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Futures, Bitcoin Crater As Yields And Dollar Surge

Futures, Bitcoin Crater As Yields And Dollar Surge

After a dismal week for risk assets, which saw equities drop the most since June 17, global…

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Futures, Bitcoin Crater As Yields And Dollar Surge

After a dismal week for risk assets, which saw equities drop the most since June 17, global markets and US equity futures are tumbling in another extremely illiquid session (Japan and UK are both closed, the latter for the state funeral of QE2) as the realization sparked by Fedex that the world is in a global recession, is starting to finally seep through. Add to that Wednesday's 75bps rate hike by the Fed (which however is more than priced in by now) as well as the previously discussed start of the buyback blackout period, and CTAs and pensions becoming forced sellers with investor sentiment that can at best be described as pervasive record doom and gloom, and it becomes clear why this week could be an even bigger bloodbath for stocks.

And sure enough, Nasdaq contracts have tumbled 1.2% as S&P futures are down 1.0%...

...the dollar is back into record territory, with rumors of a new imminent plaza accord growing louder by the day...

... 10Y yields are just shy of 3.50%, hitting a new post-2011 high this morning...

... which in turn is hammering European and Asian markets, as oil plunges in response to the fresh highs in the dollar.

In permarket trading, tech shares are lower and poised to extend last week’s decline, as investors expect the Fed to deliver a 75bps rate hike when it meets on Wednesday, putting pressure on pricier growth stocks. Tesla (TSLA US) -1.4%, Google (GOOGL US) -1.2%. Here are some other notable premarket movers:

  • Marathon Digital (MARA US) plunged as much as 8.4% in premarket trading on Monday alongside other cryptocurrency- related stocks, after Bitcoin dropped toward the lowest level since 2020 on monetary tightening concerns.
  • US-listed Chinese stocks edged lower in premarket trading Monday after Chinese stocks listed in Hong Kong dropped, putting them on track to enter bear-market territory. Alibaba (BABA US) -1.5%, Nio (NIO US) -1.6%.
  • FOXO Technologies (FOXO US) surges in premarket trading after tumbling 52% on its debut on Friday via its combination with special purpose acquisition company Delwinds Insurance Acquisition Corp.
  • Take-Two Interactive Software Inc. (TTWO US) falls 6.5% in US premarket trading Monday after a hacker published pre-release footage from development of Grand Theft Auto VI, its most anticipated video game.

In addition to the startling FedEx warning which sent the stock crashing by the most on record, investors also face potential volatility from policy decisions this week by the Bank of England, the Bank of Japan and a host of other central banks. The British pound sank to its weakest level against the dollar since 1985 on Friday and the yen remains under pressure, though it has backed off from just below the key 145 level versus the dollar.

“The aggressive tightening of policy in the coming 4-6 months, not just in the US but globally, increases the risk of a recession next year,” said Maria Landeborn, a senior strategist at Danske Bank A/S. “We expect uncertainty will remain high surrounding inflation, rates and the overall economy, which is negative for market sentiment and risk assets.”

With the Fed poised to hike 75bps (and perhaps even 100bps) and keep rising until it hits 4.50%, top Wall Street strategists see mounting risks for US earnings and equity valuations. Both Morgan Stanley’s Michael J. Wilson and Goldman Sachs Group Inc.’s David J. Kostin said headwinds to profitability are building, highlighting tighter monetary policy and pressure on company margins.

In Europe, the Stoxx 50 fell 0.9% with Spain' IBEX outperforming, dropping just 0.3%, CAC 40 lags, dropping 1.1%. Energy, financial services and real estate are the worst performing sectors. Rate-sensitive European real estate shares are among the worst-performing in Europe in Monday trading, with the region’s equity market dropping further after seeing the biggest weekly decline in three months, as investors await a Federal Reserve monetary policy meeting this week.  Here are some of the biggest European movers today:

  • Porsche Automobil Holding advances; Volkswagen AG said it’s looking to raise as much as EU9.4 billion from the IPO of its sports-car maker in what could be Europe’s largest listing in more than a decade
  • European energy stocks fall, making them the worst-performing sector in Europe on Monday, as oil prices dipped, erasing earlier gains, with the Stoxx 600 Energy index declining 1.8%
  • European real estate shares are among the worst- performing in Europe in Monday trading, with the region’s equity market dropping as investors await a Federal Reserve monetary policy meeting this week
  • TF1 and M6 slumped after the French TV companies called off a planned combination because of objections from the country’s antitrust regulator; also today, Oddo cut TF1 to neutral
  • Valneva falls as much as 16% after the French vaccines maker said it will terminate a Covid-19 vaccine collaboration with IDT Biologika, agreeing to pay as much as EU36.2 million in cash.

Earlier in the session, Asian equities fell, poised for a fifth session of decline, as the dollar strengthened ahead of the Federal Reserve’s meeting this week. The MSCI Asia Pacific ex-Japan index erased early gains and fell as much as 0.8%, dragged by consumer discretionary and tech shares. Benchmarks in Hong Kong and South Korea were among the worst performers in the region. Japan’s market was shut for a holiday. The dollar’s gains put pressure on regional currencies, and stocks tumbled in the Philippines, Malaysia and Vietnam. Traders are watching the Federal Open Market Committee’s interest-rate decision on Wednesday for signals on further policy tightening, pricing in a 75-basis-point hike. The Hang Seng China Enterprises Index fell more than 1%, taking its losses from a June 28 peak to just short of 20%, which will mark the start of a bear market. Mainland China stocks traded little changed Monday as megacity Chengdu exited a lockdown.

