Another day, another UK company issues a profit warning. Last week it was Tesco, the country’s largest retailer, which cut its outlook for the third time in two months and suspended four senior executives after admitting to a multi-million pound accounting error. Today, it’s constructor Balfour Beatty, which has cut its profit outlook for the third time in less than five months after suffering contract losses and write-downs at its UK arm. Considering the amount of column inches devoted to the boom in the UK housing, investors aren’t happy and have knocked over 20 percent off Balfour’s shares as a result.
Britain’s economic growth is such that the Bank of England is likely to beat the Federal Reserve to the punch in the “race for the rate hike”. A recent Reuters poll shows most economists believe the BoE will deliver its first quarter-point rise in the first three months of next year, while the Fed will wait until the second quarter before delivering its first rate rise since mid-2006.
Welcome to a new week and the shocking revelation across the markets is that with the uncertainty stemming from the Scottish referendum – which briefly rattled markets around the world – behind us, it turns out that the global economy’s problems aren’t fixed after all. European Central Bank President Mario Draghi’s pledge to support the euro zone economy via low interest rates and cheap loans for the banks hasn’t been enough to convince our guest today, Royal London Asset Management portfolio manger Andrea Williams, that Europe’s financial sector is anywhere near being able to open the floodgates to allow the flow of credit back into the real economy and get things moving on the ground. “The problem is not one of liquidity, but lack of demand for loans. Banks say the regulator has made it too hard for them to lend to (small- and medium-sized enterprises) due to the risk weights required and many customers are still deleveraging,” she said. “Other worries (include) the lack of European economic growth. I saw quite a lot of companies last week at a conference and they seem to suggest Europe is not improving!”
The most recent ECB data shows private-sector loan growth in the euro zone picked up to show “just” a 1.6 percent year-on-year decline in July, having recovered from a record-low contraction of 2.3 percent late last year, but remains a far cry from the apparent hey-day of 2006, when loan growth hit a record high of 11.4 percent. Andrea said the ECB’s ongoing Asset Quality Review (AQR), a series of stress-tests to ensure the region’s banks have shored up enough capital to withstand any major disruption in the financial markets, should restore some confidence in the banking sector, provided the tests are perceived to be robust enough, but this alone won’t lead to a magical explosion in cheap credit for the region’s SME’s. “In terms of getting credit flowing, there is little (the banks) can do,” Andrea said. “I just think it takes time for the economic conditions to improve, for individuals to reduce the debt on their balance sheet – as long as rates stay low, it is the prudent thing to do … it’s taken the U.S. economy a few years to deleverage and Europe will take some time.” With that in mind, Andrea’s bottom line is “avoid banks”.
Scotland has rejected independence and opted instead to preserve its 300-year old union with the rest of the United Kingdom. A “No” was always the outcome predicted by the financial spreadbetters, but according to surveys in the run-up to last night’s vote, the general public appeared to be a lot more divided. Sterling has hit a two-year high against the euro, while UK shares have led advances in Europe, with Scottish-focussed stocks such as Royal Bank of Scotland, Lloyds, BP and whisky-maker Diageo contributing most to these gains.
The vote, in which 55 percent of Scots voted to remain in the union, has removed some of the risk of the UK leaving the European Union, something that Scottish independence could have precipitated. We’ve had a raft of great guests who have given us their take on the results and what they mean both politically and financially for the world’s sixth-largest economy. Marshall Gittler, head of global FX strategy at IronFX said the pound, which has touched its lowest in two years against the euro today, might not have much more scope to rally, no matter how great the relief over the union enduring. “For the pound, we’re back to looking at the data. The data hasn’t been that great. Meanwhile, investors are very long GBP!” Marshall told us, adding that market data showed a big buildup in long holdings of sterling last week as investors positioned for a “no” outcome. “I’m not sure there’s much more to go in this rally. I think profit-taking could be the next move,” he said.
