Look for More Defaults, Consolidations in Shipping Sector Next Year

Fitch Ratings is holding on to its negative outlook for the world’s shipping sector in 2017, due to subdued demand growth that is likely to worsen overcapacity, apply pressure on freight rates, and push more consolidations and defaults.

Tanker shipping will experience slightly less stress than dry bulk and container shipping, said Angelina Valavina, senior director of corporates, and Simon Kennedy, senior analyst at the ratings firm.

A lot of container shipping and tanker shipping firms had enough cash for short-term maturities at their most recent reporting date, but are reliant on uninterrupted access to bank funding to cover negative free cash flow, the analysts said.

“Therefore, the filing for receivership in August by Korea-based Hanjin Shipping, the seventh-largest container shipping company in the world, may have far-reaching ramifications,” Valavina and Kennedy said. “In particular, creditors' withdrawal of support may indicate a reassessment of the financing landscape, where secured bank funding for new vessels has remained relatively accessible even as market conditions have deteriorated.”

Fitch expects to see more mergers and acquisitions activity and defaults in the short- and medium-term, which will “…only restore equilibrium and boost freight rates if they prompt capacity reduction,” the ratings firm said. In the container shipping segment, Fitch foresees consolidation to affect companies in the entire sector, “…with smaller operators focusing on survival through increasing scale while market leaders such as Maersk Line defend their market position through M&A.”

Look for likely defaults among companies with weak liquidity and limited access to bank funding, Fitch said.

– Nicholas Stern, editorial associate

NACM’s Credit Managers’ Index Expands, but Data Shows Mixed Signals

The latest NACM Credit Managers’ Index (CMI) for November is mostly on track with prior months' readings, with post-election jitters sending some mixed signals of enthusiasm in some sectors and trepidation in others. Overall, the CMI score is slightly down at 52.9 from October’s reading of 53.5, but still remains in expansion territory (readings over 50).

“The data from the CMI this month reflects this shifting attitude, but there is an additional caveat to be aware of,” noted NACM Economist Chris Kuehl, Ph.D. “The response to the survey was less robust than it has been in past months. This creates some concern that readings might be skewed as compared with where they have been and might be in future months.”

An interesting dynamic to this month’s reading is found in comparing the favorable factors with the unfavorable ones, where overall favorable factors expanded beyond September’s highs, while unfavorable factors caused the most worry as they dipped below expansion territory to the lowest level so far this year, he said.

The approaching holidays have affected the retail sector as consumers have been active but targeting discounted items that bring in lower profits, Kuehl said. The manufacturing sector has been cautious as companies girded for major changes to the industry in the run-up to the election, no matter who won. The service sector stayed mostly consistent with previous months’ readings as sales increased, new credit applications fell and dollar collections improved. “The sense is that credit requests tend to flag a little this time of year as retailers have already done most of their ordering,” Kuehl explained. “Now, they will be more likely to spend to catch up with the credit they already have.”

Data for rejections of credit applications reflected a drop below the expansion level, while the dollar amount beyond terms category fell off and the accounts placed for collections category declined slightly, he said.

– Nicholas Stern, editorial associate

Developing Economies Unlikely to See Prior Growth with More Capital Spending, Trade

Developing economies and the businesses operating within them, particularly those in industrial production and exports, will likely face in the foreseeable future an uphill battle to realize the growth rates they enjoyed in past decades, Wells Fargo predicts. That will be the case even if robust capital spending reignited trade on a global level, the bank’s analysts said in a new report.

Global trade volumes, along with industrial production, have been mostly flat on a year-over-year basis in the June through August period, but developing economies appear to have been more negatively affected during the current economic cycle, noted Jay Bryson, global economist, and E. Harry Pershing, economic analyst, both with Wells Fargo. This trend follows a previous decade that saw developing economies benefitting at the expense of advanced economies, in part, as companies off-shored their production facilities. Between 2011 and 2015, however, industrial production in the developing world was cut in half relative to prior years, while export volumes have slowed.

