Chicago Fed chief projects three rate hikes before end of 2017
Fed needs to be more clear about terms of moves, he says
When the Federal Reserve next raises interest rates it should be more explicit about how policy makers will respond to new information about the economy going forward, said Federal Reserve Bank of Chicago President Charles Evans.
“I think the most important part of our communications is really around not when is the next increase, but what are the terms of the subsequent increases going to be,” Evans said Monday while answering questions from reporters after a speech in Chicago.
The U.S. central bank’s policy setting Federal Open Market Committee, on which Evans will hold a vote next year, is gearing up for a second interest-rate increase after a hike in December that marked the first in nearly a decade. Investors see better-than-even odds of a hike before the end of the year, according to pricing in federal funds futures contracts.
Evans said if the economy continues to grow in line with his forecast, it may be appropriate to raise rates three times by the end of 2017, but revamping communications with the public would allow for a more flexible approach in case those forecasts don’t pan out, especially given the downside risks he sees clouding the outlook for inflation.
“With that type of messaging, we might be well served by not so many increases,” Evans said. “It would depend on whether or not we are making that kind of progress.”
His estimate for the appropriate pace of rate increases through next year puts him in line with the median quarterly estimate submitted in September by the 17 officials of the FOMC, displayed in a so-called dot plot.
The Chicago Fed chief was upbeat about the prospects for continued hiring, adding that he saw more room for the U.S. jobs market to run than some of his colleagues on the FOMC. Over the next few years, the unemployment rate could fall as low as 4.5 percent without triggering undue inflation, he said.
“The unemployment rate right now is 5 percent, so there is still some slack measured that way,” he said. “I think that there is room for the economy to continue to grow before we see inflation really pick up.”
Posted in Uncategorized | Comments Off on Avoiding a Communications Breakdown
By Robert Elson
(Bloomberg) — Expected to price today:
* Commonwealth Bank of Australia (CBAAU) Aa2/AA-, to price
$benchmark 144a/Reg-S 2-part deal, via managers CBA/HSBC/JPM
* 3Y, IPT +90-95
* 3Y FRN, IPT equiv
* Goldman Sachs Group (GS) A3/BBB+, to price $benchmark
11/NC10 FRN; IPT 3ML +180 area
LATEST UPDATES:
* Lukoil International Finance (LUKOIL) Ba1/BBB-, mandates
C/JPM for $benchmark 144a/Reg-S deal; 10-15 year maturities
will be considered for launch, price Oct. 26
* AT&T (T) Baa1/BBB+ to buy Time Warner (TWX) Baa2/BBB for
$85b in cash, stock deal; cash portion will be financed with
new debt, cash on hand
* $40b bridge loan in place
* T may be cut by Moody’s; any potential downgrade would
be limited to one notch
* European Stability Mechanism (ESM) Aa1/na/AAA, mandates
Barc/C/DB/JPM to advise on its USD issuance program
* First ESM USD transaction scheduled for 2H 2017, subject
to market conditions
* Danone (BNFP) Baa1/BBB+, mandates BNP/JPM for investor
meetings Oct. 21-25 for multi-tranche, multi-currency deal
* Announces 5-Part Euro Bond Sale, Expected Size EU5b
* USD 144a/Reg-S 3-10 years, via BNP/Barc/C/HSBC/JPM
* Danone (BNFP) Baa1/BBB+; ~$12.1b WhiteWave (WWAV) Ba2/BB
* Co. Says deal 100% debt-financed, expects to keep IG
profile (July 7)
* Trinidad Generation (TGU) na/BBB/BBB-, mandates CS/RBC/Sco
for investor meetings Oct. 19-26; 144a/Reg-S deal expected
to follow
* ConAgra (CAG) Baa2/BBB-, could borrow up to $2.5b for
acquisitions
* EQUATE Petrochemical Baa2/BBB+, mandates C/HSBC/JPM/NBK for
investor meetings Oct. 20-26; debut 144a/Reg-S 5Y, 10Y deal
may follow
* Province of Nova Scotia (NS Gov) Aa2/A+ , filed Friday a
$1.25b debt shelf; last issued in USD in 2010, has $500m
maturing January
* Korea Hydro & Nuclear Power (KOHNPW) Aa2/AA, mandates BNP/C
for investor meetings Oct. 18-20
* International Finance Corp (IFC) Aaa/AAA, to market 5Y
inaugural Forest Bond, via BNP/BAML/JPM; at least $75m may
price week of Oct. 24
* Hyundai Capital Services (HYUCAP) Baa1/A-, to hold investor
meetings from Oct.17, via C/HSBC/Nom
* Sirius International Group (SIRINT) na/BBB/BBB-, has
mandated AMTD/BoC/C/JPM/WFS for 144a/Reg-S USD bond; last
issued in 2007
* Honeywell (HON) A2/A,announced a possible 4Q debt
refinancing in its guidance release Oct. 6
* May consider refinancing 2018, 2021 bonds, BI says
* Darden Restaurants (DRI) Baa3/BBB, filed debt shelf, last
seen in 2012
* Darden announced a new $500m share buyback program in
its 1Q earnings release
* Yes Bank (YESIN) Baa3/na, plans to raise $500m by year’s end
* Republic of Namibia (REPNAM) Baa3/BBB-, to hold non-deal
investor meetings Oct. 7-13, via Barc/JPM/StanBk
* Asciano (AIOAU) Baa3/BBB-, names ANZ/BNP/Miz for investor
meetings Oct. 10-28; it is a non-deal roadshow; last priced
a USD deal in 2011
* Western Union (WU) Baa2/BBB, filed debt shelf; last issued
Nov. 2013 following Oct. 2013 filing
* Nafin (NAFIN) A3/BBB+; mandates BofAML, HSBC for investor
meetings Sept. 27-28; USD-denominated deal may follow
* Analog Devices (ADI) A3/BBB; ~$13.1b Linear Technology acq
* $5b loan received after $11.6b bridge (Sept. 26)
MANDATES/MEETINGS
* HollyFrontier (HFC) Baa3/BBB-; investor calls Sept. 15-16
* Banco Inbursa (BINBUR) –/BBB+/BBB+; mtgs Sept. 7-12
* Woolworths (WOWAU) Baa2/BBB; investor call Sept. 7
* Sydney Airport (SYDAU) Baa2/BBB; investor calls Sept. 6-7
* Industrial Bank of Korea (INDKOR) Aa2/AA-; mtgs from Aug. 22
* Sumitomo Life (SUMILF) A3/BBB+; investor mtg July 19
* GE (GE) A1/AA-; Ratings cut by S&P on assumption of
increased debt for next couple of yrs on possible
acquisitions (Sept. 23)
* Israel Electric (ISRELE) Baa2/BBB-; said to hire C, JPM for
at least $500m bond sale in 4Q (Aug. 8)
* Visa (V) A1/A+; CFO says will issue $2b debt for buybacks by
yr end (July 21)
Posted in Uncategorized | Comments Off on Credit Pipeline
IG CREDIT: Volume Improves; Most Active Issues See Mixed Flows
2016-10-25 09:58:51.526 GMT
By Robert Elson
(Bloomberg) — Secondary IG trading ended with a Trace
count of $14b vs $12b Friday, $13.9b last Monday. 10-DMA $15.3b;
10-Monday moving avg $13b.
