Futures Reverse Losses, Hit Session HIghs Alongside Oil Despite China Covid Curbs
Futures Reverse Losses, Hit Session HIghs Alongside Oil Despite China Covid Curbs
After trading in the red for much of the overnight session,…
After trading in the red for much of the overnight session, US futures inched higher shortly after the European open after a volatile session in Asia marked by rising Covid cases in China, while a Fed president turned dovish and showed openness to slowing the path of rate hikes. Futures on the S&P 500 traded near session highs, up 0.4% to 3,972 by 8:00 a.m. in New York, while Nasdaq 100 futures gained 0.1% after struggling for direction.
Stocks in Hong Kong and Mainland China slipped as China’s daily virus infections climbed to near the highest on record, although a bounce in Japanese stocks pushed overall Asian markets higher. Europe’s Stoxx 600 Index rose, led by energy shares. The dollar weakened against all major currencies and Treasury yields declined. Crude oil prices rose after Saudi Arabia pushed back against reports of a potential OPEC+ production increase. Bitcoin's gradual, methodic slide continued interrupted by occasional bouts of ungradual, unmethodic panic liquidations.
In premarket trading, Zoom Video dropped after the firm reported its slowest quarterly sales growth on record and trimmed full-year revenue forecasts. Chinese stocks listed in US fell after a ramp-up in Covid restrictions to curb a spike in virus cases across China. Pinduoduo -2.4%, Trip.com -0.6%, Bilibili -2.8%, Nio -2.5%, Li Auto -3.9%. Here are some other notable premarket movers:
- Blackstone shares fall 2.5% in US premarket trading as Credit Suisse cut its rating to underperform from neutral and said that it is awaiting a better entry point for US alternative asset manager stocks.
- Alibaba shares pare losses in US premarket trading after Reuters reported that Chinese authorities are set to hand down a fine of over $1 billion for Jack Ma’s Ant Group, an event market watchers see as an end to Beijing’s prolonged investigation into the fintech firm and a first step to restarting its IPO.
- GameStop shares swing between slight gains and losses in US premarket trading, following a Bloomberg report that billionaire investor Carl Icahn was said to hold a large short position in the video-game retailer.
- Dell Technologies stock slipped 2% in postmarket trading on Monday as the computer company’s revenue forecasts for the current quarter missed estimates, as economic uncertainty begins to affect information technology customers.
- Keep an eye on Amazon.com after its price target was cut at Piper Sandler as AWS revenue decelerates along with an industry-wide slowdown at major cloud computing firms. The brokerage notes, however, that while “industry growth ticks down, AWS leadership remains.”
- Watch Activision Blizzard as Baird raised the recommendation on the stock to outperform from neutral, while downgrading Airbnb, Carvana and Vroom all to neutral since these companies are exposed to pullbacks in discretionary “high ticket” purchases.
- Keep an eye on software stocks, including Workday and Coupa Software as Morgan Stanley cuts price targets across the sector, with analyst saying that consensus estimates for 2023 are likely too high while customer IT budgets are set to be reduced.
"Market sentiment remains toneless for the second trading day of the week as most investors are still struggling to assess the short- to mid-term outlook for risky assets," said Pierre Veyret, technical analyst at ActivTrades. “Despite the market starting to price in a potential slowing in rate hikes, some Fed officials have moved to temper these anticipations by reiterating their will to tackle inflation, and that this goal was far from being achieved.”
Fed officials continued to highlight the need to curb inflation but hinted that a slower pace of hikes could be possible. On Monday, San Fran Fed President Mary Daly said officials need to be mindful of the lags with which monetary policy works, while repeating that she sees interest rates rising to at least 5%. Separately, Cleveland Fed President Loretta Mester said she has no problem with slowing down the central bank’s rapid rate increases when officials meet next month.
“Markets get jittery whenever the Federal Reserve is due to speak or issue important information,” said Russ Mould, investment director at AJ Bell. “With the central bank set to publish the minutes from its November meeting tomorrow, equity investors need to brace themselves for the Fed to say it is likely to keep raising rates to tame inflation, even though October’s consumer prices figure was below expectations.”
After this quarter’s 10% rally in the S&P 500, Goldman strategists expressed skepticism about US stocks returns next year, setting a 4000 points target for the benchmark by Dec. 2023 as earnings growth stalls. “Zero earnings growth will match zero appreciation in the S&P 500,” strategists led by David Kostin wrote in a note on Tuesday. Then again, the same David Kostin said excatly one year ago that the S&P would close 2022 at 5,100 so expect him to be dead wrong again.
In Europe, Stoxx Europe 600 Index climbed 0.2%, with energy stocks the best-performing sector as crude advanced after Saudi Arabia denied report of discussion about OPEC+ oil-output hike. BP rose 5.3% and Repsol was 6% higher after both stocks got analyst upgrades. Hong Kong stocks slid as China’s daily virus infections climbed to near the highest on record. Covid-control restrictions now affect a fifth of China’s economy. Still, the eventual easing by China of its curbs to counter the virus are likely to mean that European profits will hold up relatively well because of the benefits to luxury and mining companies, according to strategists at Goldman Sachs. Here are some of the notable European movers:
- AO World shares jumped as much as 17%, to the highest since early July, after the online appliances retailer raised its FY adjusted Ebitda forecast.