The banks’ analysts believe that developing nations are more dependent on foreign trade than advanced-economy nations, which would most likely benefit more from any acceleration in global capital spending that may appear on the horizon. “Specifically, spending in the rest of the world on capital goods accounts for 2.8% of value added in advanced economies, whereas the comparable ration in developing countries is 2.2%,” Bryson and Pershing said.

Likewise, international trade in raw materials and intermediate inputs is particularly important for developing nations; 9.2% of the value added that is generated in developing economies is accounted for by final domestic demand in foreign economies, compared to 4% in advanced economies, the Wells analysts said. “In short, it appears that the developing world is more dependent on the secular forces of globalization and its positive effect on global trade volumes than are advanced economies,” they said.

– Nicholas Stern, editorial associate

Illinois Appellate Court Affirms Decision to Dismiss Mechanic’s Lien Claim

A recent decision by the Appellate Court of Illinois, Second Judicial District, is likely bad news for suppliers and subcontractors in the state, as it may erode the mechanic’s lien act protections for work on commercial projects that involves property improvement subject to an easement and title retention agreement.

The ruling was a surprise to Connie Baker, CBA, director of operations for NACM’s Secured Transactions Services (STS). “It will add another layer of research for credit professionals to look over easement agreements and to know when something could be considered removable and, therefore, non-lienable,” she said.

The American Subcontractors Association’s (ASA) Subcontractors Legal Defense Fund filed a “friend of the court” brief in support of the unpaid subcontractor in this case. Eric Travers, a partner with the Columbus, OH, law firm of Kegler, Brown, Hill and Ritter, ASA’s general counsel, described the appellate court’s decision as “discouraging” and “at odds with the public policy of the Illinois Mechanic’s Lien Act,” noting that the rationale used by the court could “deprive untold numbers of subcontractors and suppliers on future projects of mechanic’s lien rights the Illinois legislature granted.”

The appellate court affirmed on Aug. 9 a summary dismissal of subcontractor’s mechanic’s lien claim in AUI Construction Group, LLC, vs. Louis J. Vaessen, et al. (For more details from NACM’s Secured Transaction Services on the case, click here.) According to court documents, AUI Construction Group entered into a cost-plus agreement with Postensa Wind Structures U.S., LLC, to build a 500-foot-tall wind power plant in 2011. A memorandum of the wind park easement agreement between the project owners and developers was recorded on Dec. 22, 2011.

After completing the work in mid-2012, AUI ultimately billed Postensa for more than $3 million. In late 2013, after Postensa filed for bankruptcy, an arbitrator awarded AUI $3.5 million, including attorney’s fees. In 2014, AUI filed a foreclosure complaint on a mechanic’s lien against the project’s owner, the estate of Louis and Carol Vaessen, asserting the estate’s property should be sold at public auction to satisfy its lien.

Earlier in the year, an Illinois circuit court summarily dismissed AUI’s lien claim, holding AUI’s 500-foot-tall wind power plant was removable, was not an improvement to real property under the state’s mechanic’s lien act and was a non-lienable trade fixture.

“As the intent of the parties is the most important factor in determining whether an item is a removable trade fixture or a permanent improvement, the easement agreement establishes that the tower was a trade fixture,” the appellate court said in its ruling.

– Nicholas Stern, editorial associate

China’s Rebalancing Act Sees Limited Progress

While China has made advances in rebalancing its investment-driven economy to one that is consumption-driven, that progress is limited and risks are increasing, according to credit insurer Atradius.

Investments and exports have driven the Chinese economy for decades. As the second-largest economy in the world, China had maintained GDP growth of 10% per year for nearly 30 years. The country’s growth policy was supported by large numbers of workers moving from rural areas to the cities, with only modest increases in wages. Its export policy was supported by the undervalued renminbi. China’s economy remains highly reliant on investments, which have become increasingly credit-driven.

Future growth is not sustainable under this model. The Chinese leadership has sought a transition whereby consumption becomes the driver for growth. In 2013, the Third Plenum meeting of the Central Committee proposed reforms that included an increased role of the market in the allocation of resources, as well as plans to liberalize exchange and interest rates.