* 144a trading added $1.8b of IG volume vs $1.6b Friday, $2b
last Monday
* Trace most active issues:
* AMZN 4.95% 2044 was 1st with client flows accounting for
100% of volume; selling twice buying
* T 4.125% 2026 was next with client flows at 81% of
volume; buying 3x selling
* JPM 2.95% 2026 was 3rd with client and affiliate trades
taking 100% of volume
* CS 6.50% 2023 was the most active 144a issue with mixed
client, affiliate and dealer-to-dealer volume
* Bloomberg Barclays US IG Corporate Bond Index OAS unchanged
at 130
* 2016 wide/tight: 215 (a new wide since Jan. 2012)/129
* 2015 wide/tight: 171/122
* 2014 wide/tight: 137/97
* All time wide/tight back to 1989: 555 (Dec. 2008)/54
(March 1997)
* BofAML IG Master Index at +135, unchanged at its tightest
spread of 2016; 2015 tight was +129
* Current markets vs early Monday, Friday levels:
* 2Y 0.844% vs 0.828% vs 0.827%
* 10Y 1.768% vs 1.724% vs 1.747%
* Dow futures +22 vs +77 vs -58
* Oil $50.86 vs $50.86 vs $50.70
* ¥en 104.46 vs 103.91 vs 103.81
* U.S. IG BONDWRAP: Week Starts With Highest Volume in 5 Weeks
* October total now $115.755b; YTD $1.45t
Posted in Uncategorized | Comments Off on Some Corporate Bond Stuff
The driving force is the rising US rates and increased expectations that the Fed will hike rates in December
The German IFO business climate is at its highest level in 2.5 years
The Richmond Fed index, S&P CoreLogic (formerly CaseShiller) house prices, and the Conference Board’s consumer confidence will be reported
Brazil’s central bank releases minutes of its last meeting; Hungary’s central bank meets and is expected to keep policy steady
The dollar is mixed against the majors in narrow ranges. The Antipodeans are outperforming while the yen and the Loonie are underperforming. EM currencies are mostly firmer. ZAR, MYR, and RON are outperforming while KRW, TRY, and CNY are underperforming. MSCI Asia Pacific was up 0.4%, as the Nikkei rose 0.8%. MSCI EM is up 0.1%, with Chinese markets flat. Euro Stoxx 600 is up 0.2% near midday, while S&P futures are pointing to a lower open. The 10-year UST yield is flat at 1.77%. Commodity prices are mostly higher, with WTI oil up 0.5%, copper up nearly 2%, and gold up 0.4%.
The US dollar has been confined to extremely narrow ranges against the euro, yen, and sterling. To the extent that there is much action in the foreign exchange market, it is with the dollar-bloc and emerging market currencies.
The Canadian dollar was whipsawed by comments from the Bank of Canada. A reference to waiting for 18-months initially sent the US dollar from near CAD1.3380 to CAD1.3280. As Governor Poloz clarified in his remarks, linking the reference to closing the output gap rather than monetary policy per se. The dollar recovered to CAD1.3360 before consolidating.
Higher metal prices, including a 6% rally in iron ore, a record high in coking coal, and a five-year zinc may have provided the latest excuse to buy the Australian dollar. It is the strongest of the majors today, gaining around 0.4% against the greenback. It has traded on both sides of yesterday’s range but is likely to hold below the key $0.7700 cap that has marked the upper end of the range over the last several months, ahead of the Q3 CPI to be reported in early Sydney on Wednesday.
The higher metal prices are also helping lift the South African rand. It is the strongest of the emerging market currencies today, gaining 0.65% against the US dollar. On the other hand, the South Korean won is the only emerging market currency outside of the Chinese yuan that has slipped against the US dollar today. The 0.2% decline in the won comes despite a preliminary Q3 GDP that was a little better than expected. The 0.7% quarter-over-quarter growth was a little better than expected, though off from the 0.8% expansion in Q2. The year-over-year pace was 2.7%, again slightly better than expected, but off the 3.3% pace since in Q2. Net exports were a drag.
Perhaps the weakness of the yen has acted as a drag on the Korean won. The yen is the weakest of the majors after the Canadian dollar. The US dollar is knocking against the highs from earlier this month near JPY104.65. That is the highest level since late-July. Since the early in the Asian session, the dollar has been in a JPY104.35-JPY104.45 range for the most part.
The driving force is the rising US rates and increased expectations that the Fed will hike rates in December. The CME and Bloomberg calculations put the odds of a hike before the end of the year around 68-70%. The odds are roughly double what they were a year ago at this time.
The US-Japanese 10-year spread is near 184 bp, the upper end of where it has been since the UK referendum. The US 2-year premium over Japan is near 110 bp, which is also among its best levels since Q2.
The driver is the same for the euro, with an additional twist. The market is more confident that the ECB will extend its asset purchases in December than it is about additional measures by the BOJ this year. The US-2-year premium over Germany is near its best levels since the financial crisis, and the 10-year premium is near the largest since Q1.
Yesterday’s stronger than expected flash eurozone PMI was unable to do more than steady the euro in its seven-month trough. Today’s recovery in the German IFO survey barely elicited a reaction from the single currency. It has been confined to less than a third of a cent within yesterday’s ranges. Some buying has emerged in the $1.0870 area for three sessions now. However, lower highs are being recorded, and the euro has been unable to resurface above $1.09 since the European session last Friday.
The IFO business climate (current assessment and expectations) improved more than expected (110.5 vs. 109.5 in Sept) and is at its highest level in 2.5 years. The Bundesbank warned that the slowdown in Q3 was temporary. The recent data lends support to this optimism.
The US economy also appears to have begun Q4 on a positive note, but the NY Fed GDPtracker warns of another quarter of sub-2% growth. Yesterday’s flash Markit manufacturing PMI rose to its highest level in a year. The October Empire State manufacturing survey did disappoint, but the Philadelphia survey was better than expected. Today, the Richmond Fed reports alongside the S&P CoreLogic (formerly CaseShiller) and the Conference Board’s measure of consumer confidence. The September reading was at new highs since the crisis, and a small pullback would not be surprising. Lastly, Atlanta Fed’s Lockhart appears to be the last Fed speaker ahead of the blackout around next week’s FOMC meeting.
