Weekly – Investment Adviser 25 September
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A confidential segment of the capital markets
Global bonds sales reached 3,7tn in the first half of 2019. US accounted for about $1,4tn and North Asia $0,6tn. To put green bond into perspective this (new) type of securities managed to drain above $100bn in a semester. This spells less than 1%! France has been the leading issuing country with above $15bn, closely followed by the US (14,5) and the Netherlands (10,5). Moody’s and the Climate Bonds Initiative (an NGO) expect 250bn issuance for 2020. Engie, the French Utility group has been the largest players.
Up to now, Green Bonds’ issuance have been limited in size and scope
Germany unveils its tepid ¨Klimaschutzplan 2030¨
Chancellor Merkel’s green credential waned. Indeed, Germany is still the 6th worlds’ largest carbon emitter (about 2% of total). It has also failed to comply with its 2020 emissions target. This may explain the large demonstrations across the country and the relentless rise of ecologist parties (about 20% intentions, higher than Social Democrats). Most German voters now consider the climate issue as pivotal.
In a tentative reaction, Chancellor Merkel acknowledged climate change as a major challenge for mankind… Europe’s largest economy unveils a plan, whereby EUR54bn will be spent to encourage companies and households reduce their carbon emissions. In short, it will implement a tax incentive system for consumers (bonus-malus type) and reinforce carbon taxes for polluting companies. The idea is to ensure that the country will respect its former engagement to reduce by 55% its 1990 level of carbon emissions. Hard to call it a definitive breakthrough!
Merkel’s government does not take full stock of the major challenges facing Germany and Europe
The German Climate plan spells neither a bold, nor a global – European – vision
Time has come for a European Grand plan
About a decade ago, the US launched its TARP program. US Treasury purchased / insured over $700bn of troubled assets. These one-off and short-term capital injections were in total contradiction with the basic principles of liberal – non-interventionist – capitalism. Still, it proved instrumental in bailing-out important US banks and a couple of large car manufacturers. This was a visionary move, actually allowing for the US economy to avoid falling into corrosive debt-deflation.
Europe will eventually be ahead of comparable type of trouble. The European banking system would not stand a (serious) recession.
Pre-conditions are gradually setting-up for a change. Indeed, political pressure is rising fast in Northern Europe and Germany for bold initiatives on Climate. A window is therefore opening-up for a pan-European initiative. The issuance of mutualized debt by the EU – say European Green bonds – to finance a global climate plan, must be considered. It should essentially be based on infrastructure spending, rather than on fiscal incentives. It could even be financed by the ECB. Such a major cause would tentatively eclipse the austerity concerns from Europe Northern Countries.
Conveniently, it would broaden the universe of securities allowed for ECB purchase at a time when eligible bonds are drying-up, pushing yields into negative territory.
Draghi was an unequivocal Maestro, who saved the Euro currency from the Abyss
Let’s hope C. Lagarde will manage to engage both ECB and European leaders into unprecedented economic policies
- Europe urgently needs to address climate change and restore capex / investment
- Public opinions seem ready to support Euro Green Bonds
- Yield hungry capital markets would easily absorb Pan-European Green Bonds
- Such green bonds would be a prelude to a larger – overdue – European risk mutualization
Fixed income. Political developments outpaced fundamentals
At its September meeting, the FOMC voted to cut the Fed Funds rate by 25 bps, to 1.75%-2.00% and to cut the IOER by 5 bps. Chair Powell confirmed that the Fed is ready to act to alleviate money market pressures. Once again Esther George and Eric Rosengren were in favor of no cut, and James Bullard was in favor of a 50 bps cut.
When the Fed has re-assessed its outlook, inflation should have posed some challenges. The Fed’s initial assumption has proved accurate: the Q1 weakness in core inflation was temporary. Given the recent regional Fed elements, the core PCE should rebound and according to the current trend, it will be comfortably above 2% in Q1 2020. It is not a game changer in its own. But unless growth is more clearly headed for recession, it is enough to question the market expectations for more rate cuts. This is also part of the answer regarding dissident voices within the board. Furthermore, there is a big disconnection between the realized inflation and inflation expectations for some months like in 2016.
Brexit optimism in the UK waned and Merkel played down spending hopes. Trump did not help either when he said that they need a complete deal or no deal. Trade war fears resurfaced further when China cancelled farm visits.
Money market stress episode reminds of 2008. But it is nothing more than a consequence of technical factors. Cash available to banks for their short-term funding needs dried up earlier last week, and money markets rates shot up. That forced a Fed emergency injection of $125 bn over 2 days.
The first liquidity injection since the financial crisis. Two coincidental events were to blame. First, US companies have withdrawn funds from money market products to pay their quarterly tax bills. And, on the same day, investors have settled the $78 bn of new US Treasury issued the week before. On top of that, the reserves that banks park with the Fed, and which are available to other banks on an overnight basis, were at their lowest level since 2011. Added together, these factors have tested the $2.2trn repo market limits. Whatever the cause, the episode has added fuel to the argument that the Fed needs to take steps to avoid more disruptions in the repo market down the road.
- Inflation linked bonds are an interesting alternative to allocate risks in the fixed income universe
- Downside risks are still pointing for additional Fed Funds cut before year-end, even though Powell was careful not to telegraph future moves
Currencies. Norway remains an exception
The Norges Bank caught markets off guard with its 4th interest rate increase within a year. While this hike sharply contrasts with most other central banks, the Norges Bank’s guidance suggests this may be the end of its tightening cycle. The central bank raised its policy rate by 25 bps to 1.50%. The future rate path has been revised down, as global headwinds have lowered global forward rates. The rate path now suggests a 40% probability of a rate hike in S1 next year. Further out the rate path signals unchanged rates and then a roughly 30% probability of a rate cut in 2022. Importantly, this indicates that government bond yields are more likely to fall than rise next year. A March hike remains a real possibility, but too optimistic.