MSCI’s broadest Asia Pacific stock gauge has clocked five consecutive weeks of losses as investors factor in higher US interest rates and a strong dollar. Optimism over any easing of China’s Covid-Zero stance after the party congress in October is also waning. “Unless the Fed is done with rate hikes, the US dollar bull market is not over yet,” Lim Say Boon, chief investment strategist at CGS-CIMB Securities wrote in a note.

In Australia, The t&P/ASX 200 index fell 0.3% to close at 6,719.90, the lowest since July 19, dragged by losses in health care and energy shares.  In New Zealand, the S&P/NZX 50 index fell 0.4% to 11,531.99. The nation’s economic outlook is sound, despite increasing domestic and international turbulence, S&P said in a statement

Stocks in India snapped three days of declines, helped by a rally in consumer and auto firms on expectations of a boost in demand during the upcoming festive season. The S&P BSE Sensex rose 0.5% to 59,141.23 in Mumbai, while the NSE Nifty 50 Index also gained by a similar magnitude. Out of 30 shares in the Sensex index, 20 rose and 10 fell. A gauge of fast-moving consumer-goods makers was the best performer among 19 sectoral sub-indexes compiled by BSE Ltd. Most stocks across Asia declined ahead of key rate decisions by various central banks, including the US Federal Reserve. A higher-than-expected inflation in the US has raised expectations of another 75-basis-point hike when Fed policymakers meet on Wednesday. Housing Development Finance Corp contributed the most to the Sensex’s gains, increasing 1.5%. 

In rates, Treasuries re-opened with yields cheaper by up to 5.5bp across front end of the curve in a bear flattening move. Into the weakness 10-year yields top at 3.506% and cheapest levels since June 2011. Cash market was closed overnight as UK observes a day of mourning for Queen Elizabeth II and Japan is out on holiday. Treasury yields 3.5bp to 5.5bp cheaper across the curve with long end outperforming slightly, flattening 2s10s, 5s30s spreads by 0.5bp and 1bp on the day. IG dollar issuance slate empty so far; up to $20b expected for the week with Monday and Tuesday potentially busy ahead of Wednesday FOMC. Latest CFTC positioning data shows hedge fund net short in two-year note futures, biggest since June 2021. Bund yields climb some 3bps across the curve. Australia’s bonds rose for the first time in four days. Yields fell 3-5bps across the curve.

In FX, the dollar strengthens against all FX majors; euro trades below parity while cable trades at around 1.13/USD and the yen slides near 143.43/USD. UK observes a day of mourning for Queen Elizabeth II. Some more details:

  • The Bloomberg Dollar Spot Index advanced 0.3% as the greenback strengthened against all Group-of-10 peers. Risk-sensitive Scandinavian and Antipodean currencies were the worst performers. Treasury futures eased, sending yields a few basis points higher
  • The euro gave up an Asia session gain to drop for the first time in four days, yet momentum in options is less bearish across all tenors compared to a week ago. German bonds inched lower, with yields rising 3-4 bps, ahead of ECB speakers today
  • The Swiss franc and the yen held up best against wide dollar gains. Hedge funds ramped up bearish yen bets to a three-month high on expectations Japan would languish in a world where developed market peers are racing to hike interest rates
  • The yuan fell even as the People’s Bank of China fixed the currency at 6.9396 per dollar, 647 pips stronger than the average estimate in a Bloomberg survey of analysts and traders, the widest difference on record since Bloomberg started the survey in 2018

In commodities, WTI drifts 1.3% lower to trade near $83.98. Oil futures have resumed the sell-off, in part amid the cautious risk tone/firmer Dollar. Nord Stream AG says it cannot confirm nominations for the Nord Stream 1 gas pipeline on Monday. Kuwait produces more than 2.8mln bpd and has plans to increase oil output whenever the market needs it, while Kuwait currently produces 650mln cubic feet of gas per day and plans to raise it to 1bln cubic feet, according to Kuwaiti Petroleum Corporation’s CEO, cited by Reuters. Spot gold falls roughly $10 to trade near $1,665/oz. European natural gas futures fall again to their lowest level in almost two months. Bitcoin extends decline to $18k-level as broad crypto selloff continues.

Bitcoin remained under pressure sub-USD 18,500. Ethereum extended on losses under USD 1,300.

It's a busy week on the macro front, but Monday will be quiet with just the September NAHB housing market index on deck in the US. We also get the Eurozone July construction output, Canada August industrial product and raw materials prices.

