BoE View: PMI improvement would probably prevent a January cut – Market expectations for a rate cut at the 30 January meeting surged today, with a 25bp move now more than 50% priced in, up from just 5% from last week. The move came after weekend comments from MPC member Gertjan Vlieghe suggested he supported a near-term cut unless there was ‘an imminent and significant improvement’ in data. He pointed to survey data due at the end of the month, likely referring to the flash PMIs due out on 24 January, as being key inputs to the decision. In favouring a near-term cut, he joins two others (Carney and Tenreyro) who have signalled a willingness to support easing, depending on how quickly confidence returns to the economy, as well as two MPC members who have already voted for a cut (Saunders and Haskell). While the balance on the MPC has clearly shifted to an easing bias, there are signs that confidence might be returning to the extent that it would indeed stave off a move. Most notably, business confidence as measured by the Deloitte survey of CFOs – which was conducted in the election aftermath between 13 December and 6 January – rose by the most in the survey’s 11-year history. While this measure of confidence tends to under- and overshoot moves in the PMIs, directionally they historically move in sync. This suggests a considerable improvement in the January flash PMIs, which would probably be enough for the MPC to hold fire at this stage, in our view (although it could be a close call). Further out, we continue to expect relatively muted growth in the UK in 2020, with uncertainty likely to weigh on business sentiment again later in the year as we approach the end of the Brexit transition period, and in the absence of significant progress towards a trade deal. See our UK Watch for more. (Bill Diviney)
EUR IG Corporate Credit: ECB keeps playing the popular tunes during the credit after-party – Today, we released our 2020 Outlook for EUR IG corporate credit. We note that company fundamentals are deteriorating quickly. For example, the median net debt to EBITDA on IG rated corporate constituents of the S&P 500 already stands close to 2 times. The likelihood of this coming down soon is slim given the more moderate outlook for corporate earnings. The economy is unlikely to post a V-shaped recovery, and in our base case the economy will only muddle through, as investment in capital stock remains restrained and spill-over effects from manufacturing start to feed into the services sector. Furthermore, the recent rise in corporate funding gaps (and hence higher leverage) can be attributed to a rise in shareholder distributions. There is a case for these distributions to rise and in our Outlook, we show that corporates have significant headroom in their ratings to do so. These distributions are entirely at the expense of creditors, since they have no corresponding future earning capacity.
Hence, credit investors are highly dependent on central banks to play the right tunes during the after-party. We still think that credit markets can derive comfort from the fact that central banks, in particular the ECB, will maintain an accommodative stance. While we believe that increased asset purchases are on the cards, spread tightening will however be challenging to achieve. Indeed, the latest APP announcements (including a re-start of the corporate purchases) had hardly any impact on credit markets, measured by movements in spreads just before and after the announcement date. Furthermore, while we expect the economy to perform sluggishly, corporate earnings are unlikely to nose-dive. With spreads being range-bound, the return potential from the index seems slim, since it is trading at 56bp to swap rates. For our key recommendations, we refer you to our full Outlook document, which can be found here. (Shanawaz Bhimji)