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Another Day Of Gains As Futures Trade Within 1% Of All Time Highs

Another Day Of Gains As Futures Trade Within 1% Of All Time Highs

US futures, European bourses and Asian markets extended on recent sharp gains on Thursday, the 10Y yields rose above 1.30% after hitting 1.13% just two days earlier and oil…

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Another Day Of Gains As Futures Trade Within 1% Of All Time Highs

US futures, European bourses and Asian markets extended on recent sharp gains on Thursday, the 10Y yields rose above 1.30% after hitting 1.13% just two days earlier and oil held onto sharp gains as investors seemed to set aside virus jitters for now and looked ahead to the European Central Bank for reassurance that policy support will continue; the dollar was steady. Japanese markets were closed for a holiday. At 7:15 a.m. ET, Dow e-minis were up 71 points, or 0.20%, S&P 500 e-minis were up 8 points, or 0.19%, and Nasdaq 100 e-minis were up 24.50 points, or 0.16%. Futures traded less than 1% from their record highs, completing a definitive V-shaped recovery from the recent slide.

The turnaround from the Monday selloff shows “corporations have been very resilient through all this,” David Mazza, Direxion head of product, said on Bloomberg Television. “Earnings estimates are quite remarkable, probably some of the best on record. Even through all this, we have central-bank liquidity remaining very abundant, economic growth being robust.”

Energy and mega-cap tech stocks gained ahead of a new batch of earnings reports, the latest initial claims data and the first ECB meeting to incorporate the bank's new strategic review. Energy stocks Chevron Corp, Exxon Mobil, Schlumberger NV, Occidental Petroleum and Marathon Petroleum Corp climbed between 0.1% and 1%, tracking crude prices. Some other notable pre-market movers:

  • Didi Global (DIDI) drops 3% in premarket trading after people familiar with the matter said Chinese regulators are considering serious, perhaps unprecedented, penalties for for the ride-hailing giant after its controversial initial public offering last month.
  • Texas Instruments (TXN) drops 4.8% after third-quarter sales and profit forecasts left analysts disappointed, with Barclays saying the “flat outlook leaves little to live for this late in the cycle.”
  • AT&T (T) added 0.9% as the telecom operator beat analysts’ estimates for monthly phone bill paying subscriber additions in the second quarter, fueled by more Americans converting to 5G phones.
  • Dow (DOW) rose 1.3% after its second-quarter profit doubled from the first, as prices for its chemicals used in plastics and packaging rose on the back of strong consumer and industrial demand as well as lower inventories.
  • Chembio Diagnostics (CEMI) gains 9.9% and NeuroMetrix (NURO) surges 33% amid discussions on message boards at Reddit and StockTwits.

There was no obvious catalyst for the recent rebound in stocks, or the drawdown on Friday and Monday, though a study on Wednesday showed both Pfizer and AstraZeneca vaccines were effective against the Delta coronavirus variant. "Every now and then investors look for reasons to take some profits off and that's what we saw," said Jun Bei Liu, portfolio manager at Tribeca Investment Partners in Sydney. "The market suddenly became worried about the delta variant and how it might affect the path to recovery," she said. "But what we have compared with 12 months ago is quite a few viable vaccines...eventually we will be coming out of this and we are much closer to the end than we were 12 months ago."

In Europe, investors awaited the European Central Bank’s policy decision and guidance as the Stoxx 600 index turned positive for the week only three days after Monday’s selloff. Travel and leisure stocks led the advance, with 19 of the 20 industry sectors in the green. Unilever Plc was an exception, tumbling the most since Feb. 4 in London after the company lowered its guidance for profitability, citing cost inflation. Here are some of the biggest European movers today:

  • EQT shares gain as much as 16% in the stock’s steepest intraday advance since Jan. 26 after the Swedish investment firm reported better-than-expected numbers for the first six months of the year.
  • Aalberts climbs as much as 5.3% to a record high, after the company reported half-year results ahead of expectations.
  • Flutter rises as much as 4.3% in London after RBC upgraded to outperform, saying concerns on the stock are overdone.
  • Huhtamaki jumps as much as 5.6% in Helsinki after the Finnish food- packaging maker reported 2Q results that beat analysts’ profit and revenue estimates.
  • Publicis climbs as much as 4.6% with analysts positive on the advertising firm’s growth in the second quarter.
  • Temenos drops as much as 8.5%. Jefferies says the software firm’s 2Q revenue looks in line, but expectations on the buyside for beat-and-raise may mean the results fall slightly short.

Earlier in the session, the MSCI index of Asia-Pacific shares rose for a second day, climbing as much as 0.9%, led by Hong Kong, as investors became more confident about economic growth after U.S. companies reported solid corporate earnings overnight despite persistent concerns about burgeoning outbreaks in unvaccinated populations and as nerves persist around China's regulatory crackdown on technology firms. Shares in heavily-indebted Chinese property developer Evergrande (3333.HK) rebounded about 11% in Hong Kong after it said it had resolved legal disputes with a lender.

Benchmarks in Hong Kong and Indonesia each added 1.8% as several sectors including materials and technology advanced in the region. “Strong U.S. earnings confirm the strength of global economic recovery and therefore demand for Asian exports, which is good for the region,” said Olivier d’Assier, head of applied research for Asia Pacific at Qontigo. Better-than-expected results for companies such as Verizon Communications Inc. and Coca-Cola Co. lifted sentiment and eased concerns over peak economic growth, while shifting investor focus away from the rapid spread of the delta variant that might dent the recovery. U.S. 10-year Treasury yields hovered close to 1.3%. Shares in Indonesia climbed after the central bank decided to hold its benchmark rate at 3.5%. The Jakarta Composite Index gained 1.8%, the biggest rise in three months. Japan’s stock market is closed Thursday and Friday for holidays.

Australia's S&P/ASX 200 index rose 1.1% to close at 7,386.40, a fresh record high, led by gains in miners and banks. Australia’s iron ore shipments climbed to a record last month, cushioning against the impacts of nationwide lockdowns. Orocobre was among the biggest gainers after reporting 4Q sales results. Zip was the biggest laggard after posting 4Q revenue of A$129.9m. In New Zealand, the S&P/NZX 50 index rose 0.1% to 12,720.84

Here are the latest coronavirus news:

  • Texas Tribune: 99.5% of the 8,787 people who died from Covid from 8th Feb to 14 July were unvaccinated (citing prelim numbers from Texas Dept of State Health Services)
  • China pushes back against WHO calls for another probe in to the virus’s origins, including whether leaked from a lab, saying no evidence and defies common sense
  • Thailand (13,655) and S Korea (1842) post record new cases
  • Queensland to close New South Wales border from 1am Friday
  • Biden urges more people to get vaccinated saying the pandemic is only among the unvaccinated
  • Texas reports 3,261 cases in past 24hrs, highest since 13 Apr, but no new fatalities in 4 of last 5 days

Elsewhere, the Labor Department’s report, due at 8:30 a.m. ET, is expected to show the number of Americans filing new claims for unemployment benefits fell to 350K (from 360K) for the week ended July 17, amid rampant worker shortages. Investors have been closely following the health of the jobs market on which monetary policy hinges, especially after a series of higher inflation reading recently sparked fears about a sooner-than expected paring of policy support as the economy reopens.

