02.03.18

Snapshots has been bracing against snow and freezing temperatures in London this week. Meteorologists are attributing the weather to a “polar vortex anomaly” that they think was caused by an unusual jump in temperatures in the Arctic on Valentine’s Day. It is a good reminder that the weather is a globally connected system.

Global Connections

Trade and the economy are also part of a globally connected system. President Trump wants to regulate some of these connections and has imposed a 25% tariff on US steel imports and a 10% tariff on US aluminium imports. This has led to warnings of tariff retaliation from the EU and China.  The corporate sector was already dealing with the reduction in its interest rate tax shield (in the US), tightening monetary conditions, rising labour costs and “Amazonification”.  Rising raw material prices from tariffs could now add to this.  There will be winners and losers but the trend is clear.  Idiosyncratic risks are continuing to rise for corporate credit, which has been leveraging up in this credit cycle.  The good news is that profit margins and interest rate coverage ratios are strong.  Assessing all of these factors requires a strong credit underwriting process and an investment team willing to debate and question past assumptions.

Discount Windows

The Bank of England’s term funding facility has now expired.  We have mentioned this scheme a number of times in Snapshots.  As a reminder, the facility allowed UK banks to borrow cheaply directly from the central bank.  Capital requirements under Basel 4 have created a level playing field for banks, but cheap funding has allowed challenger banks in particular to grow their lending books rapidly by offering very competitive lending rates.  We think the end of this facility will have two effects.  The first is more issuance in the securitisation market, which we view as a healthy sign.  The second is margin pressure for the challenger banks if the large banks keep pricing at competitive rates. We note that HSBC has already indicated it wants to grow its presence in the UK mortgage market.

Italy and Germany

The Italians go to elections this weekend.  Whatever the outcome, Europe needs to move ahead with structural reforms.  That has been hampered by Angela Merkel’s delay in creating a coalition government in Germany. We should have news on this over the weekend too.

Good luck.

Asif Godall
Co-Chief Investment Officer