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What Is Volatility in Finance? Definition, Calculation & Examples

What Is Volatility in Simple Terms? Volatility is the degree to which a security (or an index, or the market at large) varies in price or value over the course of a particular period of time. Volatility refers to the frequency with which a security change

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More volatile securities come with more risk, but they may also produce more substantial returns. 

Jerry Zhang via Unsplash; Canva

What Is Volatility in Simple Terms?

Volatility is the degree to which a security (or an index, or the market at large) varies in price or value over the course of a particular period of time. Volatility refers to the frequency with which a security changes in price and the severity with which it changes in price. Typically, the more volatile a security is, the riskier of an investment it is. That being said, more volatile securities may also offer more substantial potential returns.

Risk-tolerant investors interested in growth tend to like volatile securities and markets because of their higher potential upside, whereas risk-averse investors who prefer modest-but-stable returns and lower risk tend to steer clear of highly volatile investments.

What Causes Volatility in the Market?

When it comes to the market as a whole, volatility is often related to macroeconomic factors rather than industry or company-specific issues. These can include things like abnormally high or low inflation, interest rate hikes, geopolitical events like international conflict, economic recessions, supply-chain issues, and even so-called forces majeures like environmental catastrophes or viral outbreaks like the COVID-19 pandemic. In many cases, a combination of these types of factors may be the catalyst for market-wide volatility.

During periods of market-wide volatility, risk-averse investors tend to move their money toward safer, more stable securities like precious metals, government bonds, or shares of preferred stock, depending on individual risk tolerance.

What Causes Volatility in Particular Stocks?

Individual stocks can experience volatility independent of the market at large. Some stocks are known to be more volatile than others, and generally, the higher a stock’s trading volume is, the more volatile it is likely to be. Well-known companies that are constantly in the public eye (think Tesla, Amazon, Meta, etc.), have a large market cap, and experience huge daily trading volume are naturally more volatile than lesser-known stocks that don’t have as public a persona and aren’t as often discussed in the media.

Individual stocks can also experience short-term volatility around certain events. The release of a new product, the hiring, firing, or retirement of an executive, or the buzz surrounding an upcoming earnings call can all send a stock’s price for a tailspin until things have settled down.

How Can Investors Benefit From Volatility?

There are many ways investors can incorporate volatility into their trading strategies, but all involve risk. An average, buy-and-hold value investor could identify a few stocks they like, keep an eye on price movements and volatility, then buy into each stock when its price seems relatively low (i.e., when it approaches an established support level) so they stand to gain more when the stock’s price goes back up in the longer term.

More active, shorter-term investors (like day traders and swing traders) use volatility to make buy and sell decisions much more frequently. Day traders aim to buy low and sell high multiple times over the course of a single day, and swing traders do the same over the course of days or weeks.

Options traders who simply want to bet on volatility but aren’t sure if the price of a stock will go up or down may buy straddles (at-the-money put and call options for the same stock that expire at the same time) so that they can profit off of price movement in any direction.

How Is Volatility Measured?

There are a number of ways to measure and interpret volatility, but most commonly, investors use standard deviation to determine how much a stock’s price is likely to change on any given day.

What Is Standard Deviation?

Standard deviation tells us how much a stock’s price was likely to change on any given day (in either direction—positive or negative) over a particular period.

How Do You Calculate the Standard Deviation of a Stock’s Price?

  1. To calculate standard deviation, first choose a time period (e.g., 10 days).
  2. Take an average of a stock’s closing prices for that period.
  3. Calculate the difference between each day’s closing price and the stock’s average closing price for that time period.
  4. Square each of these differences.
  5. Add the squared differences up.
  6. Divide this sum by the number of data points in the set (e.g., if the time period is 10 days, divide the sum by 10).
  7. Take the square root of the result to find the stock’s standard deviation for the period in question.

The resulting number will be in dollars and cents, so comparing standard deviation between two stocks can’t tell you how volatile they are in comparison to one another because different stocks have different average prices. For instance, if stock A has an average price of $200, and stock B has an average price of $100, a standard deviation of $5 would be a lot more significant in stock B than stock A.

To compare standard deviations between stocks, use the same time time period to calculate a standard deviation for each stock, then divide that stock’s standard deviation by its average price over the period in question. The resulting figures are percentages and can thus be compared to one another more meaningfully.