A shift in attention to corporate earnings and the so-called value stocks have helped Wall Street recoup most of its declines from earlier in the week that were triggered by concerns about the fast-spreading Delta variant of the coronavirus. Q2 earnings are expected to grow 75% for S&P 500 companies, according to Refinitiv IBES estimates, with 88% of the 73 reported companies in the benchmark index beating consensus expectations. Abbott Laboratories, Domino’s Pizza Inc, Biogen Inc, Snap Inc and Intel Corp are among the major companies reporting results later in the day.

Investors also have one eye on a brewing partisan showdown in Washington over the U.S. debt ceiling, as the U.S. Treasury is projected to exhaust its borrowing authority in October, which put upward pressure on short-end rates overnight.

With a mostly bare data calendar on Thursday the European Central Bank's policy-setting decision, due at 745am ET, and the subsequent press conference from President Christine Lagarde are the main focus for markets (see preview here). Lagarde infused traders with a sense of anticipation after flagging an adjustment to the bank's rates guidance to reflect a new and more flexible inflation-targeting strategy. read more. "To really enforce their credibility, the ECB could tie their rate path to an explicit calendar date - i.e. no rate hike until late 2024," said Luke Suddards, a strategist at brokerage Pepperstone. "That would be a dovish surprise for FX markets and put pressure on euro crosses."

In rates, the 10Y Treasury yield edged above 1.3% as rates markets idled in Asia, with trade thinned by Tokyo's holiday, following a sell-off in Treasuries overnight. Losses were led by intermediates with 5- to 7-year yields cheaper by ~1bp on the day; 10-year around 1.30% lags bunds by ~1bp while gilts slightly underperform. Futures activity has been light with cash markets closed in Asia for Japanese holidays and resuming at 7am London time.

In FX, the dollar index sat at 92.812, off a three-month peak of 93.194 and the euro was steady just above recent lows at $1.1791. The Bloomberg dollar index edged lower with Treasuries as earnings optimism tempered concerns about the delta variant and its threat to economic growth. "The dollar has been trading on the front foot regardless of the risk sentiment swings in recent days," Westpac analysts said in a note, supported by the view that high inflation could drive U.S. rate rises. A shift to a more structurally dovish European Central Bank should cement the dollar index at higher levels, the analysts said, with a test of the year's highs likely this quarter. The risk-sensitive Norwegian krone and pound led G-10 gains while the Swiss franc underperformed

Bitcoin briefly rose above $32,000 after getting a boost from Elon Musk, who said his space exploration company SpaceX owns the digital token.

In commodities oil hung on to most of Wednesday's sharp price rise, its biggest one-day gain in three months. Brent crude futures were last 0.4% softer at $71.94 a barrel, but had gained more than 4% on Wednesday. Gold was steady at $1,801 an ounce and cryptocurrencies were firm after bouncing from lows when Tesla boss Elon Musk said the carmaker would likely restart accepting bitcoin payments after due diligence on its energy use.

To the day ahead now, and the main highlight will likely be the aforementioned ECB meeting and President Lagarde’s subsequent press conference. Otherwise, data releases from the US include the weekly initial jobless claims, June data on existing home sales and the Conference Board’s leading index. And over in Europe, there’s the EC’s advance consumer confidence reading for the Euro Area in July. Finally, earnings releases include Twitter, Intel, AT&T, Danaher, Unilever, Blackstone and Biogen, whilst BoE Deputy Governor Broadbent will be speaking.

Market Snapshot

  • S&P 500 futures up 0.2% to 4,357.50
  • STOXX Europe 600 up 0.7% to 457.11
  • MXAP up 0.9% to 202.70
  • MXAPJ up 1.3% to 680.01
  • Nikkei up 0.6% to 27,548.00
  • Topix up 0.8% to 1,904.41
  • Hang Seng Index up 1.8% to 27,723.84
  • Shanghai Composite up 0.3% to 3,574.73
  • Sensex up 1.1% to 52,783.51
  • Australia S&P/ASX 200 up 1.1% to 7,386.41
  • Kospi up 1.1% to 3,250.21
  • Brent Futures up 0.6% to $72.64/bbl
  • Gold spot down 0.5% to $1,794.06
  • U.S. Dollar Index little changed at 92.83
  • German 10Y yield rose 0.3 bps to -0.392%
  • Euro little changed at $1.1786

Top Overnight News from Bloomberg

  • Chinese regulators are considering serious, perhaps unprecedented, penalties for Didi Global Inc. after its controversial initial public offering last month
  • For credit investors, today’s ECB meeting is all about whether policymakers hint at any changes that could spell an end to the cheapest funding costs on record
  • Bank of England Deputy Governor Ben Broadbent said policy makers may be right to overlook a surge in inflation now, arguing that many of the increases are likely to be temporary
  • Britain is set to be handed a final warning from the European Union to meet its commitments under the Northern Ireland Protocol as the two sides struggle to work out their post-Brexit relationship

A more detailed look at global markets courtesy of Newsquawk

Asia-Pac stocks traded higher following the extended rebound across global counterparts including the continued cyclical outperformance stateside where the mood was also helped by several blue-chip earnings. ASX 200 (+1.1%) was led higher by strength in the commodity-related sectors as energy spearheaded the advances after oil prices gained by around 4.5% on Wednesday and with mining names also lifted by quarterly production updates which propelled Orocobre and Iluka Resources to the top performers list. The latest data releases also provided some slight encouragement including stable NAB Quarterly Business Confidence which benefitted from an upward revision to the prior and the preliminary trade data showed that Exports and Imports rose 8% M/M. Hang Seng (+1.8%) and Shanghai Comp. (+0.3%) were positive as reports that US Deputy Secretary of State Sherman is to visit China for talks between 25th-26th July, spurred some hopes for a potential de-escalation in tensions, although other commentary remained hawkish including from US Secretary of Defense Austin who vowed to counter 'unfounded' China claims in the South China Sea. Nonetheless, Hong Kong led the gains in the region as the broad strength permeated across various industries including property, energy, tech and financials, while Evergrande found some relief after resolving the dispute with Guangfa Bank, although the advances for the mainland were capped after the recent flooding catastrophe and with China’s trade-weighted currency rose to a fresh 5-year high. KOSPI (+1.1%) was also underpinned by the broad constructive mood in the region with some earnings releases helping divert attention away from another record daily increase in infections, and Japanese markets are closed for the rest of the week due to Marine Day and Sports Day holidays.