Scotland decides today whether or not it will continue as part of the United Kingdom, or end a centuries-old union. The markets have been pretty quiet, but largely because most of the “will they/won’t they” action took place over the last couple of weeks and today is a day for watching and waiting. The headlines in the newspapers suggest the two sides – Yes Scotland and the pro-union Better Together – are neck and neck. But the financial markets have offered a much clearer message throughout the campaign. Our guest today from online financial spreadbetters IG Index, strategist Alastair McCaig, said all the evidence he’s seen from clients’ positions heading into the vote suggests a clear win for “No”. “IG have been running a binary bet on this for a couple of months and the lowest ‘No’ vote that has been on our platform was 62 percent. This morning, we are currently indicating an 83 percent chance of a ‘No’ win. With voter turnout expected to be almost 90 percent, Scotland looks to be taking this very seriously.”
We asked Alastair, himself a Scot based in London, why there should be such a discrepancy. ““The demographics of the voters mean that the more pro Yes have tended to be younger and many of the older voters have already posted in their opinions,” he said. “Also, younger voters more able keen to be involved on social media hence appearing to be in the ascendancy … Historically, news agencies and specifically TV have been eager to portray the image of a close two-horse race. That’s not necessarily what will happen,” he said. Voter turnout is expected to be over 90 percent, highlighting how strongly the Scots and non-Scots living in Scotland feel about this issue. That’s one thing the man on the street has in common with the man in the City. Alastair said there has been a very marked rise in the bearish bets against sterling, which has fallen by some 1.3 percent this month against the dollar to $1.638, near its lowest for 2014, ahead of the vote. He said there has been a swell in holdings of put options – contracts that give the holder the right, but not the obligation to sell an asset at a predetermined price by a set date. “We have seen a jump in trading of put options, strikes ranging from $1.6 to $1.55. In terms of hedging sterling exposure, the pound has bounced off the last weeks low and seems to be holding tight around the $1.63 mark. The bias is towards the downside.”
The Federal Reserve’s policy-setting committee meets this week to discuss the outlook for the U.S. economy and for rates. It’s something of a shame for Janet Yellen & Co that the event will be mostly overshadowed by the outcome of the Scottish independence referendum two days later. The dollar is around its highest in over a year and logic would dictate that this is a function of the growing expectations for the Fed to signal its first rate rise in almost a decade. At least that’s the theory.
The practice is a lot less dollar-centric, according to BNY Mellon chief currency strategist, Simon Derrick. The dollar has gained more than 5 percent so far in 2014 against a basket of currencies, putting in track for its largest increase in a year since 2008, the year the financial crisis exploded. But this has a lot less to do with the Fed gradually inching towards tighter monetary policy and a lot more to do with just about everything else. “It seems to me that expectations about Fed have actually been least important element in USD performance over past month,” Simon said. “Look over the past month and each USD move has really been about external factors Mid-August – that was about Japan and (its pension fund); early September – that was about the ECB and then Scotland. It feels very much as if the dollar has been the funding currency of choice over past 12 months and that what we are really seeing is a variety of factors that are denting confidence in carry trade.”
