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Jump in US rates and end of eurozone QE will hurt investors, says UBS chairman

Investors are dangerously unprepared for a sharp rise in eurozone bond yields when US interest rates march higher and European quantitative easing ends, Axel Weber, chairman of UBS and the former head of the Bundesbank, has warned.

The jump in US rates could spark big jolts in the markets as the long spell of aggressive monetary easing across the globe has left many investors off-guard over a swing in the global rate cycle, he added.

“I don’t think we will have increasing divergence among the major central banks in the world for much longer,” Mr Weber said, predicting that Europe would follow the US with a rate rise by next September at the latest. “I think the ECB is closer to slowing its current quantitative easing programme than many in the market expect.”

The comments by Mr Weber are likely to be closely watched in the markets, not least because he led the German central bank between 2004 and 2011 and served on the governing council of the ECB.

In recent weeks, benchmark 10-year Treasury yields have risen sharply on expectations that Donald Trump’s new government will launch policies to boost US growth as well as the strong likelihood that the Federal Reserve will raise short-term interest rates this month.

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Until now, the eurozone has not seen a similar swing in rates as short-term rates have stayed low — or even negative in some markets — while the ECB has been engaged in aggressive QE, including extensive bond purchases.

But Mr Weber predicted that the ECB would end its bond purchases sooner than many investors had assumed, sending the eurozone yield curve higher. “A large part of the market is uni-directionally positioned and it is positioned in a direction where you will have to take off some of those positions over the course of 2017,” he said.

Mr Weber also voiced support for Mr Trump’s plans to move away from only monetary stimulus toward more structural measures and fiscal stimulus, such as large-scale infrastructure projects. He aired concern that US companies with international operations could be negatively affected by the president-elect’s plans to alter trade agreements.

He warned that political uncertainty would be a key factor driving financial markets in 2017, and suggested that financial institutions would need to adopt a strategy of maximum “optionality” to prepare for multiple outcomes in the looming votes in the European region, and the Brexit negotiations.

UBS recently announced it would create a hub for its wealth management operations in Frankfurt, Germany, which could prove important if a so-called hard Brexit materialised.

“Markets know how to price and discount market risk,” he said. “Markets are much less good at pricing political uncertainty . . . Our broad presence in continental Europe gives us optionality in case we need to move employees from London to onshore locations. Optionality is going to be the name of the game.”

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Kingdom sought views on likely market reaction should deal fail

Saudi Arabia convened private talks with the world’s largest oil traders in Vienna before Opec’s crunch meeting on whether to cut oil output, seeking views about the likely market reaction should they fail to clinch a deal, it has emerged.

Mark Couling, head of crude oil at Vitol, the world’s biggest independent oil trading company, was invited to Vienna by the Saudi delegation, according to people with knowledge of the talks.

Pierre Andurand, who runs the $1.5bn Andurand Capital fund, one of the world’s biggest oil hedge funds, was also invited, alongside at least one trader from Russian independent oil company, Lukoil.

The meetings between Saudi Arabia and the traders came just a day before Opec’s official talks in Vienna last week, which saw the cartel reduce production by more than 1m barrels a day in an attempt to end a two-year price rout that has hit oil producers’ economies — the first such supply deal since 2008.

While Saudi Arabia routinely gives private briefings to energy analysts in the days leading up to an Opec meeting, it is rarer, but not untoward, for the kingdom to call together the traders responsible for shipping millions of barrels of oil or trading thousands of futures and options contracts.

Saudi delegates have previously done so on occasion when they were looking to get a better feel for the market, said one person who has been attending Opec meetings for more than a decade.

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The talks highlight the deep concern within the Saudi camp right to the last minute, despite months of shuttle diplomacy between Opec members, with the world’s top oil exporter worried about further price falls if they failed to secure a cut.

Brent, the international oil benchmark, did fall 4 per cent on Tuesday as the market bet that a deal was slipping beyond Opec’s reach. Prices then rocketed more than 15 per cent between Wednesday and Friday after Opec members reached an output reduction deal.

Mr Couling and Mr Andurand attended a meeting with the Saudi delegation on Tuesday morning, before the kingdom’s oil minister Khalid al Falih arrived in Vienna, people familiar with the meeting said. A trader from Litasco, Lukoil’s trading arm, also attended, they said.

Lukoil did not respond to a request for comment. Vitol and Andurand declined to comment.

Mr Andurand declined to comment on the meetings, but said in an earlier interview that he had been betting on rising prices since January and had not changed his position.

At the meetings, the Saudi delegation expressed caution about the likely outcome of the Opec gathering, warning that a deal to reduce output to try and bolster the price was still in doubt, according to sources familiar with the conversations.