Standard Deviation Calculation Example: Acme Adhesives

Let’s say we want to find the standard deviation of the stock price of a fictional company called Acme Adhesives over the course of a particular five-day trading week. Let’s assume the stock closed at $19, $22, $21.50, $23, and $24 that week.

First, let’s find the average closing price for the week.

Average = (19 + 22 +21.50 + 23 + 24) / 5
Average = 109.5 / 5
Average = 21.9

Next, we need to find the difference between each closing price and the average closing price for the five-day period in question.

19 – 21.9 = -2.9
22 – 21.9 = 0.1
21.5 – 21.9 = -0.4
23 – 21.9 = 1.1
24 – 21.9 = 2.1

Next, we need to square each of these differences.

(-2.9) * (-2.9) = 8.41
0.1 * 0.1 = 0.01
(-0.4) * (-0.4) = 0.16
1.1 * 1.1 = 1.21
2.1 * 2.1 = 4.41

Next, we need to add these squared differences up.

8.41 + 0.01 + 0.16 + 1.21 + 4.41 = 14.2

Next, we need to divide this sum by the number of data points in the set (i.e., the number of days we’re looking at)

14.2 / 5 = 2.84

Finally, we need to take the square root of this result.

Square Root of 2.84 = 1.69

So, the standard deviation of Acme Adhesives’ stock price for the five-day period in question is $1.69. If we divide this by the stock’s average price for the time period ($21.90), we get 0.077, which tells us that the stock’s price was likely to deviate from its mean by about 8% each day during that period.

What Is the Volatility Index (VIX)?

The volatility index, or VIX, is an index created by the Chicago Board Options Exchange designed to track implied market volatility based on price changes in S&P 500 index options with upcoming expiration dates.

Analysts look to the VIX as a measure of fear and uncertainty in the investment community because it represents the market’s volatility expectations for the next month or so. Because the S&P 500 tracks 500 of the biggest U.S. stocks by float-adjusted market capitalization, it is thought to be a good representation of the American stock market, and subsequently, the VIX is thought to be a good representation of the American stock market’s short-term volatility expectations. 

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China Will Struggle To Reach Positive GDP This Quarter Premier Says, Warning Economy “To Some Degree” Worse Than 2020

China Will Struggle To Reach Positive GDP This Quarter Premier Says, Warning Economy "To Some Degree" Worse Than 2020

Over the weekend, we…

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China Will Struggle To Reach Positive GDP This Quarter Premier Says, Warning Economy "To Some Degree" Worse Than 2020

Over the weekend, we quoted Goldman's head of hedge fund sales Tony Pasquariello who had some very choice words for China, saying its economy was so bad, "it’s simply eye-popping (witness the worst IP print on record)", and prompted Goldman's sellside research desk to cut its expectation for 2022 Chinese GDP growth to just 4%, which ex-2020 would be the slowest growth rate since 1990! For the sake of balance, Pasquariello noted that Shanghai was set to reopen on June 1st which could be a potential upside catalyst at a time when foreign investors have largely written away Chinese equities.

Fast forward to today when we find that Pasquariello's hedging was not necessary, because on Wednesday, China's Premier Li Keqiang held a teleconference this afternoon under the topic of "stabilizing economic growth" with provincial, city-level and county-level local government officials across the country in which he had some very dismal comments about the current state of China's economy.

As Goldman notes, "while there are not many new measures being announced from this conference, the nature and scale of this conference is quite unusual. Chinese policymakers are in greater urgency to support the economy after the very weak activity growth in April, anemic recovery month-to-date in May, and continued increases in unemployment rates."

Specifically, premier Li said China’s economy is worse off to a “certain extent” than 2020 when the pandemic first emerged, urging efforts to reduce the unemployment rate which as we noted recently has soared to the highest level since the covid crash.

“Economic indicators in China have fallen significantly, and difficulties in some aspects and to a certain extent are greater than when the epidemic hit us severely in 2020,” Li said Wednesday following a meeting with local authorities, state-owned companies and financial firms to discuss how to stabilize the economy, Bloomberg reported.

China’s premier also said the world’s second-largest economy would struggle to record positive growth in the current quarter, urging officials to help companies resume production after Covid-19 lockdowns, according to the FT.