Market Snapshot

  • S&P 500 futures down 0.8% to 3,861.00
  • STOXX Europe 600 down 0.7%
  • MXAP down 0.5% to 149.48
  • MXAPJ down 0.6% to 487.97
  • Nikkei down 1.1% to 27,567.65
  • Topix down 0.6% to 1,938.56
  • Hang Seng Index down 1.0% to 18,565.97
  • Shanghai Composite down 0.3% to 3,115.60
  • Sensex up 0.6% to 59,203.12
  • Australia S&P/ASX 200 down 0.3% to 6,719.92
  • Kospi down 1.1% to 2,355.66
  • German 10Y yield up 3 bps to 1.78%
  • Euro down 0.4% to $0.9978
  • Brent futures down 0.9% to $90.53/bbl
  • Gold spot down 0.7% to $1,663.72
  • U.S. Dollar Index up 0.3% to 110.05

Top Overnight News from Bloomberg

  • Federal Reserve officials are on track to raise interest rates by 75 basis points for the third consecutive meeting this week and signal they’re heading above 4% and will then go on hold
  • Investors bracing for another jumbo Federal Reserve interest-rate hike are focused on a few key trades: betting on deeper inversion in the US yield curve, further losses in stocks and a stronger dollar
  • The risk of a euro-area recession has reached its highest level since July 2020 as concerns grow that a winter energy squeeze will cause a slump in economic activity. Economists polled by Bloomberg now put the probability of two straight quarters of contraction at 80% in the next 12 months, up from 60% in a previous survey
  • European Central Bank interest rates will need to rise a lot more to get inflation under control, Bundesbank President Joachim Nagel said over the weekend
  • The Chinese megacity of Chengdu exited its lockdown on Monday, with 21 million people allowed to leave their homes and resume most aspects of normal life for the first time since Sept. 1, provided they’re tested regularly for Covid-19

A more detailed look at global markets courtesy of Newsquawk

APAC stocks were mostly subdued with the region lacking firm direction amid holiday-quietened conditions and with participants cautious ahead of this week’s slew of central bank policy decisions including from the FOMC, BoE and BoJ. ASX 200 was indecisive after gains in the mining industry were offset by underperformance in tech and defensives, with risk appetite also contained amid further calls for the RBA to hike by 50bps next month. Nikkei 225 was closed due to a domestic holiday. Hang Seng and Shanghai Comp declined with the Hong Kong benchmark pressured by losses in tech and pharmaceuticals, while the mainland was also subdued despite the cities of Chengdu and Dalian lifting lockdowns and the PBoC conducting 14-day reverse repos for the first time since January at a lower rate. Nonetheless, the injection was likely due to the upcoming National Day holidays and the rate cut was not much of a surprise after a similar cut in the 7-day reverse repo rate last month, while geopolitical concerns also lingered following comments from US President Biden that US forces would defend Taiwan in the event of a Chinese invasion.

Top Asian News

  • China’s Chengdu lifted the lockdown for the entire city and Dalian will also lift the citywide lockdown effective this Monday, according to Bloomberg.
  • China NDRC is seeking to promote an acceleration of the recovery in domestic consumption and speed up the injection of funds to start project construction ASAP. NDRC said the foundation of the economic recovery is still weak despite positive changes in main economic indicators and that external environment for utilising foreign capital is increasingly complex and severe, while it added there remains some factors affecting foreign investment confidence.
  • UBS cut its China 2022 GDP growth forecast to 2.7% from 3.0% due to a weak Q3 recovery, according to Bloomberg.
  • China’s Global Times stated that economists urged US regulators to serve market fairness and not let their work be trained with political factors as they are about to begin reviewing audit files of Chinese companies.
  • US tsunami warning system issued a tsunami threat in Taiwan on Sunday morning following a magnitude 7.2 earthquake.
  • Japan’s weather agency issued a special typhoon warning for the Kagoshima prefecture in southern Japan on Saturday, according to Reuters. It was later reported that the typhoon made landfall and millions were told to evacuate homes, according to FT.

The subdued tone seen across a holiday-thinned APAC session reverberated into Europe, with UK markets closed due to the funeral of Queen Elizabeth II. European cash bourses are lower across the board but off worst levels. European sectors are mostly lower with no overarching theme. US equity futures are softer in tandem with their European counterparts with relatively broad-based losses seen across the main December contracts.

Top European News

  • UK PM Truss will conduct a bilateral meeting with US President Biden at the UN General Assembly on Wednesday instead of meeting in Downing Street on Sunday, according to a statement cited by Reuters.
  • UK PM Truss agreed with Irish PM Martin that an opportunity exists for the UK and the EU for a negotiated Brexit resolution to the Northern Ireland protocol, according to RTE.
  • UK PM Truss’s chief of staff Fullbrook said he is cooperating with the FBI regarding an investigation into a Conservative Party donor charged with illegally providing campaign donations to a former Puerto Rico governor, although Fullbrook denied any wrongdoing, according to FT.
  • ECB’s Lane said there will probably be several more rate hikes this year and early next year, while he noted signs that inflation will come down but not just yet and said that a recession cannot be ruled out, according to Reuters.
  • ECB’s Nagel said the ECB are ‘a good way off’ from where rates should be and rates will need to rise a lot more to get inflation under control, although is confident that inflation rates will fall after a tough winter, according to Bloomberg.
  • EU is set to withhold EUR 7.5bln of funding from Hungary due to rule of law violations regarding corruption in awarding public contracts, according to FT.
  • EU may ask companies to expand or repurpose production lines, according to European Commission emergency powers to avert supply crisis