- Verbund rose as much as 8.2% after Stifel upgraded the utility company to buy from hold, saying conditions of Austria’s price cap are “much better” than had been anticipated.
- Allfunds shares fell as much as 11% after a discounted share offering by holders LHC3 and BNP Paribas in the mutual-fund distributor.
- Shares in digital price-tag maker SES- imagotag fell as much as 6%, before paring the drop, after majority shareholder BOE Smart Retail offered 1.5 million shares at a 7.3% discount to the last close.
- ThyssenKrupp declined as much as 5.9% after holder Cevian offered ~23.4m shares via UBS with price guidance of €5.15 apiece, representing a 4.7% discount to last close.
- Vodafone shares fell as much as 3.4% after the telecoms group was double-downgraded to underperform from outperform at Credit Suisse, which cited a growing risk to the dividend and elevated costs weighing on its outlook.
Earlier in the session, Asian stocks advanced as the yen’s recent weakness boosted Japanese exporters, offsetting losses in Chinese tech shares. The MSCI Asia Pacific Index gained as much as 0.7%, with Japanese firms Toyota, Sony and Mitsubishi helping lift the gauge along with Taiwan’s TSMC. Up more than 10% this month, the MSCI Asian stock benchmark has outperformed its US or European peers in November thanks to China’s rally. Among sectors, energy and industrials advanced the most, while communication services and consumer discretionary shares edged lower. Chinese stocks in Hong Kong fell for another day, as a worsening outbreak on the mainland raised doubts as to whether authorities can hold on to their softer Covid Zero stance. A rally this month fueled by reopening hopes has now come to a halt as investors come to terms with China’s Covid reality. “As we’ve seen in the Covid issues in China, it’s going to be stop-go sort of news flow in terms of the lockdowns et cetera and that’s going to add volatility to markets,” Lorraine Tan, director of equity research at Morningstar, said in an interview with Bloomberg TV.
Japan equities climbed as the yen’s retreat over the past four days supported exporters’ shares in the face of concerns over China’s Covid Zero policy and the Federal Reserve’s hawkish stance. The Topix rose 1.1% to 1,994.75 as of the market close in Tokyo, while the Nikkei 225 advanced 0.6% to 28,115.74. Toyota Motor contributed the most to the Topix’s gain, increasing 2.3%. Out of 2,165 stocks in the index, 1,737 rose and 366 fell, while 62 were unchanged. “There is an impression that the market will be quiet with no major selloffs ahead of the Japanese and US holidays,” said Hirokazu Kabeya, chief global strategist at Daiwa Securities. “In some aspects, it is difficult for the stock market to fall as investors find it hard to make a move.”
Stocks in Malaysia fell for a second day after Saturday’s election produced the country’s first-ever hung parliament. Australia’s equity benchmark rose to a five-month high buoyed by miners.The S&P/ASX 200 index rose 0.6% to close at 7,181.30, its highest since June 6, driven by a rebound in mining and energy shares. In New Zealand, the S&P/NZX 50 index fell 0.2% to 11,420.42. New Zealand’s central bank is poised to raise interest rates by an unprecedented 75 basis points on Wednesday, accelerating its monetary tightening to get inflation under control. Elsewhere, markets were mixed with moderate gains or losses.
In FX, the Bloomberg Dollar Spot Index fell as the greenback fell against all of its Group-of-10 peers. Risk-sensitive Antipodean currencies and the Norwegian krone were the top performers. CFTC data showed that speculative and institutional traders turned their back to the dollar yet again last week as the currency stayed under pressure. At the same time, one-month risk reversals in the Bloomberg Dollar Spot Index rallied in favor of the topside.
- The euro rose versus the greenback but underperformed most of its major peers. Bunds slipped and Italian bonds inched lower.
- The pound rose against a broadly weaker dollar and was steady against the euro. Data showed UK government borrowing grew less than forecast in October, ahead of a testimony in Parliament by officials from the Office for Budget Responsibility.
- The yen rose for the first time in five days after remarks from some Federal Reserve officials solidified bets for smaller US rate hikes. Japan’s yield curve steepened a tad ahead of a local holiday. One-week risk reversals in dollar-yen traded earlier at 24 basis points in favor of the Japanese currency, which marked the least bearish sentiment for the greenback in more than a month.
In rates, Treasuries ground higher leaving yields near session lows into the early US session with 10-year at around 3.79%. Bunds and gilts both lag Treasuries, trading slightly cheaper over early London session. US session focus is on Fed speakers and conclusion of this week’s auctions with a 7-year sale at 1pm. Treasury 10-year yields outperforming bunds and gilts by ~5bp on the day. Long-end of the Treasuries curve underperforms, steepening 10s30s spread by 2.5bp on the day. This week’s auctions conclude with $35b 7-year note sale at 1pm, follows Monday’s double auction of 2- and 5-year notes.