“We will try to make sure the economy grows in the second quarter,” Li said, according to a transcript that the Financial Times verified with three people briefed on the premier’s remarks. “This is not a high target and a far cry from our 5.5 per cent goal. But we have to do so.”

The last time China’s growth entered negative territory was when output plunged 6.9 per cent year on year in the first quarter of 2020 after the coronavirus pandemic ended an era of uninterrupted growth dating back more than 30 years.

The comments by Li Keqiang, to tens of thousands of officials on an internal videocast on Wednesday, underscore the difficulties President Xi Jinping’s administration will have in reaching its annual growth target of 5.5% while also battling Omicron outbreaks.

Concerned that the unemployment rate is approaching levels where the dreaded "social unrest" becomes a possibility, the premier urged officials to make sure the unemployment rate falls and the economy “operates in a reasonable range” in the second quarter of this year, state media cited him as saying. Earlier in May, Li warned of a “complicated and grave” employment situation after the nation’s surveyed jobless rate climbed to 6.1% in April, the highest since February 2020, and sent the yuan plunging to the lowest level since late 2020.

Today's meeting was the latest in a series of urgent calls by Li (who is quitting his job next March) to shore up the economy, which has come under enormous pressure from Covid outbreaks and lockdowns in recent months, threatening the government's growth target of about 5.5%. President Xi's stubborn commitment to Covid Zero means China is guaranteed to miss that goal this year: Economists now forecast gross domestic product growth will hit just 4.5%, according to a new Bloomberg survey, with Goldman predicting GDP will rise just 4.0% as noted above.

In hopes of offsetting some of the gloom and doom unleashed by Beijing's flawed covid policies, Li indicated that China will try to reduce the impact of its strict Zero-Covid policy on the economy. “At the same time as controlling the epidemic, we must complete the task of economic development,” he said.

Li also stressed implementation of current support policies, and said more detailed implementation measures would be issued by the end of this month. Somewhat bizarrely, he said that economic data for the second quarter would be released “accurately”, hinting that prior Chinese data was - gasp - inaccurate? Perish the thought.

As Bloomberg reported earlier this week, China's State Council outlined 33 support measures on Monday to help businesses struggling to cope with the lockdowns, including extra tax rebates, relief on social insurance payments and loans, and additional funding for aviation and rail construction. Local governments were told to spend most of the proceeds from special bonds -- used mainly for infrastructure -- by the end of August. Judging by the lack of market reaction, investors saw right through this latest mostly verbal attempt to prop up confidence in the country ahead of the 20th Party Congress later this year, where Xi's fate will be determine (amid some rumors that his political career may be cut short if China's economy does not stabilize).

The central bank and banking regulator also held a meeting with major financial institutions on Monday to urge them to boost loans.
Li met with local authorities in April, when Shanghai was in the middle of a lockdown, telling them to “add a sense of urgency” as they rolled out policy. During a trip to Yunnan province last week, he said they should “act decisively” to support growth. Of course, when banks artificially inject loans into an economy where there is no loan demand, what you end up getting is just another bubble.

Tyler Durden Wed, 05/25/2022 - 11:25

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Futures Slide Before Fed Minutes, Dollar Jumps As China Lockdown Fears Return

Futures Slide Before Fed Minutes, Dollar Jumps As China Lockdown Fears Return

Another day, another failure by markets to hold on to even the…

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Futures Slide Before Fed Minutes, Dollar Jumps As China Lockdown Fears Return

Another day, another failure by markets to hold on to even the smallest overnight gains: US futures erased earlier profits and dipped as traders prepared for potential volatility surrounding the release of the Federal Reserve’s minutes which may provide insight into the central bank’s tightening path, while fears over Chinese lockdowns returned as Beijing recorded more Covid cases and the nearby port city of Tianjin locked down a city-center district. Contracts on the Nasdaq 100 and the S&P 500 were each down 0.5% at 7:30 a.m. in New York after gaining as much as 1% earlier, signaling an extension to Tuesday’s slide that followed a profit warning from Snap.

