US futures were flat as the Fed minutes did not help resolve the uncertainty about the path of Federal Reserve monetary tightening, while fresh prospects about China’s economic reopening sent oil higher. Nasdaq 100 and S&P 500 futures were up 0.2% at 745am ET having recovered from an earlier loss, as traders assessed minutes from the Fed’s last meeting which noted that officials saw risks from tightening more than necessary even as they planned on hiking until inflation was on a steady downward slope, while President Xi Jinping’s comments that China will persist with opening up its economy were also in focus and boosted commodities. The dollar gave up gains, and Treasury yields dipped, reversing some of this week's sharp gains. Bitcoin traded in a tight range around $23,500.
In US premarket trading, Cisco Systems advanced after issuing an upbeat forecast for quarterly sales as chip-supply shortages ease and the company is able to fill more orders. Keep an eye on US building products stocks as Deutsche Bank initiates coverage on 22 names, saying the US housing market is in the midst of a “mid-cycle crisis,” but that this is likely to be different from the downturn seen in the mid-2000s. Here are some other notable premarket movers:
- Bluebird Bio’s (BLUE) shares rise as much as 10% as analysts digest yesterday’s FDA clearance of its Zynteglo therapy, ahead of its launch call due later today.
- BJ’s Wholesale (BJ) shares gain 6% after the warehouse club operator reported adjusted earnings per share for the second quarter that beat the average analyst estimate.
- Cisco Systems (CSCO) rose 6% after issuing an upbeat forecast for quarterly sales as chip-supply shortages ease and the company is able to fill more orders.
- Elanco Animal Health (ELAN) cut to equal-weight from overweight at Morgan Stanley as visibility on the firm’s outlook remains weak. Elanco shares fall 1.7% in US premarket trading.
- Estee Lauder (EL) falls 1.3% after the beauty company’s forecasts for first quarter and the full year trailed consensus estimates. In Europe, shares of L’Oreal declined after EL’s release.
- Five months after disclosing a stake in Bed Bath & Beyond Inc., (BBBY) activist shareholder Ryan Cohen wants out, sparking a selloff in the shares of the home goods retailer. Shares fall 13%.
- Kohl’s (KSS) drops 7% after slashing its guidance for the year, including adjusted earnings per share, operating margin and net sales growth. Peer Macy’s (M), which reports Aug. 23, falls 3%.
- Mattel (MAT) rises 0.8% after it was initiated with a buy rating at BofA, which said that the company has “successfully” completed its turnaround and is now in growth mode.
- MoffettNathanson cut the recommendation on Verizon Communications Inc. (VZ) to underperform from market perform, as T-Mobile widens its competitive advantage in 5G and AT&T undercuts it with aggressive promotions. Verizon shares fall 0.8%.
- NetEase (NTES) shares rise as much as 3% after the Chinese video-game giant’s 2Q revenue came in slightly above the consensus analyst estimate.
- NuScale Power (SMR) was initiated with a recommendation of buy at Guggenheim Securities, as analyst Shahriar Pourreza says its “shares represent one of the only opportunities for public exposure to the next generation of nuclear.” Shares gain 4%.
While policy makers warned against over-tightening and signaled the potential for slower rate increases at some point, they also flagged the risk of inflation pressures becoming entrenched. The nuanced messaging wasn’t dovish enough for markets to sustain a risk-on stance into Thursday. Caution was the byword of the moment with further clues awaited at the Fed’s annual symposium in Jackson Hole, Wyoming next week.
“People are a little overly optimistic about how likely it is that we can solve the inflation problem quickly and in a way where we don’t have to include more policy and more rising rates,” Kathryn Kaminski, AlphaSimplex Group chief research strategist and portfolio manager, said on Bloomberg Television.
While most saw the FOMC minutes as dovish, others disagreed. According to Ipek Ozkardeskaya, a senior analyst at Swissquote, the Fed meeting minutes were more hawkish than what was needed to give another boost to US equities. “Investors quickly realized that there was no mention of cutting the rates in the foreseeable future. If anything, the Fed would continue lifting the rates, and keep them steady for a while.”
Equities had rallied in recent weeks as investors bet July’s softer inflation print would allow the Fed to rethink its aggressive pace of hiking rates. The Nasdaq 100 had led the advance amid relief at the prospect of easier policy, boosted by raging CTA buying, stock buybacks, a return of retail investors and hedge funds forced to FOMO-chase higher.
