Overseas Headlines – July 19, 2018

Date: July 19, 2018 

United States:

Fed’s Powell Says Gradual Rate Hikes Are the Best Path ‘For Now’ 

Federal Reserve Chairman Jerome Powell said the central bank will continue to gradually raise interest rates “for now’’ to keep inflation near target amid a strong U.S. labor market. The Federal Open Market Committee, the Fed panel that sets interest rates, “believes that — for now — the best way forward is to keep gradually raising the federal funds rate,” Powell said in prepared testimony before the Senate Banking Committee. “We are aware that, on the one hand, raising interest rates too slowly may lead to high inflation or financial market excesses,” Powell said in the text of his remarks Tuesday. “On the other hand, if we raise rates too rapidly, the economy could weaken and inflation could run persistently below our objective.’’ Powell addresses Congress with the underpinnings of the U.S. expansion looking solid. Unemployment stands close to an 18-year low and inflation is around the Fed’s 2 percent target, though some sentiment indicators are starting to flash warning signs over escalating trade disputes. He will appear before the House Financial Services Committee Wednesday. Officials in June signaled they plan to continue to raise rates at a gradual pace, penciling in two more quarter-point hikes for 2018. Powell’s emphasis that gradual increases are the right path “for now’’ may suggest the committee’s debate about pausing those hikes once the rate gets closer to a level they consider neutral — neither adding stimulus nor hurting growth — is likely to intensify. Powell listed four reasons why the job market will remain strong with inflation near the Fed’s 2 percent target “over the next several years.’’ Financial conditions remain favorable to growth, he said, and a stronger financial system is prepared to meet the credit needs of the economy. “Federal tax and spending policies likely will continue to support the expansion,’’ Powell said, and “the outlook for economic growth abroad remains solid despite greater uncertainties in several parts of the world.’’ Powell also warned that it is “difficult to predict’’ how trade tensions as well as “the size and timing of the economic effects of the recent changes in fiscal policy’’ will shape the economic outlook. The risks of a weaker or stronger economy are “roughly balanced,’’ he said. The U.S. economy grew at a 2 percent annual rate in the first quarter and that pace is expected to double to 4 percent in the second quarter, according to analysts surveyed by Bloomberg.



Three Strikes Should Rule Out U.K. Rate Increase

The interest-rate futures market is convinced the Bank of England will raise borrowing costs next month. But three consecutive sets of disappointing economic statistics this week should restrain the hawks on the Monetary Policy Committee from turning the present political and economic drama into a crisis. The pound lurched lower on Thursday, dropping below $1.30, after disappointing retail sales figures. The combination of a heatwave and the start of the World Cup soccer tournament failed to generate the expected surge in demand: the median forecast of economists surveyed by Bloomberg News was for a gain of 0.2 percent. Instead, they got a drop of 0.5 percent. The retail sales data followed Wednesday’s June inflation report, which also undershot expectations. Price growth has been slower than expected in four of the past five months, and for half of the past year. And while inflation is currently stuck above the Bank of England’s 2 percent target, in the three years between 2014 and 2016 it averaged just 0.7 percent. But it’s the contrast between the increase in prices in the shops and the moribund pace of wage growth that should give the central bank the biggest reason to pause before tightening monetary conditions. With the benchmark rate at 0.5 percent, the central bank doesn’t have much scope to act if the U.K. drops out of the European Union without a deal and the economy dives into a tailspin. By raising rates now, while growth is still positive and prices are rising, policy makers would give themselves more room to loosen monetary conditions if needed in future. It seems the Bank of England has a case of “fear of missing out,” and I have some sympathy for that. But there’s too much of a risk that Britons, still feeling poorer after those long months of inflation eroding their incomes, will react badly to higher borrowing costs. Moreover, the global outlook for growth grows more fragile by the day. The Bank of England would do better to wait and see what Brexit actually delivers – and for any long-delayed increase in wage pressures to actually arrive – than risk turning the current slowdown into a full-blown recession by raising rates in two weeks’ time.



A China Borrower’s $11 Billion Debt Mountain Comes Crashing Down

China this month recorded one of its biggest corporate-debt defaults yet, with the downfall of a coal miner that had ridden the country’s wave of credit until policy makers changed the game with their deleveraging campaign. For investors in Wintime Energy Co., it’s been far from a winning time now that the company from northern Shanxi province is proving incapable of rolling over debt that quadrupled in less than five years. How the borrower ran up a 72.2 billion yuan ($10.8 billion) tab that it now can’t make good on illustrates why this year will be China’s worst yet for corporate defaults. And with a potential lifeline from state-owned banks unveiled Wednesday, it could also emerge as an example of China’s unwillingness to allow unbridled corporate failures. Wintime’s original plan was to borrow to fund acquisitions and expand into areas including finance and logistics. As borrowing costs tumbled from 2014, funding was easy to get and the miner took full advantage of creditors’ largesse. Things started changing in 2016, when President Xi Jinping began putting emphasis on reining in financial risks. Now, Wintime has the unfortunate distinction of being the largest defaulter in China so far in 2018, delinquent on 11.4 billion yuan of securities after it failed to pay a local bond this month. China’s changing environment for financing has had quite a big impact on the company, an officer with Wintime’s information disclosure department said by phone, declining to be identified by name. The firm is trying to raise new debt to repay existing obligations and is selling assets, he said, declining to comment on Wintime’s past run-up in debt. That run-up came amid a near-doubling in size of China’s domestic bond market, now roughly $12 trillion and the world’s third largest. The government had encouraged companies to use bonds for financing as they embraced financial innovation to make the economy less dependent on state-owned banks.


Yen May Trigger ‘Strong’ Rally in Japanese Stocks: JPMorgan

Japan’s currency is increasingly trading in tandem with American stocks, in a correlation that resembles moves in September 2017, which presaged a surge in Japanese shares, according to JPMorgan Chase & Co. “A pattern similar to last September seems to be emerging suggesting a further yen depreciation and strong Nikkei rally,” JPMorgan strategists Tohru Sasaki and Shumpei Kobayashi wrote in a note Wednesday. The currency is now likely to hit 115 per dollar “near term,” they forecast. It was around 113 Thursday afternoon in Tokyo. The yen’s recent bout of weakness has been connected to Japanese companies sending direct investment abroad and domestic investors piling into overseas securities, countering any of the safe-haven demand that the currency might otherwise have enjoyed from rising U.S.-China trade tensions, the strategists wrote. The Nikkei 225 Stock Average surged more than 13 percent from late September to early November 2017, following the increase in correlation cited by JPMorgan for the yen and the S&P 500. Japan’s currency might still appreciate toward year-end, though, and investors should be watchful for any shift in Bank of Japan policy, Sasaki and Kobayashi said. While the BOJ has said any exit from its mega stimulus isn’t on the horizon, it has also been tapering its purchases of government bonds — including at an operation Thursday. “The current market is ideal for the BOJ to tweak its policy,” the JPMorgan strategists wrote.