In premarket trading, Nordstrom jumped 10% after raising its forecast for earnings and revenue for the coming year suggesting that the luxury consumer is doing quite fine even as most of the middle class has tapped out; analysts highlighted the department store’s exposure to higher-end customers.Meanwhile, Wendy’s surged 12% after shareholder Trian Fund Management, billionaire Nelson Peltz' investment vehicle, said it will explore a transaction that could give it control of the fast-food chain. Here are the most notable premarket movers in the US:

  • Urban Outfitters (URBN US) shares rose as much as 5.7% in premarket trading after Nordstrom’s annual forecasts provided some relief for the beaten down retail sector. Shares rallied even as Urban Outfitters reported lower-than-expected profit and sales for the 1Q.
  • Best Buy (BBY US) shares could be in focus as Citi cuts its price target on electronics retailer to a new Street-low of $65 from $80, saying that there continues to be “significant risk” to 2H estimates.
  • Dick’s Sporting Goods (DKS US) sinks as much as 20% premarket after the retailer cut its year adjusted earnings per share and comparable sales guidance for the full year. Peers including Big 5 Sporting Goods, Hibbett and Foot Locker also fell after the DKS earnings release
  • 2U Inc. (TWOU US) shares drop as much as 4.3% in US premarket trading after Piper Sandler downgraded the online educational services provider to underweight from neutral, with broker flagging growing regulatory risk.
  • Verrica Pharma (VRCA US) shares slump as much as 61% in US premarket trading after the drug developer received an FDA Complete Response Letter for its VP-102 molluscum treatment.
  • Shopify’s (SHOP US) U.S.-listed shares fell 0.7% in premarket trading after a second prominent shareholder advisory firm ISS joined its peer Glass Lewis to oppose the Canadian company’s plan to give CEO Tobi Lutke a special “founder share” that will preserve his voting power.
  • Cazoo (CZOO US) shares declined 3.3% in premarket trading as Goldman Sachs initiated coverage of the stock with a neutral recommendation, saying the company is well positioned to capture the significant growth in online used car sales.
  • CME Group (CME US Equity) may be in focus as its stock was upgraded to outperform from market perform at Oppenheimer on attractive valuation and an “appealing” dividend policy.

US stocks have slumped this year, with the S&P 500 flirting with a bear market on Friday, as investors fear that the Fed’s active monetary tightening will plunge the economy into a recession: as Bloomberg notes, amid surging inflation, lackluster earnings and bleak company guidance have added to market concerns. The tech sector has been particularly in focus amid higher rates, which mean a bigger discount for the present value of future profits. The Nasdaq 100 index has tumbled to the lowest since November 2020 and its 12-month forward price-to-earnings ratio of 19.7 is the lowest since the start of the pandemic and below its 10-year average.

“The consumer in the US is still showing really good signs of strength,” said Michael Metcalfe, global head of macro strategy at State Street Global Markets. “Even if there is a slowdown it’s going to be quite mild,” he said in an interview with Bloomberg Television.

Meanwhile, Barclays Plc strategists including Emmanuel Cau see scope for stocks to fall further if outflows from mutual funds pick up, unless recession fears are alleviated. Retail investors have also not yet fully capitulated and “still look to be buying dips in old favorites in tech/growth,” the strategists said.

"Our central scenario remains that a recession can be avoided and that geopolitical risks will moderate over the course of the year, allowing equities to move higher,” said Mark Haefele,  chief investment officer at UBS Global Wealth Management. “But recent market falls have underlined the importance of being selective and considering strategies that mitigate volatility."

The Fed raised interest rates by 50 basis points earlier this month -- to a target range of 0.75% to 1% -- and Chair Jerome Powell has signaled it was on track to make similar-sized moves at its meetings in June and July. Investors are now awaiting the release of the May 3-4 meeting minutes later on Wednesday to evaluate the future path of rate hikes. However, in recent days, traders have dialed back the expected pace of Fed interest-rate increases over worse-than-expected economic data and the selloff in equities. Sales of new US homes fell more in April than economists forecast, and the Richmond Fed’s measure of business activity dropped to a two-year low. The yield on the 10-year Treasury slipped for a second day to 2.73%.

“Given the risks to growth and our view that positive real rates will be unmanageable for any significant length of time, we expect the Fed to deliver less tightening in 2022 overall than it and markets currently expect,” Salman Ahmed, global head of macro and strategic asset allocation at Fidelity International, wrote in a note.