Geopolitics

  • US President Biden warned Russian President Putin against changing the face of the war by using tactical nuclear or chemical weapons in Ukraine, while he also stated that Ukraine is not losing the war and is making progress in some areas, according to an interview on CBS’s 60 Minutes. Furthermore, President Biden said he warned Chinese President Xi of an investment chill and that it would be a gigantic mistake if China violates sanctions on Russia but noted that there has been no indication that Beijing has provided weapons to Moscow for its invasion of Ukraine.
  • US Joint Chief of Staff chairman General Milley said during a visit to a military base in Poland that it is still unclear how Russia will react to the battlefield setbacks in Ukraine and now is the time for increased vigilance and preparedness, according to Reuters.
  • IAEA said one of the Zaporizhzhia nuclear power plant’s regular external power lines has been repaired and the plant is receiving electricity directly from the national grid, while it added that although there has not been any recent shelling at or near the plant, it continues to occur in the wider area, according to Reuters.
  • Russia and China have agreed on further cooperating on defence with a focus on joint exercises, according to Interfax cited Russian Security Council.
  • US President Biden said US forces would defend Taiwan in the event of a Chinese invasion, according to Reuters.
  • Taiwan said China continued its military activities around the island and that it detected 20 Chinese aircraft and 5 Chinese ships operating around Taiwan on Saturday, according to Reuters.

FX

  • The Dollar regrouped and regained a bid on a combination of technical and positional factors; DXY topped 110.00 but remains shy of Friday's best.
  • EUR/USD retreated back under parity, GBP/USD under 1.1400 from a 1.1442 peak.
  • USD/JPY grinds upwards and briefly topped 143.50, whilst antipodeans are the G10 laggards.

Fixed Income

  • Bonds have extended to the downside after waning from best levels earlier or overnight.
  • Bunds are off a deeper 142.43 Eurex trough and the US 10-year T-note is nearer the base of its 114-12+/114-25+ range.

Commodities

  • WTI and Brent futures have resumed the sell-off, in part amid the cautious risk tone/firmer Dollar.
  • Nord Stream AG says it cannot confirm nominations for the Nord Stream 1 gas pipeline on Monday.
  • Kuwait produces more than 2.8mln bpd and has plans to increase oil output whenever the market needs it, while Kuwait currently produces 650mln cubic feet of gas per day and plans to raise it to 1bln cubic feet, according to Kuwaiti Petroleum Corporation’s CEO, cited by Reuters.
  • Spot gold has been under pressure as the Dollar gained traction, whilst CME copper is softer amid the risk tone
  • Chinese copper tycoon He Jinbi’s Maike Metals International is reportedly suffering a liquidity crisis that threatens his empire which handles one of every four tons of copper imported into China, according to Bloomberg.

US Event Calendar

  • 10:00: Sept. NAHB Housing Market Index, est. 47, prior 49

DB's Jim Reid concludes the overnight wrap

A packed week will kick off with a quiet, solemn, start, as the UK is closed for the Queen’s funeral. Japan is also out on holiday. Looking forward, the postponed BoE meeting will nudge its way into an already packed central bank meeting schedule which includes the BoJ, SNB, Riksbank, Norgesbank, and of course, the Fed. Suffice to say, monetary policy will be in focus this week.

On the Fed, market pricing glided toward Matt Luzzetti’s expectations (full FOMC preview here) that the Fed will deliver a 75bp hike next week, having decayed from last week’s peaks after the stronger than expected CPI data. Much closer to consensus PPI and University of Michigan inflation expectations data helped bring pricing back from the peaks, let alone no press reports seemingly confirming pricing one way or another (finishing the week at 79.8bps priced). Regardless, some premium of a 100bp move will probably stay priced in for Wednesday, either on the off chance of some late blackout-period guidance.

Beyond the rate move itself, the new SEP should show unemployment ticking higher, moving farther from a soft-landing forecast. Luzzetti and co. expect the dots will show unemployment ratcheting to 4.5%. The September FOMC also adds another year to the SEP, so we will get figures for 2025, showing how steep a hiking cycle, how deep any recession, and how quick the subsequent recovery policymakers are expecting if their preferred policy path is realized.

On the BoE, our economists expect (full preview here) the MPC to vote for a second consecutive 50bp hike, albeit along divisive lines, with dissents favouring both a 25bp and a 75bp move likely surfacing. On the balance sheet, the MPC should confirm the start of gilt sales from later on this month, totaling GBP 10bn per quarter. Our economists expect the BoE’s terminal rate will be 4%, reached in May of next year, which is a 150bp upgrade over their old forecast.

The Bank of Japan also meets, where our economist expects (full preview here) the BoJ to remain the DM outlier by maintaining an easy policy stance, while agreeing to end their special pandemic funds-supplying operation as scheduled at the end of the month. The policy divergence will continue to weigh on a yen which is around its weakest levels versus the dollar since the early 90s, but our economists do not expect that augurs intervention, as fundamentals are driving the weakening and reduce the chance any intervention is effective.

Geopolitical risks will remain in focus, where the Ukraine war is most front-and-center. Elsewhere, a few conflagrations have broken out in former USSR states which individually may not be macro moving events, but are something to keep an eye on if symptomatic of something broader. Finally, an ever-looming potential issue, President Biden said in an interview with 60 minutes that the US would defend Taiwan if invaded, even as he downplayed the claim as not official US policy.

