Almost Daily grant writes..
The Gauls are on the rampage, The Wall Street Journal reports today. Citing data from Dealogic, The Journal notes that French corporations have allocated a post-2008 high of roughly $100 billion to foreign acquisitions in each of the last two years (equating to roughly 4% of France’s 2018 nominal GDP) with the United States a particularly attractive target. Eighteen stateside deals have been consummated by French companies already this year.
That shopping spree coincides with an increase in France’s corporate debt load, now at 143% of GDP, up from 116% in 2008 and well above the 74% seen in the U.S., per the Bank for International Settlements. The rise in corporate debt comes as the European Central Bank marks the fifth anniversary of its foray into negative interest rates, along with the recently-paused corporate bond buying program which was in place since 2016 and held some €178 billion in assets as of April 30.
A spokesperson for drug maker Sanofi S.A., which bought Waltham, Mass.-based Bioverativ, Inc. for $11.6 billion in March 2018, got to the crux of the matter, explaining to The Journal: “Obviously, cost of funding is one of the key elements to take into account for debt-funded deals.”
While the ECB’s aggressive monetary policy has helped spur corporate consolidation, underlying economic activity remains turgid. Thus, euro-area core CPI rose to 1.3% year-over-year in April, the highest reading since April 2017 but still far below the near-2% threshold favored by the central bankers (core CPI growth has averaged 1% since the ECB pushed the deposit rate below zero). Meanwhile, the European Commission now forecasts 1.2% real GDP growth this year in the eurozone, down from a 1.9% guesstimate for 2019 at the end of last year.
But hope springs eternal. Over the weekend, ECB governing council member Klaas Knot said in an interview with Corriere della Sera that “if the economy continues to rebound. . . then I think we are on course” to reach that 2% inflation bogey. Knot attributed weak European growth to globalization, stating: “the only thing that we can do is to keep the pressure up, make sure the economy continues to perform at high levels of capacity utilization and the economy continues to print GDP numbers in excess of potential growth.”
Taking no chances, the mandarins are prepared to go back to the well. In an April press conference, soon-to-be-outgoing President Mario Draghi said that the ECB is prepared to “adjust all its instruments” if data aren’t to their liking. More specifically, the Financial Times surmises that “additional measures [designed] to keep the cost of credit cheaper for longer” will be in store if growth and inflation continue to disappoint. Then, too, investors see no policy normalization any time soon. Interest rate futures currently predict 29% odds of a rate cut by year end and virtually no chance of a hike. One month ago, the odds of a rate cut, and rate hike were both between 7% and 8%. Meanwhile, the March 2020 three-month Euribor futures contract has risen to 100.35, suggesting a deposit rate of negative 35 basis points 10 months from now. That compares to 99.88 last spring, when investors were expecting a return to positive rates and the April 6, 2018 edition of Grant’s Interest Rate Observer suggested that call options on this instrument would be a good way to profit from the ongoing financial repression in the eurozone.
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March 2020 three-month Euribor futures, one-year chart. Source: The Bloomberg
With positive nominal interest rates not forthcoming any time soon, Europe’s financial institutions continue to falter. The Stoxx 600 Banks Index is now down 25% year-to-date, badly lagging the 5% decline in the broad Stoxx 600 Index. Bank valuations have descended into consignment-type depths, with that Stoxx gauge now trading at 0.58 times book value, less than half of the 1.23 times book value fetched by the KBW Banks Index in the U.S.
The travails of Deutsche Bank, A.G., which has seen shares plummet by 93% since 2007 and carries a €43.5 trillion ($48.8 trillion) derivatives book equal to nearly three times 2018 Eurozone GDP, are front and center. But other institutions are also attracting unwanted attention. Last week, BlackRock, Inc. backed out of a deal to rescue Banca Carige S.p.A. (founded in 1483), which the ECB had placed the Italian lender in administration in January. In response, Italian deputy prime minster Matteo Salvini told reporters: “It’s an important bank. Obviously, we won’t let things collapse.” Don’t blame the ECB, according to governing council member Benoit Coeuré. Speaking in French parliament last Wednesday, Coeuré estimated that negative interest rates are costing eurozone banks €8 billion in annual lost income, which he termed “really peanuts.” Instead of positive nominal rates, Coeuré offered a familiar solution for the banks’ woes: Industry consolidation