In commodities, it has been a contained session for the crude complex after yesterday’s WSJ fake news-prompted rollercoaster, with benchmarks higher by around 1% amid further pushback to the production increase report. Kuwait Oil Minister has pushed back against reports of any discussions over OPEC+ raising production at its next meeting, according to the State news agency; Iraq's SOMO says no discussions have taken place over an increase at the next OPEC meeting. China has reportedly paused the purchase of some Russian oil, awaiting details of the price cap to see if it provides a better price. Spot gold and silver are firmer, with the yellow metal at session highs just below the USD 1750/oz mark as risk sentiment struggles to find firm direction and the USD continues to pullback. For reference, the current spot gold peak of USD 1748/oz is shy of the 10-DMA at USD 1755/oz and still some way from the 200-DMA at USD 1801/oz.
Cryptocurrency prices were mixed, with investors braced for more ructions as further digital-asset sector bankruptcies loom following the demise of Sam Bankman-Fried’s FTX empire.
Looking to the day ahead now, and central bank speakers include the Fed’s Mester, George and Bullard, along with the ECB’s Holzmann, Rehn and Nagel. Data releases include Euro Area consumer confidence for November, as well as the US Richmond Fed manufacturing index for November. Lastly, the OECD will be releasing their Economic Outlook.
- S&P 500 futures up 0.2% to 3,964.00
- STOXX Europe 600 up 0.6% to 435.56
- MXAP up 0.4% to 151.12
- MXAPJ down 0.1% to 486.08
- Nikkei up 0.6% to 28,115.74
- Topix up 1.1% to 1,994.75
- Hang Seng Index down 1.3% to 17,424.41
- Shanghai Composite up 0.1% to 3,088.94
- Sensex up 0.4% to 61,380.15
- Australia S&P/ASX 200 up 0.6% to 7,181.30
- Kospi down 0.6% to 2,405.27
- German 10Y yield little changed at 1.99%
- Euro up 0.3% to $1.0272
- Brent Futures up 0.7% to $88.04/bbl
- Gold spot up 0.5% to $1,745.92
- U.S. Dollar Index down 0.35% to 107.46
Top Overnight News from Bloomberg
- More than six years after voting to leave the EU, the UK is facing a prolonged recession, a deep cost-of-living crisis and a shortage of workers. Last week’s Autumn Statement heralded years of higher taxes and cuts to public spending
- The ECB needs to maintain the pace of rate increases at its next meeting on Dec. 15 to demonstrate policy makers are “serious” about taming inflation, Financial Times reports, citing an interview with Robert Holzmann, governor of the National Bank of Austria and member of the ECB’s governing council
- Germany will introduce a cap on gas and electricity prices for companies and households as Europe’s largest economy seeks to contain the fallout from Russia’s moves to slash energy supplies. Large parts of German industry will no longer be able to avoid production cuts if companies need to further reduce natural gas consumption, according to a survey
- Italy has signed off on a €35 billion ($36 billion) budget law for next year which will raise a windfall tax on energy companies in order to expand aid to families and businesses hit by higher prices
- Spain announced a series of steps to shield mortgage-holders on lower incomes from rising costs, stepping up efforts to cushion the economic blow from high inflation and surging interest rates
- The premium investors pay for German two-year bonds over equivalent swaps has dropped to levels last seen in July in recent days, down more than 40 basis points from a record high in September. It comes after the German finance agency and the European Central Bank took steps to increase the supply of debt available to borrow in repo markets
- An FTX Group bankruptcy filing showed that the fallen cryptocurrency exchange and a number of affiliates had a combined cash balance of $1.24 billion
- A new currency trading algorithm developed by a Dutch fund threatens to wrest away millions of euros of fees from investment banks if it gains traction in the pension industry
- China’s overnight repo rate plunged to its lowest level in nearly two years, an indication that a liquidity squeeze seen last week has eased following measures by the central bank
A more detailed look at global markets courtesy of Nesquawk
Asia-Pac stocks were mostly positive as the regional bourses attempted to recover from the recent China COVID woes but with price action contained amid quiet newsflow and a lack of fresh macro drivers. ASX 200 was positive amid strength in the commodity-related sectors in which energy led the advances after oil prices rebounded following Saudi’s denial that it was considering a production increase. Nikkei 225 higher and reclaimed the 28,000 level with early outperformance in Shionogi after its COVID-19 therapeutic drug was presumed effective by Japan’s PMDA. Hang Seng and Shanghai Comp traded mixed with Hong Kong pressured by weakness in the tech sector, while losses in the mainland were reversed after the latest policy support pledges by China including measures to sustain the recovery momentum of the industrial economy and with the PBoC to release CNY 200bln worth of loan support for commercial banks to ensure near-term delivery of homes.
Top Asian News
- US Defence Secretary Austin met with Chinese Defence Minister Wei Fenghe in Cambodia, according to a US official cited by Reuters. US Defence Secretary Austin discussed the need for dialogue on reducing risk and improving communication with his Chinese counterpart, according to a Pentagon spokesperson. Furthermore, Austin raised concern about increasingly dangerous behaviour by Chinese aircraft which increases the risk of an accident and he reiterated that the US remains committed to the longstanding Once China Policy.
- Chinese Defence Ministry spokesman said the main reason for the current situation faced by China and the US is because the US made the wrong strategic judgement. In relevant news, Global Times' Hu Xijin tweeted that the meeting between the two defence ministers must be supported and that no matter how many frictions, China and the US cannot fight militarily which is the bottom line and the two sides’ due responsibility to the world.