Overnight in Asia equity markets are trading in negative territory at the start of the week after the US equities ended in the red on Friday. The Kospi (-0.98%) is the largest underperformer across the region followed by the Hang Seng (-0.88%). Over in mainland China, the Shanghai Composite (-0.22%) is trading lower while the CSI (-0.11%) is swinging between gains and losses. Elsewhere, as mentioned, markets in Japan are closed for a holiday with no trading in Treasuries until the US session. In overnight trading, US stock futures are pointing to further losses with contracts on the S&P 500 (-0.27%) and NASDAQ 100 (-0.50%) both edging lower.

A quick recap of last week, which was a reliable microcosm of the major macro stories over the year, namely the war in Ukraine and the central bank battle over inflation.

Ukraine’s successful counter-offensive stoked some optimism early in the week, optimism which faded from risk assets (along with the tightening in global policy paths, more below) as the pathway to peace and an end to the war were not any clearer. That was ossified on Friday with President Putin giving a press conference where he warned about escalating the conflict in so many words. Global equity indices retreated over the week, with the STOXX 600 down -2.89% (-1.58% Friday), the DAX -2.65% lower (-1.66% Friday), and the CAC down -2.17% (-1.31% Friday). Banks proved one bright spot in European equities given the rate selloff, with the Euro Banks index gaining +2.90% despite pulling back -1.88% on Friday. US equities underperformed given the salience of steeper Fed policy post CPI, with the S&P 500 pulling back -4.77% (-0.72% Friday) and the NASDAQ down -5.48% (-0.90% Friday), the worst weekly return for both since mid-June.

The EU’s unveiling of measures to curtail energy price pressures, combined with some national-level efforts, drove European natural gas futures -9.82% lower to close the week at EUR 186.75, the first time they’ve ended a week below EUR 200 since the end of July.

For rates, the main event was the above-consensus US CPI data, which saw a repricing of global policy paths steeper, with 2yr Treasuries gaining +31.1bps (+0.3bps Friday) and 2yr Bunds +20.6bps higher (-0.7bps Friday). Curves flattened in both jurisdictions given the harder-landing implications of such a steep policy path, with 10yr Treasuries up +14.0bps (flat Friday) and Bunds up +5.8bps (-1.4bps Friday). It also coincided with terminal rates pricing higher, where the market is expecting fed funds rates to get up just shy of 4.4% in the spring of next year, albeit below our revised in-house call of terminal closer to 5%.

Tyler Durden Mon, 09/19/2022 - 07:32

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Spread & Containment

Plunging pound and crumbling confidence: How the new UK government stumbled into a political and financial crisis of its own making

Liz Truss took over as prime minister with an ambitious plan to cut taxes by the most since 1972 – investors balked after it wasn’t clear how she would…

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The hard hats likely came in handy recently for Prime Minister Liz Truss and Chancellor of the Exchequer Kwasi Kwarteng. Stefan Rousseau/Pool Photo via AP

The new British government is off to a very rocky start – after stumbling through an economic and financial crisis of its own making.

Just a few weeks into its term on Sept. 23, 2022, Prime Minister Liz Truss’ government released a so-called mini-budget that proposed £161 billion – about US$184 billion at today’s rate – in new spending and the biggest tax cuts in half a century, with the benefits mainly going to Britain’s top earners. The aim was to jump-start growth in an economy on the verge of recession, but the government didn’t indicate how it would pay for it – or provide evidence that the spending and tax cuts would actually work.

Financial markets reacted badly, prompting interest rates to soar and the pound to plunge to the lowest level against the dollar since 1985. The Bank of England was forced to gobble up government bonds to avoid a financial crisis.

After days of defending the plan, the government did a U-turn of sorts on Oct. 3 by scrapping the most controversial component of the budget – elimination of its top 45% tax rate on high earners. This calmed markets, leading to a rally in the pound and government bonds.

As a finance professor who tracks markets closely, I believe at the heart of this mini-crisis over the mini-budget was a lack of confidence – and now a lack of credibility.

A looming recession

Truss’ government inherited a troubled economy.

Growth has been sluggish, with the latest quarterly figure at 0.2%. The Bank of England predicts the U.K. will soon enter a recession that could last until 2024. The latest data on U.K. manufacturing shows the sector is contracting.

Consumer confidence is at its lowest level ever as soaring inflation – currently at an annualized pace of 9.9% – drives up the cost of living, especially for food and fuel. At the same time, real, inflation-adjusted wages are falling by a record amount, or around 3%.

It’s important to note that many countries in the world, including the U.S. and in mainland Europe, are experiencing the same problems of low growth and high inflation. But rumblings in the background in the U.K. are also other weaknesses.

Since the financial crisis of 2008, the U.K. has suffered from lower productivity compared with other major economies. Business investment plateaued after Brexit in 2016 – when a slim majority of voters chose to leave the European Union – and remains significantly below pre-COVID-19 levels. And the U.K. also consistently runs a balance of payments deficit, which means the country imports a lot more goods and services than it exports, with a trade deficit of over 5% of gross domestic product.

