New Bank of England Governor appointment surprises the City

In this week’s bulletin:

  • New Bank of England Governor appointment surprises the City but otherwise market excitement is in short supply.
  • US companies rush to pay special dividends on fears of higher taxes, as President Obama puts a ‘fiscal cliff’ solution on his Christmas wish list.
  • Greece gets another lifeline as policymakers scrape the proverbial barrel and EU governments face up to losses of €53 billion on Greek loans.
  • Pension contributions in the firing line ahead of the Autumn Statement on Wednesday, as the City anticipates “conjuring tricks on capital spending” from the Chancellor.


Market eye

  • Choice of new Bank of England governor surprises the City
  • Financial markets quiet as investors stay on the sidelines

The surprise appointment of Canadian Mark Carney as the new Governor of the Bank of England was one of the few moments of excitement last week as markets spent much of it trading sideways. Not even Greece’s bailout or the US ‘fiscal cliff’ managed to galvanise investors into action, which meant that, by close of business on Friday, most major indices registered only modest movements for the week. Elsewhere in the financial markets, gold fell but silver was up; crude oil prices and quality bond prices barely moved; and in the currency markets only the yen blinked, rising marginally against the US dollar. Mr Carney’s appointment as Sir Mervyn King’s successor was generally well received, with his experience at Canada’s central bank likely to be invaluable given Mr Osborne’s desire to see the UK’s central bank undergo reform. Mr Carney will take up his new post in June next year.


Action stations

  • Record number of American companies rush to pay special dividends to avoid possible tax hike next year
  • US president optimistic over deal to resolve US ‘fiscal cliff’
  • Federal Reserve warns of adverse impact on business

Whilst the markets are taking the view that US politicians will ultimately broker a deal to address the country’s so-called ‘fiscal cliff’, both parties are positioning themselves for what could be a war of attrition, despite the positive noises emanating from Capitol Hill. The Democrats have a simple message: tax the rich and make them bear a greater share of the burden. President Obama is seeking to mobilise as many middle-class Americans as possible, asking them to lobby their Congress representatives to work hard to finalise a deal. Republicans, whilst accepting the need for some higher taxes on the rich, are making this conditional on concessions from the Democrats to agree to structural changes to Medicare and Social Security. The Republican proposals are looking to ‘means-test’ the two largest safety-net schemes supporting elderly Americans. Although there have been few real signs of progress, Mr Obama said he was optimistic about the chances of an agreement being reached.

“My hope is to get this done before Christmas.”

President Barack Obama

While the politicians are still talking, it has been US businesses that have responded to the call for action and probably not in the way Mr Obama would like. Faced with uncertainty over future tax rates, a swathe of American companies have decided to take matters into their own hands by announcing special dividends in order to escape possible higher taxes on equity income payments come next year. The current rate is 15% but this could spike to 40% unless a deal is agreed. So, against this backdrop, and with many companies being flush with cash, it is no real surprise that, in the fourth quarter, a record 103 businesses have announced that they will pay a special dividend before the year-end, according to data firm Markit. Some companies, such as retail giant Wal-Mart, have even brought forward their scheduled dividend payment date to avoid the possibility of being taxed more heavily.

The implications of an impasse have been highlighted by the US Federal Reserve in its latest Beige Book report, saying it had picked up “concern and uncertainty about the federal budget, especially the fiscal cliff”. The report went on to note that a number of Federal districts had expressed concern about business conditions for the months ahead as firms and their customers waited for the outcome of the budget negotiations. Whilst the raft of special dividends will be welcomed by shareholders, there is a downside. For one thing, companies declaring special dividends will enter 2013 with less cash, reducing their ability to invest in their businesses or make acquisitions. Coupled with this, it is likely that there will be more share buy-backs as corporations try to find other ways to get cash back to shareholders without paying dividends that are likely to be taxed more severely. There is also the possibility that entrepreneurs, faced with higher capital gains taxes – up from 15.0% to 23.8% – will try to dispose of assets in the run-up to the year-end.

Given this scenario, it is no surprise that Wall Street has been jittery; but so far investors continue to take the view that a compromise will be reached, with confidence being boosted by signs that the economy continues to make progress. Last week, US growth for the third quarter was revised up from 2.0% to 2.7% and the latest S&P/Case-Schiller housing data showed prices rising for the sixth consecutive month. This coincided with news that consumer confidence rose to its highest level for four years and that US companies increased their orders for durable goods.


