Beaufort Analysis No. 307 – Between Scylla & Charybdis
Market volatility continued over the course of the last week leaving the MSCI USA Equity index down -3.0% in USD terms for the month to date, while the MSCI All Country Global Equity index is down -1.6% in local currency terms. By Tuesday of last week, the “FAANGs” group of tech stocks, Facebook, Apple, Amazon, Netflix and Google, had lost more than $1trn of their market value since their highs of this year.
In other asset classes, credit spreads have widened as investors’ fears about the level of corporate indebtedness mount. High yield bond spreads are now at their widest for two years, while the prices of leveraged loans are at their lowest since 2016.
10 Year US Treasuries yields entered the Thanksgiving weekend at eight-week lows, giving up 1.6 basis points on Friday to touch 3.04%. Bank of America Merrill Lynch’s rates team is now forecasting an inverted yield curve next year, while their credit team forecasts widening credit spreads.
In the UK, the withdrawal and future relationship agreement negotiated by Theresa May was ratified by the leaders of the European Union at the weekend, after some opportunistic posturing by Spain over Gibraltar. The Prime Minister now faces the Homeric task of steering the agreement through the House of Commons, beset by threats on both sides.
With the Brexit standoff ongoing, budget frictions between the Italian government and EU Commission and lack of progress in resolving the US-China trade dispute, investors are now considering the possibility that the Federal Reserve might slow its planned path of interest rate increases, the so-called “Fed Pause”. A widely followed measure of financial conditions, the Goldman Sachs Financial Conditions Index, has risen to its highest level since early 2017 denoting tightening monetary conditions. One of the Fed’s primary reasons for raising rates is so that it can lower them again to stimulate the economy should there be another significant economic slowdown; this is particularly important given the high level of government debt and the constraints that places on fiscal stimulus.
Against this backdrop, oil prices have slid precipitously. On Friday, the price of Brent crude dropped 6% to below $60 per barrel. Low energy prices are a key policy goal of President Trump, and he has been putting pressure on his Saudi Arabian counterpart to achieve this. This drove quick declines in the equity value of the major oil-producing companies and will have contributed to widening credit spreads on the debt of shale producers in the US mid-west. As in so many other circumstances (eg the tariff war), President Trump has to walk the tightrope between something that is beneficial for his support base (higher energy prices for shale and coal producers) and what is beneficial for the wider US economy (lower energy prices as an input cost).