Top Asian News

  • KakaoBank to Raise $2.2 Billion as Korean IPO Boom Continues
  • As Singapore Frets Over the Elderly, Virus Rise Among Young
  • Iron Ore Futures Slump Amid Demand Fears, Improved Flows
  • Hyundai Has Biggest Profit in Seven Years, Warns About Chips

Major Euro bourses trade higher (Euro Stoxx 50 +1.1%) as the region adopted the positive performance seen across APAC. This come as earnings in the continent pick up in pace ahead of the ECB policy decision, which is expected to enforce a more dovish pursuit of its new inflation mandate. Meanwhile, the UK’s FTSE 100 (+0.3%) and Switzerland’s SMI (-0.2%) lag, with the former weighed on by a firmer Pound alongside the ill-effects of losses in both benchmarks’ heavyweight pharma sectors. US equity futures are flat with a positive bias, with the NQ (+0.2%) initially outperforming the ES (+0.2%), YM (+0.3%) and RTY (+0.2%) amid a more favourable yield environment, albeit that faded with the contracts now seeing modest broad-based upside. The yield picture is once again a cyclical. Travel & Leisure is again the winner, closely followed by Autos & Parts, Basic Resources and Tech. The other end of the spectrum consists of the defensives: Healthcare, Consumer Staples and Telecoms, albeit with some possible idiosyncratic influences. The former is weighed on by pharma-giant Roche (-1.1%) post-earnings, who in-spite of beating on main metrics, underwhelmed investors who expected upgraded guidance. Consumer Staples sees hefty losses in Unilever (-4.5%) as earnings were largely in-line with analyst expectations but the group expects FY margins to remain flat as a result of rising costs. Meanwhile, Telecoms have clambered off the lows seen at the cash open in the aftermath of Spain’s 5G auction, whereby Orange (+0.1%), Telefonica (+0.4%) and Vodafone (+1%) have together paid over EUR 1bln. In terms of other moves, NatWest (-1.5%) is pressured amid reports that the UK government is looking to offload NatWest shares, with the earliest sale to occur on August 12%. ABB (+1.9%) is bolstered by earnings beats alongside plans for its EV charging spin-off early next year.

Top European News

  • EQT Plans to Step Up Hiring as Assets Under Management Soar 95%
  • North Sea Green Hydrogen Pilot Gains Grant from Dutch Government
  • ABB Gains; Orders the Standout of Strong 2Q, JPMorgan Says
  • Euro Can Excite Markets Only on Downside Break: ECB Cheat Sheet

In FX, the ECB has been afforded top billing in terms of this week’s main events and potential market movers following the strategy review and shift to a new inflation target, and on this occasion the 12.45BST policy announcement may well take centre stage before the spotlight shifts to President Largarde for the post-meeting press conference and Q&A. Indeed, rate guidance will change by definition to reflect symmetry around 2% rather than the old ‘close to, but below’ remit, and the wording or phrasing could be pivotal from the perspective of perception and determining whether the GC retains a dovish bias or not, just as much as the tone of the text and responses to questions 45 minutes later. Note, a full preview is available via the Research Suite and will be re-posted on the Headline Feed in due course. In the run up to the ECB, the Euro remains relatively rangy and tactically, if not necessarily well positioned pending the outcome after almost guaranteed initial knee-jerk moves, with Eur/Usd hovering below 1.1800 where 1.3 bn option expiries start and end at 1.1810, Eur/Gbp pivoting 0.8600 and the 50 DMA that comes in at 0.8590 today, Eur/Jpy straddling 130.00 and Eur/Chf rotating around 1.0825.

  • GBP/AUD/DXY - Sterling seems to have weathered a set-back amidst fairly benign views on inflation from BoE’s Broadbent (see 9.30BST post on the Headline Feed for details) allied to a broad Buck bounce that pushed the index back over 92.800 between 92.868-704 parameters, as Cable consolidates recovery gains through 1.3700 and the 200 DMA, while the Aussie is also rebounding further and has breached half round number resistance against its US peer at 0.7350 with some traction coming via preliminary trade data overnight showing a wider surplus and acceleration in both exports and imports. However, hefty 1.5 bn option expiry interest between 0.7370-75 could cap Aud/Usd in the same vein as the psychological 1.0600 level in Aud/Nzd as attention turns to flash PMIs. Back to the DXY and Greenback in general, upcoming IJC tallies and existing home sales appear more influential than the national activity or leading indices as the increasingly buoyant risk backdrop detracts from a more supportive yield landscape (outright and curve profile).
  • JPY/CHF/CAD/NZD - The Yen is holding within 110.36-07 confines absent of many Japanese participants due to Marine Day and also braced for another market holiday before the weekend given Sports Day on Friday, so pointers and direction will largely be gleaned from elsewhere. Conversely, the Franc is closer to w-t-d peaks than lows having rebounded from 0.9232 to 0.9164, like the Loonie that has derived momentum from the improving market mood and pronounced revival in WTI crude to top Usd 71/brl compared to lows only a cent above Usd 65 on Tuesday. Usd/Cad is currently circa 1.2560 vs 1.2525 at one stage and 1.2800+ at the start of the week, while Nzd/Usd is meandering from 0.6971-47 following the turn in cross tides noted above that has undermined the Kiwi to an extent.
  • SCANDI/EM - More fuel to fire the Nok’s comeback from under 10.7000 against the Eur to 10.4000+ at one stage, as Brent nears Usd 73/brl for a Usd 5.5 or so surge from worst levels, and the Rub is also gleaning some traction. Elsewhere, the Cnh and Cny remain firmer following confirmation that the meeting between Chinese and US Deputy Secretaries of States is back on and the Zar is on the front foot into the SARB.

In commodities, WTI and Brent front month futures are firmer on the day as the complex experiences tailwinds from another risk-on day. Furthermore, the supply/demand balance remains in favour of a deficit over the second half the year. Analysts at Morgan Stanley reaffirmed their view that the oil market will be in a deeper deficit in H2 vs H1 2021. The bank maintained its forecast for Brent to trade in the mid-to-high 70s for the remainder of the year. Meanwhile, Barclays raised its 2021 oil price forecast by USD 3-5/bbl due to expectations of a faster-than-forecast normalisation in OECD inventories. The British bank does warn that prices could rise to USD 100/bbl over the coming months if OPEC+ is slow to meet demand. Looking ahead, MS sees OPEC maintaining a slight deficit in 2022. Note, other desks expect demand in H1 2022 to be somewhat sluggish before seeing a pick-up in H2. Barclays downgraded its 2022 oil price forecasts by USD 3/bbl. This sentiment also been echoed by sources via Energy Intel earlier this week who “see the potential for a significant dip in oil demand in the first half of next year…. it is likely they [OPEC+] will take a pause [from production hikes] from monthly increases this December." Over to the US, Barclays sees US oil demand growing by 1.6mln BPD YY this year vs 1.4mln BPD earlier, and forecast the Brent-WTI spread to average USD 2/bbl in H2 2021, with risks to the downside on a potentially continued inventory draw-down at the Cushing hub. WTI and Brent Sept reside north of USD 70.50/bbl and USD 72.50/bbl respectively from USD 69.88/bbl and USD 71.74/bbl at worst, with the benchmarks now closer to the round numbers on the upside. Elsewhere, spot gold and silver are swayed by the Buck. Spot gold briefly dipped below its 100DMA (USD 1,795/oz) to a base at USD 1,791/oz, whilst the 21DMA also resides nearby at USD 1,796.80/oz. LME copper is on a firmer footing with traders citing lower-than-expect sales plans by China, although the constructive risk tone is also providing the red metal with tailwinds. Finally, Dalian iron ore fell some 5% as participants point to a double whammy of factors with higher imports and lower demand from China.

US Event Calendar

  • 8:30am: July Initial Jobless Claims, est. 350,000, prior 360,000; Continuing Claims, est. 3.1m, prior 3.24m
  • 8:30am: June Chicago Fed Nat Activity Index, est. 0.30, prior 0.29
  • 10am: June Existing Home Sales MoM, est. 1.7%, prior -0.9%
  • 10am: June Leading Index, est. 0.8%, prior 1.3%;
  • 11am: July Kansas City Fed Manf. Activity, est. 25, prior 27

DB's Jim Reid concludes the overnight wrap

Yesterday we launched our latest monthly survey, link here, which remains open until late morning tomorrow. We ask a number of questions about covid restrictions to judge how you feel about how life is progressing and will progress over the coming months. We also ask whether the UK has done the right or wrong thing by lifting all legal covid restrictions. In addition, we ask all the normal regular and market directional questions. All responses gratefully received. It should only take 3-4 minutes to complete and is totally anonymous.

