Market Bulletin - Borrowed time
Slow growth and rising debt levels continued to worry policymakers, as the UK entered the final month of referendum campaigning.
In fiction as in history, debt has played a large role, from the plot of The Merchant of Venice to Britain’s funding of the Napoleonic Wars. Even if he never said it, Winston Churchill’s supposed line sums up the unthinking abandon with which individuals and nations can slip too far into debt: “Gentlemen, we have run out of money. Now we have to think.”
Last week, much thinking was needed. For Greece, negotiations between the EU and IMF reached a familiar conclusion; Russia returned to the debt markets for the first time since its invasion of the Crimea; a Moody’s report showed that financial risk among China’s debt issuers has spiked sharply; and Britain posted another increase in its own national debt.
The most significant news came from Greece. In order to secure its next round of support from the IMF and European Central Bank, Greece was relying on a deal between the IMF and EU. The IMF increasingly favours some kind of forgiveness package, whereby Greece’s creditors agree to cut the country’s debt obligations – such reductions are generally referred to as ‘haircuts’. Germany remains opposed to any such reduction, worried that it will create a precedent.
Although there had been expectations that the IMF might stand its ground this time around, in the end it conceded. This heralded a return to the tried-and-tested approach of stumping up money for interest payments in the short term – known in the business as ‘extend and pretend’.
In the short term, the decision did at least shift one problem out of the EU’s in-tray, but there were plenty of others. Last week saw still more migrant deaths in the Mediterranean, and David Cameron announced the dispatch of a second Royal Navy vessel to Libya to help with monitoring. Another concern came in the form of the eurozone Purchasing Managers’ Index, a key indicator of growth expectations, which fell to a 16-month low last week – although both France and Germany performed far better. The FTSEurofirst 300 Index rose a healthy 3.5% over the week, reflecting the easing of concerns following the tentative deal to reduce Greece’s debt mountain.
Inevitably, however, much of the focus was on Britain’s forthcoming referendum – last week the country entered the final month of campaigning. David Cameron pleaded with voters to register before the 7 June deadline, doubtless concerned by studies showing that pro-Remain candidates are typically younger and less likely to vote.
A poll of more than 600 of the country’s top economists, commissioned by The Observer, and carried out by Ipsos MORI, found that 88% believed an exit from the EU and the single market would damage Britain’s growth prospects over the next five years. A telling 82% thought there would be a negative impact on household incomes over the same period.
Roberto Azevêdo, director-general of the World Trade Organization (WTO), warned that a UK exit from the EU would oblige the UK to renegotiate the terms of its WTO membership, requiring agreement with the 161 members of the body. “Pretty much all the UK’s trade [with the rest of the world] would have to be negotiated,” said Azevêdo. A WTO analysis claimed that the UK would face trade tariffs of £9 billion if it left the EU. A report published last week by Britain’s Institute for Fiscal Studies said that the UK economy would shrink for two years following an exit from the EU.
Meanwhile Lord Lawson, former chancellor of the exchequer, went public last week with criticism of the UK Treasury’s recent forecast of the economic impact on the UK of an EU exit, saying that the Treasury had a poor record on forecasts, and that the report had been designed to “scare the pants off people”.
Many commentators have put sterling’s weakness against the dollar this year down to referendum uncertainty. Wellington, which manages the St. James’s Place Gilts fund, said in a recent note that the hit to sterling would be far greater than any rebound from a Remain vote, and that current signs of weakness in the UK economy are due to uncertainty attached to the EU referendum.
Last week a report by Henderson Global Investors argued that sterling’s fall has also affected dividend payments, which dropped 5% (year-on-year) in the first quarter of 2016. An Ernst & Young report found that investor sentiment towards the UK has fallen due to referendum fears, limited infrastructure capacity, and property prices; among those surveyed, 16% expected the UK’s appeal to foreign direct investment to decline in the next three years – the previous figure had been just 5%.
“Brexit has been a big overhang this year; it feels like foreign investors have been on strike,” said Chris Reid of Majedie Asset Management. “We expect activity to pick up in July after the vote.”
Indeed, another survey published last week showed fund allocations to UK equities at their lowest since November 2008; although the FTSE’s heavy weighting to mining and finance may explain the slip as much as the prospect of an EU vote.
Finance was high on the list of UK concerns last week. Figures showed that government borrowing continued to miss targets in April. On Thursday, the Bank of England said that it would press ahead with rules to ring-fence banks’ retail operations from their commercial and investment banking arms. Meanwhile, a CBRE report showed that London banks are reducing their floor space, as more jobs are moved overseas and a range of factors continue to squeeze bank margins. There was good news, too – the first foreign sale of Chinese finance ministry bonds took place in the British capital last week, which should be the thin end of the wedge.
Oil finally crested above $50 a barrel for the first time since last autumn (although it ended close to $49). The rise was one of the chief reasons the FTSE 100 enjoyed its biggest weekly gain in six weeks, rising 1.86%; but short-term supply disruptions (especially in Nigeria and Canada) suggest the rise in the oil price may not be sustained.
In the US, the S&P 500 rose 2.2%, despite Donald Trump winning enough votes to secure the Republican nomination and the first slip in US productivity for three decades. Strength in other economic data pushed a governor at the Federal Reserve to say that a Fed rate rise should happen “fairly soon”.
“The US will put interest rates up in time, and the rest of the world will have to live with that,” said Majedie’s Reid. “When? My view is that the first rise was perhaps a little early. So my guess is September but there is a possibility of two rises this year.”
As global leaders met in Japan for the G7 last week, the intersection of politics and economics continued to dominate, as disagreements over how to respond to sluggish growth made meaningful announcements more difficult, although leaders issued a joint statement that a British exit from the EU would pose a “serious risk” to global growth.
Japan announced that inflation had fallen for a second consecutive month, raising fears about growth, as well as expectations of further central bank intervention. But the Nikkei 225 ended the week up 1% and there was renewed commitment to signing a free trade deal with the EU by the end of the year – with or without the UK.
Majedie Asset Management and Wellington Management are fund managers for St. James’s Place.
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