As expected, the US Federal Reserve reacted to the current robust US economy by raising the key interest rate for the third time this year on Wednesday. The target for the Fed Funds Rate was raised by 0.25 percentage points to a range of 2.0 to 2.25 per cent. A further increase towards the end of the year is likely, going by the central bankers’ outlook for the interest rate. Three further hikes are currently planned for 2019.
While the financial markets pretty much regarded the interest rate hike as a done deal, the accompanying comments on the Fed’s further steps were awaited with anticipation. The central bankers’ assessments regarding inflation and the labour market are considered important indicators for future interest rate policy, seeing as the Fed’s monetary policy strives to achieve maximum employment as well as price stability.Ž
Robust economy, but trade conflict is a potential risk
The Fed now confirmed its assessment of the economic situation, noting that the labour market continues its consolidation, while economic activity grows at a rapid pace. Consumer spending and corporate investment have increased, while inflation remains close to the Fed’s two-per-cent target. However, a possible risk the currency guardians see is the global trade conflict, which is fueled by US President Donald Trump’s protectionist economic policy.
An increasing number of companies is worried about the dangers of rising costs and growing uncertainties, said Fed Chairman Jerome Powell. Fears include supply chain disruptions, loss of market access and a general decline in investment willingness.
Meanwhile, U.S. President Donald Trump fears that the Fed’s interest rate hikes will have a negative impact, as rising interest rates make loans more expensive for businesses and consumers. After repeatedly criticizing the Fed’s monetary policy in the past, he also took issue with the Fed’s latest interest rate decision.
Eighth increase since 2015 interest rate turnaround
The Fed has now raised its key interest rates for the eighth time since the start of the interest rate turnaround in late 2015. The interest rate hikes were accompanied by increasing stock market prices, with the Dow Jones stock index, among others, climbing to new all-time highs in September.
Interest rates and stock prices are thus continuing to recover from the aftermath of the 2008 financial crisis. At the time, the US Federal Reserve had tried to slow the economic downturn by slashing interest rates, keeping the key interest rate at the then-all-time low of 0 to 0.25 per cent between the end of 2008 and 2015.
US retailers are looking forward to another high-turnover summer season leading up to the start of the school year. During the summer holidays, many parents buy books, notebooks, writing utensils, smartphones, laptops and clothing for their children, generating massive sales for the retailers. Back-to-school season plays an important role in the US and is regarded as the second-strongest sales driver after Christmas season.
Matthew Shay, president of the National Retail Federation (NRF), expects very strong back-to-school business this year, thanks to solid consumer confidence: a study commissioned by the NRF projects USD 27.5bn spendings by US families. According to the trade association, there have only been two years with higher sales in the past ten years – 2012 (30.3bn) and 2017 (29.5bn).
A recent study by consulting firm Deloitte comes to similar conclusions and estimates the market volume at 27.6 billion dollars. According to the study, the lion share of this figure, 15.1bn, goes towards new clothes, followed by school materials (6.0bn), computers (3.7bn), and other electronic devices such as tablets or smartphones (2.8bn).
Highest spending in northeastern USA, classic retailers continue to outperform online shops
The Deloitte study finds clear differences in spending volume between regions. While spending in the northeast of the USA averages 568 dollars per household and in the west 513 dollars, the midwest (493 dollars) and the southern states (488 dollars) fall short of the US average (510 dollars).
Traditional shops remain the preferred choice for shoppers: 57 per cent of the planned spendings occurs in physical stores, while only 23 per cent is spent in online stores. At the time of the survey, the 1,200 households surveyed by Deloitte were undecided where to spend the remaining 20 per cent.
Back-to-school-season has even bigger impact when considering purchases for college students. The expenditures for the start of the semester are expected to reach record level this year, explains Shay. According to the NRF-commissioned study, conducted by Prosper Insights and Analytics, spending for school and college students is expected to total USD 82.8bn this year, just short of the 83.6 billion of the previous year.
