond – read our preview here.

Election Watch

Biden leads by 9.8pts nationally and by 4.5pts in the battlegrounds. The Democrats lead by 4.9pts in the battleground states four years ago – Trump has been over this ground before and won against the odds – don’t write him off just yet. Trump has pulled ads in Ohio and Iowa leaving him off air in those states for a third week in a row. According to our friends over at BlondeMoney are the two most winnable swing states for Trump.

They say: “Either Trump is supremely confident he’s got these in the bag, despite polling neck-and-neck with Biden. Or he realises that he’s got to double down and go for the tougher states, and hope to sweep up those that are easier to win in the process. If he doesn’t get Florida or Wisconsin, Ohio or Iowa barely matter.”

My sense is that there is do-or-die attitude in the White House and he needs to shore up support elsewhere, such as Florida as his campaign finances, rather like his business empire, are not all they appear to be.

The dollar appeared to roll over last week. On DXY we had a MACD bearish crossover and 14-day RSI trendline break that indicated (as we flagged) that there could be downside.

What’s harder to say is whether this is yet more of a chop sideways for the dollar or renewal of the downtrend.

The close under the 50-day SMA could be taken as bearish signal and we may yet see the 91 handle tested again. The near-term support at the mid-Sep swing low sits around 92.70.

 

The Dollar index on the morning of12.10.2020

UK growth cools, British Land resumes dividend

Morning Note

UK growth unexpectedly cooled  in August, signalling a slower pace of recovery into the back-end of the year. GDP rose by 2.1% in August, which was below the 4.6% expected, despite the eat out to help out scheme boosting the hospitality sector significantly. The food and beverage service activities industry grew almost 70% over July thanks to the easing of lockdown restrictions and the government support scheme. 

 

Nevertheless, the outlook is not particularly encouraging. August 2020 GDP was now 21.7% higher than its April 2020 low, but the UK economy is still 9.2% below pre-pandemic levels. Sticking plasters like eat out to help out act only as a mild salve. Moreover, as the government considers more restrictions on people’s liberties to combat the virus, it is clear the path of recovery to pre-pandemic levels of activity will be slow and difficult. The pace of recovery has peaked, and things may get worse as we head into the winter before they improve again. The UK Chancellor Rishi Sunak will announce the next phase of the job support programme later today, which is set to include support for workers in industries forced to close under local lockdowns, such as bars and pubs. Sterling was unfazed by the loss of momentum in the economy with GBPUSD nudging up to 1.2970, yesterday’s high and close to the top of the range at 1.30.

 

Markets of course rather decoupled from the realities of the economy thanks to vast amounts of central bank stimulus and liquidity. The FTSE 100 rose above 6,000 for the first time in three weeks but this level continues to act as a very difficult barrier for bulls to clear. The S&P 500 closed up 0.8% at the highs of the day at 3,446. The Dow added 0.43% for its third positive session of the week and the Nasdaq added 0.5%. House speaker Nancy Pelosi said Democrats would reject any standalone stimulus packages. But we know stimulus of some sort is coming either before or after the election – the problem emerges if there is a contested election. 

 

Dallas Fed president Robert Kaplan underscored his more hawkish credentials, saying there is no need for additional QE on top of the Fed’s $120bn-a-month programme. A Fed paper this week suggested it could increase asset purchases by $3.5tn to boost the economy. Kaplan said that “the bond-buying needs to curtail, the Fed balance sheet growth needs to curtail”. The Fed’s position however remains that it will continue to purchase assets at least at the current clip.  

 

Election Watch 

 

With 25 days to go to the US election, Joe Biden leads Donald Trump by 9.7pts at a national level but his lead in the top battlegrounds has come down to 4.6pts. Trump trailed Hilary Clinton by 5.1pts in the key battleground states at this stage in 2016, but we should note there are fewer undecided voters this time. Latest betting odds imply 65% chance of a Biden win. 

