Market week

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In this week’s market update: Emerging markets under pressure as Turkey’s financial crisis unfolds; there’s more evidence of weak consumer demand in the UK as House of Fraser fall into, and then out of, administration; there’s attention on the bond market as a key driver of demand is withdrawn; and Elon Musk has been making waves again.

14 August 2018 - Ed Monk

Transcript - market week

14 August 2018In this week’s market update: Emerging markets under pressure as Turkey’s financial crisis unfolds; there’s more evidence of weak consumer demand in the UK as House of Fraser fall into, and then out of, administration; there’s attention on the bond market as a key driver of demand is withdrawn; and Elon Musk has been making waves again.

As the week gets under way, the attention is on Turkey, where a financial crisis has taken hold. Investors have been taking shelter while the full ramifications become clear.

Most of the attention has been on the Turkish lira, which has plummeted 20% against the US dollar in the past week and was down 11% at one stage on Monday.

Turkey’s economy has been in sliding for a while. Inflation and government borrowing costs have risen dramatically while the stock market has been falling.

Investors are worried about a credit crunch, with Turkish companies having borrowed heavily to profit from a construction boom and now struggling to repay loans made in foreign currencies.

The recent worsening of economic indicators has been driven by a row with Donald Trump. The US President said he would double steel and aluminium tariffs on Turkey, following the country’s refusal to release an American Pastor detained on terrorism charges.

For markets more widely, there are specific dangers to holders of Turkish corporate debt - notably some European banks - but beyond that the harm comes from a general sense that now is the time to flee from riskier assets. EM currencies and stock markets took the brunt of the damage on Monday.

Investors sold out of equities in Asia, which were down across the board. Japan’s Topix index was down 2.1% while China’s benchmark CSI 300 was down 1.1%. The Japanese yen, which is typically viewed as a haven asset, strengthened 0.6% against the dollar.

European stocks were down slightly, with the StoxxEurope 600 down 0.2% and the FTSE 100 down 0.6% ahead of the market open in America.

Turning to the UK, then, the economic newsflow comes this week in the form of labour and inflation data. Key will be whether wages can continue to grow more quickly than inflation, thereby making workers richer in real terms.

The numbers will also give an early indication as to whether the Bank of England was correct to raise rates two weeks ago. The Bank raised on the basis that an economic slowdown at the start of the year would be short-lived and that a tight labour market would soon translate into higher wages and inflation.

Analysts expects wages to be growing at 2.7%, the same reading as last month, and CPI inflation to tick slightly higher to 2.5% when the numbers land. That would actually reduce real wage growth, but perhaps support the Bank’s prediction that prices rises will accelerate from here.

UK corporate newsflow is ebbing away as the summer lull in activity takes hold. After a busy few weeks, updates of any kind are limited but will this week include Antofagasta, Kingfisher, Lookers , Mears Group and Rank Group.

The business headlines in the past week have been dominated by more woe on the High Street, with the news that House of Fraser entered administration before being rescued in a £90m acquisition by Sport’s Direct owner Mike Ashley.

The writing has been on the wall for the department store and House of Fraser had previously announced that half of its 59 stores will close as part of a complete restructuring of the business.

It has struggled with a legacy of costly premises for which it is having to pay rent and business taxes, in locations that were desirable once but which now just seem expensive. A statistic doing the rounds on social media is that House of Fraser’s business rates bill is larger than Amazon’s UK corporate tax bill - highlighting the extra obstacles for bricks and mortar retailers compared to their online counterparts.

House of Fraser’s collapse came as retail data showed a slowing of consumer spending this summer. Consumer spending was 0.9% lower during July than the same month last year, according to figures from Visa.

They come on top of figures published last week by the British Retail Consortium that found spending on items other than food fell during July. It suggests that a surge in retail sales that helped lift growth during the second quarter of the year has failed to extend into the third quarter.

Visa suggested that the heatwave had affected spending patterns, with spending on food and drink 3.5% higher than a year earlier and spending in hotels and bars up 2.5%. Meanwhile, spending on household goods, such as home appliances, fell 3.2% compared with a year ago, while transport and communication expenditure was down 4.1%.

Turning back to markets and bonds, in particular. There has been much discussion of the flattening yield curve for US government bonds. That is where the difference in the return offered by short-term 2-year Treasuries and long-term 10-year Treasuries reduces.

This represents an inversion of normal conditions, where you would expect to be offered a higher reward for committing to a longer-term bond. The reality now is that this yield curve has been flattening for almost two years. This is potentially worrying, as inverted yield curves can be an indicator of trouble to come.

There are some factors to explain all this. Interest rates in the US have been rising, which ups the yield on short-term debt in particular, but there is also a technical factor pushing down the yield of 10-year Treasuries.

That is extra demand in the past year from the pension schemes of US companies. Under Trump tax reforms last year, the corporate tax rate fell from 35% to 21%. The cut, however, did not apply to tax relief on pension contributions meaning US workers have been able to continue to get 35% relief, and will be able to until a deadline of September 15.

Unsurprisingly, that has created a rush to pump money into pensions and prompted schemes to purchase long-dated bonds to meet liabilities.  

Finally, are more unusual story to break this past week has been Elon Musk’s surprise announcement that he is exploring taking Tesla, the electric car company, off the stock and back into private ownership.

The proposed deal was priced at $420 a share and triggered an 11% surge in Tesla’s share price. It would value the company, including existing debt, at $82bn.

Reversing Tesla ‘s listing would be highly unusual and may require the deep pockets of sovereign wealth fund in the Middle East. The manner of the announcement by Musk, via a tweet which suggested funding had been secured, was also unusual and may even land the entrepreneur in hot water.

He was sued on Friday by investors who say Musk fraudulently engineered a scheme to squeeze Tesla short-sellers by inflating the share price.

In one of the lawsuits, the plaintiff Kalman Isaacs said Musk’s tweets were false and misleading, and together with Tesla’s failure to correct them was designed to decimate” short-sellers.

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