We decided to take a break from Scot-fever today and take a long hard look at how the European Central Bank’s latest lifeline will have an impact on the euro zone economy, which seems to be sinking into dangerously deflationary territory, and what it means for the euro, which is rapidly looking like the last child to be picked for the school sports team. The euro has borne the brunt of investor desire for yield and the bears are now prowling around it. The ECB last week cut interest rates to just 0.05 percent and pledged to buy asset-backed securities and covered bonds as a means of thawing out long-frozen credit flows to small- and medium-sized businesses in the euro zone. The bank stopped short of unveiling full-blown quantitative easing – where it would purchase sovereign bonds – but government bond yields have hit record lows and the euro has lost ground against every major currency bar the rouble, the Polish zloty and the New Zealand dollar over the last month as a result. But will it be worth it? Our guest today, Professor Reto Foellmi of the University of St. Gallen, said he wasn’t sure it was a price worth paying. “Concerning the ECB, I doubt whether these additional measures work. It is more of the same,” he said. ECB president Mario Draghi did the right thing by promising two years ago to do “whatever it takes” to save the euro and the commitment to buy the sovereign bonds of any euro zone nation in need of an emergency financial lifeline that met a series of conditions. “ This bought time for “real politics” but they did not use it,” Reto said, on the pressure from the ECB on the more indebted nations to bring their houses in order and implement serious structural reforms, rather than relying on handouts from the central bank. “The imbalances in the euro zone are still present and I fear more and more that we resemble the Japan experience two decades ago,” Reto added. Japan spent years trying to exit deflation and only now, having thrown trillions of yen at the economy, has started to do so. Bank of France governor Christian Noyer, who is also a member of the ECB’s governing council, said the central bank had achieved its aim of bringing the euro lower, but the currency needed to fall much further in order to raise inflation, currently running at around 0.3 percent, closer to the ECB’s threshold of near 2 percent. How much lower is “lower”? A Reuters poll taken last week showed most traders believe the euro will rise to around $1.31 in a month before falling to $1.28 by the end of the year, below its current level of around $1.29. In an informal straw poll in the forum, members were split over whether the euro’s next move over the coming week would be up or down, but in the longer run, it seems the single European currency doesn’t have that many friends out there right now.
Apple’s hotly-awaited iWatch smartwatch has featured on the front page of virtually every major news outlet and blog today, eclipsing the company’s new iPhone 6 model. The all-singing, all-dancing gadget will receive phone calls and messages, play music and monitor heart rates via special sensors. But almost more interestingly, it will incorporate Apple Pay, the company’s new mobile payments system that it unveiled at the iPhone 6 launch last night. One of the obstacles that a lot of fledgling digital payments systems face is not the unwillingness of consumers to embrace e-cash, but that of the retailers. But perhaps not for long, according to our guest today. who founded asset manager Altana Wealth, runs an alternative currency fund and is something of a digital money convert. He said this trend among consumers to conduct more and more of their transactions electronically poses one the biggest threats the traditional retail banking model has ever faced. Lee said the banks’ grim reality is that of the ever-changing demands of their customers and this could ultimately cause retail banking to go the way of the dodo. “Surveys that say 18-35 year olds would rather bank with Google/apple than a normal bank,” he told us. Sources of credit that totally exclude the banks, such as peer-to-peer lending or crowd-funding, digital currencies like bitcoin and electronic payment systems such as PayPal, all raise the possibility that banks may become extinct, Lee said. “Does anyone really care who lends them money as long as the rate is good?” Lee said. “Banks are entering a competitive commodity space. It’s very bad for profits especially levered companies like banks,” he said. “We are living in very exciting times. more going on today than late 90s in my opinion in tech world … supermarkets are just warehouses with bright lights and shelves (although) there are exceptions … Similarly banks.”