 

Equities 

 

The pandemic has wrought damage on the commercial property sector as businesses have found it difficult to meet rent payments on time and the value of assets has been written down. Land Securities advised today that of £110m rent due Sep 29th, just 62% was paid within 5 working days, vs 95% for the same period a year before. Businesses renting office space (82% on time) were timelier than retailers (33% on time). For the earlier part of the year, the company has received 84% of rent due on 25 March (up from 75% at 2 July) and 81% of rent due on 24 June. Nevertheless, shares rose 3.5% in early trade as these numbers are perhaps not as bad as feared. 

 

British Land gave a very robust update though, noting all retail assets and 86% of stores are open. Footfall is 21% ahead of benchmark, retailer sales 90% of the same period last year. Collection rates for June have improved to 74%; 98% offices, 57% retail. Meanwhile 69% of September rents have been collected (91% offices, 50% retail). Management was also keen to talk up balance sheet strength – £1bn in undrawn facilities and cash, with no need to refinance until 2024. So robust in fact it’s resuming dividend payments – another little boost for the bedraggled income investor. Divis will be paid at 80% of underlying EPS. Those income investors cheered as shares rose 5%. 

 

London Stock Exchange confirmed plans to offload Borsa Italiana to Euronext. The €4.325bn is perhaps a little behind what had been touted, but it’s a necessary step to clear the decks for their Refinitiv acquisitions.  

 

Charts 

 

Gold still within the falling channel but making higher lows and now pushing up to the top of the channel – 50-day SMA above but the horizontal resistance at $1.920 needs to be cleared first.

Euro Stoxx 50 – still within the long-term range but after moving above 21-day SMA now is looking to clear a cluster of moving averages including the 50-day SMA and 200-day EMA.

UK enters worst recession, European stocks steady after Wall St slips on stimulus doubts

Morning Note

What did I miss? Stimulus measures keep being debated, vaccine hopes are at first raised then more sensibly assessed, and stocks in the US keep going up; the S&P 500 has risen about 5%, whilst European markets are flat over the period. I seem to recall in July a lot of chatter about European equities outperforming, but there has been little to show from that trade so far. Gold has smashed a new all-time high and profits been taken, an easy win for most, whilst oil prices have barely moved.

UK economy posts worst decline since records began

So, what has changed? Britain’s economy is on the ropes, but we knew this already. UK GDP fell by 20.4% in the second quarter, which was largely in line with expectations. Economic activity is bouncing back – the economy grew 8.7% in June but remains well below the levels seen in February. Having been out and about over the last three weeks, I can safely say there will be more recovery recorded in July and August.

But getting back to 2019 levels of activity is going to take a very long time as we see permanent impairment in certain sectors of the economy, as well as behavioural and social changes. Cable recovered off the 1.3020 horizontal support formed by the low on Monday on the update to continue to trade its August range. With the dollar turning around and seemingly finding its near-term support, GBPUSD may struggled to hold its 1.30 level.

Gridlocked US stimulus talks weigh on stocks

The Democrats and Republicans can’t agree anything. Stocks on Wall Street slipped after gridlock in Washington left investors wary of pinning their hopes on a bipartisan stimulus package, but the S&P 500 was at one point just a few points from its all-time high at one point and could still take it out this week. Senate majority leader Mitch McConnell naturally blamed the Democrats for this but revealed the two sides had not spoken since Friday.

The Dow and S&P 500 both snapped a 7-day winning streak, whist European markets rose a touch on Wednesday’s open after a strong run-up on Tuesday. The FTSE 100 continues to trade the narrow range of the June pullback without any signs of breaking out.

Gold tumbles on profit-taking

The lack of fresh stimulus left gold bulls wary and profits were taken but we have seen a big bounce off some important technical support this morning.  Spot dropped under $1900 but found support on the old resistance at $1865 and the 200-period SMA on the 4hr charts may offer some technical support. More important is the trend support offered by the line drawn from the lows made since the March trough.

Gold’s rally has been all about stimulus and inflation and so doubts about whether there will be more stimulus saw investors recast inflation expectations a little and the technical exhaustion of the move needed to be factored in. US real rates rose, with 10yr TIPS back to –0.99%, having struck a low of –1.08% last week. Benchmark 10yr yields rose to 0.66% but whilst real rates are so deeply negative gold will have support.

