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Surviving Deutsche Bank

| October 03, 2016
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MPCA Weekly Market Update

Global equities were little changed on the week as the markets digested a rally in oil prices and an increase in concern over the health of Germany’s largest lender. Here at home, the S&P 500 barely moved, both for the week and in the month of September as a whole. The index posted a 0.20% return for the week and was up 0.02% for the month.

After opening lower on Monday, stocks climbed through Wednesday, retreated Thursday, and ended up relatively flat for the week through Friday. The major volatility culprit was Deutsche Bank. Shares of the systemically important lender were pressured last week by a looming legal settlement with the US government over mortgage-backed securities sales during the mid-2000s housing bubble.

After contributing meaningfully to market angst early in the week, the bank helped boost market sentiment, reportedly nearing a deal to pay a $5.4 billion settlement to the U.S. Department of Justice. This amount is less than half the amount originally requested by the DOJ.  The bank’s woes helped push the yield on the 10-year German bund to -0.15%, the lowest since July. Negative interest rates in Europe are pressuring the financial sector as a whole, leading two large European lenders, Commerzbank and ING Group to announce large layoffs this week.

In a bit of good news, economic growth in the second quarter was revised slightly higher by the US Bureau of Economic Analysis. Gross domestic product expanded by a revised 1.4%, up from an earlier 1.1% estimate. Early indications are that growth picked up further in the third quarter, with estimates by the US Federal Reserve banks of New York and Atlanta averaging 2.5% for the quarter, which ended on Friday of last week.

Longer term, however, slow growth remains a significant issue. Since the bottom of the financial crisis in 2009, overall US gross domestic product (“GDP”) growth has averaged only 3.3%, compared to 5.3% during the previous expansion. Unfortunately, a continuing debt overhang, meager productivity growth, stringent lending standards, and the need to structurally reform the tax code all suggest that the current slow growth trend may be far from over.  

As mentioned above, OPEC members agreed to the need for a production cap to help reduce a surplus in the global crude oil market but revealed few specifics ahead of a meeting in November. It is expected that production will be trimmed between 500,000 and 750,000 barrels per day from the August level of 33.2 million barrels per day. What is unclear is which member countries will be exempt from production cuts. Given OPEC’s history of failing to adhere to production quotas, markets remain skeptical.

We continue to keep an eye on Italy, where a December 4 vote on constitutional reforms has the potential to create market volatility. The proposed reform would limit the power of Italy’s Senate and lead to greater government stability, its backers say. Prime Minister Matteo Renzi has said he will resign if the reforms are rejected, so the referendum is potentially as much a referendum on Renzi’s stewardship of the anemic Italian economy as it is on reforming government institutions. Given the populist wave that is building in Europe — and elsewhere — an outcome favorable to the sitting government is far from assured.

Finally, global trade is growing slower than the world economy for the first time in 15 years, the World Trade Organization reported this week. The WTO sees trade expanding at a 1.7% rate this year, while global GDP is expected to expand by 2.2%. WTO Director-General Roberto Azevêdo warned that the slowing of trade is a serious wake-up call, particularly in the context of growing anti-globalization sentiment.

RELEASES THIS WEEK

Today:  Global manufacturing purchasing managers’ indices (“PMIs”)

Wednesday:  Global service sector PMIs

Thursday: The minutes of the European Central Bank’s September meeting

Friday:  The September US employment report

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