Markets Weekly podcast - 09 August 2021

Julien Lafargue (JL): Welcome to a new edition of the Market Weekly podcast. My name is Julien Lafargue and I’m the Chief Market Strategist for Barclays Private Bank.

As usual this podcast will be divided in two sections. First, we’ll run through last week’s main events and their implications for investors. And second, we will delve into a specific topic. This week I have the pleasure to be joined by Damian Payiatakis, the Head of Impact and Sustainable Investing here at Barclays Private Bank, to discuss Europe’s “Fit for 55” plan.

But first let’s take a look at last week’s events. The main news was the blowout US job report for July that showed that the US economy added 943,000 jobs last month easily surpassing consensus expectations for a more modest gain of 870,000.

In addition, both the May and the June figures were revised up by an additional 119,000. As a result, the unemployment rate dropped to 5.4% from 5.9% previously. Obviously, such a strong set of data triggered a procyclical move in markets with the growth yield more defensive part of the stock market in particular lagging and the US 10-year bond yield jumping higher as investors reassessed the path for interest rates.

Right now, the level of nonfarm unemployment is 5.7 million below its February 2020 peak. This is clearly significant progress, something the Fed has highlighted as a prerequisite to start tightening monetary policy.

As such we see the bar as very high for the Fed not to start tapering. However, we don’t think this is going to be a major problem for markets. The Fed should remain very accommodative and will likely remove their foot from the brakes at the first sign of excessive slowdown.

The other key development that took place last week was the change of tone from the Bank of England. The BoE signalled the possibility of upcoming tapering and rate hikes. In fact, the Bank of England lowered the threshold for balance sheet unwind from a bank rate level of 1.5% to 0.5%.

However, when the time comes, as opposed to selling any bonds the Bank will likely let bonds mature and not reinvest the proceeds received initially and this should remain the case until rates are above 1%.

In our view that is unlikely to happen in the next 12 months and possibly much after that. As such, rates are likely to remain at depressed levels for now and this is why we continue to see most value in investment grade and selective BB-rated bonds.

With that let’s move on to the second section of today’s podcast and I’m very pleased to be joined by Damian to discuss the Europe’s Fit for 55 plan.

So, Damian, let’s start by asking you this question. What is exactly the EU’s Fit for 55 plan?

Damian Payiatakis (DP): Thanks, Julien. Pleasure to be here. The European Union has made it clear that in order to transform the region to be more green, sustainable and inclusive in line with its commitment to its net zero ambition for 2050 that what it’s really doing is setting out a blueprint for how the community is going to cut greenhouse gas emissions by at least 55% by 2030 from the 1990 levels hence calling the plan Fit for 55.

The proposed legislation package aims to, as it says, make all sectors of the EU’s economy fit to meet this challenge and to reach its climate targets by 2030 in a fair, cost effective and competitive way.

JL: Great. So how does this fit into other EU sustainability plans and commitments?

DP: Well, really this is the next step in the transition in its overall ambitions and plans. So in December 2019 the EU released its European Green New Deal which has the goal of making Europe the first climate-neutral continent by 2050.

Then in January 2020, just before the real onset of the pandemic, it announced the Green Deal’s Investment Plan which is also sometimes called the Sustainable European Investment Plan. Now this was a commitment to mobilise at least €1 trillion in sustainable investments over the next decade to support this transition.

And then more recently of course the next generation EU recovery funding, which Henk has covered before and again in this month’s edition, has a minimum target of 30% of its €800 million spending target to be focused on climate transition. So this isn’t some crash diet before the holidays or the latest slimming pill but really part of a long term change of lifestyle that the EU is trying to engender.

JL: Now can you elaborate a bit more and tell us what’s included in the proposals?

DP: Yeah, it’s a great question. In short, a lot. The breadth and the scale of the ambitions are impressive, right? The aim is to accelerate reconfiguration of the European economy in terms of how people live, how they travel, how key industries operate, even how the EU trades with its partners.

I mean if we look at the specific, some of the specific sectors renewables are going to be boosted with proposals to make binding that the EU’s energy mix has to be at least 40% in renewables by the end of the decade. And already last year renewables overtook fossil fuels in terms of energy generation for Europe and this is obviously going to further support those renewable energy producers, as well as the adjacent sectors you know, that are going to continue to benefit from this.

If we look similarly at transport, thinking about passenger cars, emissions from new cars are going to have to drop by 55% by 2030 and then fall to zero from 2035 under these new proposals. Now this results in a real significant pressure for hybrids and fully electric vehicles in the EU to be able to come on to stream a lot faster than they have been. And also the underlying demand for technologies, the materials and the charging infrastructure that we’re going to need to have.