- EU is poised to renew sanctions on Chinese officials accused of human rights violations in Xinjiang for an additional year, according to SCMP.
- RBA's Lowe say the Bank is not on a pre-set path and could return to 50bps increase or keep rates unchanged for a time. The Board expects to increase interest rates further over the period ahead. Understand that many people are finding the rise in interest rates difficult. It is necessary, though, to ensure that the current period of higher inflation is only temporary.
- Beijing City reports 634 (prev. 274) COVID infections on November 22nd as of 3pm, according to a health official, via Reuters. Subsequently, Beijing will tighten COVID testing requirements as of November 24th, according to an official; COVID tests within 48 hours will be required to enter public venues.
European bourses are modestly firmer, Euro Stoxx 50 +0.2%, though fresh developments have been limited and the upside itself is tentative at best. Sectors are mixed with the likes of Energy outperforming after yesterday's noted pressure, no overarching bias present in the European morning. Stateside, US futures are near the unchanged mark but have, similar to European peers, been modestly firmer/softer throughout the morning, ES +0.1%. Samsung Electronics (005930 KS) is to jointly develop 3nm chips with five-six fabless clients for large quantity supply as soon as 2023, via Korea Economic Daily citing sources.
Top European News
- ECB's Centeno sees conditions for rate hikes to be less than 75bps in December and said they "really have to reverse" the trend of rising inflation to have greater visibility on monetary policy, according to Bloomberg.
- ECB's Holzmann said he supports a 75bps hike in December and noted there are no signs that price pressures are easing, according to FT.
- ECB's Rehn says they will probably hike rates again, pace depends on how the economy develops.
- ECB's Nagel says a 50bp rate hike is "strong", rates are still "relatively far" from restrictive territory, via Reuters; calls for commencing a gradual APP unwind in Q1-2023.
- Italy approved a EUR 35bln budget law for next year which plans to increase an energy windfall tax, according to Bloomberg.
- Dollar loses recovery momentum as risk appetite picks up, DXY drifts between 107.810-300 bounds and retests a Fib retracement level just over 107.500
- Kiwi rebounds to top 0.6150 vs Buck irrespective of worrying NZ trade data, as RBNZ looms amidst expectations of a larger 75bp hike in the OCR
- Aussie recovers alongside Yuan and amidst comments from RBA Governor Lowe reaffirming guidance for further tightening, AUD/USD eyes 0.6650 from around 0.6600 at the low
- Loonie regains poise in tandem with oil and probes 1.3400 against its US rival pre-Canadian data and remarks from BoC's Rogers
- Yen, Franc, Euro and Pound all take advantage of Greenback fade plus yield convergence to Treasuries as USD/JPY reverses from 142.00+ and USD/CHF from almost 0.9600, while EUR/USD eyes 1.0300 and Cable 1.1900 vs sub-1.0250 and 1.0825.
- Rangebound trade for core fixed income, though intraday boundaries have extended on both sides throughout the European morning as the complex struggles for firm direction.
- Bund unreactive to a well-received Bobl auction while USTs are a handful of ticks firmer ahead of the week's last US auction, with volumes currently fairly light.
- Note, final orders for the UK's 0.125% 2073 Gilt I/L exceed GBP 16.8bln, according to a bookrunner, with pricing set 20bp below the 2068 comparable.
- Comparably contained session for the crude complex after yesterday’s pronounced OPEC+ related price action; benchmarks currently firmer by around 0.5% amid further pushback to the production increase report.
- White House Press Secretary said President Biden is committed to further lowering gasoline prices.
- Kuwait Oil Minister has pushed back against reports of any discussions over OPEC+ raising production at its next meeting, according to the State news agency; Iraq's SOMO says no discussions have taken place over an increase at the next OPEC meeting.
- China has reportedly paused the purchase of some Russian oil, awaiting details of the price cap to see if it provides a better price, via Bloomberg citing sources.
- German gas price break will apply retroactively from January, via der Spiegel; reduction in gas and heat prices is not expected to take effect until March 1st.
- European Commission proposes to introduce a gas price correction mechanism for one-year from January 1st 2023, via Reuters citing draft legislation; proposal leaves the actual price cap blank for now. Diplomats say that EU gov'ts want the gas price cap at EUR 159-180/MWh, vs the much higher cap expected to be proposed by the Commission.
- UK officials visited Brazil in October to assess the regions beef standards, via Politico; a visit which has fuelled hopes in Brazil of a future trade deal.
- Spot gold and silver are firmer, with the yellow metal at session highs just below the USD 1750/oz mark as risk sentiment struggles to find firm direction and the USD continues to pullback
- For reference, the current spot gold peak of USD 1748/oz is shy of the 10-DMA at USD 1755/oz and still some way from the 200-DMA at USD 1801/oz.
- Moscow considers a search necessary for a peaceful solution to the Kurdish issue after Turkey's strikes in Syria and believes Turkey should restrain from the use of excessive military force, according to RIA citing Moscow's Syria envoy.
- N. Korea will take an ultra strong response to anyone that interferes with its sovereign rights, via KCNA; US will face a greater security crisis the more it insists on taking hostile actions.
