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11 December 2018 – In this week’s market update: Brexit chaos unsettles markets; Huawei arrest adds to Trade War fears; OPEC defies Trump to cut production; and the yield curve signals trouble ahead.
Investors in the UK have been transfixed since the weekend by the fast-shifting sands of Brexit, with the pound, as usual, bearing the brunt of market jitters.
The pound fell by more than 1.5% yesterday after Theresa May confirmed that she has abandoned hope of getting parliamentary approval for the withdrawal agreement she has negotiated with the EU. The vote planned for this evening has been pulled and the Prime Minister is heading back to Brussels to seek a deal that is acceptable to a majority of MPs.
The pound is at its lowest level since April 2017.
Sterling fell to around $1.25 against the dollar and to €1.11 against the euro, hitting the value of UK-focused shares like housebuilders and airlines but boosting overseas earners like Imperial Brands. That resulted in a much bigger fall for the FTSE 250 index yesterday than for the FTSE 100 which tends to be supported by a weaker currency.
Elsewhere in the UK, the yield on gilts fell, pushing the value of UK government bonds higher, as investors grew more concerned about economic growth, amid shorter odds on a no-deal Brexit. The yield on the 10-year UK government bond fell from 1.26% to 1.22% in less than an hour.
In reality, investors are almost wholly in the dark about the likely direction of Brexit developments in the wake of the cancelled parliamentary vote. All options from no-deal to no-Brexit and all stops in between remain possible.
Rumours that the vote would be cancelled emerged mid-morning on Monday as the Government appeared to accept that any last hope of persuading waverers to back the withdrawal plan had disappeared over the weekend.
The humiliating climb-down was confirmed at 3.30 when the Prime Minister made an announcement in the House of Commons to explain her decision. She said that she planned to travel to Brussels to try and persuade the EU to renegotiate the terms of the so-called backstop agreement which was designed to prevent the return of a hard border between Ireland and Northern Ireland.
This has been the major sticking point among Brexiteers and the main reason Mrs May was unable to gain the necessary support for her deal. Unfortunately, the EU has indicated that it is not willing to re-open negotiations. Yesterday’s cancellation of the vote looks like nothing more than kicking the can down the road.
In other developments yesterday, the European Court of Justice confirmed its judgement that Britain could, if it chose, cancel its notification that it would be leaving the EU without the consent of other member states. This raises the possibility that, two and a half years after the EU referendum, Britain may simply choose to stay in the EU.
The two most likely solutions now look like being a soft Norway-plus type of Brexit which sees Britain remaining in the single market and customs union or a second referendum. However, the default option, if nothing happens to change it, is a no-deal exit on 29 March next year.
Hard as it is to believe in the UK, where Brexit dominates, the rest of the world has found plenty of other things to worry about. Top of the list of concerns is the ongoing trade tensions between the US and China.
This came to a head last week when the finance chief of Chinese telecoms group Huawei was arrested in Canada. Meng Wanzhou, daughter of Huawei’s founder Ren Zhengfei, is accused of lying to US banks in order to circumvent sanctions on Iran. The arrest has intensified an already fraught diplomatic stand-off between the world’s two largest economies.
The prospect of a full-blown trade war between China and the US has seen investors running for cover, with money flowing out of US and Chinese shares and into the relative safety of US government debt. Funds invested in US equities saw $3.5bn of outflows for the week ending Dec 5, nearly reversing all inflows so far this year.
The S&P 500 index fell yesterday to its lowest level for eight months, adding to last week’s selling pressure, although a late rebound saw it end marginally positive on the day. The Dow Jones joined the main US benchmark and the tech heavy Nasdaq in correction territory - a fall of more than 10% from the recent high - as it fell by more than 2% to a seven-month low.
US shares have been under pressure since October when it became clear that Donald Trump is determined to increase the tariff squeeze on China by increasing 10% levies on more than $200bn of imports from China to a 25% tax from the beginning of next year.
China managed to secure a temporary reprieve, with a deferral of that hike until the beginning of March at the earliest but tensions between the two countries remain high.
In China, trade tensions are building on a pre-existing economic slowdown as the Government seeks to rein in excessive borrowing. Data over the weekend showed consumer price growth slowing to 2.2% from 2.5%, undershooting forecasts. Export growth also slowed to 5.4% from 15.6% in October.
The deteriorating outlook for the global economy has also been reflected in the tumbling price of oil, which has fallen from a recent high of $86 a barrel to below $60. Flagging demand for crude has come as the world’s main producers, including Saudi Arabia, have been put under pressure by the US to raise production levels and so push the oil price lower.
The willingness to co-operate of Saudi Arabia and other big producers in the OPEC group plus Russia appeared to evaporate last week. They defied the White House’s calls to keep production high by agreeing a 1.2m barrels a day cut in output. That sent the oil price 5% higher on Friday, with Brent reaching $63.
Other signs of a slowdown in global activity this week have included a revision of Japan’s third quarter GDP estimate to show a 2.5% shrinking of the economy. This was much worse than the 1.9% fall that had been predicted on the back of a series of natural disasters in the country, although the optimistic view is that these disasters make the downturn a one-off that will be reversed in the fourth quarter..
Japanese shares, which have been among the worst performers in 2018, as investors have fretted about Japan’s exposure to trade tensions, fell another 1.9% at the beginning of the week. The Topix is now at its lowest level for 18 months and, like the UK, starting to attract contrarian investors.
Fears that the upswing in global activity since the financial crisis ten years ago may be coming to an end are starting to show up in a key financial markets indicator too. The so-called yield curve which compares the yields on different maturities of government bonds is close to a key level that in the past has been a clear indicator of a looming slowdown.
Normally, the yields on longer-dated bonds are higher than those on shorter-dated ones because investors demand more reward for tying their money up for longer periods. This is because of the higher risk that inflation may erode the value of their money over time or that companies or governments will default on their obligations before they are due to be repaid.
When investors worry that the outlook is deteriorating, this state of affairs can be reversed and bonds maturing several years hence can yield less than those maturing in the near future. In the jargon this is known as an inverted yield curve and in the past this has tended to precede the arrival of a recession.
What is worrying investors today is the fact that the yields on 10-year bonds and those on 2-year bonds are almost the same. The yield curve, in other words, has flattened if not yet inverted. Investors are watching nervously to see if it will invert in the weeks and months ahead.
One of the key determinants of the yield curve is what happens to interest rates because these have a bigger influence on short-term bond yields than longer ones. If the Federal Reserve continues with its current pace of rate hikes then the yield curve will almost certainly invert so all eyes are looking out for evidence that Fed governor Jay Powell is easing back on the Fed’s tightening path.
Last week’s non-farm payrolls were slightly disappointing, with only 155,000 new jobs created, lower than the recent average. This suggests that there may be less pressure on the Fed to raise rates, although most people still expect at least one more rate rise next week even if there are few or none more in 2019.
On the corporate front things actually are calming down a little although this week still offers quite a few company results and trading statements for investors to focus attention on. Thursday is a particularly busy day with announcements due from Ocado, Sports Direct, Tui, Purplebricks and PZ Cussons.
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