Oh NO…2


A recent ruling by the UK Supreme Court has set a deadline of the end of the year for plans to improve air quality in the UK and tackle dangerously high levels of Nitrogen Dioxide (NO2). Currently diesel cars produce less CO2 but emit much more NO2 and it is estimated that diesel road traffic is responsible for 40% of London’s NO2 emmissions. Current UK legislation has focused on reducing CO2 emissions whilst Europe has instead focused on reducing NO2.

According to the AA, this could lead to the imposition of extra charges on diesel car and van drivers. London Mayor Boris Jonson has called for urgent action. London is already introducing an Ultra-Low Emission Zone in 2020 with a charge of £12.50 and other cities, including Bristol are considering similar schemes.

Which got us thinking. Legislation, like the above, can create extra costs for businesses, such as city centre retailers, restaurants and their suppliers along with smaller tradesmen and taxi drivers. On the other hand it can also create investment opportunities. We are invested in a number of companies which are involved in vehicle engine design or fuel efficient systems that should benefit from increasing European emission legislation.

What have we been watching?

Talking of cars, it looks as if petrol prices should be coming down, giving another small but helpful spur to UK consumer spending. Brent oil slipped to a six month low of under $50. This has been driven by a combination of factors but basically, production is continuing to grow while demand is slowing. China, the world’s largest oil importer is slowing. However, some OPEC members such as Saudi Arabia and Iraq are lifting production while there is potentially the additional Iranian production to come back into the market following last month’s nuclear deal.


In the UK, consumer confidence should be supported by the housing market. Nationwide data showed house price growth picked up again in July although its chief economist flagged the risk from the first interest rate hike. ‘Buyers often do not realise the impact of a rate rise until the first one actually happens’. Elsewhere, despite a slight dip, UK service sector activity remained strong. The BoE turned over a new leaf with ‘Super Thursday’ following criticism about its inconsistent message on forward guidance for UK interest rates. While it was the first time since December that the committee had not voted unanimously to keep rates unchanged, most analysts had been expecting a bigger split than 8-1. If anything the minutes were unexpectedly dovish suggesting an interest rate rise was unlikely until next year. The inflation outlook is more benign given the weakness in oil price and recent strength in Sterling. Other key messages to come out of ‘Super Thursday’ were that, the increment of future interest rate rises might be smaller than previously, so 0.25% instead of 0.5% while rates could normalise around the suggested ‘new norm’ – 2% over the next two or three years.

Market trading volumes remain painfully thin with most fund managers away on summer holiday or affected by last week’s tube strike. We expect markets to remain volatile in the short-term with continued gyrations in commodity sensitive stocks likely on Chinese news flow.

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In Europe, the National Institute of Economic and Social Research estimated that Greece needs a €95bn debt write-down, equivalent to 55% of GDP if it is to avoid a severe, prolonged recession and default. This is higher than the IMF write-down estimate of 30% of GDP. Despite the problems in Greece, business growth in the Eurozone accelerated in July.

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In China, equities rallied helped by the ‘national team’, a coalition of state-owned financial institutions. These appear to have stepped into the market at one point last week when the ChiNext Composite Index, which tracks Shenzen traded technology biased smaller companies, came close to levels that would have triggered losses on equity-linked structured products and possibly started a chain reaction. Goldman Sachs has estimated that the national team has so far spent $144bn in supporting the wider Chinese equity market out of a war chest of some $322bn. Despite the support the market remains almost 30% below its mid-June peak.

The Chinese authorities have undertaken a major diplomatic push to get the Renminbi included in the IMF’s Special Drawing Rights currency basket. However, an IMF report has suggested that, while a significant currency in terms of international trade that the Renminbi did not meet criteria that it should be freely useable and that possible inclusion should be delayed until September 2016.

The weekend saw further evidence of the challenges faced by the Chinese economy. July exports dropped by 8.9% yoy, some way below forecasts of a fall of 0.3%. Elsewhere, provider prices fell 5.4%, the 40th straight month of price falls, it is also increasingly likely that 2015 will be the first year in 17, where Chinese car sales may fall. This points to further Chinese stimulus in the near-term as the chances of 7% economic growth look increasingly stretched.

Bonds
Bond and currency markets are continuing to reflect the increasing likelihood of the first US interest hike in September. For example, the JP Morgan emerging market currency index hit its lowest level on record while the divergence between US and Eurozone monetary policy saw the spread between the yield on US two year Treasuries and equivalent German Bunds stretch to more than 100 basis points, a level not seen since the last financial crisis in 2007.

Finally, it’s not all gloom out there. Consumers would appear to be benefiting from a ‘double whammy’ with lower petrol prices and global food prices at a six year low following significant falls in the price of a range of soft commodities. The lower oil price should also provide a more benign inflation outlook. Every cloud has a silver lining unless that cloud happens to be Nitrogen Dioxide!

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