In other words, investors were already predisposed to view the long-term trajectory of the U.K. economy and the British pound in a negative light.

An ambitious agenda

Truss, who became prime minister on Sept. 6, 2022, also didn’t have a strong start politically.

The government of Boris Johnson lost the confidence of his party and the electorate after a series of scandals, including accusations he mishandled sexual abuse allegations and revelations about parties being held in government offices while the country was in lockdown.

Truss was not the preferred candidate of lawmakers in her own Conservative Party, who had the task of submitting two choices for the wider party membership to vote on. The rest of the party – dues-paying members of the general public – chose Truss. The lack of support from Conservative members of Parliament meant she wasn’t in a position of strength coming into the job.

Nonetheless, the new cabinet had an ambitious agenda of cutting taxes and deregulating energy and business.

Some of the decisions, laid out in the mini-budget, were expected, such as subsidies limiting higher energy prices, reversing an increase in social security taxes and a planned increase in the corporate tax rate.

But others, notably a plan to abolish the 45% tax rate on incomes over £150,000, were not anticipated by markets. Since there were no explicit spending cuts cited, funding for the £161 billion package was expected to come from selling more debt. There was also the threat that this would be paid for, in part, by lower welfare payments at a time when poorer Britons are suffering from the soaring cost of living. The fear of welfare cuts is putting more pressure on the Truss government.

a man in a brown stocking hat inspects souvenirs near a bunch of UK flags and other trinkets
The cost of living crisis in the U.K. has everyone looking for deals where they can. AP Photo/Kirsty Wigglesworth

A collapse in confidence

Even as the new U.K. Chancellor of the Exchequer Kwasi Kwarteng was presenting the mini-budget on Sept. 23, the British pound was already getting hammered. It sank from $1.13 the day before the proposal to as low as $1.03 in intraday trading on Sept. 26. Yields on 10-year government bonds, known as gilts, jumped from about 3.5% to 4.5% – the highest level since 2008 – in the same period.

The jump in rates prompted mortgage lenders to suspend deals with new customers, eventually offering them again at significantly higher borrowing costs. There were fears that this would lead to a crash in the housing market.

In addition, the drop in gilt prices led to a crisis in pension funds, putting them at risk of insolvency.

Many members of Truss’ party voiced opposition to the high levels of borrowing likely necessary to finance the tax cuts and spending and said they would vote against the package.

The International Monetary Fund, which bailed out the U.K. in 1976, even offered its figurative two cents on the tax cuts, urging the government to “reevaluate” the plan. The comments further spooked investors.

To prevent a broader crisis in financial markets, the Bank of England stepped in and pledged to purchase up to £65 billion in government bonds.

Besides causing investors to lose faith, the crisis also severely dented the public’s confidence in the U.K. government. The latest polls showed the opposition Labour Party enjoying a 24-point lead, on average, over the Conservatives.

So the government likely had little choice but to reverse course and drop the most controversial part of the plan, the abolition of the 45% tax rate. The pound recovered its losses. The recovery in gilts was more modest, with bonds still trading at elevated levels.

Putting this all together, less than a month into the job, Truss has lost confidence – and credibility – with international investors, voters and her own party. And all this over a “mini-budget” – the full budget isn’t due until November 2022. It suggests the U.K.‘s troubles are far from over, a view echoed by credit rating agencies.

David McMillan 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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Economics

Roubini: The Stagflationary Debt Crisis Is Here

Roubini: The Stagflationary Debt Crisis Is Here

Authored by Nouriel Roubini via Project Syndicate,

The Great Moderation has given way to…

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Roubini: The Stagflationary Debt Crisis Is Here

Authored by Nouriel Roubini via Project Syndicate,

The Great Moderation has given way to the Great Stagflation, which will be characterized by instability and a confluence of slow-motion negative supply shocks. US and global equities are already back in a bear market, and the scale of the crisis that awaits has not even been fully priced in yet.

For a year now, I have argued that the increase in inflation would be persistent, that its causes include not only bad policies but also negative supply shocks, and that central banks’ attempt to fight it would cause a hard economic landing. When the recession comes, I warned, it will be severe and protracted, with widespread financial distress and debt crises. Notwithstanding their hawkish talk, central bankers, caught in a debt trap, may still wimp out and settle for above-target inflation. Any portfolio of risky equities and less risky fixed-income bonds will lose money on the bonds, owing to higher inflation and inflation expectations.

How do these predictions stack up? First, Team Transitory clearly lost to Team Persistent in the inflation debate. On top of excessively loose monetary, fiscal, and credit policies, negative supply shocks caused price growth to surge. COVID-19 lockdowns led to supply bottlenecks, including for labor. China’s “zero-COVID” policy created even more problems for global supply chains. Russia’s invasion of Ukraine sent shockwaves through energy and other commodity markets. And the broader sanctions regime – not least the weaponization of the US dollar and other currencies – has further balkanized the global economy, with “friend-shoring” and trade and immigration restrictions accelerating the trend toward deglobalization.

Everyone now recognizes that these persistent negative supply shocks have contributed to inflation, and the European Central Bank, the Bank of England, and the US Federal Reserve have begun to acknowledge that a soft landing will be exceedingly difficult to pull off. Fed Chair Jerome Powell now speaks of a “softish landing” with at least “some pain.” Meanwhile, a hard-landing scenario is becoming the consensus among market analysts, economists, and investors.