"This rally is over-extended in the technology sector,” said Freddie Lait, chief investment officer at Latitude Investment Management. “The relative valuation of most of those Nasdaq stocks compared to other stocks around the world has become extreme again, and positioning has become quite extreme again, and so I wouldn’t be surprised to see that rolling over into the end of the summer.” The Nasdaq 100 is now trading at 23.2 times forward earnings, above the average level of 20.2 times over the past decade.
In Europe, the Stoxx 600 index was 0.2% higher as the latest report of euro-area inflation met expectations, sparing traders of any ugly surprise. FTSE MIB outperforms, adding 0.4%, IBEX lags, dropping 0.2%. Autos, energy and chemicals are the strongest-performing sectors. Concerns of tightening monetary conditions increased after the European Central Bank’s Governing Council member Martins Kazaks said rate hikes will continue in the region. Thin trading exaggerated moves across markets. The Stoxx 600 witnessed a 33% drop in volumes relative to the 30-day average. Here are the biggest European movers:
- Siegfried shares jump as much as 13%, the most since October 1998, after 1H results analysts say were a significant beat, also noting effective management of macro risks.
- GN Store Nord shares rise as much as 10% after the Danish audio firm presented its latest earnings, which included a guidance cut that was less pessimistic than analysts expected.
- Zur Rose shares rise as much as 14%, the most since May, after its latest earnings report, which includes a goal to be profitable in 2023, a plan Jefferies call “very positive.”
- Nibe rise as much as 8.6% after the Swedish heat pump manufacturer published earnings. Analysts note solid results, which beat expectations, as well as a positive outlook.
- Global Fashion Group shares rise as much as 31%, the most intraday on record, after reporting better-than-expected earnings for the second quarter, also offering some FY clarity.
- Balfour Beatty shares rise as much as 3.8% after Peel Hunt further raised FY22 profit forecasts for the UK construction and engineering firm and saw scope for material share price upside.
- Adyen shares tumble the most since 2018 as 1H Ebitda and net revenue missed consensus analyst forecasts. Analysts point out that accelerated hiring is also a cause of Ebitda miss.
- AutoStore shares wipe out an earlier jump of 13% to fall as much as 6.8%. Analysts say results look strong, albeit they note a small miss on orders and guidance for more margin pressure in 2H.
- Made.com shares drop as much as 12%, biggest decliner in the FTSE All-Share Index, after the online furniture seller said it’s considering “all options” to strengthen its balance sheet.
Earlier in the session, Asian stocks fell as disappointing results from some key Chinese firms and worries about the outlook for the region’s biggest economy weighed on investor sentiment. The MSCI Asia Pacific Index slipped as much as 0.7%, with benchmarks in the biggest markets of Japan and China down close to 1%. Risk appetite improved a smidge after President Xi Jinping said China will persist with opening up its economy, the comments coming in after the nation’s markets closed. China’s largest developer Country Garden Holdings, saw its stock slump after it warned that first-half earnings probably tumbled by as much as 70% amid an escalating property crisis. Tencent, the nation’s most-valuable company, logged its first-ever revenue drop though its shares -- which have fallen for three straight months -- advanced.
Thursday’s losses in Asia tracked declines in US shares overnight. Minutes of the Fed’s latest meeting showed that officials agreed on the need to eventually dial back the pace of interest-rate hikes but also wanted to gauge how their monetary tightening was working toward curbing US inflation. The minutes “lacked fresh impetus needed to bring up the pricing of Fed’s rate hikes,” Saxo Capital Markets’ Asia-Pacific strategy team wrote in a note. “Chairman Powell’s speech at the Jackson Hole Symposium next week will be keenly watched for further inputs.” Meanwhile, consumer discretionary and technology were among the worst-performing sectors on the Asian benchmark. Goldman Sachs and Nomura further cut their forecasts for China’s economic growth, with a power supply crunch adding more uncertainty to the outlook.
Japanese stocks fell, following US peers lower after minutes from the Federal Reserve’s last meeting showed officials see risks from tightening more than necessary. The Topix fell 0.8% to close at 1,990.50, while the Nikkei declined 1% to 28,942.14. Toyota Motor Corp. contributed the most to the Topix decline, decreasing 1.8%. Out of 2,170 shares in the index, 565 rose and 1,503 fell, while 102 were unchanged.
Australia's S&P/ASX 200 index fell 0.2% to close at 7,112.80 as investors assessed a slew of corporate results and jobs data. Australian employment unexpectedly dropped in July, giving the Reserve Bank scope for more flexibility in its tightening cycle. Telix Pharma slumped after reporting a net loss for the first half. IPH was the top performer after saying it’s buying Canadian firm Smart & Biggar. In New Zealand, the S&P/NZX 50 index fell 0.3% to 11,814.34.
