1. UK – All I Want for Christmas are More Gilts
Last week the UK Chancellor (or Minister for Finance) unveiled what is known as the Autumn Statement – a kind of update on the UK government’s tax and spending plans. As expected it was a fairly unexciting affair, but with a couple of interesting points. The Office for Budget Responsibility (OBR) outlined a more positive outlook for UK growth relative to the Bank of England and many market forecasters, even if it did reduce growth forecasts significantly. GDP is forecast to be 1.4% in 2017 and 1.7% in 2018, before increasing to 2.1% for 2019 and 2020. Overall, over the next five years, the OBR forecasts growth to be cumulatively 1.4% lower than previously, mainly due to Brexit-related uncertainties. But rumours about the death of austerity in the UK were greatly exaggerated, to quote one commentator. Given all the talk about a global rotation from monetary stimulus to fiscal stimulus, UK Chancellor Philip Hammond tried to keep all his options open. Ex-Chancellor George Osborne had already abandoned plans to deliver a budget surplus by 2020, and Hammond pledged to target a structural deficit below 2% of GDP by March 2021. That gives Hammond some leeway to increase borrowing in the event of a hit to economic activity, which in our opinion is quite likely. The fiscal easing or stimulus that was developed amounts to approx. GBP£6bn per year or about 0.3% of GDP, and is heavily tilted towards infrastructure. Overall, the net effect is that cumulative borrowing over the next five years in the UK is expected to be an extra GBP£122bn, most of which is attributable to weaker growth and consequent lower tax revenues. For fiscal year 2016-2017, the net financing requirement has increased by GBP£20bn since previous numbers published last March. This will be funded by an increase of GBP£5bn in T-Bills and a GBP£15bn increase in gilt issuance. This was more than the market had expected, as is the anticipated duration profile of the extra issuance, with more long-dated Gilts being issued than expected – the market had factored in an extra GBP£4.4bn of extra gilt issuance. The consequence was some upward pressure on UK bond yields. We continue to believe that an underweight position in UK Gilts is warranted. One last point – of the extra GBP£122bn that needs to be borrowed over the next 5 years, GBP£59bn is attributable to Brexit. We’ll just leave that there.
2. France – Return of the Right
Two Sundays, two important election results. Next week when we arrive into the office, we’ll know the result of the Italian referendum on electoral reform. Last night Francois Fillon won the French centre-right Republican presidential election nomination. With most of the polls counted, it appears that Mr. Fillon attracted over 67% of the vote with defeated candidate Alain Juppe polling 33%. By all accounts, this is a landslide margin, and should make Mr Fillon the favourite to become the next resident of the Elysee Palace next year. The first round of elections are held on 23 April 2017 with the two leading candidates going head-to-head in a “winner-takes-all” vote two weeks later on 7 May. There will be numerous candidates in the first round, including Marine Le Pen, leader of the far-right National Front party. This party has consistently polled in the region of 25%-30%, so it seems fair to conclude that Le Pen should be one of the two candidates in the final vote. Assuming Mr Fillon is the second candidate, initial polls appear to indicate that he would be the most likely winner. This morning Bloomberg are reporting two polls that show Fillon beating Le Pen in both rounds of the presidential election and by a substantial margin as well – the margins are close to the results seen last night. Neither do we know who else may decide to contest the first round in April – should Mr Hollande stand representing the Socialists, it might draw centralists like Mr Macron into the fray. Of course, political polls are no longer trusted by many people after their poor record in other elections this year (Brexit and U.S. elections), and there is a long time until the first round in April. Mr Fillon’s emergence as front-runner has shown that voting intentions can change very quickly and by substantial margins. Harold Wilson, a UK Prime Minister in the 1960’s and 1970’s was rumoured to have said “a week is a long time in politics” – by that measure the five months until 23rd April may see large swings in polls. In the short-term, Mr Fillon’s victory should support the Euro and European government bonds.
3. Busy Week Ahead
We have plenty to keep us occupied during the coming week, both in terms of economic data and political news. The Organisation of the Petroleum Exporting Countries (OPEC) will meet on Wednesday 30th in Vienna, with hopes appearing to fade over the weekend of a production cut, and shifting more towards a production freeze. Saudi Arabian officials appear to believe that demand will recover in 2017 on the back of recovering consumption and oil prices may therefore stabilise without OPEC intervention. As mentioned above, next Sunday we will have the result of the Italian referendum, and we’ll know whether Italian Prime Minister Matteo Renzi has decided to remain as leader. In the event that Renzi does step down, rumours suggest that current Finance Minister Pier Carlo Padoan would be his replacement. With current 10-year Italian government bonds yielding nearly 1.90% higher than their German equivalents, we think Italian bonds are beginning to look interesting. We were also unimpressed with the weekend story in the Financial Times concerning the potential bail-in of up to eight Italian banks in the event of a “No” vote. Finally, on the economic front, this week sees the publication of some important data, not least the monthly U.S. non-farm payrolls on Friday 2nd December. With a 90% expectation of a rate hike from the Fed at their December meeting, the payrolls number is unlikely to affect the outcome. Also of note this week will be U.S. Personal Consumption & Expenditure numbers (expected to print at close to 2%) and European November inflation numbers (expected to rise to 0.7% year-on-year).