Aug 30, 2019

Axios Markets

By Dion Rabouin
Dion Rabouin

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Situational awareness:

  • Uber, Lyft and DoorDash are prepared to spend a collective $90 million to fight a California bill that would designate its workers in the state as employees, rather than independent contractors. (AP)
  • A proposed Purdue Pharma settlement for more than 2,000 lawsuits related to the opioid crisis is facing pushback from a group of state attorneys general who say it doesn’t bring in enough cash. (WSJ)
  • Saudi Aramco is considering splitting its IPO, the world’s largest, into two stages, with a portion on the Saudi stock exchange later this year and an international offering in Tokyo in 2020 or 2021. (WSJ)
  • The dollar’s status as a “hegemon” is “putting the global economy under increasing strain” and needs to end, Bank of England Gov. Mark Carney writes. (Bloomberg)
1 big thing: Negative interest rates have hurt, not helped

Illustration: Aïda Amer/Axios

The ECB is expected to push forward with deeper negative interest rates next month and the Fed looks to be considering implementing them in the U.S. should the current economic slowdown accelerate.

  • But there's growing evidence that the experimental policy designed to increase spending, boost inflation and stimulate the economy has done more harm than good.

What they're saying: Recent research from the San Francisco Fed finds that after the Bank of Japan announced negative rates in 2016, "market expectations for inflation over the medium term fell immediately."

  • "The reaction stresses the uncertainty surrounding the effectiveness of negative policy rates as expansionary tools," especially when inflation is as stubbornly low as it is now, researchers Jens Christensen and Mark Spiegel write.

Research on Europe's experiment with negative yields has drawn similar conclusions.

  • A study from the University of Bath concludes that negative interest rates have weakened demand and decreased lending because the additional costs reduce banks’ profit margins.
  • “This is a good example of unintended consequences,” said Ru Xie, one of the study’s authors. “Negative interest rate policy has backfired, particularly in an environment where banks are already struggling with profitability.”

Even so, incoming ECB president Christine Lagarde insists the eurozone would be "worse off" without negative rates, and the Fed looks to be headed toward an embrace of negative rates as well.

  • Minutes from July's FOMC meeting mention “ELB" 15 times. (ELB is the effective lower bound, a reference to the lowest level interest rates can go.) That's up from 0 mentions in the June meeting’s minutes, notes Ed Yardeni, president and chief investment strategist of Yardeni Research.
  • "The presumption is that the federal funds rate can’t fall below zero," he says in a note to clients. "Yet the minutes hinted that Fed officials might be thinking that if they have to lower the federal funds rate to zero, it’s a slippery slope from there to considering going negative."

Watch this space: European bankers are increasingly worried about the harm negative rates are doing to the business of banking and are trying to pass the cost onto consumers.

  • If that happens, people may start stuffing cash in their mattresses, worries Jesper Berg, director general of the Financial Supervisory Authority in Denmark. That would likely put more pressure on banks and shrink the financial industry.
  • “If you continue to stay in this environment,” Berg told Bloomberg recently, "something needs to give."
2. German unemployment is not improving
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Data:; Chart: Axios Visuals

More signs are pointing towards a recession in Germany, as the country's economy turns under the weight of its manufacturing collapse.

The latest: The number of people who are out of work increased by 4,000, touching 2.29 million in August.

The big picture: The German unemployment rate has increased in 3 of the past 4 months, including the largest spike in unemployment in May since the financial crisis.

  • In the one month unemployment did not increase, the economy added just 1,000 jobs.
  • The recent turn follows 6 straight years of almost continuous reductions in unemployment — which still remains at a historically low 5%.
3. The rich are hoarding their money

In June I wrote about a truly bizarre phenomenon — wealthy people and corporations have so much money they literally don't know what to do with it. They're holding it in cash and socking it away in savings accounts.

What's new: Data shows that theme has accelerated recently, with the rich cutting back on buying everything from penthouses to high-end art.

What they're saying: "While the middle class and broader consumer sections continue to spend, economists say the sudden pullback among the wealthy could cascade down to the rest of the economy and create a further drag on growth," CNBC's Robert Frank writes.

  • "Luxury real estate is having its worst year since the financial crisis, with pricey markets like Manhattan seeing six straight quarters of sales declines."
  • "Luxury retailers are struggling while discounters like Walmart and Target thrive."
  • "At this month’s massive Pebble Beach car auctions, the most expensive cars faltered on the block."
  • "In the first half of 2019, art auction sales were down for the first time in years. Sales at Sotheby’s dropped 10% and Christie’s auction sales were down 22% from a year ago."

Why it matters: With the rich pinching pennies, worry is growing about a "trickle-down recession that starts at the top," Frank writes.

  • Even worse, much of the spending by poor and middle-class Americans is debt financed, as many are taking on loans to meet basic living costs, pushing Americans' debt to record levels.

The big picture: "The top 10% of earners account for nearly half of all consumer outlays," Mark Zandi, chief economist at Moody’s Analytics, tells Frank. "But their spending has fallen over the past two years, while spending for the middle class has accelerated."

  • “If high-income consumers pull back any further on their spending, it will be a significant threat to the economic expansion,” Zandi says.
4. Remember: No one wanted a 30-year bond for almost 4 years
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Data: Federal Reserve Bank of St. Louis; Chart: Axios Visuals

Treasury Secretary Steve Mnuchin said yesterday the Trump administration is seriously considering issuing 50- or even 100-year bonds, an idea that has gained traction among some market participants.

  • "How far we've come," notes LPL Financial senior market strategist Ryan Detrick, as the U.S. didn't even issue 30-year bonds between 2002–2006 "due to a lack of perceived demand."
5. U.S. companies aren't leaving China for America
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Reproduced from US-China Business Council Member Survey, 2019; Chart: Axios Visuals

Axios' Dan Primack and Courtenay Brown write: 13% of American companies with operations in China have moved or plan to move all or part of their business out of China. But only 3% plan to relocate those operations to the U.S., according to a survey of 220 members of the U.S.-China Business Council.

  • Members include companies like Walmart, Caterpillar and Apple.

Why it matters: It undercuts White House arguments that the trade war with China is causing U.S. companies to return home. In fact, a larger percentage planned to relocate from China to the U.S. in 2015.

Caveat: The survey was done in June, before the recent tariff escalations.

6. The world is increasing its China investment, especially Americans
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Data: Wind Information; Chart: Chris Canipe/Axios

China's bond and equity markets have been slowly opening up to foreigners. They're now beginning to see fairly significant inflows that are growing much more quickly than foreign direct investment.

What's happening: Over the past 8 years, foreign investment in China's stocks and bonds has grown 6-fold to nearly $1.3 trillion, per Wind Information data shared by Seafarer Funds.

  • Americans are responsible for nearly half of that total, scooping up $535 billion worth of Chinese assets, with significant flows in recent months.

What they're saying: Nicholas Borst, director of China research at Seafarer Funds, writes...

"A recent spate of reforms have led to a considerable opening of China’s capital account. Whether via the Stock Connect, the Bond Connect, the expansion of the Qualified Foreign Institutional Investor (QFII) program, or direct access to the interbank bond market, foreign investors have an unprecedented ability to buy and sell Chinese securities.
"Capital inflows into China have increased significantly, even amid the volatilities of its economy and stock markets."

Yes, but: The level of Chinese assets owned by American investors is still low compared to U.S.-based funds and even to other emerging markets, Borst tells Axios. The current level of investment represents less than 5% of total U.S. investor holdings.

  • "Consequently, it’s hard to argue that U.S. investors play an important role as a source of capital for domestically listed Chinese companies."
Dion Rabouin