In China, about 45% of GDP is devoted to fixed capital investment, a level well above neighboring East Asian countries. Overinvestment and excess capacity in the construction sector and industries such as steel and cement have contributed to a leveling off of China’s productivity. Investment-driven growth has also impeded the growth of personal consumption. The share of household consumption in GDP reached 35.5% in 2010, a low that has increased only slightly since then. (In the U.S., the consumption share is 68.8%.) Chinese authorities believe that if they can grow private consumption, it will foster employment growth and reverse income inequality.

Progress has been made. The size of the industry sector has declined over the past few years, while the services sector has grown, favoring a consumption-driven economy. China’s trade balance has declined, and steps have been taken in opening up the capital account and lifting the peg of the renminbi. Consumption rates are kept down, however, by high savings rates. Chinese families are forced to save large amounts of disposable income due to the lack of developed health care and a pension system. They must self-insure.

After the financial crisis of 2008, consumption and investments were equal partners in GDP growth, with consumption pulling forward in 2011. But the share of total investments in GDP remains high at 45%. While consumption increasingly drives growth, its share in GDP has not risen extensively since its low in 2010.

Further steps toward rebalancing are necessary, according to Atradius. The risk lies in China’s high growth rate, rather than its total debt. The debt problem can be alleviated if the savings rate goes down, if social welfare is extended in order to reduce the necessity of households to save as a precautionary measure. Overcapacity issues in the coal and steel industries have been addressed, but a more comprehensive and centrally led approach is needed, the credit insurer said.

– Adam Fusco, editorial associate

Rebounding Commodities Expected to Keep Asian Nonfinancial Corporate Sector Stable in 2017

Analysts at Moody’s Investors Service anticipate that recovering commodity prices, sound macroeconomic conditions and market liquidity likely will keep Asian nonfinancial corporate credit quality in stable territory in 2017.

"We expect growth in global and regional economies to stabilize in 2017, which will mitigate the risk of any material deterioration in the credit quality of rated Asian corporates," said Gary Lau, a managing director in Moody's Corporate Finance Group. "That said, we expect a continued trend of modest negative-biased rating actions in 2017, mainly because of still-high financial leverage for many companies and company-specific reasons," adds Lau.

Moderate earnings growth should help improve corporate leverage next year, though it should remain high, Moody’s predicts. Monetary easing, bank funding and “strong onshore markets” should redound positively for adequate domestic liquidity. "On the other hand, capital flows will likely remain volatile due to prolonged uncertainty over potential U.S. rate hikes,” said Laura Acres, a managing director in Moody's Corporate Finance Group. “Asia-bound portfolio flows continue to decline, and a continuation of this trend could weaken Asian currencies and fuel further credit market volatility." Protectionist policies in advanced economies also place trade-reliant nations and exporters in the region at risk.

Companies in India should see the strongest profit growth in 2017, boosted by capacity add-ons and higher commodity prices, while China’s expected 6.2% GDP growth and market liquidity may support moderate revenue and cash flow growth, though the country’s substantial investment needs could further heighten financial leverage, Moody’s analysts predict.

Moody’s outlook by industry is stable for China’s property developers, as it is for the Asian marketing, telecommunications and power sectors, analysts said. The outlook for Asian steel is negative, however, as the ratings firms anticipates declining production and low profitability will weaken earnings in the sector.

– Nicholas Stern, editorial associate

Lower Liquidity Stress Index Reflects Strength in Credit Market

Moody’s Liquidity Stress Index lowered to 6.2% in the middle of November, down from 6.6% at the end of October. This is the seventh consecutive month the index, which falls when corporate liquidity appears to improve, showed improvement and indicates ongoing strength in the credit markets, according to the latest SGL Monitor report from Moody’s Investors Service.

“The LSI’s improving trajectory is the result of a confluence of factors, including healthy credit market access, which has helped speculative-grade companies enhance investment funding capacity and proactively manage their balance sheet needs, including refinancing upcoming maturities,” said Moody’s Senior Vice President John Puchalla. “The index has also benefited as the level of rating activity in the energy sector continues to moderate, following a large number of rating actions in late 2015 and early 2016.”

Speculative-grade companies may be benefitting from an environment of ongoing low interest rates, however, rather than improved fundamentals. Risks remain, Puchalla said.