The hot week continues here in the U.K.. This has made sleeping tough. Adding to my sleeping woes, last night my wife got woken up by our downstairs hallway light coming on at 2am and given it was on a sensor we went downstairs to investigate. Such a scare seems to happen a couple of times a year in our house. I had a golf club in our bedroom so I took that as a precaution. Just in case the intruder fancied a round. No one was there but when looking at the sensor we found two Daddy Long-Legs walking across it. I felt a bit silly wielding a golf club. It took a while to get back to sleep after that and then the wake-up alarm went off!! So I’m shattered.

There were few alarms in markets yesterday and the main story was the continued recovery after Monday’s rout, as decent corporate earnings releases outweighed investor concern about the rise in Covid casesand the more-infectious delta variant. In fact by the close of trade, it was almost as though the slump at the start of the week had never happened. The S&P 500 (+0.82%) is back into positive territory for the week and less than 1% from record highs thanks to further advances for cyclical industries. And Treasuries also continued their wild ride, moving 11bps off their London morning lows at one point and having now recovered by c.16.3bps since their intraday lows on Tuesday.

To run through the moves in more detail, equity indices rallied on both sides of the Atlantic, particularly in Europe as the STOXX 600 (+1.65%) recorded its strongest performance in over 2 months, and Spain’s IBEX 35 (+2.50%) had its best day since January. As mentioned, the rally was supported by positive corporate earnings releases, including from Johnson & Johnson, Coca-Cola and Verizon, although Netflix’s (-3.30%) relatively weak earnings the previous day meant that the FANG+ index of megacap tech stocks had a relatively subdued +0.30% gain - not helped by rising yields. On the other hand, small-cap stocks surged, with the Russell 2000 up +1.64%, which means that it’s performance over the last 2 sessions (+4.85%) is the strongest 2-day gain since we found out the results of the Georgia senate election back in January that paved the way for more fiscal stimulus.

Speaking of stimulus, Senate Republicans yesterday blocked the immediate debate on the infrastructure bill. Negotiators from both parties are continuing to work on the deal and expect the vote to pass early next week. In fact, Senate Majority Leader Schumer is reported to have received a note from 11 GOP members that they will vote to progress the legislation on Monday if a deal on spending can be reached. The legislation has stalled in recent weeks as the Senators could not agree on how to pay for the $579bn of new spending over the next 8 years.

Staying with politics, multiple outlets yesterday reported that top White House advisers broadly support giving Fed Chair Jerome Powell another term. However, no formal decision is expected on the matter until September. Chair Powell and Vice Chair Quarles’s terms currently expire in January. Former Fed Chair and current Treasury Secretary Yellen has yet to fully weigh in on the topic, telling CNBC last week she would be discussing it with President Biden soon. How the Fed maneuvers through the taper discussion into year-end may also have role to play in this as well.

The risk-on move and subsiding worries about Covid (at least for the time being) meant that sovereign bond yields rose across the board yesterday, with those on 10yr Treasuries up +6.7bps to 1.288% having been at 1.19% around London breakfast time. Both higher inflation breakevens (+3.1bps) and real rates (+3.5bps) contributed to the move, whilst the 2s10s curve steepened +6.4bps in its biggest daily move higher since March. It was a similar pattern in Europe too, where yields on 10yr bunds (+1.5bps), OATs (+1.1bps) and BTPs (+0.2bps) all moved higher, with the 2s10s curve steepening in all 3.

Overnight, Asian markets have taken Wall Street’s lead with the Hang Seng (+1.77%), Shanghai Comp (+0.33%) and Kospi (+1.12%) all up. Japanese markets are closed for a holiday. Futures on the S&P 500 have edged up +0.06% and those on the Stoxx 50 are up +0.40%. US treasuries haven’t traded this morning with it being a holiday in Japan. Elsewhere, Texas Instruments’ stock fell -4.6% in after hours trading as the company gave a revenue forecast that missed expectations raising doubts that a jump in chip demand caused by the pandemic will not be sustained.

In other overnight news, US President Joe Biden said at a CNN town hall that the inflation is likely to be transitory while adding that restaurants and other businesses in the hospitality and tourism sector may remain “in a bind for a while” due to hiring challenges as workers in the sectors are seeking better wages and working conditions. He has said that the businesses facing hiring challenges should offer higher pay in response, calling rising wages “a feature” of his economic plans.

Looking ahead now, one of the main highlights today will be the latest ECB decision at 12:45 London time and President Lagarde’s subsequent press conference at 13:30. This meeting has assumed an unexpected importance following the release of their Strategy Review earlier this month, which saw the inflation target changed to a symmetric 2%, along with a commitment to forceful or persistent policy easing when the effective lower bound is nearby, as at the moment. And as a result of this, our European economists write in their preview (link here), that they’re expecting some changes to the ECB’s forward guidance, with the wording needing to be updated to capture that 2% target and the commitment to persistence around the lower bound. They’re also expecting forward guidance to continue to refer to underlying inflation needing to be consistently on target. Generally speaking however, the ECB only conducts a deep dive into their policy stance once per quarter when the new staff forecasts are available, which would be at the September meeting, so our economists’ baseline is that it won’t be until then that they confirm that PEPP net purchases won’t continue beyond March 2022.

In terms of the latest on the pandemic, cases are unfortunately continuing to rise at the global level, as well as in every G7 economy except Canada. With increasing numbers being vaccinated throughout the developed world, this clearly isn’t the trajectory that many governments hoped to see by this point. However, as we looked at in my chart of the day yesterday (link here), the UK’s ONS now estimate that 92% of the adult population in England had antibodies in the week ending July 4. So an interesting one to follow as if a country with 92% of adults with antibodies (and rising since this study) continued to struggle then we could be in for a longer winter. On the other hand, if cases plateau in August and hospitals aren’t overwhelmed, the developed world may move on quicker than the delta-focused market currently expects. In fact, we got a slither of good news yesterday in that the number of daily cases reported was at 44,104, which is just +4% higher than the number on the previous Wednesday, and the smallest week-on-week growth number for a single day we’ve seen since May 25. Has the football effect started to wane? And might that offset some of the likely impact of this week’s reopening.

Back to Europe and there were some fresh Brexit headlines yesterday as the UK government said that it wanted to make changes to the Northern Ireland Protocol, which is a part of the Brexit deal put in place to prevent a hard border on the island of Ireland after the UK left the EU. This meant that goods wouldn’t see customs checks when passing between Northern Ireland and the Republic of Ireland, but instead meant that goods coming into Northern Ireland from the rest of the UK could instead be checked when they reached Northern Ireland, meaning that there was effectively an economic border within the UK. The two sides have had a number of disputes over the Protocol already, including a notable row last year over whether the UK’s proposed Internal Market Bill would break international law, although an agreement between the two sides was subsequently reached. This time around, the UK government have said that they believed there were grounds to trigger Article 16 that would suspend parts of the Brexit deal, but that they wouldn’t do so for now and instead “seek a consensual approach with the EU”. In response, the EU Commission Vice President Maroš Šefčovič said that they were “ready to continue to seek create solutions, within the framework of the Protocol”, but that they would “not agree to a renegotiation of the Protocol”.