In Europe, stocks pared an earlier advance but hold in the green while the dollar rallies. The Stoxx 600 gave back most of the morning’s gains with autos, financial services and travel weighing while miners and utilities outperformed. The euro slid as comments by European Central Bank officials indicated policy normalization will be gradual. The ECB is in the midst of a debate over how aggressive it should act to rein in inflation. Here are some of the most notable European movers today:

SSE shares rise as much as 6.3% after strong guidance and amid reports that electricity generators are likely to escape windfall taxes being considered by the U.K. government.

  • Air France-KLM jumps as much as 13% in Paris after falling 21% on Tuesday as the airline kicked off a EU2.26 billion rights offering.
  • Mining and energy stocks outperform the broader market in Europe as iron ore rebounded, while oil rose after a report that showed a decline in US gasoline stockpiles. Rio Tinto gains as much as 2.3%, Anglo American +2.6%, TotalEnergies +2.8%, Equinor +3.7%
  • Elekta rises as much as 9.3% after releasing a 4Q earnings report that beat analysts’ expectations.
  • Torm climbs as much as 12% after Pareto initiates coverage at buy and says the company may pay out dividends equal to 40% of its market value over the next 3 years.
  • Mercell rises as much as 104% to NOK6.13/share after recommending a NOK6.3/share offer from Spring Cayman Bidco.
  • Luxury stocks traded lower amid rekindled Covid-19 worries in China as Beijing continued to report new infections while nearby Tianjin locked down its city center. LVMH declines as much as 1.4%, Burberry -2.6% and Hermes -1.7%
  • Sodexo falls as much as 5.7% after the French caterer decided not to open up the capital of its benefits & rewards unit to a partner following a review of the business.
  • Ocado slumps as much as 8% after its grocery joint venture with Marks & Spencer slashed its forecast for FY22 sales growth to low single digits, rather than around 10% guided previously.

Earlier in the session, Asian stocks were steady as traders continued to gauge growth concerns and fears of a US recession. The MSCI Asia Pacific Index rose 0.1%, paring an earlier increase of as much as 0.5%, as gains in the financial sector were offset by losses in consumer names. New Zealand equities dipped on Wednesday after the central bank delivered an expected half-point interest rate hike to combat inflation. Chinese shares stabilized after the central bank and banking regulator urged lenders to boost loans as the nation grapples with ongoing Covid outbreaks. The benchmark CSI 300 Index snapped a two-day losing streak to close 0.6% higher.

Asian equities have been trading sideways as the prospect of slower growth amid tighter monetary conditions, as well as China’s strict Covid policy and supply-chain disruptions, remain key overhangs for the market. In China, the country’s strict Covid policy is outweighing broad measures to support growth and keeping investors wary. Its commitment to Covid Zero means it’s all but certain to miss its economic growth target by a large margin for the first time ever. The nation’s central bank and banking regulator urged lenders to boost loans in the latest effort to shore up the battered economy.

“The valuation is still nowhere near attractive and you have a number of leading indicators, whether its credit, liquidity or growth, which are not yet indicating that we want to take more risks on the market,” Frank Benzimra, head of Asia equity strategy at Societe Generale, said in a Bloomberg TV interview. He added that the preferred strategy in equities will focus on defensive plays like resources and income. Investors will get further clues on the Federal Reserve’s interest-rate policies with the release in Washington of minutes from the latest meeting on Wednesday. Concerns that the Fed’s tightening will plunge the nation into recession had spurred a sharp selloff in US shares recently.

Japanese stocks ended a bumpy day lower as investors awaited minutes from the latest Federal Reserve meeting and continued to gauge the impact of China’s rising Covid cases. The Topix fell 0.1% to close at 1,876.58, while the Nikkei declined 0.3% to 26,677.80. Nintendo Co. contributed the most to the Topix Index decline, decreasing 4.3%. Out of 2,171 shares in the index, 793 rose and 1,257 fell, while 121 were unchanged.

Meanwhile, Australian stocks bounced with the S&P/ASX 200 index rising 0.4% to close at 7,155.20, with banks and miners contributing the most to its move. Costa Group was the top performer after reaffirming its operating capex guidance. Chalice Mining dropped after an equity raising. In New Zealand, the S&P/NZX 50 index fell 0.7% to 11,173.37 after the RBNZ’s policy decision. The central bank raised interest rates by half a percentage point for a second straight meeting and forecast further aggressive hikes to come to tame inflation.