US Event Calendar
- 10am: U.S. Richmond Fed Index, Nov., est. -8, prior -10
Central bank speakers
- 11am: Fed’s Mester Discusses Wages and Inflation
- 11:45am: Bank of Canada’s Carolyn Rogers Speaks on Financial Stability
- 2:15pm: Fed’s George Takes Part in Policy Panel
- 2:45pm: Fed’s Bullard Discusses Heterogeneity in Macroeconomics
DB's Jim Reid concludes the overnight wrap
A decent slug of yesterday was spent debating whether England's 6-2 win at the World Cup was a performance to scare the world of football into submission or whether Iran's 20th spot in the FIFA World rankings may slightly flatter them. As ever, your opinions are welcome! Good luck to all your teams as the WC introduces a few big hitters today!
I'm not sure if it was the World Cup but markets had a rather slow and lacklustre start to the week yesterday. The S&P 500 (-0.39%) fell back amidst concerns about rising Covid cases in China and ongoing fears about a US recession next year. The effects were evident across multiple asset classes, and WTI oil prices fell below their start of 2022 levels briefly intra-day (-6.24% on the day at the lows) as investors grappled with the prospect of lower Chinese demand alongside speculation about an OPEC+ output increase, which was eventually denied. WTI rallied back hard on a Saudi denial of the story to close just -0.44% lower, while Brent futures were -6.06% lower before closing down only -0.19%. In Asia trading, WTI prices (+0.74%) have climbed back above the start of week levels and are trading just above $80/bbl while Brent futures (+0.49%) are fractionally higher as we go to print.
In terms of what’s coming out of China, there are growing concerns among investors that there’ll be a return to lockdowns following the weekend news that they’d had their first Covid death in six months. The overall rise in case numbers now makes this the third-largest outbreak of the pandemic so far, behind only the Shanghai lockdowns in Q2 and the Wuhan outbreak in early 2020. Beijing has increased its restrictions, and now requires arrivals to take three PCR tests within the first three days and to stay at home until they get a negative result. In the Haidian district of Beijing, schools have now switched to online learning as well. This has all served to dampen the speculation of recent weeks that China might be moving gradually away from its zero-Covid strategy, and the city of Shijiazhuang has even asked residents to stay at home for 5 days. China recorded 27,307 new local Covid cases nationally yesterday, almost close to the record high of 28k seen in March.
The irony is that the China reopening story has been a big positive driver of China-related risk and overall markets over the last couple of weeks, so we are trading between feast and famine on this story. Both could of course be ultimately right. There might be many more restrictions in the near term but stronger more durable reopenings by the spring. Markets are struggling to price this at the moment though.
For now, the effects were apparent among Chinese stocks listed in the US, with companies like Alibaba (-4.41%), JD.com (-6.37%) and Bilibili (-8.15%) underperforming the broader equity moves. The Chinese Yuan (-0.64%) also weakened against the US Dollar, although to be fair this was partly a function of dollar strength.
Overnight in Asia, China risk has bounced a bit. The Shanghai Composite (+0.75%) and the CSI (+0.77%) are both up alongside the Nikkei (+0.72%). The Hang Seng (-0.39%) and KOSPI (-0.35%) are both lower. US equity futures are just above flat as we type.
Staying with equities, the earlier plunge in oil prices was bad news for energy stocks, which were among the biggest sectoral underperformers on both sides of the Atlantic. By the close of trade, the S&P 500 was down -0.39%, with energy down -1.39%, rallying midday from -4.64% to beat out consumer discretionary shares which were -1.41% lower. A number of other cyclical industries underperformed as well, and the NASDAQ fell -1.09% on the day, whilst the small-cap Russell 2000 fell -0.57%. In Europe, the performance was marginally better, but that still wasn’t enough to stop the STOXX 600 posting a very marginal -0.06% decline, with energy (-3.02%) far and away the underperformer as shares closed near the nadir of Brent and WTI futures pricing. There clearly should be a bounce this morning.
The more negative tone out of China yesterday has only added to existing fears about a US recession over the coming months, which the latest moves in the Treasury yield curve did little to dispel. The 2s10s yield curve flattened another -2.2bps to -73bps taking it beneath the 1982 low of -71.65bps to a level unseen since 1981. This came as the 10yr tracked intraday pricing in oil as well, having fallen as much as -7.1bps intraday before finishing the day more or less unchanged. This morning in Asia, 10yr UST yields (-1.12 bps) are slightly lower, trading at 3.82%.
There have been a few Fed speakers over the last 24 hours to impact treasury pricing. SF Fed President Daly warned against the two-sided risks of over-tightening, but hinted that her estimate of terminal may have risen to around 5.1% since the November meeting. Meanwhile, Cleveland Fed President Mester supported downshifting to a 50bps hike in December, but noted the Fed was not “anywhere near to stopping”, echoing Chair Powell’s tone from the November FOMC presser. There's quite a bit of Fed speak today as you'll see in the day ahead at the end.