To the day ahead now, and the main highlight will likely be the aforementioned ECB meeting and President Lagarde’s subsequent press conference. Otherwise, data releases from the US include the weekly initial jobless claims, June data on existing home sales and the Conference Board’s leading index. And over in Europe, there’s the EC’s advance consumer confidence reading for the Euro Area in July. Finally, earnings releases include Twitter, Intel, AT&T, Danaher, Unilever, Blackstone and Biogen, whilst BoE Deputy Governor Broadbent will be speaking.

Tyler Durden Thu, 07/22/2021 - 07:41

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Economics

Weekly investment update – Emerging markets miss out on equities and bonds surge

At first sight, the direction of financial markets in July might have come as a surprise: global equities posted their sixth consecutive monthly gain despite a steep drop in emerging market equities, while bond markets also recorded strong advances, again

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At first sight, the direction of financial markets in July might have come as a surprise: global equities posted their sixth consecutive monthly gain despite a steep drop in emerging market equities, while bond markets also recorded strong advances, again except for those in emerging markets.

Volatility spiked at times during July. Indeed, it hit its highest since early May and took equities from a historical peak to the lowest level in a month within the space of a week before they set another high towards month-end. Emerging market equities suffered from a persistent sell-off in Chinese stocks over the government’s regulatory clampdown on sectors ranging from ride hailing to gaming.

Economic growth – On an even keel  

While markets worried that the economic recovery had peaked, the latest purchasing managers’ data – seen as a leading indicator of the direction of growth – did not signal a sharp slowdown. China’s PMI for July, typically also a proxy for wider emerging market growth, fell by 0.5 of a percentage point from the previous month, indicating that company activity had slowed down. Remaining at above 50, the indicator also signalled that overall economic expansion overall is continuing.

In the eurozone, business activity rose at its fastest rate in just over 15 years in July. At 59.8 in July, after 58.3 in June, the services sector PMI was at its highest since June 2006 and consistent with a sharp rate of activity growth.

US GDP growth was 6.5% annualised in Q2 after 6.3% in Q1 and fell short of expectations. While inventories and net exports contracted, personal spending on consumption and non-residential private investment grew strongly. GDP was above its pre-Covid peak. Thanks to massive fiscal and monetary stimulus, it is now back on its pre-Covid trend.

Despite this economic progress, the US Federal Reserve has continued to indicate that there is still ‘some ground to cover’ before it will start reducing its pandemic support for the economy. Employment is still some seven million jobs below pre-Covid levels. Risks to the outlook remain, not least as Delta variant Covid cases rise.

Equities: Record-setting

July saw concern over slowing global growth offset by news of strong corporate earnings and still record-low interest rates. Markets were buoyed by optimism over the outlook for the US economy in the second half of 2021, even in the face of a pickup in Covid infections due to the more contagious Delta variant.

Some observers are pointing to the small chance of widespread lockdowns, while others have noted that although caseloads are rising rapidly, hospitalisations and fatalities are not.

US stocks recorded their sixth monthly rise in a row. The S&P 500 rose by more than 2%, while the tech-heavy NASDAQ and the Dow Jones added more than 1%.

There were all-time highs for European stocks as well, allowing them to record a sixth consecutive month of gains. Mid-caps, IT and dividend stocks led the market, while the energy sector lagged.

Asia takes a dip

In contrast, Asian equity indices had a poor month due to rising Covid cases across the region and concerns that a regulatory crackdown on tech businesses in China could slow already decelerating growth. This came on top of spreading Delta cases in the country and a softening land and property market. The developments clouded market sentiment across various regions.

Japanese equities lost more than 2% on concerns about another coronavirus wave and its impact on the economic recovery. Investor worries over global economic growth not only drove down US Treasury yields, but also the US dollar, allowing the yen to strengthen. The break in what had been the yen’s weakening trend also roiled Japanese markets.

Tepid domestic data, concerns about growth in China and volatile oil prices – Japan imports some three quarters of its oil consumption – also weighed on the market.

We believe there are reasons to be somewhat cautious on equities despite the good recent earnings momentum and the continued support from central bank pandemic measures. Recent recoveries followed sell-offs on a modest scale rather than sharp retrenchments and dips have not attracted many more new buyers or more widespread buying. Recent gains look vulnerable to us.

Bonds: The rally rolls on

Yields fell as investors sought shelter in haven assets such as US Treasuries and Bunds, extending the rally by a third month.

In the US market Treasury, 2- and 10-year yields notched their biggest one-month drops in over a year (March 2020), even as the Federal Reserve’s preferred inflation gauge rose sharply in June for the fourth big gain in a row. However, June’s increase was smaller than forecasters had expected.

Investors still appear to be siding with the Fed, accepting its view that higher inflation is due to supply bottlenecks and shortages and that these should ease off as the recovery matures. Ironically, the pressure should also ease as a growth slowdown tamps demand.

Over the month, long-dated debt yields fell to around five-month lows.

What’s up with real yields?

Some investors appear to worry that very low real yields — which measure the returns investors can expect once inflation is taken into account — are warning of a (coming) sharp slowdown in growth as the more contagious Delta variant spreads, turning businesses and consumers cautious again.

Others have argued that market pricing has become too pessimistic, pointing to the US economy’s strong rebound, even if growth has now peaked.

A further explanation could be that continued large-scale bond buying by central banks is still holding down yields across the board – even yields that are adjusted for inflation that has seen high readings in the US, the UK and Europe. An end to this form of support for economies does not appear to be in sight any time soon.

The Fed, which has bought about USD 120 billion of bonds monthly throughout the pandemic to pin down borrowing costs for households and businesses, reiterated after its latest policy meeting that the economy was making ‘progress’, but it remained too early to tighten monetary policy. Any tapering of bond purchases could be delayed by a growth slowdown, which should support markets.

Elsewhere in bond markets, high-yield credit in USD, EUR and GBP had another good month, extending their run of gains by a seventh month. UK inflation-linked bonds were in the lead in the fixed income segment.   

Gold was supported by the continued rise in inflation and the declines in real yields that have made it more attractive as an inflation hedge. Commodities more broadly were the best-performing asset class in July.

BOND MARKETS      
10-year yields   Monthly change 2021
US T-note 1.22 -25 31
JGB 0.02 -4 0
OAT -0.11 -23 23
Bund -0.46 -25 11
EQUITY MARKETS      
Euro Stoxx 50 4089.3 0.6% 15.1%
Stoxx Europe 50 3555.8 1.2% 14.4%
       
Dow Jones 30 34935.5 1.3% 14.1%
Nasdaq 14672.7 1.2% 13.8%
S&P 500 4395.3 2.3% 17.0%
       
Topix 1901.08 -2.2% 5.3%
       
MSCI all countries (*) 724.2 0.6% 12.1%
MSCI Emerging (*) 1277.8 -7.0% -1.0%
(*) in USD      

Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. The views expressed in this podcast do not in any way constitute investment advice.

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

Writen by Nathalie Benatia. The post Weekly investment update – Emerging markets miss out on equities and bonds surge appeared first on Investors' Corner - The official blog of BNP Paribas Asset Management, the sustainable investor for a changing world.

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What is swing pricing?