Chart: Gold recovers $1,927 after finding support at $1,865

Biden picks Harriss as running mate

Joe Biden named Kamala Harris his running mate for the race to the White House. Two points about this really stand out. The duo needs to get the vote out, and Harris should energise many who may not otherwise vote, but they cannot risk losing the centre in the rust belt where the issue is the economy.

But the problem for Trump is that accusations that Biden’s VP pick was too zealous a prosecutor when acting as California attorney general make it difficult for Republicans to say the Democrats won’t be tough on crime. Her appointment will somewhat blunt Republican attacks on law & order.

The key question for investors is who wins in November and whilst details like VP picks are important, they are just a small part of the story. Trump still wins in my opinion whatever the polls are saying.

Kiwi weakens after RBNZ extends QE, opens door to negative interest rates

New Zealand is in full panic mode, locking down Auckland amid a mystery outbreak of Covid. The RBNZ duly announced it would expand the Large Scale Asset Purchase programme to $100bn, which just nudged the kiwi lower. But the real focus is on negative rates – a full four mentions of the committee looking at a negative OCR were in the release. Lower and negative rates is increasingly the path of least resistance for the RBNZ, which makes the NZD open to further downside risk.

Oil prices were up a touch, with WTI (Sep) taking a $42 handle this morning ahead of the inventory figures from the US Energy Information Administration, which are expected to show a draw of 2.9m barrels. API data yesterday showed stockpiles fell 4.4m barrels last week.

Elsewhere in FX land, watch the double top on the EURUSD pair with the rejection of 1.19 looking more convincing we look for neckline support around the 1.17 level to hold for bulls to make a fresh drive higher. However, the pullback in US Treasuries and uptick in yields may offer support for the dollar to push back hard.

Cable drops as UK economy contracts

Forex

The UK economy contracted by 0.2% in the second quarter of the year, its worst performance since 2012.

Figures from the Office for National Statistics showed the surprise contraction, which was significantly lower than the flatline economists expected. It also follows strong growth of 1.8% seen in Q1.

“PMI data had indicated we were set for a contraction, albeit not so severe,” explained Neil Wilson, Chief Markets Analyst at MARKETS.COM.

Much of the growth in the first quarter was attributed to panic buying and stockpiling before the original March Brexit deadline. Indeed, Head of GDP Rob Kent-Smith, also blamed the 2.3% drop in Manufacturing output in the Brexit delay. The initial strong start to the year included production brought forward ahead of the UK’s departure from the EU.

The services sector was the only positive contributor to GDP growth in the quarter to June 2019 – but only just at 0.1%. This marks the weakest quarterly growth in this sector since Q2 2016.

Output from the production and construction sectors also contracted at -1.4% and -1.3% respectively.

Cable dropped sharply on the news, before recovering slightly. Having fallen below 1.2090, GBPUSD was last recovering above 1.21 but remains under pressure and a good 30 pips away from its highs of the day. Having breached yesterday’s lows we may see further testing of the downside.

“Clearly the unwind of stockpiling carried out in Q1 ahead of the aborted March 31st Brexit deadline has had an impact. Also, we can point to plenty of data around the world that shows we are in the middle of a broad global slowdown,” Wilson said.

“But you do have to admit that the pervasive uncertainty around Brexit is acting as a brake on the economy.”

Rolling three-month growth was negative 0.2% in the three months to June 2019, the first time since Q4 2012. This continued a steady decline in three-month growth since the start of the year.

So, was there anything positive in the latest GDP figures?

“Well, a lot of the decline seems to be down to the fall in car making as companies brought forward usual summer shutdowns of factories. The sharp fall in manufacturing output was led by a 5.2% decline transport equipment, which the ONS says largely reflected the partial closures of various car manufacturing plants. This may be partially recovered in the second half, while we may see further stockpiling ahead of the October 31st deadline that leads to a boost to Q3 numbers,” said Wilson.

However, he added, “but on the whole the figures make for worrying reading”.

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