Any complacency about the outcome of the Scottish independence vote on Sept. 18 was knocked out of the UK markets today after a pre-election survey over the weekend gave the “yes” campaign a lead for the first time. Sterling has fallen to its lowest in 10 months against the dollar, having suffered its largest week-on-week fall in nearly three years, while the FTSE100 has lagged behind the rest of the major European benchmarks. A YouGov survey for the Sunday Times newspaper was the first this year to give the “Yes” to independence campaign a lead, putting it on 51 percent against the “no” camp on 49 percent, overturning a 22-point lead for the unionist campaign in just a month. “My own view is that media spin is intended to frighten soft Noes to the polls,” Reuters analyst Neal Kimberley told us today. “Sterling could conceivably go below $1.60 if the polls stay tight.” All very dramatic stuff. Online peer-to-peer betting platform Betfair said today on its blog this was “easily the biggest UK political market of recent years. With the result on a knife-edge, expect much more over the final fortnight of the campaign, with each poll prompting further market volatility.” Indeed, as “#indyref” fever has broken out, short-term option volatility on sterling is at its most expensive – indicating that traders believe the currency could move sharply in one direction for another after the vote – for two months. The pound is one of several contentious issues in an increasingly heated Scottish referendum debate. Pro-independence leader Alex Salmond says Scotland will share the currency while Westminster has ruled this out, leading to uncertainty about valuations, debt and the sharing of North Sea oil revenues. Neal said so much uncertainty will weigh on the pound, but any weakness goes beyond the Scottish vote. “With the spin on the YouGov poll, rather than the poll itself, being the story, the pound is set to stay soft,” Neal said. “But let’s understand what’s really going on… this is not so much a market getting short of sterling, but one getting out of a structural long position,” He said. “The … mentality has been to focus on the Bank of England and a possible rate hike, and better UK data than being seen elsewhere it was ill prepared for the tightening of the polls north of the border, a fact realised in the lack of movement in volatility until last week.”
All hail the dollar/yen! The greenback gained nearly 4 percent against the Japanese yen in the space of just 6 weeks and is now close to its highest since the start of the year. It doesn’t look like it will stop there either, thanks to a heady mix of geopolitical and macroeconomic uncertainty, according to our guest today, IFR technical analyst Martin Miller. Even with the confusion over today’s mixed messages from Kiev and Moscow about a potential ceasefire in Ukraine’s war-torn east, there is enough risk appetite out there to give the dollar another lift and against what better currency to fund such a position as the low-yielding yen?
“The overall scope is for eventual gains through towards 105.45, which was the 2014 high posted back in January,” Martin said. “It might well struggle for the rest of this week to get through this level, but eventually, perhaps next week, we should see a daily close above 105.45 which will unmask 106.00.” The dollar hasn’t caught a whiff of 106.00 since the depths of the financial crisis in late 2008, when Lehman Brothers collapsed. Aside from any lingering geopolitical risk, there’s plenty of macro risk this week as well, with the European Central Bank set to release its policy decision on Thursday and then the all-important monthly U.S. jobs report and dollar/yen is reacting accordingly.
Martin noted one-month at-the-money implied volatility for dollar/yen – a short-term gauge of how active traders expect this currency pair to be – has risen to its highest in three and a half months today, having topped 6 percent and beating its three-month average of closer to 5.1 percent. “I would stick to USD/JPY if you are looking for more vol,” he said, adding that volatility could rise even further, especially given the scope for the unexpected.
Financial markets have got it into their collective head that the UK economy is recovering and that a rate rise is imminent. But is Bank of England governor Mark Carney on the same page? Almost certainly not, according to Ian Campbell, our guest today from Breakingviews, who says the UK may continue to see low rates until 2016, a year later than markets are currently pricing in, after Wednesday’s quarterly inflation report. “I’m not sure he is deliberately trying to confuse the markets,” Ian said of Carney. “His ‘Mansion House’ speech sounded more hawkish—perhaps more hawkish than he intended. One thing he is saying is that markets should look at the data.” Depressed UK wage growth, the prospect of softer inflation as the oil price barely holds above $100 a barrel and the eurozone – the UK’s key export market – struggling to fend off deflation as many of its key economies falter are some of the factors that could well stay the BoE’s hand. Sterling as a result has dropped to its lowest in four months against the dollar, which some of our GMF members believe is something of a welcome development, after cable touched a five-year high above $1.70 just a month ago. “I’m with you on the pound. In the U.S., earnings are rising by close to 2 percent. Labour participation has dropped and the inflation rate is pushing up—though not very different to the UK’s for now,” Ian said. “However, I think the Fed will need to raise rates next year. The U.S. economy has grown by a lot more than the UK since 2008 and has recovered for more. The delay there could be inflationary,” he added.