Brazil’s central bank releases minutes of its last meeting, when it started the easing cycle with a 25 bp cut to 14%. The move was seen as cautious, and so the minutes will be scoured for clues to future moves. The next COPOM meeting is November 30, and markets are split now between 25 and 50 bp cuts. Brazil also reports September current account and FDI data.
Hungary’s central bank meets and is expected to keep policy steady. Deflation has ended for now, but the bank may tweak its unconventional policies in the coming months if the economy slows.
MINNEAPOLIS (AP) — Pop idol Bobby Vee, the boyish, grinning 1960s singer whose career was born when he took a Midwestern stage as a teenager to fill in after the 1959 plane crash that killed rock ‘n’ roll stars Buddy Holly, Ritchie Valens and J.P. “The Big Bopper” Richardson, has died. He was 73.
Vee, whose hits included the chart-topping “Take Good Care of My Baby” and who helped a young Bob Dylan get his start, died Monday of advanced Alzheimer’s disease, said his son, Jeff Velline. Vee was diagnosed with Alzheimer’s disease in 2011, and performed his last show that year.
Vee had been in memory care at The Wellstead of Rogers & Diamondcrest in Rogers, about 25 miles northwest of Minneapolis, for the past 13 months and in hospice care in recent weeks, his son said.
Vee died peacefully surrounded by family, Velline said, calling it “the end of a long hard road.”
He said his father was “a person who brought joy all over the world. That was his job.”
Born Robert Velline in Fargo, North Dakota, Vee was only 15 when he took the stage in Moorhead, Minnesota, after the Feb. 3, 1959, plane crash in Iowa that killed Holly, Valens and Richardson on their way to the concert. That dark day in rock history was commemorated by singer-songwriter Don McLean in his 1972 pop song “American Pie” as “The Day The Music Died.”
The call went out for local acts to replace Holly at his scheduled show at the Moorhead National Guard Armory. Vee and his 2-week-old band volunteered, along with three or four other bands. The show’s emcee, Charlie Boone, then a disc jockey at KFGO Radio, turned to Vee and asked him the name of his band. Vee looked at the shadows of his bandmates on the floor and answered: The Shadows.
“I didn’t have any fear right then,” Vee recalled in a 1999 interview with The Associated Press. “The fear didn’t hit me until the spotlight came on, and then I was just shattered by it. I didn’t think that I’d be able to sing. If I opened my mouth, I wasn’t sure anything would come out.”
Vee called his debut a milestone in his life, and “the start of a wonderful career.”
Within months the young singer and The Shadows, which included his older brother Bill on lead guitar, recorded Vee’s “Suzie Baby” for Soma Records in Minneapolis. It was a regional hit, and Vee soon signed with Liberty Records.
He went on to record 38 Top 100 hits from 1959 to 1970, hitting the top of the charts in 1961 with the Carole King-Gerry Goffin song “Take Good Care of My Baby,” and reaching No. 2 with the follow-up, “Run to Him.” Other Vee hits include “Rubber Ball,” ”The Night Has A Thousand Eyes,” ”Devil or Angel,” ”Come Back When You Grow Up,” ”Please Don’t Ask About Barbara” and “Punish Her.”
Besides his clear, ringing voice, Vee also was a skilled rhythm guitarist and occasional songwriter. He racked up six gold singles, but saw his hits diminish with the British Invasion of The Beatles and other English groups in the mid-1960s.
Vee kept recording into the 2000s, and maintained a steady touring schedule. But he began having trouble remembering lyrics during performances, and he was diagnosed with Alzheimer’s disease in 2011. He performed his last show that year, billed only as his retirement, during an annual community fundraiser that his family holds near their home in St. Joseph, Minnesota, about 65 miles northwest of Minneapolis. But he didn’t announce his diagnosis until a year later on his website.
In a 2013 interview with The Associated Press, Vee said he knew his abilities were diminishing and he didn’t want to put his family through a public decline.
“It’s not getting any better, I can tell you that,” Vee said. “But I’m doing the best I can.”
Vee still released a new album, “The Adobe Sessions,” a loose jam session recorded with family members in Vee’s adobe garage north of Tucson, Arizona. The 2014 album featured some of Vee’s favorite songs from Townes Van Zandt, Gordon Lightfoot and Ricky Nelson. It was released on the 55th anniversary of the Holly plane crash.
The album also included Vee’s cover of Bob Dylan’s “The Man in Me,” a nod to the folk-rock legend who got his start in Vee’s band in Fargo.
Dylan grew up in Hibbing, a town on northern Minnesota’s Iron Range, and briefly played with Vee’s band. Although their time playing together was short, Dylan had a lasting effect on Vee’s career: It was Dylan, himself going by the name Elston Gunn when he hammered on the piano at a couple of The Shadows’ gigs, who suggested Vee change his last name from Velline to Vee.
In his “Chronicles: Volume One” memoir, Dylan recalled that Vee “had a metallic, edgy tone to his voice and it was as musical as a silver bell.” When Dylan performed in St. Paul in 2013, he saluted Vee in the audience and performed “Suzie Baby.”
Vee and his wife, Karen, were married for more than 50 years. She died of kidney failure in 2015 at age 71. The couple had four children, including sons who performed with Vee.
Family members said Vee’s memory wasn’t affected so much by Alzheimer’s as his speech. During the AP interview in 2013, he answered questions but would become tongue-tied searching for the right word. Vee tried unconventional methods to alleviate his Alzheimer’s symptoms, from chiropractor visits to acupuncture, and also renewed his passion for painting.
And while he sometimes wished he could do the things that once came easily, Vee said he was “not going to cry about it.”
“God brought me home,” he said. “And that’s the deal.”
Posted in Uncategorized | Comments Off on Aging Baby Boomer Alert
Her plans, little discussed, would ripple across the economy
Election has become referendum on Republican Donald Trump
Hillary Clinton’s brightening White House prospects have cleared a path for her to pursue a $275 billion infrastructure plan that would be paid for by corporate tax-law changes, a central part of a broad agenda that has been overshadowed by her attacks on Republican rival Donald Trump.
The rising likelihood of a Clinton presidency also augurs new influence for liberals in financial regulation, a strong push to expand workplace policies including paid medical and family leave, and efforts to fix Obamacare. The proposals if enacted would ripple across the economy, affecting companies including Apple Inc., Google Inc. and Microsoft Corp.
Yet her plans have received little attention in a 2016 race that’s largely been a referendum on Trump’s qualifications, particularly after allegations that the billionaire businessman made unwanted sexual advances toward women. Polls indicate the outcome is in little doubt: The election prognostication website FiveThirtyEight on Monday assessed an 86 percent chance of a Clinton victory.
Clinton says on her website that in her first 100 days as president she’ll seek approval of the “biggest investment in American infrastructure in decades,” creating tens of thousands of jobs. Gene Sperling, a Clinton economic adviser, said that a $275 billion infrastructure plan would be among her top three domestic priorities at a forum this month sponsored by the National Association for Business Economics.
