While the macro and corporate news is looking to be a bit slow this week — compared to last week, anyway — there is plenty to discuss, starting with a speech today from European Central Bank President Mario Draghi before the European Parliament and speeches from seven U.S. Federal Reserve officials.
Tesco is lost in the supermarket. Tesco, the U.K.’s largest supermarket chain, announced today a restatement of profits for the first half of 2014 and a probe into past accounting practices to look into the £250 million ($408.8 million) overstatement of profits. Four senior executives have been suspended in connection with the investigation. Tesco also lowered its forward profit outlook for the third time in as many months.
German companies are on U.S. buying spree. Pharmaceuticals giant Merck announced an acquisition of St. Louis–headquartered Sigma-Aldrich in a $17 billion deal that will double the German company’s exposure to life sciences. Separately, Siemens announced an agreement to acquire Dresser-Rand Group, which as headquarters in both Houston and in Paris, in a $7.6 billion acquisition. This marks a significant increase in Siemens’s footprint in the North American oil and natural gas equipment industry. At $140 and $83 a share respectively, both purchase prices represents an approximate 37 percent increase from Friday’s close.
U.S. home sales numbers expected to show faster pace. Existing home sales data for August will be released this morning at 10 U.S. Eastern, with consensus forecasts for a marginal uptick to an annual pace of 5.18 million units. After a gain in July and upward revision for June in the prior release, analysts predict that single family homes will continue to be the strongest segment.
Group of 20 meeting concludes. The G-20 meeting wound down over the weekend with a stark warning. According to an official communiqué released at the event, held in the tropical, northern Australian city of Cairns, “We are mindful of the potential for a build-up of excessive risk in financial markets, particularly in an environment of low interest rates and low asset price volatility.” U.S. Treasury Secretary Jack Lew had pressed to have currency intervention be a primary topic of discussion at the meeting.
Portfolio Perspective: Draghi’s Game Changer — Francis Scotland, Brandywine Global Investment Management
ECB President Mario Draghi has finally unleashed European-style quantitative easing. It took seeing the whites of the eyes of deflation before the Italian central banker with a U.S. economics pedigree could act. But in doing so, he has set the stage for a major game changer in European and global fixed-income markets if he delivers all that he has promised.
His actions weigh in on one of this year’s great conundrums: the strength of the U.S. government bond market. There are clear signs that America’s mojo is stirring, contrary to the economic pessimism implied by the low level of long-term Treasury yields. Industrial production, payroll employment and real retail sales are well above 2007 highs, with car sales cruising into that zone. The National Federation of Independent Business (NFIB) small business survey reports hiring plans and job openings in a strong upward trend. Businesses will be more worried about finding employees than sales by the end of the year if trends persist. Consumer confidence is on the rise. Lending is expanding.
So, what’s holding down Treasury yields? In our opinion, deflationary pressure outside of the U.S. economy and none more so than what’s coming from Europe are factors in this suppression of Treasury yields.
Europe is on the verge of another recession with inflation already below zero in parts of the union and the unemployment rate stuck at postrecession highs. This self-inflicted economic mess represents a colossal failure of economic policy. Following the worst financial crisis since the Great Depression, the ECB chose to raise interest rates while the EU pursued dogmatic fiscal consolidation. The union would have blown up without Draghi’s 2012 commitment to do what it takes. With that risk off the table, European bond yields have fallen to multi-century lows across the board, reflective of the deflation taking hold.
In our view, Draghi’s move to introduce aggressive monetary reflation is the beginning of the end of this great bond rally, and with it comes the beginning of a lessening of external deflationary pressure weighing on the U.S. The rally in core European government bonds is over, and the weight on Treasury yields will soon begin to lift.
Francis Scotland is the director of global macro research for Brandywine Global Investment Management at the firm’s Montreal office.
