Crunching the credit signals
* This time last year central banks in the rich world were poised to tighten monetary policy. The US Federal Reserve was expected to continue raising interest rates and the European Central Bank (ECB) president Mario Draghi had announced the end of its programme of quantitative easing.
* Faced with a gathering global slowdown central banks have U-turned, switching from tightening to easing monetary policy. Last week the Fed cut rates for the third time in three months. The ECB has recently cut rates further into negative territory and restarted asset purchases. Interest rates are at historic lows in the UK, with the base rate at just 0.75% and markets anticipate the next move by the Bank of England will be down.
* Rate cuts and central bank asset purchases aim to reduce the cost, and increase the supply, of credit in order to bolster growth. Central banks have huge influence over credit conditions – but not complete control.
* The propensity of banks to lend and corporates to borrow is also influenced by the economic outlook. The prospect of weaker growth is likely to make banks more reluctant to lend, and the private sector more wary of borrowing. Taking on debt is less attractive when growth is weak, uncertainty is high and asset prices are under pressure.
* The Bank of England’s regular survey of banks shows that UK lenders are increasingly concerned about the outlook for growth and expect corporate defaults to rise. As a result banks have become more risk averse and are planning to cut back lending to corporates.
* A Confederation of British Industry survey of manufacturers reports that in the last six months the cost of credit has had a more adverse effect on manufacturing investment than during the financial crisis.
* Demand for credit is slowing. Big UK corporates are more focussed on reducing levels of debt than at any time in the last nine years, according to the latest Deloitte CFO Survey. Just as banks are paring back risk appetite so are corporates.
* This makes sense. GDP growth and profits have done well in most Western countries in recent years. But with corporate earnings not far off a cyclical peak and activity slowing the outlook for profits looks less rosy. Corporates bankruptcies in the US and UK are starting to nudge up.
* This isn’t only a problem for banks. Corporate bond markets are also at risk.
* The cheap-money policies of recent years have lowered the return on safe assets and encouraged investors to move into riskier areas, including corporate debt, in search of higher returns. Non-financial corporates have taken advantage of the new source of funding to switch from equity to cheaper debt finance. In the US, the euro area and China non-financial businesses are running higher levels of debt today than they were ten years ago. (The UK is the exception. Its corporate sector has deleveraged and is now less indebted than those in the euro area and, indeed, China.)
* A particular area of concern is the leveraged loan market which typically extends credit to less creditworthy, more indebted companies, usually without the kind of investor protection traditionally sought for such loans.
* The leveraged loan market has doubled in size over the last ten years, overshadowing high-yield bonds as a source of financing for riskier businesses. With global growth slowing, and growth in the developed world widely acknowledged to have peaked, investors are beginning to pull back from the market. Many worry that the next recession could bring about a string of corporate defaults that hit these lenders hard.
* Analysts at Bank of America Merrill Lynch recently wrote of the US leveraged loan market, “we are seeing numerous new signs of tightening credit conditions…ranging from wide market bifurcation, to a prevalence of downgrades, rising distress, lower availability of capital for the lowest rated names”.
* In recent years even less creditworthy businesses have enjoyed easy credit conditions. Credit has been cheap and easy to find. As growth slows banks and the corporate bond market will become more discriminating in their lending decisions.
In the lead up to the general election on December 12, we will provide a brief update each week of the latest opinion polls and betting odds.
Opinion polls betting odds
Note: Probabilities derived from betting odds from bookmaker Smarkets at 17.00 on Friday.
* The opinion polls show the Conservative Party with a 11 percentage point lead over Labour averaging the last five polls. The lead has narrowed from a 13 point lead from the five previous polls.
* Betting odds imply a 77% probability of the Conservative Party winning the most seats in the general election.
* However, betting markets see the most likely outcome, with an implied probability of 49%, as a hung parliament. Betting markets assign a probability of 43% to a Conservative majority and 6% to a Labour majority.
OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week down 0.3% at 7,302.
Economics and business
* The Fed cut interest rates for the third time in three meetings, reducing the target rate by 0.25%, citing weak global growth
* Markets interpreted the Fed’s comments accompanying the decision as signalling no further rate cuts for the time being
* The US economy slowed in the third quarter, but exceeded expectations, posting growth of 1.9% on an annualised basis
* The US economy added 128,000 jobs in October, beating expectations and defying fears that slowing activity had spread to the labour market
* The S&P 500 equity index hit an all-time high following the Fed’s interest rate cut and a string of positive economic data
* Populist candidate Alberto Fernández won the Argentinian presidential election, increasing uncertainty for the country’s troubled economy
* Former managing director of the IMF Christine Lagarde began her tenure as president of the ECB, taking over from Mario Draghi
* Ms Lagarde called for Germany and the Netherlands to increase government investment to support growth
* French car-marker and Vauxhall’s owner PSA is to merge with Fiat-Chrysler, creating the world’s fourth largest car company
* The decision on the new governor of the Bank of England is to be delayed until after the election, the FT reports
* Twitter announced it will ban all political advertising on its platform saying “while internet advertising is incredibly powerful and very effective for commercial advertisers, that power brings significant risks to politics”
* Hong Kong’s economy entered recession in the third quarter following months of political unrest and US-China trade tensions
* The French economy posted better than expected growth of 0.3% in the third quarter, boosted by domestic consumption and robust services sector activity
* UK manufacturing activity remained in contractionary territory in October but showed a slight improvement from the previous month
* Chinese manufacturing activity expanded at its fastest rate in nearly three years in October, according to the Caixin PMI survey, despite continued trade tensions with the US. Other data for the sector were mixed
* Wildfire-hit California saw significant power outages amid fears that power lines could ignite new blazes. Rating agency Moody’s said the State of California could see its credit rating drop as a result of the blackouts
* The EU is considering the creation of an anti-money laundering authority following a series of scandals in recent years
* The US House of Representatives voted to hold public hearings as part of its impeachment inquiry into president Donald Trump over alleged impropriety in dealings with Ukraine
* A nuclear plant in India was the target of a cyber-attack, underlining the threat such attacks could pose to organisations and the wider economy
Brexit and European politics
* British MPs voted to hold an early general election on December 12. The Labour Party dropped its opposition to a snap election after Labour leader Jeremy Corbyn said he was satisfied that the risk of a no-deal Brexit had been removed
* In an effort to improve his party’s electoral chances, prime minister Boris Johnson returned the whip to 10 Conservative MPs, after having sacked 21 MPs in September over their opposition to his Brexit plans
* Former Conservative MP Antoinette Sandbach became the eighth MP to defect to the Liberal Democrats since 2017
* US president Donald Trump weighted in on the UK election, voicing his support for Mr Johnson, despite warning that his Brexit deal could prevent a trade deal with the US. He also stated that Mr Corbyn would be “so bad for your country”
* The UK National Institute of Economic and Social Research estimates that in the long run the UK economy would be 3.5% smaller under Mr Johnson’s Brexit deal than under continued EU membership
And finally… a team of Russian scientists were hit with an unexpected bill after migrating eagles they had fitted with SMS trackers ran up large data roaming charges. One Eagle, named Min, unexpectedly flew to Iran from Kazakhstan causing significant expense – soaring costs