President Barack Obama proposed an infrastructure plan, financed by a one-time tax on the profits of U.S. multinational corporations repatriated from overseas, that failed because congressional Republicans insisted on a U.S. corporate tax overhaul. While House Speaker Paul Ryan still seeks a broader tax deal, Republicans might be more willing to consider a piecemeal approach after a bruising Election Day loss.
Many of the policy shifts Clinton will attempt as president depend on the results of congressional elections, fights within both parties, and Clinton’s ability to influence lawmakers. But the parameters of the looming legislative battles are clear.
Tax Bonanza
Should Republicans retain control of at least one chamber of Congress, the infrastructure bill is a likelier win for the new president than the other two priorities Sperling said lead Clinton’s agenda: a comprehensive immigration overhaul and changes to strengthen the Affordable Care Act. Sperling and other Democrats say Republicans may be willing to make deals on those issues as well — if they lose badly at the polls.
Clinton has said she would finance infrastructure spending through unspecified “business tax reform.” Incoming Senate Democratic Leader Chuck Schumer of New York said on CNBC Oct. 18 that the money would come from a lower tax rate on profits stashed overseas by U.S. corporations. Other Democrats close to the Clinton camp said they anticipate she would adopt the Schumer approach.
The lower tax rate would produce a one-time bonanza as companies brought home an estimated $2.5 trillion stockpiled abroad. Obama proposed an infrastructure plan financed by a one-time 14 percent tax rate on overseas profits returned to the U.S. instead of the current 35 percent maximum rate. Congressional Republicans previously proposed an 8.75 percent rate on repatriated cash.
Goldman Sachs Group Inc. said in a recent report that Obama’s plan would have yielded at least $240 billion for the government to spend.
Liberal Friction
Liberals in Clinton’s party would likely chafe at tax cuts solely benefiting multinational corporations, probably requiring the deal be sweetened for low- and middle-income families, a Democrat close to the Clinton camp said. The person asked not to be identified to candidly discuss Clinton’s likely legislative strategy.
Clinton has proposed an expanded child-tax credit, a tax credit for low-income workers without children, and paid family and medical leave for up 12 weeks.
Republican congressional leaders, particularly Senate Republican leader Mitch McConnell of Kentucky, have said that broader business tax cuts should be included in a repatriation of overseas profits. Ryan and his party have pushed for a more comprehensive overhaul of the U.S. tax code that would include the largest cut in corporate tax rates in history.
Should Republicans hold the House of Representatives, a deal with Clinton on an infrastructure bill is unlikely, one Republican leadership aide said. In the last year, Obama has signed laws authorizing new spending for highways and airports, and a bill for water projects is expected to become law after the election, reducing the appetite for a large infrastructure plan, the person said. The aide asked not be identified handicapping a debate that hasn’t yet happened.
Clinton is also likely to encounter pressure in her own party as she chooses people for key jobs in agencies regulating banks and Wall Street firms. Liberal allies, led by Senator Elizabeth Warren of Massachusetts, are pushing for a more activist stance by regulators, which could include tougher rules on executive compensation, more disclosure of corporate political contributions and stricter rules on bank capital and liquidity.
Immigration Overhaul
Hispanic advocacy groups that supported Clinton’s campaign — and registered large numbers of Latino voters — are pressuring her to revise U.S. immigration law and create a path to citizenship for undocumented workers. Many Republicans, including Trump, have derided such a policy as amnesty, and his campaign is centered on a plan to seal off the southern border with Mexico and deport undocumented immigrants.
Work and family issues also are likely to be an early focus of a Clinton administration, reflecting the biography of a former working mother who would become the first female president. One sign of the issue’s political power during the campaign was Trump’s own proposal, contrary to Republican orthodoxy, to require paid maternity leave and enact larger tax benefits to offset child-care costs.
“I think she is going to put her paid family leave, her work-family balance agenda right up there in the first 100 days,” said Jared Bernstein, a senior fellow at the Center on Budget and Policy Priorities and a former Obama administration economic adviser. “She is so identified with that, it really makes sense for her to come right out of the gate with that.”
Clinton also must grapple with the Affordable Care Act’s problems: large insurers have pulled out of government-run marketplaces selling insurance, citing financial losses, and premiums are rising across the country as enrollment has lagged projections. While some congressional Republicans have suggested they would be willing to work with Clinton to change the law, their party has sought its repeal ever since Obamacare was signed in 2010.
Posted in Uncategorized | Comments Off on President Clinton’s First 100 Days
This is an excellent article from Bloomberg on the M and A binge and reviews by ratings agencies which are reminiscent of the lax standards applied prior to credit crisis.
AT&T’s bid to buy Time Warner just the latest mega-deal
Moody’s, S&P go beyond financial metrics on acquisitions
A decade after the triple-A failures of the subprime era, grade inflation is back on Wall Street.
This time, Moody’s Investors Service and S&P Global Ratings Inc. are cutting companies slack on mergers and acquisitions, an analysis of credit-ratings data by Bloomberg News found.
Over the past year and a half, both have bumped up their ratings by two, three or even six levels on a majority of the biggest deals, the analysis found.
Moody’s and S&P don’t dispute those findings, which are based on ratings guidelines posted on their websites. But the firms say a by-the-numbers approach overlooks one of their most valuable assets: human judgment. Both make clear that their analysts have leeway to nudge ratings up or down, based on a company’s track record and their confidence in management’s commitment to reduce indebtedness.
“We want our analysts and committees to get behind the story and make their judgments about what they think the organization will look like in the next couple of years,” says Mark Puccia, a chief credit officer at S&P.
Says Stephanie Leavitt, a spokeswoman for Moody’s: “The evaluation of financial metrics alone provides an incomplete view of credit risk to investors.”
AT&T-Time Warner
Some investors warn the approach has encouraged an epic debt binge that could pose dangers as years of near-zero interest rates come to an end. AT&T’s plan to borrow about $40 billion to buy Time Warner Inc., in addition to its $120 billion of debt already outstanding, is just the latest example. In 2015 alone, U.S. companies borrowed a record $1.6 trillion in the bond markets, with $258 billion of that going to finance acquisitions by investment-grade companies, Barclays Plc says. According to Morgan Stanley, corporate America is now more leveraged than ever.
“You have some very large companies that are getting the benefit of the doubt from ratings agencies and from the market,” says Jerry Cudzil, head of U.S. credit trading for TCW Group, which manages $197 billion in assets. “The longer this goes on, the higher the likelihood that all of that leads to not only financial losses but to a significant slowdown in the economy and ultimately a recession.”
