Fed rate decision catches markets by surprise

Copper prompts rally in miners

Resources companies are pushing the FTSE index higher this morning, particularly miners, which are benefiting from a spike in metals prices. Copper staged a surprise 1.5% rally overnight helping the likes of Glencore, Antofagasta and Fresnillo, which gained between 2.5% and 5%. On the other end of the scale are banks, insurers and retailer Next, which reported a decline in profits, all of which are encumbering the rally. But the big news was last night's Fed announcement, which has shaken up the US Treasury market.

Fed rate decision catches markets by surprise

The markets didn’t expect much by way of a surprise from the Federal Reserve yesterday, the assumption being that the central bank would keep rates unchanged and that comments would indicate a relatively slow growth in the US economy. And while the bank obliged on the two main issues, the big surprise came with the announcement that there would be no more rate increases this year and potentially only one between now and the end of 2021. 

What spooked bond and currency investors even more was the Fed’s decision to slow down the reduction of its bond portfolio from May and to completely stop it in September. The bond issues were brought in after the crisis in 2008 to help boost liquidity in a system in which lending was seizing up and the Fed has been gradually reducing the bond issuance as the US economy stabilized. 

This move more than the rate hike indicates the Fed’s true level of caution not only about the state of the US economy but also the danger that banks may find themselves in again. Bond yields on 10-year Treasuries were the first to react, dropping to the lowest level in over a year, while the dollar weakened against most major currencies. Gold also reacted with a rally, pulling in safe haven investors nervous about the decline in the US economy.

US elections and China

In a comment that has yet to be digested by the markets President Trump said that he plans on leaving trade tariffs on China in place for a substantial period of time to make sure that China complies with a trade deal that has yet to be put in place. The rhetoric on China is getting slightly harsher as the President starts touring US states as part of his election preparations and there is likely to be more of it over the months to come as the pre-election battle intensifies. In Europe the comments proved particularly negative for German companies, which was reflected in a slide in the DAX of 0.43%. Trump’s comments come ahead of the next round of talks that is due to take place in Beijing next week.

Next and Ted Baker’s profit slump

Next has stuck to the guidance that it issued in January for a fall in profits this year. More interestingly, it has provided a refreshing amount of detail about its longer-term prospects.

Management has put together a stress test that indicates that Next could generate £12bn of cash over the next 15 years -- even if sales at its bricks and mortar stores slump by 10% a year.

It's certainly an optimistic scenario and depends on a lot of swing factors going the right way for Next. But it makes for interesting reading and shows the company has a way out of its current profit-growth quagmire.

To hit a £12bn cash goal, Next would have to continue to grow its online offering quickly, while enjoying a substantial reduction in rental costs, among other assumptions.

Next's online business is certainly performing well. It isn't some bit player these days and it's pleasing to see its operating profits jump 14% in 2018 to make it by far the company's biggest earnings contributor.

The online business has plenty of potential to keep growing overseas, while the existence of some physical stores will complement the offering at home.

In the short term, Next will have to contend with a tough consumer backdrop. Over the longer term, execution will be everything if it wants that rosy 15-year scenario it outlined today to come true. Getting there won't be easy, but it's by no means impossible.

Ted Baker has lost much of its luster in the past 12 months and it faces an uphill battle regaining its status as a high street star.

Gross margins shrank by 2.7 percentage points last year, indicating just how much discounting was required to keep shoppers interested.

The company's outlook statement, while light on detail, indicates that pressure on margins is continuing amid 'elevated levels' of promotional activity.

Ted Baker has also revealed that its internal investigation into Ray Kelvin's conduct cost it £1.1m. Harder to judge is how much the scandal has reduced the value of the Ted Baker brand.

Investors will have to wait until the next trading statement, due in June, to get a better handle on how much the scandal has impacted sales.