The problem In March 2020, at the start of the COVID-19 pandemic in the U.S., investors pulled more than $100 billion out of corporate investment-grade and high-yield bond mutual funds, forcing funds to sell some of their holdings. The spread between…

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By Anil Kashyap, Donald Kohn, David Wessel

The problem

In March 2020, at the start of the COVID-19 pandemic in the U.S., investors pulled more than $100 billion out of corporate investment-grade and high-yield bond mutual funds, forcing funds to sell some of their holdings. The spread between corporate bond yields and U.S. Treasuries (a market that had its own dysfunction) widened, transaction costs rose, and issuance of new bonds came to a halt, disrupting the flow of credit to the nation’s corporations. This led the Federal Reserve to intervene by offering, for the first time, to buy corporate bonds and exchange traded corporate bond funds in what proved a successful effort to keep credit to corporations flowing. It was an extraordinary move that underscores the risks these funds pose to financial stability. (For details, see this Federal Reserve note.)

The growth of open-end fixed income funds magnifies the systemic significance of the tension between shareholders’ expectations of daily liquidity and the (often illiquid) holdings of the funds. The average corporate bond is traded about once a month. Shareholders in an open-end bond fund expect (and receive in many cases) to be able to sell their shares much more easily and quickly than if they held bonds directly. When he was governor of the Bank of England, Mark Carney said, “These funds are built on a lie, which is that you can have daily liquidity, and that for assets that fundamentally aren’t liquid.”

In normal times, redemptions are modest and can be met by an offsetting inflow of funds or by selling liquid securities in the portfolio like Treasuries.[1] But big outflows can force a fund to sell holdings of less liquid securities that may require a price concession to attract a buyer. Especially in times of stress, big sales force down bond prices because of the absence of a truly liquid market for the underlying bonds. This, in turn, raises the rates that all corporate borrowers have to pay on newly issued bonds—if they can sell them at all—thus harming the overall economy.

Shareholders in a fund who get out early can redeem at a better price than those who remain, because their redemptions are met before the fire sale forces the fund to mark down the value of its portfolio. This creates a “first-mover advantage,” which can induce a rush to the door that amplifies the price movements that would otherwise occur. (With equity funds, this is less of an issue. Most equities are traded in highly liquid markets where prices quickly reflect order flow.  To be sure, there are small stocks that do not trade every day, but most trade every few days, and there is not enough volume in any single small stock to create a problem. The average corporate bond trades once a month; some commercial paper hardly ever trades. So any selling of such fixed-income securities can affect the price substantially.)

Open-end bond mutual funds have grown over past couple decades

A possible solution

More widespread adoption of swing pricing. Swing pricing is widely used in Europe but not in the U.S., although its use was authorized by the SEC in 2018. Basically, it allows the manager of an open-end fund to adjust its net asset value up or down when inflows or outflows of securities exceed some threshold. In this way, a fund can pass along to first movers the cost associated with their trading activity, better protect existing shareholders from dilution, and reduce the threats to financial stability.

This brief draws from the report of the Task Force on Financial Stability, which recommended more widespread use of swing pricing, and a roundtable the Task Force convened with industry, academic, and public sector officials to consider the pros, cons, challenges and costs to doing so.

What is an NAV, and why is that important for open-end funds?

The net asset value (NAV) is the price at which shareholders can purchase or sell their shares in an open-end mutual fund. The Investment Company Act of 1940 requires mutual funds to offer and redeem shares at the next net asset value calculated by the fund after receipt of an order.  The NAV is usually calculated by dividing the value of the fund’s assets by the number of its shares. With swing pricing, this calculation of the NAV is adjusted up or down to account for the price impact and transactions costs that will be incurred because of redemptions and new share purchases that will occur after the NAV is calculated. Most U.S. funds calculate their daily NAV using the closing market price of the securities at 4:00 pm Eastern time. Orders from investors that are submitted after 4:00 pm are executed at the next day’s NAV.

Open-end funds can issue an unlimited number of shares. In contrast, a closed-end fund has a set number of shares, the price of which is determined in the market and can diverge from the net asset value of the underlying assets. Exchange-traded funds (ETFs) combine characteristics of open-end and closed-end funds. The price of ETFs fluctuates throughout the day and is determined by the price in the market. The movement in ETF prices is indicative of the kind of swing in an NAV that might be needed in stress, because the ETF price adjusts to attract a willing buyer.

What is dilution and the first-mover advantage in open-end funds?

If shareholders redeem a large quantity of shares in an open-end mutual fund, the fund may be forced to sell not only the highly liquid U.S. Treasuries it holds, but other assets as well. If many funds are doing the same thing at the same time—as they were in March 2020—the price of their underlying assets can fall; this is known as a “fire sale.” The first redeemer or first mover gets out at the initial NAV, which does not reflect the price declines associated with the subsequent fire sale, leaving the remaining investors to bear the costs associated with the portfolio manager having to sell assets to satisfy the first movers. This decline in the value of the fund’s holdings, which are owned by the remaining investors, is known as “dilution.” In a stress situation, therefore, investors have strong incentives to be among the “first movers,” which itself can amplify redemptions and resulting fire sales.

Using data on daily fund flows, Falato, Goldstein, and Hortacsu find that between February and March 2020, the average bond fund experienced outflows of about 10% of net asset value, far larger than the 2.2% experienced during the peak of the 2013 taper tantrum. They find that fund illiquidity and vulnerability to fire-sale spillovers were the primary drivers of these outflows, and that the “more fragile funds benefitted relatively more from the announcement effect of the Fed facilities.”

How does swing pricing address this issue?

Swing pricing is a mechanism to apportion the costs of redemption and purchase requests on the shareholders whose orders caused the trades. It is designed so that remaining shareholders don’t bear all the costs (including dilution) caused by first movers. In effect, those attempting to take advantage of limited fund liquidity are charged for their redemptions by adjusting the price they receive to reflect the liquidity of the market for the fund’s assets. With swing pricing, the incentive to be a first mover is diminished, and with it the risk that existing shareholders will be diluted and the risk that large redemptions will drive prices down sharply with spillover effects on the market and the economy. To be fair both to those who sell and those who remain, a swing price must reflect a fair valuation and approximate the costs imposed by first movers; it cannot be set simply to impose an enormous penalty on redeeming shareholders.

Under full swing pricing, the NAV is adjusted daily for the likely costs of redemptions, regardless of the amount of shareholder activity. Under partial swing pricing, the adjustment is triggered only when net redemptions exceed some pre-determined threshold—a recognition that small transactions do not pose much of a problem.

How does swing pricing work in Europe?

Many global open-end mutual funds are based in Luxembourg (because it has a favorable regulatory climate), and many of those routinely use swing pricing.

Not all funds follow the same procedures, but here’s an illustrative example. All orders that will be redeemed at a given day’s NAV must be received by noon CET on the day of the trade. In that case, any orders received after noon will be processed at the next day’s NAV. The NAV itself is not set until 4 pm CET each day. This gives the fund four hours to assess its order imbalance and determine the gap between buy and sell orders. Most buy and sell orders can be “crossed,” so that rather than buying and selling new securities, the redeeming and purchasing customers can have ownership transferred without incurring any transactions costs or putting pressure on prices. If there is a net imbalance (say, many more requests to redeem than to purchase), then to meet the net demands, some securities will need to be sold. If there is a large imbalance, then the NAV is adjusted (or “swung”) to reflect the impact of the sales.