Whilst it’s widely expected that the Fed will slow down the pace of hikes to 50bps in December, there’s somewhat more doubt about the ECB’s next move the following day, who it seems are still weighing up another 75bps hike or slowing down to 50bps. Yesterday, we heard from Austria’s Holzmann (a hawk), who said he’d only favour a 50bps hike if there was a “major reduction” in inflation this month. But Portugal’s Centeno (a dove) said that the conditions were in place for a hike beneath 75bps next month. Separately, Slovenia’s Vasle talked about the need for restrictive policy, saying that the ECB needs to “keep gradually raising rates, even into the territory where monetary policy won’t be just neutral, but will become more restrictive.”
European sovereigns seemed unfazed by this debate, trading in line with the broader global moves. Yields on 10yr bunds (-2.1bps) and OATs (-1.8bps) moved lower, but there was an underperformance among southern European countries, with yields on Italian BTPs up +4.3bps. Interestingly, there was a notable downside surprise in the latest German PPI reading, which came in at +34.5% in October (vs. +42.1% expected). Now it’s worth noting that the decline was driven by energy, but at -4.2% on the month, that was the first monthly decline in the index since mid-2020.
To the day ahead now, and central bank speakers include the Fed’s Mester, George and Bullard, along with the ECB’s Holzmann, Rehn and Nagel. Data releases include Euro Area consumer confidence for November, as well as the US Richmond Fed manufacturing index for November. Lastly, the OECD will be releasing their Economic Outlook.
Financial Market Integration Assessed
In a new paper prepared for the Handbook of Financial Integration, edited by Guglielmo Maria Caporale, Hiro Ito and I examine bond based measures of financial…
In a new paper prepared for the Handbook of Financial Integration, edited by Guglielmo Maria Caporale, Hiro Ito and I examine bond based measures of financial market integration (so, no quantity stock/flow measures, nor banking integration).
In short, covered interest differentials have risen, but uncovered interest differentials seem to have shrunk. There is ambiguous evidence regarding real interest differentials.
Figure 1: Covered interest differentials, bps. Source: Cerutti et al. (2021).
See some discussion of this phenomenon in this 2016 post.
Figure 2: Average absolute uncovered interest differential for advanced economy currencies (blue), for emerging market currencies (tan), annualized. Calculated using survey data.
See discussion of using survey data to infer what is happening with expectations, and how this changes our view of uncovered interest parity, here, and here; see Chinn and Frankel (2020).
Figure 3: Average absolute real interest differentials (3 month rates, using ex post inflation rates)
- Covered interest parity which was previously thought to hold, up to transactions costs, no longer holds post global financial crisis. At one juncture, part of this is due to default risk (so that measured yields no longer relate to assets of same default risk), and more recently to the change in the regulatory regime that now makes hedging costly.
- Uncovered interest rate parity needs to be distinguished from the unbiasedness hypothesis – i.e., the joint hypothesis of uncovered interest parity and unbiased expectations. Once this is done, the evidence in favor of uncovered interest parity (and hence perfect capital substitutability) is much greater.
- Government bonds are not only differentiated by the degree to which their yields covary with wealth or consumption, but also by their convenience yield. Given this, it is unsurprising that nominal financial integration, defined as nominal yield equalization in common currency terms, has been incomplete.
- Ex post short term real returns have shrunk over time, but are still far from being equalized (and seemingly reversed during the pandemic and its aftermath).
The entire paper is here.default pandemic bonds government bonds currencies
A Crisis of Clarity Rippling Through Regional Banks
The past week of volatility exhibited in the banking sector was epic. It was along the lines of a redux of 2008, when some high-profile mortgage lenders…
The past week of volatility exhibited in the banking sector was epic.
It was along the lines of a redux of 2008, when some high-profile mortgage lenders and investment banks dealing in risky practices went bankrupt, filed for Chapter 11 or were acquired for pennies on the dollar. To say the recent events in the regional bank sector and with Credit Suisse are surreal would be an understatement.
Oh, how history does repeat itself — in various forms — but with the same pattern of hubris, greed and sheer stupidity.
Take Barney Frank for instance. As one of the authors of the Dodd-Frank Act enacted to prevent the excessive risk-taking that led to the financial crisis, it appears there is some twisted irony as to how Mr. Frank was a sitting board member of now-failed Signature Bank that was one of only a handful of banks allowing customers to deposit and transact in cryptocurrency assets 24/7 beginning in 2018.
One can look at the demise of FTX and the fall-off its leader Sam Bankman-Fried as the spark that led to the collapse of crypto-centric Silvergate Bank and the further chain reaction that ignited fears of depositors at Silicon Valley Bank and Signature Bank for their exposure to start-ups, crypto and commercial office space. From there, the market was taking down shares of banks with large uninsured deposit bases. First Republic Bank (FRC) is the newest poster child of this contagion.
No sooner than one day after 11 banks transferred $30 billion over to First Republic to shore up its deposit base, news reports indicated that top executives at the struggling financial institution sold millions of dollars of company stock in the two months prior to the regional bank panic. So, the rally in FRC shares last Thursday on the rescue plan fizzled Friday on news of the timely stock sales by company insiders.
The other deadly transgression by bank executives was reaching for yields on their bond portfolios. The banks invested in long-term bonds where the difference in yields compared to short-term bonds was minuscule, thereby taking huge risk of principal.