Downgrades of speculative-grade liquidity ratings outnumbered upgrades by seven to three so far in November and were dispersed across industries. The ratings moves did not affect energy companies. The downgrades came about from operational and other issues specific to those companies.

Speculative-grade companies remain at low risk of violating their debt covenants, Moody’s said, as indicated by the rating agency’s Covenant Stress Index, which enjoyed a sixth straight monthly decline, landing at 4.3% in October from 4.4% in September.

– Adam Fusco, editorial associate

Venue Reform Likely a ‘NonStarter’ in 115th U.S. Congress

Overshadowed on Election Day was that fact that, with the Republican Party maintaining of the majority in both houses of the U.S. Congress, committees responsible for potential changes to the U.S. Bankruptcy Reform will be essentially unchanged. This renders venue reform a virtual impossibility in 2017.

“Targeted, surgical, noncontroversial” federal bankruptcy changes appear very much in play, according to NACM Lobbyist Jim Wise, co-founder of Pace LLC in Washington, D.C. The areas of preferences and 503(b)(9) are the most likely to change to the benefit of unsecured creditors in the likelihood that such legislation catches on.

Grand-scale code changes, however, should also not be expected. The appetite to “crack open a complicated Bankruptcy Code” or take on something controversial is simply not apparent, Wise says. Among the more controversial changes would be limitations to venue shopping on the part of debtors in Chapter 11 cases. NACM recommended in its most recent Legislative Brief that Congress "require the debtor to file in the jurisdiction of its primary place of business or its principal assets within 180 days of a bankruptcy filing,” as it would allow more access to cases by businesses, employees and local vendors who are owed money, as well as have the case administered by a court that is familiar with the company and its operations.

Venue reform has garnered support from some federal lawmakers as recently as this spring, notably from those representing Texas and Iowa. However, significant change to venue language would divert many cases (re: revenue) from the areas with the two busiest and experienced (also most debtor-friendly in the minds of creditors) bankruptcy courts in the country: Delaware and the Southern District of New York. Discussions between lobbyists and congressional staffers from these areas on the topic did not prove fruitful this year, and no lawmakers from these areas with previous and continuing Judiciary Committee assignments of note lost seats on Nov. 8.

- Brian Shappell, CBF, CICP managing editor

China Launches Answer to Dying TPP Pact

Perhaps the most profound policy change in the near future following President-Elect Donald Trump’s surprise victory is that trade pacts will be few and far between and existing ones may well be up for review.

The United States has used its market as leverage for years—trading access to domestic markets for favors that were arguably as geopolitical as they were economic at times. The Trans-Pacific Partnership (TPP) was supposedly aimed to isolate China while opening emerging Asia-Pacific markets. The idea was to blunt China’s influence in the region with a trade pact that pulled countries away from Beijing.

If ever there was a plan that backfired, it would be the TPP. Its slow death, capped off by Trump’s successful campaign, which included promises to shut down the deal that included 11 other nations and already faced much opposition even if Hillary Clinton had won as expected, gave China plenty of time to react. A version of a Chinese-led Regional Comprehensive Economic Partnership (or RCEP) that favors it and excludes the U.S. has appeared suddenly. A key difference is that China need not go through an approval process or much public debate to get it up-and-running. TPP members like Malaysia and Australia have already hinted at interested in joining onto the RCEP if the Trump victory completely derails the long discussed trade pact, as is expected.

- Chris Kuehl, Ph.D., NACM economist and co-founder of Armada Corporate Intelligence

Property Markets Are Sound, though Supply/Demand Imbalances Linger in Some Hotel Markets

Fundamentals in the U.S. property markets improved in the second quarter, while high levels of construction in four major hotel sector markets since 2014 have led to supply/demand imbalances, according to new Moody’s Investors Service analysis.

The rating agency said its Red-Yellow-Green scores for the major U.S. property markets, including the hotel, retail, multifamily and industrial sectors, increased slightly in the second quarter to Green 70 from Green 68 in the prior quarter. The Red-Yellow-Green scoring system uses Moody’s near-term outlook for new construction and absorption. Scores indicate which markets are most (Red) or least (Green) vulnerable to short-term declines in occupancy and rent, which are indicators of Commercial Mortgage-Backed Securities (CMBS) loan default risk.

