If the US Federal Reserve was hoping to send a message of support for global equity markets and the global economy with yesterday’s 50bp rate cut, the market reaction appears to have raised more questions than answers.
The last time the US central bank acted this decisively was during the 2008 financial crisis and its actions along with other central banks was able to calm some nerves. On this occasion yesterday’s surprise emergency rate cut appeared to send all the wrong messages, prompting questions about politics, as well as inviting speculation about what the Fed was seeing that market participants weren’t.
No one doubts that the disruption from COVID-19 is likely to be extensive in the coming weeks, however as numerous Fed officials have told us in recent days, the US economy is fundamentally strong, even if there are pockets of weakness.
Tonight’s Beige Book for February could give us extra insight on that, and possibly also throw into focus the reasons behind yesterday’s decision to cut rates.
There was little doubt that that the Fed was going to act in the coming weeks in the face of the upcoming headwinds, however in acting in the way they have, hastily, they may well have fired off an almighty blank, after markets sold off in the aftermath of yesterday’s decision.
Monetary policy, as with all levers to support the economy needs to be used wisely, with forward guidance also playing a big part.
G7 finance ministers and central bankers having committed, in a fairly routine G7 statement yesterday, to act decisively and collectively to support the global economy, and meet the economic challenge posed by COVID-19, was a start, and certainly a statement of intent. In the aftermath of that, the decision by the Federal Reserve to act independently within hours of that statement, did catch markets on the hop.
This surprise was reflected in the market reaction which saw stock markets rally strongly initially before sliding back. This was always the worry for central banks given the current state of monetary policy. With so little wriggle room on rates the concern was always that any move on rates was likely to backfire in the absence of fiscal measures, and other such actions to support the disruption to supply chains, and potential hit to consumer confidence. It is against this backdrop that makes it all the more mystifying that the US administration deems it unnecessary to suspend its tariffs on China. That would send a much more powerful signal than any rate cut, however economic logic has never been a strong point for the Trump administration.
While US markets finished the day lower, they didn’t entirely reverse the gains from the previous day and for that perhaps we should be grateful, while Asia markets response has been slightly more mixed, with markets in South Korea and China advancing strongly.
This was despite the latest Caixin non-manufacturing survey from China also posting a record low in February of 26.5, down from 51.8 in January. This low reading merely serves to reinforce how badly affected the services sector in China has been hit by the impact of the coronavirus, even more so than the manufacturing sector. China auto sales also declined 80% year on year, the biggest decline on record.
Markets here in Europe, despite closing well off their highs of the day yesterday, have still opened modestly higher in the hope that governments and central banks, will offer incentives on the fiscal side to small and medium sized businesses to help them cope with the disruption. The French government have already indicated that they are thinking along those lines offering help to small businesses to help them over the hump of the disruption caused by the virus.
The FTSE100 is outperforming largely as a result of the weaker pound, which is trading near 4 month lows against the euro.
In terms of the economic data, todays services PMI’s for February from Spain, Italy, France and Germany so far are showing little evidence of a slowdown in the European economy, nonetheless we could well see spill over effects this month as the virus sweeps across Europe. Spain saw a slight decline to 52.1 from 52.3 in January.
In Italy, which is the current front line in Europe for COVID-19, economic activity improved from 51.4 to 52.1, however this probably doesn’t include the period which saw a lot of northern Italy locked down as a result of the virus quarantine.
France and Germany services activity also remained steady, both coming in at 52.5.
The Bank of Canada is expected to follow in the Federal Reserve’s footsteps later today, with the only debate being as to whether they will match the US central banks move or merely cut by 25bps.
In company news German chip maker Dialog Semiconductors downgraded their Q1 revenue outlook to between $220m and $250m, from $295m. At the same time their Q4 profits slipped from $57.9m a year ago to $44.8m, as revenues came in at $380.6m.
Legal and General has reported its latest full year numbers with an increase in operating profits of 17% to £2.5bn. profit after tax rose by a similar percentage to £1.7bn. The dividend was increased by 7% to 17.57p, while Return on Equity saw a modest decline from 22.7% to 20.4%.
Packaging company DS Smith also issued a trading update with management saying that the UK and the US business are both performing well, and that they expect to deliver margins in line with those in the first half of the year. The sale of DS Smith Plastic was also confirmed with cash proceeds of £400m.
Shopping centre owner Intu Properties has abandoned plans to raise up to £1.3bn in new equity with management blaming the current volatility in equity markets, while saying that they would be looking at other options to shore up a balance sheet which currently has up to £5bn of debt acting as a deadweight on the business.
While the recent volatility is likely to have been a factor in the failure of the fund raising, its more probable that existing shareholders were reluctant to throw good money after bad. The shares have not surprisingly plunged even further, though a 40% plunge on the open needs to be set in the context of the fact they are now a penny share, having fallen from 115p a year ago to below 10p now.
On the currencies front the US dollar has remained under pressure as the shockwaves from yesterdays Fed decision continue to reverberate through the markets. US bond yields have continued to drop on the basis that we could see further rate cuts in the coming weeks with the US 10 year yield falling below 1% for the first time ever. This is quite extraordinary given that in the last month US long term rates have slid below the levels they were in 2016, when the US Federal Reserve had just started out on its rate hiking cycle.
US markets look set for a decent rebound from last night’s sell-off as Asia and European markets absorb recent events and look to the next moves on the part of global central banks and governments.
Today’s ADP employment report for February is expected to show 170k new jobs added unchanged from January while we also have the latest reports from the services sector which is expected to show the US economy remains resilient, despite yesterday’s Fed move.
The US retail sector will continue to come under scrutiny after Target’s mixed numbers yesterday, which saw the shares slide back.
Today we get to hear from Abercrombie and Fitch which has had its fair share of problems in recent years. Its most recent update in November saw both Q3 profits and sales fall short of estimates. Management said that they expected China tariffs to shave $4m of gross profits in Q4 and $5m for the full year, though that was before the agreement of the phase one trade deal agreed in December. Events have moved on since then and there is the concern that recent events in China and the rest of Asia with respect to coronavirus could well impact the latest Q4 numbers negatively.