And then if we look at other industries, things like aviation or shipping, that previously were partially or either fully exempt from the European Union’s emissions trading systems, they’re now going to have to pay for greenhouse gas pollution by coming in the scope of that trading scheme. And this is going to affect industry dynamics and spur innovation in terms of alternative fuels or more efficient or even electric planes and ships.

And what’s interesting also is it’s not just the industries within the European Union but also how it relates to its partners. So the proposals to have a carbon border adjustment mechanism that’s going to provide some relief for the home companies who face the higher regulations by providing import taxes to the foreign competitors on things like steel or cement or aluminium in the countries that have lower environmental standards.

And lastly, the plan really sets out to support some funding for disadvantaged or vulnerable citizens facing increased costs, right? The EU is looking to avoid further gilets jaunes movements and recognise that those who are least able financially to make the transition really do need support in what’s generally known as the just transition and there’s actually a separate fund for that.

Oh, the one other thing that actually is interesting is that it doesn’t focus solely on climate change. The legislation incorporates support for biodiversity both as a carbon sink for climate change but also as a critical foundation to our food systems.

JL: I think the key question here is will it make a difference?

DP: So, yes, realistically before the legislation comes into force negotiation may take months or even years to gain approval by the European Parliament and national governments and if it’s a positive sign at all both ends of the spectrum are unhappy about the announcement. The greener side wants it to be more green and then some affected industries in countries are already pushing back.

However, even given the timeframes and potential changes in what the final legislative package looks like there are some significant implications ahead for both European citizens and industry. You know, investors should be expecting these and even further policy and fiscal responses to be addressing climate breakdown and they need to be looking at not just the EU, actually many governments are using stimulus packages to address climate change and deliver their own net zero commitments.

And being mindful of these implications of these transition measures be it carbon targets for certain industries, dedicated green infrastructure funding, clean energy task credit, support for transition for workers, all of these are really fundamentally trying to reshape economies around the world in relation to getting to a net zero or a low carbon economy.

JL: Great. And finally, what should our investors be thinking about?

DP: Well, as we’ve noted previously investors should be looking at this really I guess in terms of two lenses. First, looking at the environmental practices of all companies they hold. Even in sectors that are not directly affected or in scope for the legislation there are going to be implications. Every company requires energy, therefore, European requirements for greater renewable energy will affect power cost and consumptions. And this is really where the E of ESG considerations, most notably carbon intensity, is really valuable for investors to be thinking about.

So looking across both the industry sectors but even within industry sectors where energy or environmental considerations are a stronger consideration or component of the assessment that they should be doing.

And then obviously the second part is legislation that’s going to open up new opportunities for new entrants or disruption in specific sectors. We notice some industries above and in the rest of legislation there’s going to be change and across all of those, you know, companies that are providing solutions to these issues and to wider climate mitigation and adaptation are going to be really attractive for long-term growth and that’s something that we renewed actually back at the beginning of the year in our greening the economy market perspectives outlook.

And actually not just there. Throughout Market Perspectives we’ve published this series of articles about preparing portfolios for a transition to a low carbon economy be it explaining physical and transition risks or assessing the attractiveness of fossil fuel companies or carbon footprinting or specific sector opportunities.

And I think as we mentioned the proposed EU legislation will take time to approve and will be implemented and therefore it might feel like, well, let’s just wait to take action until the final changes are in law, sort of what Alex, our Head of Behavioural Finance, would talk about as a bias towards the status quo seeming safer to do nothing.

However, what I would think is like any lifestyle change or addressing climate change itself making smaller changes earlier can have a disproportionate benefit. So really starting by reviewing your portfolio for climate risks and then thinking about opportunities now makes greater sense because it’s going to provide you more flexibility over timing and selecting investments and I think it also may pay to consider portfolio positioning now before market movements and sentiment forces you to make those changes.

JL: Thank you very much, Damian. Definitely a lot to think about and we will certainly have you back to discuss Europe’s spending plans as they unfold.

Moving on to the agenda for the week ahead investors will focus on the July inflation figure in the US. The consensus expects a headline reading of 5.3% year over year, a slight deceleration from the 5.4% reported in June. Another strong reading would likely add fuel to the fire of those expecting the Fed to rush tapering. However, it could also raise concerns about future growth and somewhat counterintuitively lead to lower yields.

Apart from that it should be a relatively quiet week on both the macro and the micro front as most companies now have reported earnings.

This concludes this week’s podcast. We will be back next week and in the meantime we wish you all the best and for those enjoying some time off a well deserved rest.