Granted, not even die-hard pessimists say rosy ratings are about to unleash a full-blown crisis. But it was only a few years ago that Moody’s and S&P were criticized for having stamped gilt-edged grades on iffy mortgage investments. Last year, S&P was fined $1.5 billion, and Moody’s said last week that it faces a U.S. government lawsuit over grades given to securities backed by home loans. Now, by giving some corporations wiggle room to borrow for M&A, Moody’s and S&P have helped executives seal deals and borrow vast sums of money.
Post-crisis legislation required credit-rating companies to be more transparent about their ratings methodologies. Those methodologies are just a starting point, however. If ratings analysts are confident an acquirer will pay its debts, the argument goes, that confidence should be reflected in the grades. What’s more, investors expect ratings to reflect long-range views, not Wall Street’s latest whims, the firms say.
All of which may be fine for bond investors — unless companies start to struggle under the weight of this new mountain of debt. “When you start talking about the qualitative factors, you’re stepping into an area that’s by nature fuzzy,” says Scott McCleskey, a former Moody’s chief compliance officer who testified to Congress in 2009 against his former employer, saying Moody’s failed to properly monitor municipal-bond ratings. “You’re building assumptions on top of assumptions. It’s all scientific guessing.”
Human Judgment
How much does human judgment shade corporate ratings? One way to answer that question is to compare two credit scores — the grades corporate acquirers would have received based solely on financial metrics and the ones they actually got.
Bloomberg examined U.S. deals with values of at least $10 billion, excluding financial firms and utilities, that were announced in the 18 months ended June 30 and funded with debt.
Both Moody’s and S&P rated 32 such transactions. At Moody’s, 27 of the ratings were higher than the ones the firm typically assigns to companies with comparable debt loads. At S&P, 17 out of 32 of the acquiring companies got higher ratings.
In Moody’s case, no company received a rating that was lower than the metrics suggested. In other words, Moody’s bumped many ratings up, but none down.
S&P assigned lower ratings to four of the companies.
“Sometimes the ratings agencies give companies the benefit of the doubt that they can achieve the debt reduction that the company has articulated,” said Joel Levington, a former S&P director and now head of credit research for Bloomberg Intelligence.
Moody’s Formula
While neither Moody’s nor S&P took issue with those numbers, both emphasized they’re upfront about how their analysts exercise judgment.
Moody’s says its ratings reflect dozens of factors, ranging from a company’s size to its brand strength to its willingness to innovate, as well as familiar financial measures such as its leverage ratio. It makes plain that “forward-looking expectations” can influence ratings.
Moody’s analysts often assign ratings that differ from what its hard metrics might indicate, according to Mariarosa Verde, a senior credit officer. “The committee uses its own judgment,” she says.
Repay Debt
S&P evaluates a company’s ability to repay debt, referred to as financial risk. It compares that with the company’s business risk, which factors in things like the company’s profitability and how competitive it is relative to peers. Where the two risk factors intersect on a matrix determines the rating, according to S&P’s website.
In its analysis of S&P, Bloomberg used the business-risk labels that S&P established and plotted it against S&P’s benchmark for financial risk. Bloomberg found that in more than half the deals, the companies had gotten ratings that didn’t line up with the matrix.
In looking at M&A, S&P says it encourages its analysts to take stock of management’s credibility, the reasons for doing a deal and the company’s record with acquisitions, as well as its plans for structuring and financing the combined companies. According to its website, S&P’s methodology allows for committees to assign ratings that are one level above or below what the guidelines suggest.
Stretched Further
With some recent M&A deals, however, the firms stretched further. Here are examples:
-Dell Inc.’s debt relative to earnings after the purchase of EMC Corp. warranted a rating as low as the Caa band, one of the lowest rungs of speculative grade, from Moody’s, the Bloomberg analysis found. Moody’s rated the company Ba1, six notches higher.
-Charter Communications Inc. received a BB+ grade from S&P after it announced its purchase of Time Warner Cable Inc. Using S&P’s estimate of the company’s future leverage levels, its view of the company’s business risk and taking into account Charter’s $60 billion of debt, the rating should’ve been BB-, two notches lower, according to Bloomberg’s analysis. In 2009, Charter went into bankruptcy under the weight of $21 billion in debt.
-Newell Brands Inc., maker of Rubbermaid, deserved a junk-grade between B and Ba from Moody’s after it agreed to buy Jarden Corp., based on a leverage ratio that was about double its peers with similar ratings, the analysis found. Moody’s gave it an investment-grade Baa3.
-Kraft Heinz Foods Inc.’s leverage ratio and S&P’s assessment of management justified a downgrade to as low as BB-, a junk rating, the analysis found. S&P gave it an investment grade of BBB-, three notches higher.
-In June, S&P blessed Microsoft Corp.’s $26 billion purchase of LinkedIn Corp. with its highest rating. It cited Microsoft’s “long history of making investment decisions in a fiscally prudent manner” — even though Microsoft had just written down nearly the full $9.5 billion value of its 2014 purchase of Nokia Corp.’s mobile-phone unit.
Ratings officials say that deals that hurt a company’s credit health don’t always result in downgrades if analysts believe the impact will be temporary.
“If you have a seasoned management team that’s done this before, it’s a different consideration than if you have new managers with no track record,” Verde of Moody’s says.
Taking Issue
In some instances, Wall Street analysts have taken issue with the ratings firms. For instance, not everyone thought Moody’s and S&P went far enough when they downgraded Teva Pharmaceuticals Industries Ltd. by one notch after the drug company agreed to buy Allergan Plc earlier this year for $40.5 billion.
“The rating agencies have gone easy on the company,” Carol Levenson, an analyst at GimmeCredit, wrote in a July report.
While drug companies like Teva typically generate enough cash to pay their debts, the ratings companies were taking a leap in concluding that Teva’s management would refrain from acquisitions in the future, she said.
“Where faith comes into the picture is believing that management will choose to use every penny of free cash flow to reduce debt,” Levenson wrote.
More Latitude
Most people agree that credit ratings are part art and part science. S&P analysts often give high-rated companies more latitude in deal-making than low-rated ones, since high-rated companies are supposed to be financially stronger to begin with, according to its methodology.
But back in 2008, when the last crisis struck, some companies that received investment grades from Moody’s defaulted more frequently than those at the high end of the junk-bond market. The same thing happened with S&P in 2009. The ratings companies, in other words, had underestimated the risks.
This time around, some bondholders have already lost money, at least on paper.
Like many on Wall Street, Moody’s misread Valeant Pharmaceuticals International Inc., which has seen rocky times following a series of debt-fueled takeovers. Moody’s maintained its ratings as the company’s debt ballooned, citing Valeant’s “successful acquisition track record.” Over the past year, investors who hold Valeant’s most actively traded bond have lost about 8 percent, according to data compiled by Bloomberg.
Likewise, Perrigo Co. received higher credit scores because S&P said it trusted management to reduce the generic drugmaker’s indebtedness, even after Chief Executive Officer Joseph Papa increased it with another acquisition. Last year, Perrigo bonds were the second-worst-performing of investment-grade health-care companies with dollar-denominated debt in the Bank of America Merrill Lynch U.S. Healthcare Index.