Shay expects the biggest change in purchasing behavior in the electronics sector. Laptops, tablets and smartphones are now a natural part of every household, and parents are no longer waiting for school to start to buy them, explains the NRF president. On the other hand, children’s influence on their parents’ purchasing behaviour appears to be increasing. Due to social media and other channels, children are ever better informed and selective, says Shay.
Germany is not only the largest, but also one of the strongest economies in the Eurozone and the EU. This is reflected, among other things, in its stable economic growth. In 2017, Germany’s GDP increased by 2.2 per cent compared to the previous year, only slightly less than the total eurozone growth of 2.4 per cent.
Despite the risks posed by the ongoing trade wars, forecasts predict a comparable growth rate for the current year, with the International Monetary Fund (IMF) expecting a GDP increase of 2.2 per cent in 2018. Germany was already well on the way to achieving this goal in the first half of the year: German economy grew by 0.4 per cent in Q1 compared to the previous quarter; Q2 saw growth of 0.5 per cent. The DIW Institute now expects 0.4 per cent growth for the third quarter.
While higher energy prices have recently dampened consumer sentiment somewhat and inflation remained at a comparatively high level of 2.0 per cent in August, the sentiment among exporters has improved for the second consecutive month. The industry's Export Expectations indicator, calculated by the ifo Institute on the basis of a survey, raise by 0.6 to 14.4 points in August. Although the number of unemployed individuals in Germany raise to 2.351 million in August, this is the lowest figure for this month since 1991.
One of the German economy’s key factors is the current account. This balances all imported and exported goods and services in an economy against each other. If there is a surplus in a country’s balance, it exports more than it imports. In case of a deficit, on the other hand, more goods and services are imported than exported, i.e. more is consumed than is produced in the country itself. In regards to this balance, Germany is likely be the world leader yet again in 2018, as the German ifo Institute forecasts a current account surplus of 262.5 billion euros (USD 299bn) for the entire year. This puts the country in first place, followed by Japan at a comfortable distance with 200 billion dollars trade surplus.
German industry positive about surplus, IMF and EU Commission sceptical
The reason for Germany’s large current account surplus is the country's export strength, with the German industry seeing the situation in a positive light. “[The surplus] highlights the performance of German companies and the attractiveness of their products – in a currently difficult international environment, no less,” said Volker Treier, Head of Foreign Trade of the German Chamber of Industry and Commerce (DIHK).
The IMF and the EU Commission, however, are sceptical. The Commission considers a continuous surplus of more than 6% of GDP a threat to stability, owing to the disparity between countries with surpluses and countries with deficits that are indebted. According to the ifo Institute, Germany's current account constitutes 7.8 per cent of GDP in 2018. Since 2011, the current account surplus has contributed more than six per cent to Germany's GDP.
Germany has a particularly strong goods trade balance, which is also a thorn in the side of other countries. In recent months, US President Donald Trump has already repeatedly threatened punitive tariffs on Germany's no. 1 export product, cars. So far, however, he has not followed through on the threats, and after his meeting with EU Commission President Jean-Claude Juncker in July, it is unlikely that he will anytime soon. Under these considerations, it looks like smooth sailing for the German economy for the time being.
2018 could be a record year for mergers, at least if the exceptional first half of the year is any indicator. According to data from the Bloomberg news agency, the transaction volume of announced mergers and acquisitions in the first half of the year amounted to USD2.1tn, a year-on-year increase of around 36 per cent. In 24 deals, the transaction volume exceeded the USD10bn mark. Projected over the year as a whole, this figure could exceed the previous record of USD4.1tn set in 2007.
According to experts, the main drivers of this development were the US tax reform, high stock valuations and robust global economic growth. This year, the largest mergers have so far been announced in the health care and media industries. Japanese pharmaceutical company Takeda announced the purchase of the Irish pharmaceutical manufacturer Shire for USD62bn. In addition, health insurer Cigna offered USD54bn for a takeover of service provider Express Scripts.