The swing threshold is the amount of net subscriptions or redemptions that trigger the adjustment to the NAV.  The fund then estimates how much prices for the assets being sold are likely to move to meet the subscription or redemption requests it has received; other factors taken into account include transaction costs and the bid-ask spread. The fund then uses those estimates to adjust the NAV by some percentage, generally no more than 2% or 3%. The adjustment is known as the swing factor.

Swing thresholds and swing factors vary depending on the market for the fund’s underlying securities. Swing factors tend to be larger in funds that invest in more thinly traded securities.

Fund managers set the rules and size of the adjustment and disclose their procedures, but precise details are not always disclosed so as to avoid investors exploiting them unfairly. A bond fund prospectus might, for instance, set a maximum swing factor of 3%, but give the fund discretion up to that level.[2] (For an example, see paragraph 17.3 of the prospectus for BlackRock’s Luxembourg-based global funds. )

Here is a stylized example of partial swing pricing from Allianz. It shows the threshold (the volume of orders) that trigger swing pricing in normal markets and in times of distressed markets, and the size of the swing under various scenarios (0.5% or 1.0%).

A survey by the Bank of England and the Financial Conduct Authority of 272 U.K. mutual funds found that 83% (202 funds) have the option to use swing pricing in place. Most funds using partial swing pricing had a trigger of net flows of 2% or less of total NAV. During COVID, however, several funds used their discretion and reduced their swing threshold or moved to full swing pricing. Swing pricing is advantageous to investors not only because it mutes dilution, but because the fund needs to hold fewer lower-yielding highly liquid assets to meet redemptions.

Researchers at the Bank for International Settlements compared the track record of  Luxembourg-based funds (which generally use swing pricing) to similar U.S.-based funds (which do not use swing pricing). They found that the Luxembourg-based funds hold less cash than their U.S. counterparts. They also found that during the 2013 taper tantrum, the Luxembourg funds had higher returns than their U.S. counterparts (in part because there was less dilution and in part because they hold less cash), though there was more daily volatility in the Luxembourg funds.

In addition to the Luxembourg-based funds, funds based in the U.K., Ireland, France, Netherlands, and recently Germany use swing pricing.

While investor fairness has been the primary driver of swing pricing in Europe, market participants say it can affect investor behavior in ways that may contribute to financial stability. If an investor has a very large order to place in a European-based fund, the investor may spread out the purchase or sale over several days or otherwise break up the order to avoid imposing costs on the mutual fund that will be passed along in an adjusted swing price.

What are the impediments to implementing swing pricing in the U.S.?

The institutional structure of the market and operational issues are the main impediments to embracing swing pricing in the U.S.

Although the NAV is usually set at 4:00 pm Eastern time every trading day, many U.S. funds don’t know the size of their net inflows and outflows until late in the day or even the next morning. Many funds receive order flows from intermediaries that stand between an investor and the fund, such as 401k plan administrators, broker-dealers, and financial advisers. Some intermediaries have agreements that allow them to receive requests until 4:00 pm Eastern but not convey the order to the fund until that evening or even the next morning, but then upon passing them on still have the order serviced at that 4:00 pm NAV. In other words, the fund managers determine the NAV before they know how large the flow of orders is. Such agreements would need to be renegotiated and the software systems used by the intermediaries would need to be overhauled if new redemption rules were to be put in place. The intermediaries would also need to rework their client agreements.

Industry participants noted the following additional considerations:

  • Setting a cutoff at 12:00 noon New York time for investors to place mutual fund orders at today’s NAV would be 9:00 am in California and 6:00 am in Hawaii. But global funds based in Luxembourg deal with even more time zones and have navigated this problem.
  • Retirement fund record keepers and insurance companies require actual NAVs to process trades, e.g. an investor who wants to sell $1 million worth of shares need to know an NAV to translate the $1 million into an actual number of shares. European funds often price such trades at yesterday’s NAV.
  • Smaller fund management companies may not have the resources to implement swing prices.

In any event, changing all this would be costly and would require a mandate from the Securities and Exchange Commission and coordination with other regulators, including the Department of Labor (which has oversight over retirement plans) and FINRA, among others. No single fund or group of funds will make this shift unless everyone else is doing so as well.

If a shift were mandated, the same rules would need to be applied to other types of savings vehicles that are economically similar to mutual funds, such as bank collective investment trusts.

When it authorized swing pricing in the U.S. in 2018, the SEC said, “We…appreciate the extent of operational changes that will be necessary for many funds to conduct swing pricing and that these changes may still be costly to implement, but we were not persuaded by commenters who argued that these changes are insurmountable, and indeed one stated that despite these challenges ‘the long-term benefits of enabling swing pricing for U.S. open-end mutual funds outweigh the one-time costs related to implementation for industry participants.’”

What are the alternatives to full-scale swing pricing?

One alternative would be for funds to consult and gather information from intermediaries and vendors a few hours before 4:00 pm, and then allow (or mandate) the fund managers to estimate a full-day’s flows and apply a swing factor if indicated. This would accomplish some, perhaps even much, of the benefits of swing pricing without the cost of reorganizing the whole network of vendors, intermediaries, and fund managers. It probably would require a safe harbor to protect intermediaries, vendors, and funds from liability if the estimates proved inaccurate.

The SEC anticipated such a possibility in its 2018 rule: “We acknowledge that full information about shareholder flows is not likely to be available to funds by the time such funds need to make the decision as to whether the swing threshold has been crossed, but we do not believe that complete information is necessary to make a reasonable high confidence estimate. Instead, a fund may determine its shareholder flows have crossed the swing threshold based on receipt of sufficient information about the fund shareholders’ daily purchase and redemption transaction activity to allow the fund to reasonably estimate, with high confidence, whether it has crossed the swing threshold.”

Other ways that have been discussed to mitigate the impact of transaction costs to a mutual fund’s portfolio generated by subscriptions and redemptions, as well as to reduce the risks to financial stability, are:

  • An anti-dilution levy or redemption fee—a surcharge on investors subscribing or redeeming shares to offset the effect of those orders.
  • Dual pricing, i.e. one price for buying shares and another for redeeming.
  • Notice periods of perhaps a few days before an order can be executed.
  • Redemption in kind, e.g. giving the shareholder bonds, not cash (not practical for funds with retail investors).
  • Restricted redemption rights so investors can redeem up to a certain dollar amount on any one day.
  • Redemption gates that allow a fund to limit withdrawals (although the experience with these for money market funds indicates that such gates tend to exacerbate the rush for the exits).
  • A regulatory mandate to align redemption policies (including a requirement of advance notice) with the liquidity of the underlying securities.

Does the rising popularity of Exchange Traded Funds change any of these considerations?

ETFs require that buyers and sellers agree on a price that reflects market conditions. So during periods of stress, ETF prices move considerably. In a sense, they have an element of swing pricing built into them. Some investors may prefer ETFs because they know that it will be possible to sell on short notice.

ETFs have their own issues regarding the infrastructure that is needed to support them. To make sure the fund price reflects the value of the securities that the fund is supposed to track, ETFs rely on firms that serve as “authorized participants” (APs) to step in to buy or sell the fund to keep the price of the ETF close to the underlying securities. The APs make profits by arbitraging differences in the prices in the underlying securities and the ETFs. If the APs step back from trading, say, because they are exposed to more risk than they are comfortable with, the ETF prices can become disconnected from the prices of the securities that they are supposed to mimic.

