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.

European shares stutter after Wall Street’s all time high

Equities
Forex
Indices
Morning Note

US stocks closed at record highs but European stocks remain a lot more subdued, with the FTSE 100 struggling at the open today after suffering a sharp reversal in the latter part of the session yesterday. Bulls did try to wrestle control from bears in the first hour of trading, but it looks like it will be another volatile day and a lot will depend on how Wall Street performs in the first hour or two of the NY session. House speaker Nancy Pelosi said the Democrats could be willing to agree to a scaled-down stimulus package, which has helped soothe risk muscles. Asian shares were mixed and US futures are flat.

 

Whilst the S&P 500 notched record intra-day and closing highs, the FTSE 100 is tracking close to the lower end of the June range and is –20% YTD. Sterling’s strength has not helped but European equity markets just haven’t matched expectations. The DAX has done better but remains some way off its highs. While we focus on the broad market in the US, the fact is it has been driven largely by a rather narrow group of stocks and the rest of the market has not enjoyed the same bounce. Tech is up 50% for the last 12 months, whilst Energy is down 30 per cent.

 

The question is whether this is early cycle or the death throes of the last bull market. Either you read this as a sign that the market could go a lot higher as we enter a cyclical bull market with lots of cash sitting on the side lines still to pour into value, or you worry that this is a Fed-fuelled tech bubble with forward earnings multiples looking enormously stretched at around 25x on a forward basis. I would be concerned that volatility will increase as we head into the autumn with the election looming and there is at least a chance of a technical pullback for the S&P 500. And how much more stimulus can you throw at this? The Fed has killed the bond market and lifted the boats – but how much more can it do? If the market tests the Fed again, what is left in the tank?

 

For the FTSE 100, the near-term downtrend is starting to approach important support levels.

 

USD can’t catch bid

In FX trading, the US dollar was offered yesterday and was the chief driver of the market, sending the euro to its highest versus the greenback in more than two years. The break above 1.19 for EURUSD leaves bulls in control after two previous attempts failed. EURUSD eased back from these highs today but remains supported above 1.19 with bulls eyeing a recapture of the May 2018 swing high at 1.20.  

 

GBPUSD was a little softer this morning after shooting clear of the 1.32 level yesterday to hit its best level since the election last December. The move clears important technical resistance of the long-term downtrend and opens a path back to 1.35, last year’s peak, with the golden cross (50-day SMA rising through the 200-day SMA) considered a bullish confirmation of the rally. Near term the higher-than-anticipated CPI inflation reading this morning has not been able to lift the pound, although it ought to help quell immediate speculation the Bank of England will resort to negative rates. 

 

Meanwhile the pound remains exposed to significant headline risks this week. Brexit talks have not gotten off to the best start as the EU rejected British proposals for truckers’ access to the continent. I would anticipate that the longer this drags the more we see pressure come back on GBP. FOMC minutes tonight will be watched for any signs the Fed feels the need to lean even harder on rates. For now the dollar can’t seem to catch a bid with the dollar index now barely holding the 92 handle and the last line of defence before a return to the 80s sitting at 91.60 (the 78.6% retrace of the two-year uptrend) now firmly in view. 

Oil prices slip ahead of OPEC+ meeting

Crude prices were a little lower this morning ahead of an OPEC+ meeting to review after touching a 5-month high yesterday on improving risk sentiment as US equities rose, whilst the softer dollar is offering ongoing support to commodity markets. 

 

OPEC and allies are likely to stick with 7.7m bpd supply cut – what we don’t know is whether the demand side really picks up into the back end of the year. On that front a lot will depend on the containment and control of the virus in Europe – rising cases raises real risk that hamstrung governments simply revert to a wide lockdown and restrict movement again. Airlines and travel stocks will face a tough time. 

 

Gold was softer after breaking back above $2k in yesterday’s volatile session. Near-term support appears to rest on the 23.6% retracement around $1980. Whilst bulls are still just about in control, their momentum is not what it was and we would prefer to see the next swing clear $2015 for the bullish trend to be fully reasserted. A further corrective move lower should still be considered a real possibility.

Marks & Spencer, Royal Mail bank on strategy shifts

Equities

Long road for M&S

Marks & Spencer shares dropped on Wednesday after another poor scorecard. The retailer is disappointing on several fronts and the doubts about the turnaround remain. It’s also announced a £600m rights issue for its joint venture with Ocado. I’d still view the deal as an expensive entry into a sector – online groceries – that doesn’t make any money. M&S basket sizes are tiny (c£14) so they need people to change their habits entirely and think M&S is the place for their big weekly shop, which they won’t. It’s better than standing still but no silver bullet. Exposure to the UK high street is a major drag that won’t get any easier.

The numbers are still heading in the wrong direction. Underlying profits were down 10%, on revenues that fell 3%. Food revenue declined 0.6%, with like-for-like revenue down 2.3%. Clothing & Home revenue down 3.6%, with like-for-like revenue down 1.6%. So store closures are a factor, but the drop in LFL sales is the real worry here. Really LFLs should be improving as customers transfer sales to surviving stores. Gross margin is better – up 20bps.

The cost of the transformation programme is high, such that it needs to deliver or the company’s financial position would start to come under greater scrutiny, albeit net debt has fallen to £1.55bn from £1.83bn. Exceptional costs scrubbed £439m from underlying profits to reduce these to just £84.6. M&S added to last year’s £320m hit from store closures by booking a further £222m charge. These costs are not insignificant. Capex is meanwhile rising.”

Royal Mail, too little too late? 

Royal Mail is launching some eye-catching new services. These are certainly the type of thing that will make it more fit for the 21st century. But it may be too little, too late.  

Parcel post boxes and a second daily parcel delivery service for next-day orders are great improvements and help it compete with more nimble rivals. You just wonder why it’s taken so long to get to this point. Amazon has offered Prime for many years; Royal Mail has rested on its laurels for too long.  

And it’s requiring sizeable investment. A whopping £1.8bn is being spent over 5 years. A dividend cut is an absolute pre-requisite. Pay-outs are being slashed to 15p a share from 25p share this year. Investors hungry for yield may be disappointed, but strategically it is absolutely the right move. And any surplus free cash will be directed to shareholders, so 15p is just the base. Fellow monopoly incumbent BT would be wise to take notice. 

Investors worried about the divi cut can cut and run. Those with a longer-term outlook are happier with the bold new direction. Shares have rallied 6% this morning, showing those with a longer view are greater in number. FY results show more of the same we have become used to over recent years with strong parcel growth offsetting declines in letter volumes. Profits before transformation costs were down by about quarter though. Today’s strategy update means going all in on parcels – it’s about time.

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