Meanwhile in the media and telecommunications industry, T-Mobile US and their competitor Sprint drew attention with an USD26bn merger deal. In addition, the US cable tv giant Comcast and the media group 21st Century Fox are currently competing for the British broadcasting group Sky. With 34 billion dollars, the highest offer here has so far come from Comcast.
Analysts eyeing merger activity with caution
However, the current bout of mergers could soon come to an end. With an annual transaction volume of more than USD2.5tn, the past few years have gone well, according to the Bloomberg calculations. However, it is this development that makes analysts sceptical as to whether and for how long this pace can be maintained.
The experts cite geopolitical risks such as the trade war between the USA and China as potential obstacles. In addition, key interest rates in the USA are continuing to rise, and there are concerns about a weakening economy and increasing regulatory uncertainties. In March, for instance, US President Donald Trump prohibited the takeover of the 140-billion-dollar Qualcomm chip group by a Singapore competitor Broadcom. The reason given was that the deal could compromise the US national security. However, the regulatory risks were somewhat mitigated by the US ruling in June that approved the USD85bn purchase of Time-Warner by AT&T despite criticism from the US government.
History also shows that very strong mergers and acquisitions activity does not necessarily have to be a positive sign. The last two times the transaction volume reached similar levels, market specialists noted, saw the dot-com bubble burst of 2001 and the financial crisis of 2007 in the following year respectively.
The Brexit negotiations between Great Britain and the EU are in full swing. An agreement on the conditions for the exit has to be reached by October, otherwise the so-called hard Brexit, i. e. a disorderly exit from the EU, could occur.
British companies are aware of this danger, and therefore some companies are already taking precautionary measures for the event of an emergency. The London Stock Exchange (LSE) has initiated emergency measures to protect itself from the consequences of a disorderly exit. New subsidiaries are to be established in the EU and additional licenses applied for. The high-street bank Barclays is also preparing for the Brexit by relocating jobs from London to the EU mainland.
However, the Brexit has so far been of limited importance in the current British reporting season. Following a clear loss in the first quarter of 2018, Q2 saw a return to form for Barclays with a profit in the billions. The competition, insofar as results have been made public, has also started the second half of the year with substantial profits. In addition, the LSE exceeded the forecasts with its half-year figures. Meanwhile, oil companies such as BP and Royal Dutch Shell benefited mainly from the sharp rise in oil prices in recent months, while commodity companies listed in the British FTSE-100 Index saw profits surge due to higher commodity prices and increased production volumes.
Numerous remaining disagreements between EU and Great Britain in Brexit negotiations
Even if companies are already beginning to protect themselves against a hard Brexit, both the UK and the EU want to avoid this option. However, it cannot be ruled out completely, because a fair number of points are not yet agreed. The British plan presumes a free trade zone for goods with the EU, but accepts restrictions on the free movement of services and persons. This contradicts the EU’s fundamental principle of the four internal market freedoms (goods, services, capital and persons), which can only be had together in one package, emphasised EU negotiator Michel Barnier. Nor is there a solution to the future border regime for the border between Ireland and Northern Ireland.
The uncertainty surrounding the Brexit is making itself felt in the British economy. In 2017, economic growth in the United Kingdom was 1.8 per cent, well below the eurozone average (2.3 per cent). In Q1 of 2018, the UK economy grew by a meagre 0.2 per cent.
One reason for the slow economy is the Pound, which has been weak since the 2016 Brexit vote. And while a weak currency is more likely to help export-oriented companies in the FTSE-100, boosting the index, it also causes import prices to rise. This in turn causes an increase in inflation, decreasing the purchasing power of the populace: in June, inflation stood at 2.4 per cent year-on-year. To contain this, the Bank of England (BoE) raised its key interest rate on Thursday by a quarter point to 0.75 per cent, the highest level since the financial crisis, by unanimous decision.
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