It is much harder to achieve a soft landing under conditions of stagflationary negative supply shocks than it is when the economy is overheating because of excessive demand. Since World War II, there has never been a case where the Fed achieved a soft landing with inflation above 5% (it is currently above 8%) and unemployment below 5% (it is currently 3.7%). And if a hard landing is the baseline for the United States, it is even more likely in Europe, owing to the Russian energy shock, China’s slowdown, and the ECB falling even further behind the curve relative to the Fed.

Are we already in a recession? Not yet, but the US did report negative growth in the first half of the year, and most forward-looking indicators of economic activity in advanced economies point to a sharp slowdown that will grow even worse with monetary-policy tightening. A hard landing by year’s end should be regarded as the baseline scenario.

While many other analysts now agree, they seem to think that the coming recession will be short and shallow, whereas I have cautioned against such relative optimism, stressing the risk of a severe and protracted stagflationary debt crisis. And now, the latest distress in financial markets – including bond and credit markets – has reinforced my view that central banks’ efforts to bring inflation back down to target will cause both an economic and a financial crash.

I have also long argued that central banks, regardless of their tough talk, will feel immense pressure to reverse their tightening once the scenario of a hard economic landing and a financial crash materializes. Early signs of wimping out are already discernible in the United Kingdom. Faced with the market reaction to the new government’s reckless fiscal stimulus, the BOE has launched an emergency quantitative-easing (QE) program to buy up government bonds (the yields on which have spiked).

Monetary policy is increasingly subject to fiscal capture. Recall that a similar turnaround occurred in the first quarter of 2019, when the Fed stopped its quantitative-tightening (QT) program and started pursuing a mix of backdoor QE and policy-rate cuts – after previously signaling continued rate hikes and QT – at the first sign of mild financial pressures and a growth slowdown. Central banks will talk tough; but there is good reason to doubt their willingness to do “whatever it takes” to return inflation to its target rate in a world of excessive debt with risks of an economic and financial crash.

Moreover, there are early signs that the Great Moderation has given way to the Great Stagflation, which will be characterized by instability and a confluence of slow-motion negative supply shocks. In addition to the disruptions mentioned above, these shocks could include societal aging in many key economies (a problem made worse by immigration restrictions); Sino-American decoupling; a “geopolitical depression” and breakdown of multilateralism; new variants of COVID-19 and new outbreaks, such as monkeypox; the increasingly damaging consequences of climate change; cyberwarfare; and fiscal policies to boost wages and workers’ power.

Where does that leave the traditional 60/40 portfolio? I previously argued that the negative correlation between bond and equity prices would break down as inflation rises, and indeed it has. Between January and June of this year, US (and global) equity indices fell by over 20% while long-term bond yields rose from 1.5% to 3.5%, leading to massive losses on both equities and bonds (positive price correlation).

Moreover, bond yields fell during the market rally between July and mid-August (which I correctly predicted would be a dead-cat bounce), thus maintaining the positive price correlation; and since mid-August, equities have continued their sharp fall while bond yields have gone much higher. As higher inflation has led to tighter monetary policy, a balanced bear market for both equities and bonds has emerged.

But US and global equities have not yet fully priced in even a mild and short hard landing. Equities will fall by about 30% in a mild recession, and by 40% or more in the severe stagflationary debt crisis that I have predicted for the global economy. Signs of strain in debt markets are mounting: sovereign spreads and long-term bond rates are rising, and high-yield spreads are increasing sharply; leveraged-loan and collateralized-loan-obligation markets are shutting down; highly indebted firms, shadow banks, households, governments, and countries are entering debt distress.

The crisis is here.

Tyler Durden Tue, 10/04/2022 - 17:25

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A Policy Mistake In The Making

A Policy Mistake In The Making

Authored by Lance Roberts via RealInvestmentAdvice.com,

“Market Instability” Causes BOE To Reverse QT….

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A Policy Mistake In The Making

Authored by Lance Roberts via RealInvestmentAdvice.com,

“Market Instability” Causes BOE To Reverse QT. Is The Fed Next?

“Market instability” remains the most significant risk to central banks globally. Despite their desire to combat surging inflation, market instability is a greater risk to global economies due to the massive amounts of leverage. We previously discussed the importance of controlling instability. To wit:

Interestingly, the Fed is dependent on both market participants and consumers, believing in this idea. With the entirety of the financial ecosystem now more heavily levered than ever due to the Fed’s profligate measures of suppressing interest rates and flooding the system with excessive levels of liquidity, the “instability of stability” is now the most significant risk.

The ‘stability/instability paradox’ assumes that all players are rational, and such rationality implies avoidance of complete destruction. In other words, all players will act rationally, and no one will push ‘the big red button.’”

So far, the Fed remains fortunate with a low volatility decline in markets. In other words, “market stability” continues to afford the Federal Reserve the operating room needed for the most aggressive rate hiking campaign since the late 70s. Market volatility and credit spreads remain “well contained” despite drastically higher interest rates and an ongoing stock market decline.