Gulf delegates had earlier given similar warnings, with many saying a deal could be imperilled by lingering tensions between Saudi Arabia, Iran and Iraq.

Saudi oil officials sought to play down the talks, with one delegate said it was “not unusual” for them to talk to participants in the oil market.

“These discussions are a part of ongoing consultations we have with analysts, producer companies and traders particularly around Opec meetings and throughout the year,” the Saudi delegate said.

The proposals would threaten to increase federal debt and interest rates

Just as Ronald Reagan’s landmark 1986 bipartisan tax reform increased simplicity, fairness and economic efficiency by broadening the tax base and reducing rates, today reform of the system has the potential to help American families and the economy.

Properly designed, revenue-neutral reforms could help to offset the dramatic increases in inequality that have taken place over a generation, repair a business tax system that globalisation has rendered dysfunctional, reduce uncertainty and promote growth.

Unfortunately, what we know of the intentions of the president-elect and congressional leadership suggest that they risk pushing through the most misguided set of tax changes in US history.

The proposals from the presidential campaign, reiterated last week by President-elect Donald Trump’s choice for Treasury secretary, will massively favour the top 1 per cent of income earners, threaten an explosive rise in federal debt, complicate the tax code and do little if anything to spur growth.

A core principle agreed to by all in 1986 was that reform would not reduce the tax burden on high-income taxpayers. Reagan achieved this objective while reducing top marginal rates because he raised capital gains rates, scaled back investment incentives, increased corporate tax collection, curtailed shelters and left estate and gift taxes alone. Unfortunately, neither the Trump plan, nor the one put forward by Paul Ryan, speaker of the House of Representatives, provides for nearly enough base-broadening to finance all the high-end tax cutting they include.

Steven Mnuchin, Treasury secretary-designate, asserts there will be no absolute tax cut for the upper class because deductions would be scaled back. The rub is that totally eliminating all deductions for those with incomes over $1m would not even raise enough revenue to cover reducing their marginal tax rates from 39 to 33 per cent, let alone offset their benefit from huge rate reductions on business and corporate income, and the elimination of estate and gift taxes.

Estimates of the Trump plan suggest that it will raise the average after-tax income of the 0.9 per cent of the population with incomes over $1m by 14 per cent, or more than $215,000. This contrasts with proposed tax cuts for those in the middle of the income distribution of $1,000, or about 2 per cent.

The repeal of estate and gift taxes is especially problematic because it would provide a window for the very rich to use gift and trust structures to ensure that their wealth passes without tax not just to their children but to their grandchildren and great grandchildren, regardless of subsequent legislation.

The Reagan tax reform simplified the code by eliminating the need for rules distinguishing ordinary and capital gains income, because these were taxed at the same rate, and by doing away with industry-specific shelter provisions. In contrast, the Trump proposal creates sheltering opportunities by reducing to 15 per cent the tax rate on any income that can be characterised as coming from an incorporated entity. Rather than reducing targeted subsidies, it would establish a highly dubious 82 per cent credit — the highest in the world — for financial equity investments in infrastructure.

This would mean not only disproportionate tax reductions for the upper-income group that has seen its incomes rise most rapidly over the past generation. It would also mean grave damage to federal budget projections. The envisioned Trump tax cut is about the same size relative to the economy as the 1981 Reagan tax cut. It is worth remembering that Reagan, hardly a fan of reversing course or raising taxes, found it necessary to propose significant tax increases in 1982 and 1984 (the equivalent in today’s economy of $3.5tn over a decade) due to concerns about federal debt.

Today’s budget situation is much more worrisome. The baseline involves much higher levels of debt and deficits. Then the economy was suffering from a deep recession; now it approaches full employment. If extreme tax cuts are legislated in the next months, uncertainty about the federal budget and about further tax adjustments is likely to rise. Finally, I can find no basis in either economic history or logic for Mr Mnuchin’s claim that the proposed reforms would increase the economy’s growth rate from its current 2 per cent rate to the historical 3 to 4 per cent norm. Adult population growth has slowed by nearly a percentage point, the gains generated by more women entering the workforce have been exhausted, and it is far from clear why tax reform will hugely spur productivity growth.

Indeed, because the Trump proposal would redistribute after-tax income towards those most likely to save it, push up long-term interest rates because of debt pressures, increase uncertainty and the advantages of overseas production, it is as likely to retard growth as to accelerate it.

In the 1980s, treasury secretary Don Regan said the first Reagan reform proposal was written on a word processor to signal the administration’s openness to negotiation and radical alteration. We should all hope the Trump administration follows Reagan’s approach on both tax policy principles and a commitment to bipartisan negotiation.

The writer is Charles W Eliot university professor at Harvard and a former US Treasury secretary