“There has to be judgment to give real value to ratings,” says Adam Zurofsky, a former senior adviser at S&P, who was speaking generally and not about any specific deals. “But that judgment has to be exercised responsibly.”
Says David Horsfall, deputy chief investment officer at Standish Mellon Asset Management Co. in Boston: “This all works until the market says, ‘No thank you, that’s too much debt.’
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Here’s a small fact from the presidential campaign front: The numbers crunchers at the Tax Foundation estimate that there is roughly a $6 trillion difference in the amount of federal revenue that would be generated over the next decade by the rival tax plans of Hillary Clinton and Donald Trump.
That’s trillion with a “T.” The difference is larger than the annual gross domestic product of Japan. It’s a big deal.
And you almost never hear it discussed. Which illustrates in a nutshell the real problem with this year’s campaign: It is almost devoid of serious policy debate. And that, in turn means it isn’t producing any clear mandate for those who must try to govern after it ends.
More Election 2016
A week ago, this column referred to the current presidential campaign as a “dumpster fire,” and no one dissented. But the consequences will become clear only when the calendar turns to 2017 and Washington tries to break out of the dysfunction that has made everybody so angry in 2016. It will do so with no clear consensus on an agenda.
The presidential campaign often seems to be conducted in some distant galaxy where the most important issues are Mr. Trump’s issues with women and the Clinton camp’s emails, not the issues facing average Americans.
At the same time, there is a good chance the congressional and presidential elections will produce different and conflicting ideological outcomes. The bitter splits that have torn the electorate apart this year figure to carry forward into the Congress, and thereby into the governing period ahead.
The problems start with the two presidential candidates, though they aren’t entirely to blame. To her credit, Mrs. Clinton has tried to craft a detailed and substantive policy agenda. Her campaign website contains more than 40 separate policy papers, many of them in existence for months. At a rally Monday, she ticked off policy priorities and called for bipartisan efforts to enact them.
Still, there are doubts about how deeply she embraces key parts of her agenda. She once seemed inclined to support the Trans Pacific Partnership and Keystone XL Pipeline, both of which she now opposes. She has a plan for paying for college tuitions that was enlarged by the primary-season rivalry with Sen. Bernie Sanders.
The issue with Mr. Trump’s policy agenda is that it has been sketchy at best, and not something he’s seemed particularly interested in pursuing. His campaign has been more about attitude than agenda.
On Saturday, Mr. Trump gave a serious speech explaining how his antiestablishment positions could tie together into a unified policy platform and a plan of action. The problem is that it took him until late October to deliver such a speech—and then he stepped all over that message by first promising that he would sue the women who have accused him of unwanted sexual advances as soon as the election is over.
What will be the policy agenda of a party that nominated a populist, Donald Trump, but will likely be led by a classic ideological conservative, Paul Ryan, who all but disavowed the party nominee?
The candidates can’t be blamed, though, for the fact that media coverage of this campaign has done little to elucidate or elevate policy discussions. The fixation with the Trump phenomenon has been so all-consuming that substance has been drowned out like protesters at a Trump rally. If you aren’t aware of all those Clinton policy papers—well, that’s not her fault.
Beyond the presidential contest, congressional races may produce an ideological muddle, and result in executive and legislative branches that think they have received conflicting signals from voters.
At this point, the election’s most likely outcome is a White House in Democratic hands, a House in Republican hands and a Senate so evenly divided between the two parties that nobody is really in charge. If you wanted to draw up a diagram for a gridlocked Washington, it would look like that.
It gets harder. Republicans who managed to save their Senate seats will have done so by running away from Mr. Trump. Even if he were to win, they owe him nothing.
More important, most Republican Senate candidates now are asking for votes by explicitly promising to be a “check” on Mrs. Clinton. If she wins they are likely to think the mandate they received was to stand in her way, not to work with her.
If there’s a silver lining, perhaps it’s that voters appear to be shifting back toward a willingness to split their ballots among candidates from different parties.
The share of voters who split their tickets—vote for one party for the presidency, another for the Senate—has dropped precipitously over the years, from 52% in 1988 to just 19% in 2012. In that way, voters were reinforcing Washington’s partisan divide. This year, however, polls suggest the trend will reverse, with millions voting Democratic for president and Republican for Senate.
Perhaps elected officials will read that as a message that they, too, should get beyond partisan divides. Perhaps.
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Federal Reserve officials, wary of raising short-term interest rates amid the uncertainty surrounding the U.S. presidential election, are likely to stand pat at their November policy meeting and remain focused on lifting them in December.
Their challenge will be deciding how strongly to signal their expectation of a move at their last scheduled meeting of the year, Dec. 13-14. Market expectations suggest officials may not need to fire strong new warning shots: Traders in futures markets already place a 74% probability on a Fed rate increase by then, according to CME Group.
That could leave their November policy statement little changed from September, when officials said the case for an increase in their benchmark federal-funds rate had strengthened, but they wanted to wait “for the time being” for more evidence of a strengthening economy.
Investors have long been skeptical about a move at the Fed’s meeting Nov. 1-2, just a week before Election Day, putting a 9% probability on an increase then.
Officials, in public remarks and recent interviews, have made clear they expect to raise rates before the end of the year. But with the jobless rate holding steady around 5% and inflation below their 2% target, they aren’t in a rush.
“There isn’t this tremendous urgency to act on monetary policy right now,” New York Fed President William Dudley told The Wall Street Journal in an interview Oct. 14. “It’s not like if we wait a meeting or don’t wait a meeting that it has huge consequences for the trajectory of the economy.”
Mr. Dudley said he expects the Fed will raise interest rates this year, “subject to the economy continuing to evolve in line with my expectation.”
Some regional Fed bank presidents are eager to move and growing impatient. Three of them—Boston Fed President Eric Rosengren, Cleveland Fed President Loretta Mester and Kansas City Fed President Esther George—voted against the committee’s decision in September to hold the fed-funds rate in a range between 0.25% and 0.5%. The dissenters wanted to raise it then by a quarter percentage point.
Nine of the Fed’s 12 regional banks wanted to raise the interest rate on short-term loans offered to banks through the Fed’s discount window ahead of the September meeting, a possible reflection of growing support for lifting the fed-funds rate.
Still, Mr. Rosengren suggested last week he would be comfortable leaving rates unchanged right before the election and waiting until the end of the year to move. “I don’t think elections and politics should play a significant role,” he said. “That being said, a delay of one meeting, in no econometric model does that make an economic difference.”
Although consensus is building for a rate increase soon, Fed Chairwoman Janet Yellen must contend with deepening divisions within the committee over whether—and for how long—the Fed should allow the economy to run hot by keeping interest rates low and spurring investment. That would mean allowing unemployment to fall further in hopes of drawing more sidelined workers back into the labor force.