"At the end of the second quarter, our scores were Green for all the major U.S. commercial property types except hotel and suburban office, whose 'Yellow' scores indicate these markets are somewhat more vulnerable to decreasing volume," said Moody's Director of Commercial Real Estate Research Tad Philipp. "Multifamily remains the highest-scoring sector, with New York and Seattle both seeing improvement, including the pace of construction dropping below 3% of existing inventory."

The central business district office segment dropped for the third consecutive quarter, despite Seattle’s 15-point gain, while the suburban office segment declined by 18 points as demand decreased and construction increased, Moody’s analysts said. The retail sector saw a one-point gain, realizing 13 consecutive quarters with a Green reading, as the vacancy rate dropped to 10.9% in the second quarter from 11.2% in the first quarter. The industrial composite score increased as vacancy rates dropped. The hotel composite score also improved four points on revenue per available room growth despite softening demand.

All is not well in all U.S. hotel markets, however, as high construction rates in New York, Houston, Miami and Dallas hotel markets since the end of 2014 have led to a declining Red-Yellow-Green score for the sector, which stood in upper Yellow territory by the end of the second quarter, Moody’s said. "The driving force behind the deterioration in the hotel sector's Red-Yellow-Green score is projected forward supply," Philipp said. "The sector has seen a significant expansion of construction activity, with its score starting to fall after supply exceeded the long-term national average of approximately 2.0% in the fourth quarter of 2014."

– Nicholas Stern, editorial associate

Egypt’s Currency Moves Show Promise, with Possible Inflation, Social Risks

Recent moves by the Central Bank of Egypt to devalue the Egyptian pound and the possibility it will float the currency will work to improve the nation’s sovereign credit profile (‘B’/Stable). But in a new report, Fitch Ratings believes these adjustments may be tempered by the social and political risks Egypt faces.

Egypt’s Central Bank also last week raised its policy rate by 300bp to tighten monetary conditions, while the currency has since dropped further following the Central Bank’s March 13% devaluation of the pound, wrote Toby Illes, director of sovereigns at the ratings agency, and Mark Brown, senior analyst. The Egyptian government has also reduced fuel subsidies. The moves will likely be viewed favorably by the International Monetary Fund (IMF) board and could pave the way for it to approve the $12 billion Extended Fund Facility announced in August.

“We expect the IMF board to approve the deal when it meets to discuss it on Friday, Nov. 11, and release the first tranche of funding,” Fitch analysts said. The ratings agency believes the IMF funding should support the central bank’s foreign reserves stock and potentially lead to international bond issuance.

“Over the medium term, the exchange rate shift should also support external rebalancing, raise portfolio inflows, and ease FX shortages, which have weighed on economic activity, including domestic manufacturing,” Illes said.

However, FX changes could still be risky in that they could increase inflation—already at 14.1%, year-over-year, in September—and lead to exacerbated social unrest, the analysts said. “The fiscal impact of devaluation is mixed. Public sector external debt is low as a percentage of total public debt, but the weaker currency will increase the size of the debt, and the interest rate rise will push up the interest payment bill yet further. The weaker currency will also put pressure on the government's import costs. But the increase in fuel prices and the likely approval of the IMF program will help control spending (although the IMF loans themselves will also add to debt),” they said.

– Nicholas Stern, editorial associate

Turmoil Greets Trump Win

Once again, the polls and the prognosticators got it wrong and, once again, the reaction has been turmoil. The financial markets were convinced that the election would be a narrow victory for democrat Hillary Clinton, but as the races in the battleground states went to republican Donald Trump, it became obvious that this was going to be an upset win for the latter.

At this point, there is very little known about what a Trump presidency will mean, as this was a campaign very light on talk of policy specifics. Markets expressed great concerns initially, but then stabilized for a time. Either way, it is going to take a while for everyone to digest a result that surprised most analysts.

