Weekly Market Update: Worrying signs for German manufacturing

Mon 23 Sep 2019

In a sluggish week for equities, equities fell in both local and Sterling terms. US, Emerging Markets and European stocks each fell -0.6% in Sterling terms, however European stocks were up marginally +0.1% in local terms. Japanese stocks rose slightly, by +0.5% in Sterling terms, while UK stocks fell -0.3%. Over the week Sterling fell -0.2% versus the Dollar but gained +0.3% against the Euro. Sterling began the week strongly on the back of a seemingly improving outlook for Brexit, before market sentiment weakened on Friday. UK 10Y Gilts yields fell from 0.76% to 0.63% following a sharp rise in yields in the previous week. US 10Y Treasury yields also fell by 17.4bps to close the week at 1.72%. Globally, the best performing sectors were energy, utilities and healthcare. In commodities, Gold rose +1.8% in US Dollar terms and Oil rose +5.8%, to $58.4 a barrel.

Investors were rattled last week as the overnight repo market in the US spiked unexpectedly, forcing the Fed to inject $75bn of liquidity each day until mid-October. Why is this technicality important? This market allows banks to borrow over the short term to cover their liabilities. Last time it froze, it meant that banks had stopped trusting each other, triggering the 2008 crisis. This time around, though, it’s not so dramatic. 11 years ago it was lack of supply that was the problem. Now, it was excess demand, fuelled by a major US Treasury bond issuance and a mid-September deadline for corporate tax payments. The central bank, whose job description is “lender of the last resort”, stepped in and did exactly what it’s supposed to do. So, apart from some analyses about the impact of higher deficits, there’s literally “nothing to see here”. The reactions, however, to this event are important. The market often works like Pavlov’s dogs. Triggers of something that happened in the past inform the future, whether relevant or not. The mere coverage this event got suggests how markets are still afraid that 2008 will repeat itself, despite the much better capitalisation of banks and the central banks’ proven ability to intervene in time – throwing a lot of money at the problem. However, history teaches us that crises don’t come from the same place twice in a row, simply because we are more ready for them the second time around. Instead, investors should be focusing on a different part of the question:  will our – almost religious – belief in the central banks’ willingness and ability to solve any problem by throwing money at it ever erode? The US president’s attacks on the Federal Reserve, the world’s de facto central bank, don’t help. Neither does politicising the ECB or expecting a more “patriotic stance” from the BoE. Historical evidence suggests that independent central banks can effectively fight off crises. Conversely, central banks subordinate to the executive may not only cause an erosion of faith in the system, but can also be used as arms in a currency war, an insidious form of trade war. So the lesson from last week is that strong central banks calm traders quickly, preventing a liquidity crunch from becoming a crisis of faith. Investors should be weary of any signs that balance might be changing.