Shipping Market Comment Autumn 2019
Monetary Policy within the Euro Area and the Implications for shipping – Time for a shift in borrowing?
Central bank policy has recently taken centre stage again as decision-makers took action to ease downward pressure on their economies. Prior to the official announcements, the press was full of speculation how much stimulus the central banks would offer. To achieve its goal of 2 % inflation within the Euro zone, the ECB opted to boost quantitative easing again, with 20 bill. € of monthly bond buying (amongst other instruments...) in order to re-anchor the inflation expectations. Will it be enough?
We have our doubts, considering two very important factors which are not taken account of in official economic theory:
1. Increased price transparency from portals like Alibaba, Amazon and Ebay will counteract any price hikes as there is always someone in the world who is willing to do it cheaper. To put it bluntly, the transparency these portals are offering is destroying commercial margins. It is therefore acting against inflation in a year-on-year view.
2. Free movement of labour: With such disparities in local pay even among the Euro zone countries, there is going to be little pressure from wage inflation. Based on the principle of free movement of persons inside the EU, the flow of cheap labour from Eastern Europe to the wealthier countries of Western Europe is bound to continue and is acting against wage inflation.
Hence we believe it is fair to assume that the ECB will miss its core target of keeping inflation at around the 2 % mark, even though the fading president pointed out, he will do whatever it takes to spark growth and drive up stubbornly low inflation. Some of the effects of the latest policy action can be seen already, with government bonds the Euro zone staging an unprecedented summer rally and yields sinking to record lows across the currency en bloc. At the moment, investors are even paying Germany for borrowing money on the 30-year tenor. There is one caveat to be made here, though. We should bear in mind that today’s (interest) futures are no more than a bad estimate of the future spot market, they are only a tradable snapshot. Anyhow, it seems many investors are happy to hold on to negative yielding bonds on the basis of regulatory requirements and on the basis that a rebound in growth and/or annual inflation – now at only 1 % – looks distant. Assuming they are right (which we would argue...), what does it mean for business strategy?
Implications for shipping
When looking at today’s snapshot of Euro yield curves, USD yield curves and the term structure of currency swaps, we should bear in mind that the linking element is more or less the covered interest parity as there is no free lunch on arbitrage pricing!
1. The key question, though, is whether ship owners might be better off neglecting covered interest rate parity? Practically, this would mean switching ship financing away from USD into Euro. The trade-off from such a strategy is additional currency risk from a depreciation of the USD against the safe savings from a zero base interest rate? At the moment the Euro interest advantage vs. higher USD funding costs is on the 10 year tenor 23%. Right now, the US money markets are considered to be an asset class in their own right, attracting additional funds due to the relatively high interest rates. So, from a commercial point of view it seems more likely that the USD will appreciate further as trillions of USD, so far invested at negative interest rates worldwide, are pouring back into the US.
2. Turning theoretical thinking into day-to-day solutions has its challenges, though. Switching from USD to Euro has of course implications for ship financiers and for charterers, too. Both are integral stakeholders of a ship project and part of the refinancing chain. Given the fact that there are already a lot of distressed balance sheets on the container tramp owning side, shipping banks are likely to reject any additional currency risk within the financing structure. There could be a way around that risk if owners could secure longer term charter employments nominated in Euro instead of USD? Sure, container lines would ask for a favor. Perhaps a slight discount on a long-term USD employment when it’s fixed in Euro might convince them?
Written by Dr. Thomas Hartwig