Climb every mountain

  • Greece finally receives latest bailout funds as policymakers rush to avert debt default
  • EU governments likely to face losses of €53 billion on Greek loans

Last week, Europe’s troika – the IMF, ECB and EU – finally agreed to release the latest €34.4 billion tranche of bailout funding for Greece, giving the country more time to reduce its mountain of debt: some €350 billion. The plan is to reduce debt as a percentage of output to 126.6% from its current vertiginous – and ruinous – level of around 180% by 2020. The relief plan has scraped the proverbial barrel bare, even going as far as returning the ECB’s profit of €7.1 billion it has made on Greek bonds and cutting interest rates on loans to the country to a nominal 50bps (half a percent) above interbank rates. The question though remains: will this be enough? It seems that desperate EU officials are exploring other ways to help Greece hit target, including access to EU development funds which would trim another 2.6% off the deficit. German opposition MPs have accused the country’s finance minister, Wolfgang Schäuble, of trying to hide the inevitability of losses on bailout loans: documents seen by the FT suggest eurozone governments could be forced to accept losses of €53 billion in rescue loans to Athens, which trade at a lowly 28 cents to the euro. Either way though, Greece has had another lifeline thrown to it, allowing its government yet more time to get its house in order.


Inscrutable Shanghai

  • Chinese investors shun stock market despite improving economic news
  • Government spending policies start to boost growth once more

We all like good news but not, it seems, investors in China’s stock market. Last week, the Shanghai composite index closed below 2,000 for the first time since the financial crisis, as domestic private investors continued to shun equities in spite of a pick-up in the economy. This year there has been a slowdown in demand for Chinese goods from major markets such as the US, the eurozone and Japan as they struggle with their own sluggish recoveries resulting from the global economic crisis. As a result, the Chinese economy has seen its booming growth of previous years come down to a three-year low in the July to September quarter this year. However, recent data has been improving. Manufacturing activity in China has continued to rebound in November, according to two sets of recent figures. Last week, HSBC said its Purchasing Managers’ Index hit a 13-month high, rising to 50.5 from 49.5 (any figure over 50 denotes growth), while on Saturday the government’s version of this index touched a 7-month high at 50.6.

“The improving numbers are mostly because of government investment. From the second quarter the government has unleashed a lot of projects, and that has started to be felt in the economy.”

Dong Xian’an, economist with Peking First Advisory

So despite a brightening domestic economy, a successful transfer of power in Beijing and efforts by regulators to boost participation, China’s benchmark equity index seems impervious to good news. But this needs to be put into context: the Shanghai market is largely closed to foreign investors who can only access these ‘A-shares’ via a quota system. Instead, global investors looking to participate in China’s long-term growth prospects tend to buy stocks via Hong Kong ‘H-shares’ and here the story is different. The Hang Seng Index has rallied around 15% this year and, according to analysts, better reflects the prospects of the world’s second-largest economy. For most foreign investors there is likely to be safety in numbers, so gaining exposure to China is best achieved via a diversified pooled fund which specialises in investing in the Far East region as a whole.


The Magic Number

  • City economists believe Chancellor Osborne will resort to financial accounting changes to avoid further austerity cuts
  • Wealthy likely to be targeted in this week’s Autumn Statement

On Wednesday the Chancellor, George Osborne, will deliver his Autumn Statement to a packed House of Commons. Mr Osborne will have a tricky task: he needs to keep the financial markets onside by convincing them that he is still on track to meet his self-imposed fiscal targets, but at the same time avoid imposing another huge dose of austerity. Any loss of confidence by Britain’s international creditors could impact the bond market and possibly lead to the UK losing its coveted ‘AAA’ credit rating. However, there is apparently a growing feeling amongst City economists that the Chancellor will resort to financial wizardry to balance the books and avoid further government spending cuts which would hurt the consumer. The Treasury’s recent decision to subsume £35 billion of gilt coupons paid to the Bank of England into its accounts is cited as just one way the numbers can be juggled around.

Michael Saunders of Citigroup says the Chancellor has plenty of scope. “Even without conjuring tricks on capital spending, Osborne has other ‘get out of jail free’ cards to help him meet his fiscal rules.” These might include moving back the timetable for reducing debt as a percentage of GDP, as well as possibly bringing forward planned government spending from 2015/16 into earlier years. Once again, rumours abound that the wealthy will be targeted. One such idea that seems to be gaining traction is the reduction of current pension contribution limits. Currently individuals are allowed to contribute up to £50,000 into their pensions and be entitled to tax relief at their highest marginal rate and this costs the Treasury some £7 billion a year. Cutting the limit to £40,000 or even £30,000 could save up to £1.7 billion for Mr Osborne; and no doubt there will be other ‘finessing’ of current tax regimes. All will be revealed at 12.30pm on Wednesday.

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