A summer of surprises...

We may need to wait for the return of Mr. Market in September for real direction. In the interim, there are remaining themes of note likely to help set the tone as we roll towards the final months of the year. Despite the summer break we have seen rate hikes, sovereign downgrades, price pressures and (briefly the idea of) windfall taxes… anyone would think it was Christmas, or January! All this before UBS announced they would end the agreement with the Swiss National Bank, terminating the CHF 9bn guarantee along with the liquidity backstop of CHF 100 bn. Credit Suisse looking in better shape than some had purported perhaps. Either way this is good news to be celebrated (with caution). More on all of that later…

Mixed signals remain along with geopolitical tensions that, whilst not escalating dramatically, should not be forgotten. Certain themes long discussed here continue to bubble up to the surface. Signs of food prices rising once again with export halts of rice from India, prices rising 50% in recent months, and sitting at highs not seen in more than 15 years. Whilst the North American wheat harvest is shaping up well, grain around the Baltic remains a struggle. Then there is energy. Whilst stockpiles of oil have risen a touch in the US, prices are at 9 month highs and this during a summer where it seems pretty much everywhere else is having a very hot one. Supply continues to be artificially constrained. Unhelpfully, according to the IEA (International Energy Association) on Friday, global demand has actually reached a record high. Is it inflation being tamed that is transitory? We remain way off what would ordinarily be deemed acceptable already, but the blunt tool of hiking also seems less like a good option the higher we go. It’s how you break stuff.

The slowdown in China is taking hold, speculation mounting that further stimulus will be provided by The Party. Retail sales are tracking lower, with manufacturing also cooling. Unemployment is stable at a respectable 5.2%. GDP, though, is falling; with the growth rate dropping from 2.2% to 0.8% for June. There is potential reason to be envious, as consumer prices are now in negative territory, with CPI dropping 0.3% year on year. Does this represent good central bank policy, or a failure to launch following the strictest measures during the pandemic? It is starting to look like the latter.

An additional continued headwind remains the property market, which has seen multiple billionaires’ wealth fall through the roof, along with corresponding stock prices. Whilst this is of course very sad, it does not neatly resolve itself and has a tendency to infect first those similar, escalating, and leading to more widespread pain. The cutely named Country Garden (for some reason I have images of Sylvanian Families living there happily ever after), which probably actually builds on aforementioned plots, is the latest darling to fall from grace. Why is this relevant? It is the country’s largest developer, and has failed as yet to pay coupons on multiple bonds, now sitting squarely in the countdown to default bucket. This debt crisis, reemerging, is already sweeping through the country’s real estate sector. Pretty sure we learnt a while back that property prices can also go down, despite what the model says. Joe Biden has not been shy about his view at least, describing the overall picture as “a ticking time bomb”. How do you really feel Mr President?!

With higher rates, one might expect the corporate sector to be struggling with increased costs around new borrowing and servicing of existing debt. Perhaps it has been passed down the line. Whilst elsewhere Fitch has been less positive, when it comes to investment grade (IG) corporates, the picture is looking rosy. Recent earnings have come in good, as shown below with upgrades versus downgrades at a two-year high.

Credit though, is never that easy of course. The difference between the haves and have nots is still unfolding. Just a 0.10% move in the IG space, according to some analysts, could lead to a blowout for those in the sub-investment grade category seeing a widening of up to 1.00%. There may well be a reallocation of capital as yields are comparable to equities and without the associated volatility or downside protection as the R(ecession)-word rears its head once again.

The biggest recent shock to the Eurozone financial system was actually a rather brief affair. This, the latest Italian government announcing a “windfall” tax to the tune of EUR 2Bn to be raked in from domestic banks which had “profiteered” from higher rates, highlighted again the difficulty in implementing measures at the more extreme end, the government facing swift and strong opposition to the policy, which was then quickly reversed. It does highlight the danger of politicization of the sector and does not go unnoticed by shareholders in financials far and wide. Data dependency continues to be the theme, much like in other jurisdictions we follow more closely. For now, one should also pay attention to the slowing of the economic powerhouse that is Germany. Having slipped into (a technical) recession earlier this year, high inflation and weaker manufacturing have proven to also be resilient.

It was hotly contested, and could have gone either way. No, not Brexit, where I think we are all still waiting for buses with money. Maybe we’ll get three all at once! Rather, whether we would see 0.25% or 0.50% from the BoE. With inflation remaining at almost quadruple the 2% target, at 7.9%, majority rule took hold of a split MPC with the outcome being on the softer side. A sigh of relief for mortgage holders for now. With the other (sadly not in-) visible hand, continued pressure is being put on banks to up their deposit rates, with review and decisions coming down the pipes, financial institutions being coerced to decrease their spreads. Starting to feel like a theme. The good news of course is that we have a safer financial system, but, as we have seen, assumptions around solvency can be disproved even sadly with some of what have been the best in the business historically.

On a positive note, GDP for the UK has come in well above expectations, which will likely fuel speculation (although likely muted) that rates may have further to go as the economy is for now proving to be more resilient than one may have thought on pretty much every measure. The full breakdown of data released 11/08 below:

Source: Bloomberg LLP

Mapped in the below graph, looking back to pre-pandemic levels, how this “outperformance” glows. If I wore glasses I’d be reaching for them now. It’s been quite a ride to be fair.

Whilst the most recent hike was expected, the downgrade of the US was less so. Thanks Fitch! Much has been said about the timing and logic of said downgrade from AAA to AA+, most of it critical, some of it constructive. I have to agree with its logic; not a popular place to be. Thankfully this is not an exercise in just making friends. Of particular note, to Fitch at least, was around governance. The shenanigans of getting the debt ceiling lifted, along with last minute timing, did not aid its cause. To me, the notional amount outstanding now at $32.7bn (usdebtclock.org) is a (crazy) big number. The National Bureau of Statistics can be forgiven for being off as they seem to update their graph annually. Add another $2T to the below and you’ll be about right as of todays’ date.

Another and more important, to me at least, way to think about this is what it means for servicing and repayment, and the proportion of GDP that it represents. Drag on economies can come from many areas, this one is certainly gaining significant momentum. Eagerly awaiting will be the Fed minutes for direction on rate and policy, due on Wednesday.

On that happy note, wishing you all a lovely summer, hoping you are reading this from afar or not at all as you are enjoying a well-deserved break. Until September…