In FX, the Bloomberg Dollar Spot Index advanced a second day and the greenback rose versus most of its Group-of-10 peers, with Norway’s krone as the best performer. The euro traded in a narrow range against the dollar for a third consecutive day. Norway’s krone extended an advance versus the euro after Norges Bank raised the key interest rate to 1.75% from 1.25%, in line with what most economists in a Bloomberg survey had expected. The central bank also said the policy rate “will most likely be raised further in September.” The pound extended losses against the dollar, hitting the lowest since July 26, amid broad-based greenback strength.
The yen fell in a volatile session as traders mulled rising US yields and their negative impact on stocks. Japan’s government bond yields rose
In rates, Treasuries were slightly richer across the curve with gains led by long-end, having outperformed bunds and gilts during European morning. US yields richer by ~2bp across long-end of the curve with 5s30s spread flatter by ~1bp on the day; 10-year yields around 2.87% within narrow overnight range, outperforming bunds by 4bp in the sector. Front-end German yields lag after ECB’s Isabel Schnabel says the euro area’s inflation outlook has not changed fundamentally. Bunds bear-flattened out to the 10-year sector as money markets added to ECB tightening bets after the ECB’s Schnabel said the euro area’s inflation outlook has not changed fundamentally, in an interview cited by Reuters, suggesting that another hike of similar magnitude may be coming next month. Australia’s bond yields trimmed opening gains and the nation’s currency eased after employment contracted for the first time since October 2021.
In commodities, oil jumps to session high after Xi says China will persist with opening up its economy. WTI rises 1.5% to trade around $89. Spot gold rises roughly $4 to trade near $1,766/oz. Most base metals trade in the red; LME nickel falls 0.5%, underperforming peers. LME copper outperforms, adding 1%, after Xi’s comments
Looking at the day ahead, the FOMC minutes from July will be the main highlight, and the other central bank speaker will be Fed Governor Bowman. Otherwise, earnings releases include Target, Lowe’s and Cisco Systems, and data releases include US retail sales and UK CPI for July.
- S&P 500 futures down 0.3% to 4,265.50
- STOXX Europe 600 down 0.1% to 438.54
- MXAP down 0.6% to 161.98
- MXAPJ down 0.5% to 526.40
- Nikkei down 1.0% to 28,942.14
- Topix down 0.8% to 1,990.50
- Hang Seng Index down 0.8% to 19,763.91
- Shanghai Composite down 0.5% to 3,277.54
- Sensex down 0.3% to 60,079.59
- Australia S&P/ASX 200 down 0.2% to 7,112.78
- Kospi down 0.3% to 2,508.05
- German 10Y yield little changed at 1.11%
- Euro down 0.1% to $1.0165
- Gold spot up 0.1% to $1,763.18
- U.S. Dollar Index up 0.20% to 106.79
Top Overnight News from Bloomberg
- The US says it has commenced bilateral trade negotiations w/Taiwan, something Washington signaled was going to happen back in June. WSJ
- A United Nations expert on slavery has found it “reasonable to conclude” that forced labour is taking place in the China’s far-western region of Xinjiang. SCMP
- China’s state media said local governments could sell more than $229 billion of bonds to fund infrastructure investment and plug budget gaps, a further move by Beijing to shore up an economy hit by worsening coronavirus outbreaks and a property slump. BBG
- More AMTD intrigue. The investment firm that stunned investors when its post-IPO stock soared 32,000% was probed by Hong Kong's watchdog even before its US listing, people familiar said. AMTD Group's office and the home of ex-UBS banker Calvin Choi were searched in February 2021. The regulator investigated its underwriting arrangements as recently as November, one person said. BBG
- Norway hiked by 50 bps to 1.75% and flagged the potential for another increase of that magnitude next month. ECB official Martins Kazaks said euro-area rates will continue to go up, while his colleague Isabel Schnabel suggested another big hike may come in September. The Philippines raised by 50 bps as expected. Sri Lanka held. Turkey is expected to follow suit later. BBG
- Tighter links between crypto and US stock prices are forcing digital asset hedge funds to consider buying expensive data from other markets. The influx of traditional trading firms into crypto, which already have the inputs needed to track what's up in stocks, is also adding pressure. Hedge fund bosses said crypto firms may see market data costs rise to $500,000 a month from near zero. BBG
- Allen Weisselberg, a long-time executive for Donald Trump’s company, will plead guilty on Thurs and while he won’t implicate the former president or Trump’s family, his testimony could be used against the Trump Organization. NYT
- The decision of 10 members of the House of Representatives to vote to impeach former President Trump has cost some of them their seats, including the most vocal critic, Rep. Liz Cheney, R-Wyo., who lost the state's primary Tuesday to Trump-backed candidate Harriet Hageman. Trump has spent most of his post-presidency backing candidates who are running against the lawmakers he considers disloyal to him. Four of these 10 Republicans have lost the primaries, four have chosen not to seek reelection, and two made it through their primaries and are running in November’s general election to keep their seats. USA Today
- AMZN is searching for a senior movie-studio executive to help lead its growing entertainment division, turning to rivals for a chance to poach an experienced Hollywood player. Amazon Studios has held conversations with several Hollywood leaders about the role, including NFLX's film head, Scott Stuber, one of the streamer’s most powerful and visible executives, according to people familiar with the matter. WSJ
- The probability of a 75 bps rate hike in September, which was climbing on Wednesday morning, dropped below 50% after the FOMC minutes....