When money rained on the bank system from the roughly $4.7 trillion created in pandemic stimulus, banks invested heavily into long-dated government bonds. When the rate on the 10-year Treasury briefly rose to 1.75% in March 2021, banks rushed to buy.
The decision to do so by “risk managers,” instead of accepting 0.40% on 3-year T-Notes, is proving to be pretty short-sighted. At 1.75% for 10-year paper, there is really only one direction yields of that duration can go (higher), and only one direction for long-term bond prices to go — lower. To the extent these risk managers didn’t ladder their bond holdings borders on reckless, as if printing trillions of dollars wouldn’t somehow be inflationary down the road. And all for trying to bank a spread of 1.3% between the 3-year and 10-year Treasuries.
2-year T-Note www.cnbc.com
10-year T-Note www.cnbc.com
The obvious question sweeping the markets is how many, and to what extent, other banks are also underwater with their bond portfolios, their uninsured deposits and their exposure to commercial office space. In recent days, there have been numerous CEOs of small to mid-size banks putting forth statements that what happened at Silicon Valley Bank, Signature and Silvergate is unique, since those institutions engaged in non-traditional activities. They go on to say that all is well and their institutions are safe and sound, yet there is no mention of their Treasury holdings and a maturity schedule, a breakdown of commercial real estate loans and the level of uninsured deposits.
Transparency is what investors and depositors want most. Banks should immediately make public their current holdings and details of their financials and balance sheets amid this crisis. The warm and fuzzy statements do nothing to shore up confidence.
Caution takes hold when banks announce “there is nothing to worry about,” and then don’t back it up with internal numbers. With first-quarter earnings season approaching in April, investors will have ample opportunity to investigate the details of each bank during the earnings calls that follow the posting of quarterly results.
“Smaller banks are crucial drivers of credit growth, the fuel that powers the economy,” the Wall Street Journal reported on March 19. Banks smaller than the top 25 largest account for around 38% of all outstanding loans, according to Federal Reserve data. They account for 67% of commercial real estate lending. The possibility that other banks have similar problems has triggered a sell-off of financial stocks as investors scrutinize bank solvency. This, in turn, stoked public alarm about the safety of deposits and the size of unrealized losses.
This week will hopefully begin to provide some much-needed clarity of the risks within the wider banking sector. It is widely accepted that lending standards just tightened up for both businesses and consumers to raise capital ratios. Additionally, some pundits are suggesting recent events could trigger a wave of weaker banks being swallowed up by bigger banks to avoid the potential of further bank runs. These mergers could be voluntary or at the direction of state bank regulatory agencies.
What the market seeks most is a rapid response by the bank industry, the Fed and Treasury to prevent a further ripple effect. The fact that the Fed and Treasury jointly agreed to guarantee all deposits above the $250,000 FDIC level of insurance at Silicon Valley Bank is fueling a fresh debate about the moral hazard of universal deposit insurance. The potential for unintended consequences is high. If all funds are guaranteed, there’s at least some incentive to take on higher risks with depositors’ funds to chase profits.
What should come of recent events is that there should be more stress testing, more often with stricter mandates about where capital is concentrated. I think if these directives were made known to markets sooner than later, the ground under the banking sector might stop shaking. Let’s hope sound minds and proper decision making prevail in the days ahead.
P.S. Join me for a MoneyShow virtual event where I’ll be on a panel moderated by Roger Michalski and will be joined by my colleagues Jim Woods and Mark Skousen. In addition, the entire event focuses on investing for income, real estate, Master Limited Partnerships, dividend-paying stocks, bonds and more.
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Recent banking failures add another reason to halt interest rate hikes
The debate over the Federal Reserve’s proper course of action for the rest of 2023 was getting a little stagnant in recent months.
The debate over the Federal Reserve’s proper course of action for the rest of 2023 was getting a little stagnant in recent months. The argument centered on whether inflation’s persistence was really a sign of an overheated economy that still needed cooling or if it was due to stubbornly large—but dampening —ripples stemming from the huge pandemic and war shocks of previous years. The recent failures of Silicon Valley and Signature banks and chaos in other corners of the banking sector definitely provide a new twist to this debate.
My view on what the Fed should do now in the wake of banking failures is relatively straight-forward:
- Before the Silicon Valley Bank (SVB) failure, it was already clear that the Fed should pause interest rate hikes at this week’s meeting, based largely on consistent cooling in the labor market.
- The SVB failure and subsequent banking turmoil are far more likely to be demand-destroying events than not. If one thought the Fed already should be reducing the pace of their rate hikes (or even pausing entirely) due to labor market cooling, the fallout from SVB just means this cooling will happen more quickly and hence the case for halting further rate hikes is stronger.
- It is a genuine problem that interest rate hikes of nearly 5% in a year cause this much distress in the financial sector, indicating a clear failure of bank management and supervision. These failures should be addressed going forward. But they exist today and the fallout of them clearly provides another argument for standing pat on further rate increases.
Even before SVB failure, labor market cooling argued for no further rate hikes
The January consumer price index (CPI) data came in uncomfortably hot after months of good readings. The February CPI data showed a largely sideways movement in inflation. Worse, revisions to 2022 CPI data showed more disinflation in mid-2022 and less in late 2022—providing slightly weaker evidence of consistent disinflation over the course of the year.