In an Oct. 14 speech, Ms. Yellen effectively expressed sympathy for the idea of keeping rates low to let the economy gather steam and reverse some of the lingering effects of the downturn, including weak business investment and a low share of adults holding or actively seeking jobs.
She also noted that unlike the experience of past decades, the tighter labor market today doesn’t appear to be spurring inflation much. This suggests the Fed can let the employment conditions improve a bit more without risking a sharp rise in prices.
A hot economy would boost sales, which in turn would prompt managers to invest more in their businesses, she said. “In addition, a tight labor market might draw in potential workers who would otherwise sit on the sidelines.”
The counterargument from others, including Mr. Rosengren and San Francisco Fed President John Williams, is that letting unemployment fall too far could cause consumer prices to rise more than wanted, or financial markets to overheat, forcing the Fed to ratchet up rates quickly and triggering a recession.
At 5% in September, the jobless rate is already at or close to the level below which many economists expect inflation may start to accelerate. Waiting too long, some say, could shorten the length of the recovery.
“In arguing for a gradual increase in interest rates, I’m not trying to stall the economic expansion,” Mr. Williams said in an Oct. 21 speech, adding that the Fed should raise rates “sooner rather than later.” “Just the opposite: My aim is to keep it on sound footing so that it can be sustained for a long time.”
Employers have added an average of 178,000 jobs a month this year even as more workers have come back to the labor force, keeping the jobless rate steady near its current level for much 2016. But officials don’t expect that trend to continue for long. In September, they projected the rate will start to fall again next year and remain below 4.8%—their forecast of unemployment in the long run—through 2019.
Last year, Fed officials said in October it might be appropriate to raise rates at their “next meeting,” and then did so, lifting them in December. But in May this year, the minutes of their April meeting said they might raise rates in June, and they later decided not to do so. Now, officials are reluctant to specify a likely date for action.
There appears to be a high bar for not raising rates in December.
The economy has continued to strengthen since their last meeting. Claims for new unemployment insurance benefits remain low, job openings are near record highs, and the economy continued to generate solid job gains despite a low overall growth rate.
Consumer confidence rose last month to its highest level in nine years, and consumer spending remained on track. Business investment, while still modest, picked up in the second quarter.
Inflation readings also have ticked up, as the dollar has stabilized and oil prices moved slightly higher. The personal-consumption expenditures price index, the Fed’s preferred inflation gauge, showed prices excluding the volatile food and energy categories had risen 1.7% over the past 12 months in August. And some measures of inflation expectations have moved up slightly.
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Fitch surprised by cutting Italy’s credit outlook Friday to negative from stable
The eurozone flash PMI improved, which is consistent with the continued trend growth in the area
Canada walked out on the free-trade talks with the EU when a small part of Belgium succeeded in throwing a wrench into the works at the last minute
The UK reports its first estimate of Q3 GDP a day before the US does
The dollar is mixed against the majors in very narrow ranges. The Aussie is outperforming, while the yen and Swiss franc are underperforming. EM currencies are mostly firmer. ZAR, THB, and KRW are outperforming while THB, PHP, and CNY are underperforming. MSCI Asia Pacific was up 0.4%, as the Nikkei rose 0.3%. MSCI EM is up 0.7%, with Chinese markets up 1.2%. Euro Stoxx 600 is up 0.5% near midday, while S&P futures are pointing to a higher open. The 10-year UST yield is down 1 bp at 1.73%. Commodity prices are mixed, with WTO oil down 0.1%, copper up 0.2%, and gold flat.
There were two developments before the weekend that will likely spur a response in the week ahead.
First, while most were looking out for DBRS credit review of Portugal, Fitch surprised by cutting Italy’s credit outlook to negative from stable. At the heart of the decision was concern about the repeated delays and back loading of fiscal consolidation. The disappointing growth, the non-performing loan burden, and the political climate pose downside risks.
Italian bonds, which had been underperforming Spain bonds, had then begun holding their own. Last week, the benchmark 10-year bond yield fell 2.5% in Italy but rose slightly in Spain. The divergence was sufficient to change the month-over-month performances back into Italy’s favor (+18.5 bp vs. Spain’s +19.7 bp). Fitch noted that even if Renzi does not resign if the referendum fails, the government may be weaker. Parliamentary elections are scheduled for May 2018, and Euro-skeptic political forces are on the rise (5-Star Movement won Rome and Turin in elections earlier this year).
The surprise action by Fitch, coupled with EU demands that Renzi alters the draft budget, may weigh on Italian bonds. Italian bank shares rallied for three consecutive weeks, including a sharp 7.3% advance last week. They may also be vulnerable if yields continue to rise. Recall that DBRS put Italy on credit review with negative implications in August. DBRS is the only one of the top four rating agencies that puts Italy in the “A” band. A cut would increase the haircut the ECB imposes on Italian bonds used as collateral for loans. The underperformance of Italian bonds relative to Spanish bond may resume if Spain is able to avoid a new election before the end of the year.
Separately, we note that the average of the last 10 referendum polls in Italy with 1000 or more people surveyed was 35.3% supporting the change of the Senate and 41.5% opposed. Most recently, former (unelected) Prime Minister Monti came out last week siding with the No’s, as has a wing of Renzi’s own party and the leaders of all the opposition parties.
DBRS did not downgrade Portugal’s rating or cut the stable outlook. We had thought that at most, the only major rating agency to recognize Portugal as an investment grade credit could have changed the outlook to negative from stable. Investors had been anticipating that the DBRS would do little, if anything in recent weeks, and were encouraged by comments from the Finance Minister. The 10-year yield had fallen from 3.6% on October 7 to 3.14% last week. Below last week’s lows, and the yield can move back to 3.00%, where it had seemed to find an equilibrium in August and early-September.
The eurozone flash PMI improved, which is consistent with the continued trend growth in the area. The composite PMI rose to 53.7 from 52.6., which is the best of the 2016 and well above the consensus of 52.8. Germany’s rebounded smartly. The manufacturing PMI rose to 55.1 from 54.3, well above expectations and the strongest reading since Q1 14. The services PMI jumped to 54.1 from 50.9, the single biggest monthly rise in this three-year-old time series. The composite rose to 55.1 from 52.7, completely recovered from the August and September pullback. Separately, we note that the latest polls suggest Merkel’s support has improved, and the better economic performance will not hurt.
The flash French PMI was less inspiring. The good news is that manufacturing recovered above the 50 boom/bust level for the first time since February. It averaged 48.9 in Q3 and 48.2 in Q2. In October it stood at 51.3. The service PMI fell to 52.1 from 53.3. It is the lowest since July, and just above the Q3 average of 52.0. This pushed the composite to 52.2 from 52.7.