A more detailed look at global markets courtesy of Newsquawk
APAC stocks mostly declined following the weak handover from global counterparts which were pressured as yields climbed on the back of the red-hot UK inflation data and with only a brief reprieve seen after the FOMC Minutes noted many officials saw a risk the Fed could tighten more than necessary. ASX 200 was subdued as participants digested the latest influx of earnings releases and disappointing jobs data which showed a surprise contraction in headline Employment Change. Nikkei 225 slipped back beneath the 29,000 level in tandem with the overall downbeat sentiment. Hang Seng and Shanghai Comp conformed to the glum mood after both Goldman Sachs and Nomura cut their China GDP growth forecasts and with focus also on earnings releases including Tencent after it posted its first-ever decline in quarterly revenue although its shares were lifted and it had vowed a return to growth, while Country Garden led the declines after the developer issued a profit warning of as much as an 87% drop in H1 net.
Top Asian News
- China may issue CNY 1.5tln in additional debt as part of an investment push, according to China Securities News.
- China's COVID-19 cases rose to a 3-month high of 3,424 on Wednesday from 2,888 the day before.
- Nomura cut its China 2022 GDP growth forecast to 2.8% from 3.3%.
- China's MOFCOM says, re. US CHIPS act, some provisions restrict normal economic, trade and investment activities of relevant enterprises in China. Will, when necessary, take forceful measures to safeguard interests.
- China's President Xi says they will persist with opening up the economy, via CCTV.
- China's banking regulator is reportedly looking into the property sector loan portfolios of some local/foreign lenders to assess systemic risk, via Reuters citing sources.
European bourses began the session mixed/flat and are yet to gain any real traction in relatively limited newsflow, Euro Stoxx 50 +0.5%. Though, it is worth pointing out DAX 40 +1.0% outperformance, after lagging on Wednesday, amid strength in their heavyweight industry names. Stateside, performance is similar ahead of a few corporate updates, data and Fed speak, ES +0.1%
Top European News
- The FTSE 100’s Weirdly Good Run of Form Hits a Wall of Problems
- Norway Raises Rates to Highest in Decade to Stem Inflation
- Embracer CEO Eyes IP Windfall After Buying ‘Lord of the Rings’
- PwC Raises UK Partner Pay to £1 Million for First Time
- ‘Enough Is Enough’ Rally Pulls UK Crowds as Rail Strike Begins
- Truss Planning Review of Regulators in City of London Shakeup
- Buck bounces after brief post-FOMC minutes dip on dovish elements, DXY touches Fib at 106.960 from 106.500 low.
- Euro derives more support from rising EGB yields amidst hawkish ECB commentary, EUR/USD holds around 1.0150 amidst raft of option expiries extending beyond 1.0200.
- Norwegian Krona underpinned by another half point hike from Norges Bank and signal for further tightening in September, EUR/NOK towards base of 9.8550-9.9150 range.
- Aussie finds support at psychological level against Greenback after mixed jobs data, but Kiwi cautious ahead of NZ trade, AUD/USD nearer 0.6950 than 0.6900, NZD/USD closer to 0.6250 than 0.6300.
- Sterling still stunned by double digit UK CPI and economic ramifications, Cable ducks under 1.2000, albeit fractionally and briefly.
- Loonie gleans some traction from firmer oil prices pre-Canadian PPI, USD/CAD closer to 1.2900 than 1.2950.