However, nominal wage growth—what many have called a “supercore” measure of inflation—has consistently cooled over the course of 2022 and early 2023. Occasionally a single month of data has shown an uptick of wage growth and concerns are raised, but new data then show continued cooling. Figure A below shows annualized rates of wage growth for the latest three months relative to the prior three months. It shows these rates of wage growth for the initial releases of this data from December 2022 to March 2023. While wage growth blipped up in the December 2022 and February 2023 reports, the most recent report shows a clear pattern of consistent nominal wage deceleration.
This deceleration of nominal wage growth should be near-dispositive for arguments about the proper path of interest rates. If the Fed is insistent on 2% price inflation in the long run, this implies that nominal wages can grow at this 2% inflation rate plus the rate of productivity growth, which we will take as 1.5%. This 3.5% wage growth target, however, assumes no increase in the share of total income accruing to labor rather than capital. Given the large decline in labor’s share of income so far in the pandemic-driven business cycle, this means that several years of wage growth as high as 4.5% could be sustained while still seeing price inflation at the Fed’s 2% target. Nominal wage growth (as shown in Figure A) has been running at or below 4.5% for several months now. In short, wage growth is now running where it should be given the state of the business cycle and the Fed’s 2% inflation target—meaning the Fed should stand pat on any further interest rate hikes.
Besides the fact that current wage growth is consistent with the Fed’s inflation target on the cost side, the rapid normalization of nominal wage growth should also lead to rapid normalization of nominal aggregate demand. Essentially, if overheated demand is not being buoyed by above-target wage growth, it is hard to see how it could continue. The allegedly excess fiscal boost from the American Rescue Plan (and even the “excess savings” banked from this aid) is long gone. Financial and housing markets have lost significant value in recent months. Without excess wage growth, any excess of demand growth is unlikely to be sustained.
Banking stresses are likely to destroy demand in coming year
The failures of SVB and Signature banks and the associated increased stress in the banking sector are far more likely to reduce economy-wide demand in coming months than to increase it. As lending standards tighten and risk premiums rise for private lending, both consumer spending and business investment are likely to be curtailed. In short, whatever your estimate of the path of demand over the next year before SVB’s failure, your estimate now should be significantly lower. This has been recently acknowledged explicitly by the president of the Federal Reserve Bank of Boston, Eric Rosengren, who noted: “Financial crises create demand destruction. Banks reduce credit availability, consumers hold off large purchases, businesses defer spending. Interest rates should pause until the degree of demand destruction can be evaluated.”
There has been a recent debate in macroeconomic circles about the lags of monetary policy. Traditionally, these lags were thought to be “long and variable.” This would mean that a large part of the contractionary effect of the interest rate increases undertaken in 2022 and earlier this year had yet to hit the economy and would slow growth going forward even if the Fed stopped raising rates today. A newly fashionable view argues that these lags are shorter in today’s economy, meaning that the full contractionary effect of recent rate increases had already been absorbed by the economy and that a pause in rate-hiking would implicitly provide a substantial spur to demand growth. Whatever the outcome of this debate in normal times, the SVB failures clearly show that fallout from past rate increases is ongoing.
Yes, it’s a problem for macroeconomic stabilization that the banking system is this fragile
If one was worried that macroeconomic overheating remained a problem in the U.S. economy and was a key driver of inflation, the pressure to stop raising rates imposed by recent banking stress is extremely troubling. From this point of view, the recent banking stresses are demanding the Federal Reserve sacrifice efforts to cool the economy to control inflation in favor of the needs of financial stability.
It is especially perverse that increasing interest rates has appeared to throw much of the banking system into chaos. It is extremely well-documented that bank profitability is higher when interest rates are higher. However, it seems that banks cannot even make the transition to a new interest rate regime that would be highly favorable for them without substantial turmoil.
For all these reasons, if one was an inflation hawk who thought interest rates needed to be raised further, the imperative to stop raising rates now based on stresses in the banking system is an extremely dangerous development. And, in fact, even if one did not think that rates needed to be raised further in order to contain inflation, it’s still a bad thing that our financial system has become so fragile that raising rates causes these kinds of tremors. Even if I don’t think the economy needs higher interest rates today, there may be a future where higher interest rates would benefit the economy—and it would be very bad if macroeconomic stabilization options were held hostage to a fragile financial system.
These considerations argue strongly for improved regulatory and supervisory actions moving forward. The rollback of Dodd-Frank regulations in 2018 was a terrible step backwards in this regard. Further, the Federal Reserve rolled back regulatory safeguards even further than the 2018 law made necessary. Today’s hawks (and those like me who want to preserve the option of raising interest rates at some point in the future) should be among the most strident proponents for tightening these regulatory standards back up, and for holding the Fed accountable for supervisory failures.
But for now, the banking system is fragile and recent rate hikes have put stress on the system (as maddening as all of this is). This fragility is likely to cool the economy in coming months. Given this, any reasonable estimate of where interest rates should have gone in 2023 made before the SVB collapse should be marked down since.monetary policy fed federal reserve pandemic interest rates consumer spending
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