European bonds are rallying. Portugal’s 10-year yield is off 9 bp, after DBRS maintained its investment credit rating and outlook. The Spanish 10-year yield is 5 bp lower. A sufficient number of Socialists will abstain from the confidence vote, allowing Rajoy and the PP to head up a minority government and avoid going to the polls for the third time in a year. Fitch cut Italy’s outlook to negative before the weekend, but Italy’s 10-year bond yield is off 2.5 bp and the premium over Germany is a tad smaller.
The second development was that Canada walked out on the free-trade talks with the EU when a small part of Belgium succeeded in throwing a wrench into the works at the last minute. The agreement required the unanimous consent of all EU countries. Belgium could not commit without all five sub-federal governments and Wallonia objected. Its ultimate objection was over the establishment of new courts to resolve disputes. This is a controversial measure that is in the TPP and TTIP.
Wallonia’s objection is understandably frustrating for Canada. However, the walkout by the Canadian delegation, led by Trade Minister Freeland was melodramatic. She is inexperienced in an inexperienced government. The drama does not end the prospects for the deal and leaders are scrambling for a workaround.
Too much is being made of it. Even the optimists pointed to a 12 bln euro (~$13 bln) boost to the EU GDP and about CAD12 bln (~$9 bln) to the Canadian economy. It was all about symbols. For the Trudeau government, is would have been a tangible success. For the EU, a successful trade agreement would be the first with a G7 country, and show that despite its demise having been foretold, it was still forward and outward looking.
Many observers are viewing the breakdown in talks through the prism of Brexit. They blame the EU and think the failure bodes ill for its future and negotiations with the UK. This seems too seems exaggerated. First, if the deal can be successfully concluded, does it say anything about the difficulty of Brexit negotiations, whenever they begin? The failure of trade negotiations (remember Multilateral Agreement on Investment or the Free Trade Agreement for the Americas) is not the end of the world nor is it a telling sign of protectionism or incompetence.
The weight on the Canadian dollar (the weakest of the major currencies last week, falling nearly 1.5% to its lowest level since March) was largely homegrown. After upgrading the risk assessment to balanced, Bank of Canada Governor admitted that there was a discussion about easing policy. This surprised the market, and it was followed up with an unexpected contraction in August retail sales and a slightly softer CPI report.
The euro is also trading at seven-month lows. Our understanding emphasizes the role of the expected trajectory of monetary policy. Even though ECB President Draghi claimed that neither extending nor taper of the asset purchase program was discussed at the last two monthly meetings, there is a high expectation that the purchases are extended for another six months. We wonder too if sterling’s weakness has helped boost the euro on a trade-weighted basis, which is important for policymakers, needs to be neutralized by a weaker euro against the dollar.
At the same time, the pendulum of market expectations has swung toward expecting a December Fed rate hike. There is some variance of estimates due to assumptions, but the Fed funds futures imply a roughly 2/3 chance. Ironically, but importantly, the expectations have increased at the same time that Q3 GDP estimates have been cut.
The first estimate will be reported on October 28. The median Bloomberg estimate is 2.5%. The risk is on the downside. The Atlanta Fed’s GDPNow puts it at 2.0%, and the NY Fed’s tracker says 2.2%. The relevant comparison context here is not the average pace of growth in previous periods, but for the conduct of monetary. For the conduct of monetary policy, current growth and trajectory need to be assessed relative to trend growth. The Federal Reserve has been gradually cutting its estimate of trend growth. It now stands at 1.8%. Raising potential growth is not one of the masters that monetary policy can serve.
The UK reports its first estimate of Q3 GDP a day before the US. A marked slowing of the UK economy is believed to have taken place in the three months after the referendum. Most of the weakness seemed to be concentrated in July. The British economy is expected to have expanded by 0.3% in Q3 after 0.7% growth in Q2. The year-over-year pace will stay deceivingly stable at 2.1%. A substantial decline will likely be experienced this quarter as Q4 15’s 0.7% expansion drops out of the measure.
Expectations for a follow-up rate cut at the early-November MPC meeting have eased, but it has not done much for sterling. For the better part of two weeks, since the flash crash, sterling has been largely confined to a $1.21-$1.23 trading range. While the shift in Fed expectation may not have been particularly helpful for sterling, the prospect of a hard Brexit is the more potent force.
European officials, including Tusk, the President of the European Council, have made two things clear. There are no negotiations until the UK has standing, which means until Article 50 is invoked. Any Brexit will be a hard Brexit to the extent that it means that will not have unfettered access to the single market if it insists on limiting what Europeans call free movement, which is an exaggeration, especially for non-Schengen members.
It is fine and good that Prime Minister May can say Brexit means Brexit, but by allowing the inertia of the victorious Leave camp to dominate the negotiations, she must accept their narrative. The victory was by the slimmest of margins for such a momentous decision. She could have prioritized the preserving the UK standard of living and way of life.
The UK is still a member of the WTO, which keeps it integrated into the system of free-trade. But even with manufactured goods, for which the WTO is strongest, the UK is vulnerable. Japanese and German auto manufacturers are threatening to leave the UK. The UK will ultimately be poorer, and investors have already written down the value of all UK assets by 20% in dollar terms and more than 15% in yuan terms.
Japan started the week with the September trade balance and finishes the week with CPI. Japan reported a larger than expected September trade surplus. The balance almost always improves in September. The September trade surplus increased to JPY498.3 bln from a JPY18.7 bln deficit in August. Economists had expected exports to have deteriorated, but they improved. Exports were off 6.9% from a year ago. In August they were off 9.6%.
Exports to the US fell 8.7%. Exports to China, Japan’s biggest export market, fell 10.6%, while exports to the EU rose 0.7%. Imports fell 16.3% in September, after a 17.3% slide in August. Separately, Japan’s flash manufacturing PMI rose to 51.7 from 50.4, for the second consecutive month above 50. It had been below that threshold since February.
While price pressures appear to have bottomed in most high income countries, Japan is a notable exception. Headline and core inflation (excludes fresh food) may have remained stuck at minus 0.5% in September. Using a similar US definition of core, which excludes food and energy, Japan’s inflation likely slipped to 0.1%, down from 0.2% in August. It has been trending lower all year since reaching 0.9% last December.
Elsewhere, Australia also is continuing to wrestle with low inflation. Headline CPI has been trending lower and at 1.0% in Q2 was the lowest level since the late-1990s. It is expected to have stabilized at 1.1% in Q3. The central bank puts more emphasis on the trimmed mean and weighted median measures. The trimmed mean is expected to remain at the record low matched in H1 of 1.7%. The weighted median may tick up to 1.4% from 1.3% in H1, which is also a record low.
The subdued price pressures keep many expecting another rate cut next year. For the fourth month, the Australian dollar has been largely confined to a $0.7450-$0.7750 trading range. The poor employment report reinforced the upper end, while a subdued inflation report could see it head toward the lower end of the range.