- Yuan retreats amidst reports of property loan portfolio probes and PBoC LPR cuts, USD/CNY 6.7900+ and USD/CNH 6.8000+.
- EGBs and Gilts regain some poise after extended and heavy declines on hawkish ECB rhetoric.
- Bunds back up near 154.00 within 154.47-153.24 range, UK benchmark 114.00+ between 114.41-113.63 parameters.
- US Treasuries idling post-FOMC minutes and pre-busy agenda - 10 year T-note flat at 118.24+ vs 119-01+ high and 118-18 low.
- WTI and Brent were bolstered by rhetoric from the Russian Defence Ministry re. Zaporizhia and as China's President Xi spoke
- Currently, the benchmarks are in proximity to their respective highs of USD 89.56/bbl and USD 95.44/bbl.
- Spot gold experienced a marginal haven bid bringing the yellow metal to an incremental new session peak of USD 1767/oz and eclipsing the 21-DMA at USD 1764/oz.
- Broader metal space is mixed and features essentially unchanged action for Aluminium, after Wednesday’s noted rally, while LME Copper has climbed back towards a test of the USD 8k handle
- ECB's Schnabel says a recession alone would not be enough to control inflation, growth is going to slow and a technical EZ recession is possible. Inflation concerns from before the July hike have not alleviated, outlook is unchanged. Number of indicators point to a de-anchoring of inflation expectations. Short-term inflation could still accelerate. Re. fragmentation: markets are more stable now, but volatility is elevated and liquidity is low.
- Norwegian Key Policy Rate 1.75% vs. Exp. 1.75% (Prev. 1.25%) via a unanimous decision; policy rate will most likely be raised further in September. Click here for reaction & newsquawk analysis.
- BoE will aim to unwind the full stock of Corporate Bond Purchase Scheme (CBPS) holdings at end-2023/early-2024, subject to market conditions.
- Turkey's central bank shocked markets when it unexpectedly cut rates by 100bps to 13% from 14%. All 21 economists polled by Bloomberg had expected an unchanged print.
DB's Tim Wessel concludes the overnight wrap
Starting in Europe, where the looming energy crisis remains at the forefront. An update from our team, who just published the fourth edition of their indispensable gas monitor (link here), where they note the surprisingly fast rebuild of German gas storage, driven by reductions in industrial activity, reduces the risk that rationing may become reality this winter. Many more insights within, so do read the full piece for analysis spanning scenarios. Keep in mind, that while gas may be available, it is set to come at a higher clearing price, which manifest itself in markets yesterday where European natural gas futures rose a further +2.64% to €226 per megawatt-hour, just shy of their closing record at €227 in March. But, that’s still well beneath their intraday high from March, where at one point they traded at €345. Further, one-year German power futures increased +6.30%, breaching €500 for the first time, closing at €507. Germany is weighing consumer relief measures in light of climbing consumer prices and also announced that planned nuclear facility closures would be “temporarily” postponed.
The upward energy price pressure and attenuated (albeit, not eliminated) risk of rationing pushed European sovereign yields higher. 10yr German bunds climbed +7.1bps to 0.97%, while 10yr OATs kept the pace, increasing +7.4bps. 10yr BTPs increased +15.9bps, widening sovereign spreads, while high yield crossover spreads widened +10.2bps in the credit space.
Equities were resilient, however, with the STOXX 600 posting a +0.16% gain after flitting around a narrow range all day. Regional indices were also robust to climbing energy prices, with the DAX up +0.68% and the CAC +0.34% higher. In the States the S&P 500 registered a modest +0.19% gain, with the NASDAQ mirroring the index, falling -0.19%. Retail shares drove the S&P on the day, with the two consumer sectors both gaining more than +1%, following strong earnings reports from Wal Mart and Home Depot.
Treasury yields also climbed, but the story was the further flattening in the curve. 2yr yields were +7.5bps higher while 10yr yields managed to increase just +1.6bps, leaving 2s10s at its second most negative close of the cycle at -46bps. 10yr yields are another basis point higher this morning. A hodgepodge of data painted a mixed picture. Housing permits beat expectations (+1674k vs. +1640k) while starts (+1446k vs. +1527k) fell to their slowest pace since February 2021. However, under the hood, even permits weren’t necessarily as strong as first glance, as single family permits fell -4.3% with gains in multifamily pushing the aggregate higher. Indeed, year-over-year, single family permits have now fallen -11.7% while multifamily permits are +23.5% higher. So the single family housing market continues to feel the impact of Fed tightening. Meanwhile, industrial production climbed +0.6% month-over-month (vs. +0.3%), with capacity utilization hitting its highest level since 2008 at 80.3%.
