Market week

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In this week’s market update: Oil in focus as Trump hits out at Saudi Arabia; tech in focus as the FANGs report on earnings; and Europe, has growth topped out?

24 April 2018 - Tom Stevenson

Transcript - market week

24 April 2018In this week’s market update: Oil in focus as Trump hits out at Saudi Arabia; tech in focus as the FANGs report on earnings; and Europe, has growth topped out?

Donald Trump has found a new topic for his early morning tweets. The Saudi Arabians may be America’s allies in the increasingly tense Middle East but that didn’t prevent a broadside from the US President on the kingdom’s bid to push the oil price higher.

Trump’s accusation that OPEC is pushing the cost of crude up to ‘artificially’ high levels follows comments from the Saudi oil minister that the world can cope with higher oil prices. With the price of the Brent contract close to $75, nearly three times its recent low, there is speculation that the Saudis are pushing for an even higher price of between $80 and $100 a barrel.

There are plenty of reasons for the Saudis to want the oil price to rise. The country is undergoing an expensive economic transformation to reduce its dependence on oil; it is fighting a war in its southern neighbour Yemen; and its foreign currency reserves have dwindled four years after the oil price collapsed from over $100 to under $30 at one point.

Trump’s motivation for a cheaper oil price is also clear. Petrol is lightly taxed in the US, so the cost of oil is a much bigger element in the price at the pumps than in the UK or Europe. This means that a rise in the price is quickly felt by consumers. Higher oil could quickly offset the economic stimulus currently being provided by the President’s tax cuts.

‘Oil prices are artificially Very High! No good and will not be accepted!’ he tweeted with lots of capital letters and exclamation marks at the end of last week.

Saudi Arabia has managed to push the oil price higher in recent months by persuading Russia and its OPEC partners to limit production. The output curbs since January 2017 have been very successful, reducing excess inventories almost completely and offsetting rising production in the North American Shale fields.

The challenge for the Saudis is to manage the price a little higher, to boost its revenues, but not so high as to crimp demand or to accelerate alternatives like electric vehicles. Even for the world’s leading oil producing nation, managing a price with so many supply and demand variables is not easy.

The financial market implications of the ups and downs of the oil market are significant. Oil is a key driver of inflation and, with prices and wages already moving higher as the economic cycle matures, a tighter oil market is risky.

The 10-year Treasury bond yield is back above 2.9% and looks like testing 3% as inflation expectations over the next 10 years rise to levels not seen since the summer of 2014. Rising bond yields, in turn, influence equity markets as investors are less inclined to take the risk of investing in shares if they can benefit from a high and reliable income from bonds.

Rising bond yields in the US also reflect a growing conviction that the Federal Reserve will tighten monetary policy at a faster rate than in the rest of the world. The probability of four Fed rate hikes this year, as implied by the futures markets, is now around 33%, up from 18% just a couple of weeks ago.

The outlook for US interest rates is at odds with that in the UK, where Bank of England Governor Mark Carney last week seemed to row back on earlier hawkish comments. He is now suggesting that the markets may have got ahead of themselves regarding the pace of UK tightening. The consensus is still that the Bank will raise rates at its next meeting in May but that the trajectory of rates thereafter will remain shallow.

The differential between US and UK interest rates is reflected in the exchange rate because the expectation of higher rates encourages investors to hold the currency of a country on a steeper tightening path. The pound, which had been edging closer to pre-referendum levels, retreated at the end of last week to nearer $1.40.

The dollar also strengthened a bit against the Euro, which will come as a relief to the bosses of many European businesses for which Euro-strength is a significant headwind. The recent strength of the Euro is starting to look odd up against a European economy which may be losing steam and a European Central Bank which looks to be losing enthusiasm for its own retreat from easy monetary policy.

This Thursday’s ECB meeting will give some clues as to the future path of QE, which had been due to end in September but could now continue for some time after that. Pushing interest rates back into positive territory in Europe still looks some way off.

A further complication for ECB policymakers is the impact on European companies of the ongoing trade spat between Washington and Beijing. Europe is likely to be caught in the cross-fire of any deterioration of relations between the US and China, although comments from US Treasury Secretary Steven Mnuchin that he was considering a trip to China suggested that the early exchange of tariffs might soon be replaced by more constructive negotiations.

Investor sentiment was given a further boost by news that North Korea is suspending its missile testing and closing a nuclear test site.

Back to Europe, the region’s economic recovery was one of the brightest spots of 2017’s cocktail of good news so investors will worry that sentiment surveys and data are looking weaker in the first quarter of 2018. The region grew by 2.5% in 2017, the fastest rate for a decade, with most of the increase coming in the second six months of the year. It is early days yet to call the end of that uptick but the signs so far this year are less encouraging despite marginally better than expected purchasing manager index data yesterday.

The 55.2 reading is still well above the 50 mark which separates expansion from contraction but is significantly lower than the 58.8 level reported in January.

On the earnings front, technology will be in focus on the other side of the Atlantic with a clutch of the highest profile names in the sector reporting this week. There will be plenty of focus on the results from Google-owner Alphabet, Facebook, Amazon and Microsoft as the risk of tighter regulations, higher costs and a focus on the taxes this big multi-nationals pay cast a shadow over the high-flying sector.

Alphabet’s figures, out after the market closed on Monday, were a mixed bag for investors. The good news is that revenues continue to soar, exceeding expectations; the downside of this growth is that Google is having to spend heavily to keep up. Capital spending in the first quarter was half last year’s total spend.

On this side of the pond, the banks are in the spotlight. UBS, Santander, Credit Suisse, Barclays, Royal Bank of Scotland and Deutsche Bank all get an outing this week. The first to announce, Santander, has made a strong start to the year, with profits up 10% in the first quarter.

Also in focus this week is Capita, another support services group that like its peers Carillion, Mitie and Interserve has fallen on hard times as the government has squeezed the outsourcing companies that provide so many its services these days. Capita launched a deeply discounted £700m fundraising to reduce the company’s high debt level. The market took the news well, seeing the pre-emptive cash-raising as a more pro-active approach that might secure the company’s future.

Meanwhile at the macro level, there will be some key data in both the US and UK as first quarter GDP for both is unveiled on Friday. Growth in America is forecast to be at an annualised rate of 2%, which would mark a slowdown from the previous quarter’s 2.9%. That slower growth is likely to be coupled uncomfortably with higher inflation (2.3% against 1.9% in the prior period).

Here, too, growth in the first three months of the year is expected to be a bit disappointing, hit by the poor weather in February and March. Construction output fell significantly in the period and manufacturing also lost momentum. The Bank of England expects quarterly growth of just 0.3%.

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