It is assumed that part of the Trump administration plan will be an aggressive attack on trade. Stocks that took the biggest hits were those that are engaged in exports. During the campaign, there were promises to eliminate existing trade deals, such as NAFTA (North American Free Trade Agreement). This leaves virtually no chance that newer proposals, like the Trans-Pacific Partnership, will ever see the light of day. There was also talk of establishing high tariffs on imported goods, especially those from China. If that materializes, it could impair U.S. businesses from many export opportunities.

The Trump win also could influence Federal Reserve interest rate decisions. The expectation was that rates would rise again in December, but now all bets are off. Given Trump’s likely appointments, the Fed may find itself preoccupied with its own survival and playing a reduced role as economic stimulator as a result.

As for Trump’s economic plans, they were largely assailed during summer analyses by economists as a path to recession in the U.S. and even for the global economy. Moody’s Analytics, for example, predicted it would shrink the domestic growth to 0.6% from 2%, although there would likely be a small reduction in unemployment along with it.

Traditionally, much that is said in any campaign is abandoned once the real governing starts—pragmatism takes over. But there has been little about this campaign that could be described as traditional. It remains to be seen how these issues really play out. How the new administration actually addresses trade will be the first signal.

The U.S. is as divided as it has been in generations, which can perhaps be said about most every nation in the world. There are many interpretations of this phenomenon, but at the heart of most of this has been the issue of change. Broadly speaking, the people who have been supporting the Trump vision do not like the changes that have taken place in the world. Those voters, often older, have seen their jobs go to robots and overseas workers and want the old system back. This split may be reaching its peak simply due to demographics. The Millennial population will be the dominant political force for the next 35 years, but they have only barely started to play a role. The eventual transition from one to the other, like it has been in parts of Europe, could be extremely ugly.

– Chris Kuehl, Ph.D., NACM economist

Moody’s Assesses Climate Risk for Sovereigns

Scientists may debate the implications of climate change, but weather events and trends in climate can affect not only the environment, but sovereign credit as well.

Moody’s Investors Service recently described how it incorporates climate risk in its credit analyses and ratings. In the new report Environmental Risks – Sovereigns: How Moody’s Assesses the Physical Effects of Climate Change on Sovereign Issuers, the agency outlined its key rating factors for climate events that, when taken together, have an impact on a country’s ability and willingness to repay its debts. These include economic, institutional and fiscal strength, as well as susceptibility to event risk.

Moody’s classifies climate risk under two categories: climate trends and climate shocks.

 Climate trends include such phenomena as global warming and ocean acidification. They span multiple decades and are less likely to have a discernible impact on credit, since a country will have time to either adapt to the change or take steps to lessen its effects. Due to its nature, however, a climate trend can result in irreversible conditions and can bring about long-term changes in economic and social spheres. They also increase the probability of climate shocks.

Climate shocks, though they are one-time events, can cause significant disruption to economic activity. These include droughts, floods, hurricanes and wildfires.

A country’s susceptibility to climate on its sovereign credit depends on its exposure and resilience to such events. Higher-rated sovereigns are better able to endure such shocks through their diversified economies and stronger infrastructure. They also can carry a higher debt burden at more affordable interest rates. A sovereign that is dependent on agriculture and possesses a weaker infrastructure and smaller fiscal capacity has greater susceptibility to the effects of climate.

– Adam Fusco, editorial associate

Hungary Sees Sovereign Bond Upgrade on Falling Debt, Improving Employment

A declining debt burden, structural economic improvements and a more resilient credit profile have led Moody’s Investors Service to recently upgrade Hungary’s long-term government bond ratings to Baa3 from Ba1, with a stable outlook.

“The stable outlook on Hungary's Baa3 rating reflects the balanced risks to the credit rating over the coming years,” noted Moody’s analysts, including Evan Wholmann, assistant vice president with the ratings agency. “Moody's expects the greater predictability in policy making seen in the last couple of years will be sustained, resulting in a more stable, growth-friendly policy environment in Hungary than in the past. At the same time — and while we expect some further improvements in the country's key fiscal and external metrics, in some areas such as the public sector debt burden — the country will continue to lag its Baa-rated peers.”