This risk can mean that the ETF prices can also fail to reflect only fundamental risks associated with the securities. Nonetheless, ETFs are not subject to the first mover advantage and seemed to handle March 2020 better than the open-end funds.

Can swing pricing help improve the stability of money market mutual funds?

Money market funds are a special kind of open-end fund that can hold only short-dated securities such as U.S. Treasury bills, commercial paper, and certificates of deposit. By limiting the securities to those deemed relatively safe and liquid, it is expected that the price of the fund will be stable as the securities have no price risk if held to maturity. Problems can—and do—still arise for money market funds if they sell the securities they hold before maturity; in that case, there is price risk. Prime money market mutual funds invest in short-term private-sector securities such as commercial paper and certificates of deposit. Default rates on these securities are low, but they trade infrequently so they are subject to the same kind of illiquidity problems as open-end bond and loan funds.

Prime money market mutual funds suffered a run in March 2020, leading commercial paper markets to freeze up and prompting the Federal Reserve to intervene to keep credit flowing to businesses.

Investors in prime money market funds generally are using these funds as substitutes for bank accounts. They expect to withdraw, possibly large amounts in some circumstances, and at multiple times during the day. As a result, these funds often set an NAV multiple times throughout the day. Some in the industry say that feature of these funds means the information demands of setting a swing would be daunting and incompatible with how investors use them. Still, in a June 2021 consultation report, the Financial Stability Board included swing pricing among several possible policy responses to the problems posed by money market mutual funds.


[1] Heavy selling of Treasuries during the opening months of the COVID-19 pandemic created problems in that market as well. See Chapter 3 of the report of the Task Force on Financial Stability and the Group of Thirty report, “U.S. Treasury Markets: Steps Toward Increased Liquidity.”

[2] When the SEC authorized swing pricing in the U.S. in 2018, it set a 2% ceiling on the swing factor.

Anil Kashyap is a member of the Financial Policy Committee of the Bank of England and a consultant to the Federal Reserve Bank of Chicago and the European Central Bank. He did not receive financial support
from any firm or person with a relevant financial or political interest in this piece.

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Economics

Four reasons why EU is staring down the barrel of a second lost decade

If insanity is doing the same thing over and over and expecting different results, what does that say about the EU?

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Rolling the dix. Imelda, CC BY-SA

The eurozone’s latest economic growth figures are a little better than expected. This group of 19 EU nations grew 2.2% in the second quarter of 2021 compared to the first quarter, partly thanks to decent performances from Spain and Italy.

But while the US and Chinese economies are both now bigger than their 2019 peaks, the eurozone is 3% off that achievement. And when you look more broadly at the state of the eurozone, this turns out to be only the tip of the iceberg.

COVID-19 still overshadows everything around the world, but countries are likely to recover at different speeds once we get back to some sort of normality. This will depend on the structure of their economies, the effectiveness of their recovery policies, and how they deal with high sovereign debts and a foreseeable mix of weakish growth and inflation. But for several reasons, the eurozone particularly worries me.

Ghosts of the past

The first is the eurozone’s bleak performance since the global financial crisis of 2007-09. It took six years to regain its 2008 GDP level, and some members did even worse: Spain and Portugal took almost a decade, and Italy and Greece have yet to get there.

When COVID broke out, the eurozone growth rate remained well below its long-term trajectory. It was behind the US and UK, both of whom were hit harder by the global financial crisis, and even worse compared to the leading emerging economies. Neither was this a one-off. Looking at the past five recessions, the eurozone nations have been successively slower to recover from each one.

GDP by nation since 2008

Based on GDP (constant 2010 US$): Source: Authors’ calculations using World Bank data. Muhammad Ali Nasir

Since 2008, the ECB has tried numerous measures to improve growth. Like most major powers, it has done a lot of quantitative easing (QE), which involves creating money to buy sovereign bonds and other financial assets. It has sought to prop up its retail banks in various ways, while also pioneering negative interest rates and giving the markets more forward guidance about monetary policy.

Famously in 2012, then ECB president Mario Draghi said he would do “whatever it takes” to save the euro. This forward guidance kept the euro stable, but the same cannot be said of growth.

Poor policy and low ammunition

Policy errors are partly to blame for this. With the benefit of hindsight, the eurozone went into the global financial crisis with lending rates on the low side, so had less room to cut than other regions. It was also more reluctant than central banks like the Bank of England and US Federal Reserve to start QE, preferring to focus on curbing inflation and making the euro “stabil wie die mark” (stable like the German mark). The ECB did not unveil a QE programme until 2015.

Countries with the capacity to spend to stimulate their economies, such as Germany, France and the Netherlands, also did too little. Spain’s stimulus was poorly designed, while Italy was more interested in balancing its books at the time. Too soon after the crisis struck, austerity then became the priority for the whole eurozone.

A related problem has been public and private investment. In middle-income EU regions, investment rates fell by about 14% between 2002 and 2018. In thrifty Germany, public and private fixed investments declined as a percentage of GDP for decades, despite a huge surplus in public spending.

Before COVID hit, EU infrastructure investment was at a 15-year low, with the greatest declines in regions that were already lagging. Initiatives intended to help, such as the European Economic Recovery Plan of 2008 and the European Commission Investment Plan in 2014, were too little.

The overall result was that weakness: Germany and the eurozone as a whole were showing 0% growth at the time of the COVID outbreak, while Austria, France and Italy were all contracting slightly. In response, the ECB had cut its main interest rate by 0.1 percentage points to -0.5% in September 2019, and restarted monthly QE to the tune of €20 billion (£17 billion) from November 1 of that year – the date Christine Lagarde became ECB president.

The eurozone economy was therefore needing life support even before the pandemic – indeed, many of the ECB’s other unconventional support measures were in place throughout. Tellingly, the ECB’s only new measure during the pandemic has been a new form of cheaper refinancing for banks. It raises the prospect of the ECB running out of the ammunition needed to keep stimulating the eurozone’s sickly economy.

Discipline über alles

Finally, some eurozone members are obsessed with the EU’s fiscal rules around low national debt and low deficits. The Financial Times may have reported in March 2020 that “Germany tears up fiscal rule book to counter coronavirus pandemic”, but there are already calls by influential figures such as Bundestag president Wolfgang Schäuble to return to fiscal discipline.

A rush to austerity 2.0 is a luxury that the EU cannot afford. To quote something often attributed to Albert Einstein, insanity is doing the same thing over and over again and expecting different results.

German flag on top of the Reinchstag at dusk
Germans don’t do inflation. Christian Lue, CC BY-SA

For different results, the ECB should stand its ground on monetary easing and, like the Fed, avoid giving in to inflationary pressures that are likely to be short term by raising rates or paring back QE.

Meanwhile, the fiscal rules need loosening to correspond to economic realities. The temptation must be avoided to throw the nations in the peripheries under the austerity bus again, one of the main causes of the eurozone crisis of the early 2010s.

Surplus nations, particularly Germany, should revive spending in infrastructure, education and technology. The EU’s €750 billion Next Generation EU investment plan will belatedly kick in later this year, but just like the two previous EU recovery packages, will probably not be enough on its own.

With an unimpressive track record on recovery, inherently weak economies, an obsession with fiscal rules and the prospect of the ECB running out of ammunition, the alternative could be a second lost decade. What that could do to the eurozone and the EU, it would be better not to find out.

Muhammad Ali Nasir does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.

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