However, stable markets can become unstable rapidly when something breaks due to rising rates or volatility. The Bank of England (BOE) is an excellent example of what happens when things go awry. The BOE was forced to start buying bonds to solve a potential crisis with U.K. pension funds. The pension funds receive margin with yields fall and post additional collateral when yields rise. However, when yields spike, as they have recently, the pension funds are hit with “margin calls,” which have the potential to cause market instability. Due to leverage built up through the entire financial system, market instability can spread like a virus through global markets. Such was last seen with the Lehman Crisis in 2008.

Is the BOE’s actions an isolated event? Maybe not. According to Charles Gasparino, the Fed could be next.

The Market Instability Risk

The Federal Reserve is deeply committed to its aggressive campaign to quell surging inflation. As Jerome Powell stated at this year’s Jackson Hole Summit:

Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance. Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions. While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”

While the Federal Reserve is willing to cause “some pain” to achieve victory, they hope to do so without evoking a recession. Such may be a challenge for two primary reasons:

  1. The Fed remains focused on lagging economic data, such as employment, which are highly subject to future revisions, and;

  2. Changes to monetary policy do not show up in the economy until roughly 9-12 months in the future.

The problem with the Fed’s use of economic data to guide monetary policy decisions was the subject of a St. Louis Federal Reserve research note. To wit:

“In the two quarters leading up to the average recession, all measures were still experiencing varying degrees of positive growth. Meanwhile, immediately following the onset of the average recession, all six indicators declined, which ultimately persisted for the entirety of the recession.”

Such brings us to the second most critical point.

Changes to monetary policy have a 9-12 month lag before showing up in the economy. Therefore, as the Fed is hiking rates based on lagging economic data, the risk of a “policy mistake” becomes heightened. By the time the economic data deteriorates, the preceding rate hikes have yet to impact the economy, which eventually deepens the recession.

As shown, the annual rate of change of the Fed Funds rate is now the most aggressive increase in history. However, every previous rate hiking campaign has led to a recession, bear markets, or economic event.

However, the Federal Reserve does not operate in an economic vacuum. Other factors also contribute to the tightening of monetary policy and the impact on economic growth. When those other factors such as higher interest rates, falling asset prices, or a surging dollar coincide with the Fed’s policy campaign, the risk of “market instability” increases.

A Policy Mistake In The Making

The current bout of inflation is vastly different than that seen in the late 70s.

Milton Friedman once stated corporations don’t cause inflation; governments create inflation by printing money. There was no better example of this than the massive Government interventions in 2020 and 2021 that sent subsequent rounds of checks to households (creating demand) when an economic shutdown constrained supply due to the pandemic.

The following economic illustration shows such taught in every “Econ 101” class. Unsurprisingly, inflation is the consequence if supply is restricted and demand increases by providing “stimulus” checks.

The problem for the Fed is the influence of lagging economic data on its decisions. In contrast, forward estimates for inflation are already falling quickly as economic demand falters due to collapsing liquidity.

Historically, the “best cure for high prices is high prices.” In other words, inflation would resolve itself as high costs curtail consumption. However, the Fed is not operating in a vacuum. While the Fed is hiking interest rates to slow economic activity, interest rates and the dollar have also increased dramatically in recent months. Those increases apply further downward economic pressures by increasing costs domestically and globally. Not surprisingly, sharp annual increases in the dollar are coincident with market instability and economic fallout.

Furthermore, the surge in the dollar accompanied the sharpest increase in interest rates in history. Sharp increases in interest rates, particularly in a heavily indebted economy, are problematic as debt servicing requirements and borrowing costs surge. Interest rates alone can destabilize an economy, but when combined with a surging dollar and inflation, the risks of market instability increase markedly.

The Fed Will Blink

After more than 12 years of the most unprecedented monetary policy program in U.S. history, the Federal Reserve has put itself into a poor situation. They risk an inflation spiral if they don’t hike rates to quell inflation. If the Fed hikes rates to kill inflation, the risk of a recession and market instability increases.

As noted at the outset, the behavioral biases of individuals remain the most serious risk facing the Fed. For now, investors have not “hit the big red button,” which gives the Fed breathing room to lift rates. However, the BOE discovered that market instability surfaces quickly when “something breaks.”

When will the Fed find the limits of its monetary interventions? We don’t know, but we suspect they have already passed the point of no return, and history is an excellent guide to the adverse outcomes.

  • In the early ’70s, it was the “Nifty Fifty” stocks,

  • Then Mexican and Argentine bonds a few years after that

  • “Portfolio Insurance” was the “thing” in the mid -80’s

  • Dot.com anything was an excellent investment in 1999

  • Real estate has been a boom/bust cycle roughly every other decade, but 2007 was a doozy.

  • Today, it’s real estate, FAANNGT, debt, credit, private equity, SPACs, IPOs, “Meme” stocks…or rather…” everything.”

The Federal Reserve continues to state its intentions to hike rates and reduce its balance sheet at the fastest pace in history, as inflation is the enemy it must defeat. However, while high inflation is detrimental to economic growth, market instability is far more insidious. Such is why the Federal Reserve rushed to bail out banks in 2008.

Unfortunately, we doubt the Fed has the stomach for “market instability.” As such, we doubt they will hike rates as much as the market currently expects.

Tyler Durden Tue, 10/04/2022 - 16:20

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