The Hungarian government has committed, through primary surpluses, resources to reducing its debt burden that should continue into the future, Moody’s analysts said, as they expect the debt-to-GDP ratio to decline to about 72% of GDP next year from a peak of around 81% in 2011. Also, the government’s debt has a lesser share in foreign currency, which helps increase Hungary’s resiliency in the face of foreign exchange rate shocks.

Also, Hungary’s economy should grow at a rate of 2% to 2.5% in coming years as it benefits from some of the largest fund inflows from the EU to Central and Eastern Europe over the next five years, Moody’s said. A public sector work program has driven up employment rates to 67.1% in the third quarter from about 55% in 2011.

The “bread basket” nation has also benefitted from a persistent current account surplus to the tune of some 3% of GDP over the past few years, compared to a 7% deficit in 2008, analysts said. “This reflects a robust and sustained improvement in the trade balance and gains in export product diversification,” Wholmann said. “Furthermore, Hungary no longer relies on external financing as its capital account benefits from the growing absorption of EU funds, such that the combined current and capital account surplus reached around 10% of GDP in the last quarter of 2015.”

– Nicholas Stern, editorial associate

September Trade Deficit Narrows on Civilian Aircraft Exports

The U.S. trade deficit in goods and services decreased in September by $4.1 billion to $36.4 billion, a 19-month low, fueled mostly by American firms’ ramped-up exports in services.

The deficit decline was larger than analysts predicted, even as exports have been buoyed in recent months by surges in soybean exports, noted Wells Fargo Global Economist Jay Bryson. A lackluster harvest in South America benefited American soybean producers earlier in the summer, though soybean exports have since declined by some $2 billion in September.

“Looking forward, we expect that net exports will again exert headwinds on overall GDP growth,” Bryson said. “The one-off surge in soybean exports will not be repeated in coming quarters, and growth in many of America’s major trading partners remains lackluster. On the other side of the ledger, continued modest growth in domestic demand likely will cause import growth to accelerate somewhat.”

In September, capital goods exports surged with $1.4 billion in civilian aircraft trade, while consumer goods exports rose by $738 million, according to the Department of Commerce.

Imports meanwhile dropped by $2 billion as petroleum imports were mostly flat in September and imports of capital and consumer goods declined, Commerce said. “The decline in capital goods imports is consistent with the weakness in business fixed-investment spending in recent quarters,” Bryson said. “Given that personal consumption expenditures continue to grow, we view the $837 million decline in consumer goods imports in September as being somewhat of an aberration.”

– Nicholas Stern, editorial associate

U.K. May Face Downgrade if Trade Deal With EU Falls Short, Takes Too Long

Brexit has hampered the U.K.’s medium-term economic outlook, but Moody’s Investors Service believes the scale of Brexit’s damage to the U.K.’s growth prospects will depend on whether the trading relationship with the European Union (EU) remains similar to what it has been, as well as how long it will take to strike a new deal with the EU.

“We would downgrade the U.K.'s sovereign rating if the outcome of the negotiations with the EU was a loss of access to the Single Market, as this would materially damage its medium-term growth prospects," said Kathrin Muehlbronner, a Moody's senior vice president and co-author of a recent report on the topic. "A second trigger for a downgrade would be if we were to conclude that the credibility of the U.K.'s fiscal policy had been tarnished as a result of Brexit or other reasons." The U.K. government's Autumn Statement, which is slated for Nov. 23, will likely give significantly more clarity to this issue, Moody’s analysts said.

Moody’s current expectation is that the U.K. will eventually enter into some form of trade agreement with the EU, most likely in a series of accords that provide access to the EU market for goods with more limited access for services, especially financial services.

Analysts anticipate lengthy negotiations, however, with the government starting the exit process by as late as March 2017; even the two-year deadline set by the Lisbon Treaty may be too little time to finalize the process.

“But once negotiations start, the agency expects that the spirit in which they are handled by both sides will offer important insights into the likely outcome,” Moody’s said. Complex and challenging issues to be ironed out in the deal include global trade, immigration and regulation. “Given the magnitude and complexity of these decisions, the risk is material that some might damage the U.K.'s economic or fiscal strength.”

– Nicholas Stern, editorial associate