Weekly Market Commentary 12 July 2019

UK Navy Blocks Iranian Attempt to Capture BP Tanker

This week saw the UK get dragged into the simmering Middle East conflict between the US and Iran, when the Royal Navy had to intervene to prevent the Iranians from seizing a British tanker in the key shipping lane of the Strait of Hormuz. While this act of aggression has got a lot of attention, it follows on from the UK seizing an Iranian oil tanker off the coast of Gibraltar last week and arresting the Captain. While the ship was suspected of breaking sanctions on Syria, the retaliation was hardly unexpected. This tit for tat state sponsored piracy can probably be resolved without further escalation.

Elsewhere the S&P 500 broke new highs and crossed 3000 for the first time. The sudden surge in equities came after Federal Reserve Chair Jerome Powell was questioned in-front of Congress. Rookie congress-woman Alexandria Ocasio-Cortez, who bucked tradition by actually being prepared, got the governor to concede that the Phillips curve model, a mainstay of monetary policy, might indeed be broken. This could pave the way for rates to be much lower even under normal conditions.

Banks: Deutsche Bank Cuts Fifth of Workforce in Radical Restructure

In scenes reminiscent of Lehman Brothers’ collapse, albeit with slimmer fitted suits, employees of Deutsche Bank (DB) could be seen leaving in droves outside the company’s regional headquarters. 18,000 jobs are set to be culled within the next three years as part of a restructuring programme that will see whole teams being let go as part of the process. DB will wind down its investment banking (equities) position and focus more on its retail and fund management (DWS) divisions. In short, the company will effectively abandon its US investment banking presence as it consolidates back to Germany.

DB is in a similar predicament to Italian banks, laden with trillion of euros in complex derivatives and non-performing bank loans. It’s current failure stems from not recovering quick enough from the 2008 recession. A mooted merger between Commerzbank and the company fell through as it would effectively create a bigger bank – with the same problems. Instead DB will split its bank in two. The “good bank” will operate with the new structure, while the “bad bank” is where the non-performing and unwanted assets will be dumped.

US: Will the Fed cut interest rates by 25 or 50 Basis Points?

Steady US job figures reported last week led to investors questioning, given the resilient economic indicators, whether the Federal Reserve (Fed) would need to implement a rate cut. However, both the meeting minutes and strongly dovish comments from Fed chairman Jerome Powell this week swiftly quelled those thoughts. Instead the market debate is whether the Fed will cut interest rates by 25 or 50 basis points (bps). The probability of a 25bps rate cut now stands at 82.5 per cent chance and a 50bps rate cut at 17.5 per cent.

Elsewhere, fresh from picking fights with India and Japan, President Trump has turned his ire back towards Britain. Diplomatic tensions between the White House and the Government reached boiling point this week after leaked diplomatic cables showed Britain’s Ambassador to the US, Kim Darroch describing President Trump as “clumsy and inept”. The UK is currently at a cross roads, it must decide whether to continue with its long-standing European trade collaboration or step up its “special” relationship with the US. Boris Johnson’s hesitancy to back Darroch is a leading indicator as to which relationship will be prioritised.

UK: Economy returns to growth, but is there an upcoming recession?

The British economy pulled out of its brief slump to return to growth for the month of May driven by carmakers. UK GDP rose by 0.3 per cent in the three months to May as factory output rose by 1.4 per cent following a sharp slump in the month of April as anticipated disruptions to supply chains failed to materialise as Brexit was postponed. It’s worth noting that the 0.3 per cent growth reported is well within the margin of error for official figures.

Despite the recovery, pressures remain for both the manufacturing and the services industry. Given the decline in April and slight growth in May, June figures will have to be positive. With the service sector experiencing a longer-term slowdown since the summer of 2018, expectations of growth for the second quarter remains muted. And with Brexit headwinds set to intensify for the third quarter, recession talks have already started to pick up pace.

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