- The EUR/NOK is likely to remain close to the 9.80 mark
Currencies. Finally, a pragmatic SNB
Unsurprisingly, the SNB kept its policy rate unchanged at -0.75%. The last week ECB’s decision to reduce its key rate has not influenced the SNB, even though officials have emphasized the importance of the yield spread with the eurozone. The key rate spread with the ECB one is now at 25 bps, which seems sufficient given that market spreads have not changed much so far. For 2021, projected inflation stands at 0.6% from 1.1% before. This is very low and a sign that positive policy rates are unlikely in the coming years.
The big surprise came from the SNB’s revision of its tiering system for sight deposits subject to negative rates. Since 2015, the SNB has exempted 20 times the minimum reserve requirements from negative interest rates. From November 1st, the exemption threshold can vary every month and will depend on the evolution of banks’ balance sheets. For the first period, the SNB has set the exempted amount at 25 times. Under the old system, about 50% of excess liquidity was exempted from negative rates. Under the new system, about 64% of excess liquidity would be exempted i.e. around CHF 60 bn.
- The SNB has been more proactive than usually. Negative policy rates have been eased
- The CHF will remain driven by the risk-on/risk-off.
- Given better fundamentals, the CHF will remain tilted to the upside
Equities. Airbus has revised upwards its forecasts for 2038
Airbus and Boeing regularly update their estimates of commercial aircraft needs over the next 20 years. Airbus just did it.
Airbus anticipates demand to reach more than 39,000 new commercial aircraft over the next 20 years. The global fleet of passenger and cargo aircraft is expected to double from 23,000 aircraft to 48,000. The annual growth of air traffic will be 4.3%, the IATA estimating a doubling of the number of passengers in 20 years to 8.2 billion. Air traffic is resistant to economic shocks and urbanization increases the need for connection between major cities. Since 1970, air traffic doubles every 15 years. By 2038, air traffic will be multiplied by 3.2 in China and 4.8 in India according to Airbus.
Out of 48,000 aircraft, 39,500 will be new aircraft (25,000 to meet growing demand and 14,500 to replace older models) and 8,500 aircraft in the current world fleet. Boeing is more optimistic and estimates for 2038 a global fleet of 51’000 aircraft, of which 25’000 new to meet the demand and 19’000 new to replace existing aircraft.
The segmentation will be roughly equal to today’s, i.e. 75% single-aisle aircraft and 25% wide fuselage (2 corridors) of which 15% average and 10% wide.
At the Aviation Expo China in Beijing, the German engine manufacturer MTU Aero Engines has confirmed the great long-term prospects for commercial aviation.
The only two manufacturers are Airbus and Boeing. The C919 of the Chinese Comac would like to compete with the A320 and B737, but it is already 3 years late and should not enter into service before 2021 at the earliest. In 2016, Comac and the Russian UAC created a joint venture in view of the development of a jumbo jet, but not expected before 2027-2030. Safran is the leader in equipment and the joint venture CFM (Safran-GE) supplies 70% of the world market for single-aisle aircraft.
In the short-term, European manufacturers of aircraft, engines and other equipment could be under pressure due to 1) a tariff increase by Donald Trump for European products exported to the United States and 2) the bankruptcy of the tour operator Thomas Cook with new supply of aircraft on the market (Thomas Cook owned 10 aircraft and 107 aircraft leased).
By September 30th, the WTO will publish the amount of the damage suffered on the US side by the financial aid from Europe received by Airbus and what will be the level of taxation that can be imposed by US customs on European products such as olive oil, cheese, wine, luxury items and … aircraft. The UTSR (US Trade Representative) estimates this damage at $25 billion and some believe that the US would have the crazy idea to tax 100% Airbus aircraft !
- The increase in estimates for needs in new aircraft is not good news for the planet
- This is good news for the commercial aviation industry
- But watch the US vis-à-vis Airbus
Equities. Swiss watch exports
In August, Swiss watch exports rose by 1.5% in CHF compared to August 2018. But growth keeps decelerating . See graph.
In units, sales fell by 12.3%. If they increase in value, it is thanks to the Precious Metals segment which progressed by 7.2% in units and by 5.3% in CHF and the Gold-Steel segment with +4.8% and +8.8%.
The Plastic segment (which mainly concerns The Swatch Goup) saw sales fall by 15.6% in units and by 12.4% in CHF.
Hong Kong remains the leading export market for Swiss watches with a share of 13.3% (January-August 2019), followed by the USA with 10.8%, China 8.7%, Japan 7.6%, UK 6.4%, Singapore 5.7%, Germany 5.1%, France 4.9%, Italy 4.5%, South Korea 4.4% and United Arab Emirates 4.3%
With the political turbulence in Hong Kong, it is not surprising to see a drop in sales (-13%). Fortunately, the US, China and Japan have offset the decline in all other parts of the world. But the outlook remains difficult with the crisis in Hong Kong, the Brexit, the bilateral negotiations between the EU and Switzerland, as well as a risk of a large military conflict in the Persian Gulf.
- The Swatch Group is the most sensitive company in this adverse environment
- Richemont should resist better
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