Money

Watching the service sector


FT subscribers can click here to receive Market Forces every day by email.

The latest tidings on the economic front for Europe suggest the clock is ticking a little louder from a weakening service sector. Across the Channel, the much-anticipated UK flash purchasing managers’ indexreading for January may not appear sufficiently robust enough to prevent the Bank of England from easing policy when it meets next week. 

European equities opened firmly in rally mode on Friday (but trimmed gains as Wall Street extended loses) after a tough week in which the euro was slipping towards $1.10, a level not seen since early December. The main economic highlight, the IHS Markit eurozone PMI, was steady at 50.9 for January, undershooting an expected figure of 51.2. Although Germany saw a bounce in its PMI, the broader story for the eurozone was that the service sector PMI eased to 52.2 from 52.8 in December. True, France was affected by nationwide strikes for several weeks, but in spite of a pick-up for Germany, Friday’s data suggest the rate of European growth is close to stalling. A resilient service sector and consumer, buoyed by higher wages of late, has held the line as manufacturing wilted during the past year. 

Mike Bell at JPMorgan Asset Management noted: 

“Improving manufacturing is being offset by slowing service sector growth. Over the coming months the key question will remain whether the manufacturing surveys can rise above 50 before the weakness there risks dragging the service sector into contraction.”

This already challenging environment for Europe is accompanied by a fresh warning over credit and at a time when many investors believe supportive monetary policy from Frankfurt has their backs.

As S&P Global Ratings observes:

“While stronger issuers are likely to benefit from continued monetary policy support, weaker issuers face challenges. Leverage multiples are well past the prior peak, leaving less room to absorb shocks. Nearly 40% of European nonfinancial speculative-grade companies reported negative net income last year, and close to 20% meet the Bank for International Settlements’ definition of ‘zombie firms’, with a persistent pattern of EBIT [earnings before interest and taxes] not covering interest costs. Greater risk-differentiation is likely to be reflected in the cost of credit for weaker companies.”

As for the UK, market expectations for a 25 basis point rate cut from the Bank of England next week remain 50/50. The flash PMI for services and manufacturing — or the composite index — rose to 52.4 in January from 49.3 in the previous month, exceeding a forecast 50.6. With fiscal stimulus beckoning, the case for trimming the base rate from its current 0.75 per cent is no longer clear-cut. 

Recent chatter from officials about insurance cuts ahead of trade negotiations between the UK and the EU still leaves the door open to an easing. Sterling looks heavy, with the pound falling against the dollar to below $1.31 on Friday after an early jump to $1.3177. 

Philip Shaw at Investec notes:

“The biggest factor in the monetary policy assessment is the extent to which the MPC [BoE’s Monetary Policy Committee] believes the signs of a bounce are sufficient and genuine. In this respect we are forecasting that the committee will leave the Bank rate on hold at 0.75% next week. The two dissenters may well maintain their backing for a cut. However, the economic landscape seems to have taken a turn for the better and this may encourage the remaining seven to carry on voting for the status quo.”

Here’s another consideration: Andrew Bailey, the incoming BoE governor, in an interview with The Times this week, described the UK economy as being ill-prepared for a fall in asset price values, such as equities or house prices.

Little wonder investors downplay risk and fundamentals when central banks are focused on asset prices.

Quick Hits — What’s on the markets radar

US Treasury yields have hit their lowest levels since early November, with the yield on the 10-year note dipping below 1.70 per cent. The latest leg lower in yields came as the US confirmed a second person has coronavirus, the Sars-like respiratory disease that has claimed 26 lives in China. 

Also hitting new lows in yields are areas of the US high-yield market, with an index of double B-rated debt plumbing a record nadir of 3.47 per cent this week. There’s now quite a clamour for income with less regard about credit risk. This demand appears in part to come from investment-grade debt holders stretching for a little more yield.

As Bank of America notes about current risk premiums — the difference between high-yield bonds and Treasuries — in the speculative area of US credit: 

“From an absolute return HY investor standpoint these spread levels make little sense.”

As BofA highlights:

“In BBs, the ex-energy index is now at 169bps, matching its May 2007 all-time low level of 170bps. In single-Bs, the ex-energy part of the market is about to break into two handles, with current spreads at exactly 300bps. In 2006-2007, this category has consistently bottomed out at around this level as well, although the low print is still 30bps away.”

And triple C paper is also enjoying plenty of demand and pushing hard in the performance stakes. Combined with elevated equities, risk appetite is priced for a big rebound for the economy and corporate profit margins this year. 

The latest weekly flows data from EPFR note equity funds recorded consecutive weekly inflows for only the sixth time since the beginning of the third quarter in 2019 and “in geographic terms, the bulk of the fresh money went to the two biggest diversified groups, Global and Global Emerging Markets Equity Funds”.

EPFR said EM equity funds “recorded their 13th consecutive inflow during the third week of January as retail commitments jumped to a 96-week high. Frontier Markets Funds also fared well, following up their biggest inflow since 1Q18 with their second-largest in the past 18 months.”

Nearly $1bn headed into China equity funds. EPFR says:

“China’s share of any fresh money taken in by GEM Equity Funds continues to grow with the latest allocations data showing the average weighting for China climbed to a fresh record high coming into 2020.”

Your feedback

I’d love to hear from you. You can email me on michael.mackenzie@ft.com and follow me on Twitter at @michaellachlan.





READ SOURCE

Leave a Reply

This website uses cookies. By continuing to use this site, you accept our use of cookies.