Drifting north of the border, Canadian inflation slowed to 7.6% YoY in July in line with estimates, while the average of core measures climbed to a record 5.3%. Bank of Canada Governor Macklem penned an opinion piece saying that while it looks like inflation may have peaked, “the bad news is that inflation will likely remain too high for some time.” In turn, Canadian OIS rates by December climbed +16.2bps.
In other data, the expectations component of the German ZEW survey fell to -55.3, its lowest level since October 2008 at the depths of the GFC. In the UK, regular pay (excluding bonuses) fell by -3.0% in real terms over the year to April-June 2022, its fastest decline on record.
On the Iranian nuclear deal, EU negotiators reportedly found Iran’s response constructive, though Iran still had some concerns. Notably, Iran is looking for guarantees that if a future US administration withdraws from the JCPOA the US will "have to pay a price”, seeking insulation from the vagaries of representative democracy.
Asian equity markets are trading higher after Wall Street’s solid performance overnight. The Nikkei (+0.76%) is leading gains across the region with the Hang Seng (+0.57%), the Shanghai Composite (+0.23%) and the CSI (+0.51%) all rebounding from its opening losses this morning. US futures are struggling to gain traction this morning with the S&P 500 (-0.02%) and NASDAQ 100 (-0.09%) trading just below flat.
The Reserve Bank of New Zealand lifted its official cash rate (OCR) for the fourth consecutive time by an expected +50bps to 3%, a seven-year high, while bringing forward the estimate of future rate increases. The central bank expects the OCR will reach 3.69% at the end of this year and expects it to peak at 4.1% in March 2023, higher and sooner than previously forecast.
Early morning data coming out from Japan showed that exports rose +19.0% y/y in July (v/s +17.6% expected) posting 17 straight months of gains while imports advanced +47.2% (v/s +45.5% expected) driven by global fuel inflation and a weakening yen. With the imports outweighing exports, the nation reported trade deficit for the 14th consecutive month, swelling to -2.13 trillion yen in July (v/s -1.91 trillion yen expected) compared to a revised deficit of -1.95 trillion yen in June.
In terms of the day ahead, the FOMC minutes from July will be the main highlight, and the other central bank speaker will be Fed Governor Bowman. Otherwise, earnings releases include Target, Lowe’s and Cisco Systems, and data releases include US retail sales and UK CPI for July.
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…
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 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.
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.recession covid-19 subsidies bonds government bonds housing market pound lockdown recession recovery interest rates european europe uk
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…
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.
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….
“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.
SCOOP (1/2): @federalreserve officials getting increasingly worried about "financial stability" as opposed to inflation as higher rates begin to crush bonds, several big investors tell me. Fed growing worried about possible "Lehman Moment" w a 4% FF rate as Bonds and derivatives— Charles Gasparino (@CGasparino) September 30, 2022
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:
The Fed remains focused on lagging economic data, such as employment, which are highly subject to future revisions, and;
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.
Pound recovers but remains at low levels – how to assess the long-term value of sterling
RON’s competitive advantage in today’s housing market
“Market Instability” Causes BOE To Reverse QT. Is The Fed Next?
What Is the Lipstick Index? Which Stock Market Trends Does It Predict?
Deliveroo tweaks ‘dark store’ model to let grocery shoppers in the door
Major Asset Classes | September 2022 | Performance Review
Consumer Savings Shrink to 2008 Lows
September manufacturing new orders and August construction spending both turn down
A Policy Mistake In The Making
COVID and the cost of living crisis are set to collide this winter – the fallout will be greatest for the most vulnerable
Economics6 hours ago
Nearly Half Of Americans Making Six-Figures Living Paycheck To Paycheck
Economics20 hours ago
Charlotte’s Web Full Spectrum Hemp CBD Products Launching Nationwide on Gopuff
Economics17 hours ago
US Ports and Terminals Sustain Increased Cybersecurity Attacks
Spread & Containment22 hours ago
“Market Instability” Causes BOE To Reverse QT. Is The Fed Next?
Spread & Containment9 hours ago
What’s next for ancient DNA studies after Nobel Prize honors groundbreaking field of paleogenomics
Economics16 hours ago
Consumer Savings Shrink to 2008 Lows
International13 hours ago
Four States Deploy National Guard To US-Mexico Border
Government19 hours ago
Eclypsium lands $25M to secure the device supply chain