India’s key equity indexes fell for the third consecutive session, dragged by losses in software makers as worries grow over companies’ spending on technology amid a clouded growth outlook. The S&P BSE Sensex slipped 0.6% to 53,749.26 in Mumbai, while the NSE Nifty 50 Index dropped 0.6%. The benchmark has retreated for all but four sessions this month, slipping 5.8%, dragged by Infosys, Tata Consultancy and Reliance Industries. All but two of the 19 sector sub-indexes compiled by BSE Ltd. fell on Wednesday, led by information technology stocks. Out of 30 shares in the Sensex index, 12 rose and 18 fell. The S&P BSE IT Index has lost nearly 26% this year and is trading at its lowest level since June. 

In FX, the Bloomberg dollar spot index resumed rising, up 0.3% with all G-10 FX in the red against the dollar. The euro slipped and Italian bonds extended gains after comments from ECB officials. Executive board member Fabio Panetta said the ECB shouldn’t seek to raise its interest rates too far as long as the euro-area economy displays continuing signs of fragility. Board Member Olli Rehn said the ECB should raise rates to zero in autumn. The pound was steady against the dollar and gained versus the euro, paring some of its losses from Tuesday. Focus is on the long-awaited report into lockdown parties at No. 10. The BOE needs to tighten policy further to fight rising inflation, but it’s also wary of acting too quickly and risking pushing the UK into recession, according to Chief Economist Huw Pill. Sweden’s krona slumped on the back of a stronger dollar and amid data showing that consumer confidence fell to the lowest level since the global financial crisis. Yen eased as Treasury yields steadied in Asia from an overnight plunge.  China’s offshore yuan weakened for the first time in five days as Beijing recorded more Covid cases and the nearby port city of Tianjin locked down a city-center district.

New Zealand dollar and sovereign yields rose after the RBNZ hiked rates by 50 basis points for a second straight meeting and forecast more aggressive tightening, with the cash rate seen peaking at 3.95% in 2023.

Most emerging-market currencies also weakened against a stronger dollar as investors await minutes from the Federal Reserve’s last meeting for clues on the pace of US rate hikes.  The ruble extended its recent rally in Moscow even as Russia’s central bank moved up the date of its next interest-rate meeting by more than two weeks to stem gains in the currency with more monetary easing. Russia has been pushed closer to a potential default. US banks and individuals are barred from accepting bond payments from Russia’s government since 12:01 a.m. New York time on Wednesday, when a license that had allowed the cash to flow ended. The lira lagged most of its peers, weakening for a fourth day amid expectations that Turkey’s central bank will keep rates unchanged on Thursday even after consumer prices rose an annual 70% in April.

In rates, Treasuries were steady with yields slightly richer across long-end of the curve as S&P 500 futures edge lower, holding small losses. US 10-year yields around 2.745% are slightly richer vs Tuesday’s close; long-end outperformance tightens 5s30s spread by 1.4bp on the day with 30-year yields lower by ~1bp. Bunds outperform by 2bp in 10-year sector while gilts lag slightly with no major catalyst. Focal points of US session include durable goods orders data, 5-year note auction and minutes of May 3-4 FOMC meeting. The US auction cycle resumes at 1pm ET with $48b 5-year note sale, concludes Thursday with $42b 7-year notes; Tuesday’s 2-year auction stopped through despite strong rally into bidding deadline. The WI 5-year yield at ~2.740% is ~4.5bp richer than April auction, which tailed by 0.9bp.

In commodities, WTI pushed higher, heading back toward best levels of the week near $111.60. Most base metals trade in the red; LME aluminum falls 2.3%, underperforming peers. Spot gold falls roughly $10 to trade around $1,856/oz. Spot silver loses 1.1% to around.

Bitcoin trades on either side of USD 30k with no real direction.

Looking to the day ahead now, and central bank publications include the FOMC minutes from their May meeting and the ECB’s Financial Stability Review. Separately, we’ll hear from ECB President Lagarde, the ECB’s Rehn, Panetta, Holzmann, de Cos and Lane, BoJ Governor Kuroda, Fed Vice Chair Brainard and the BoE’s Tenreyro. Otherwise, data releases from the US include preliminary April data on durable goods orders and core capital goods orders.

Market Snapshot

  • S&P 500 futures little changed at 3,942.75
  • STOXX Europe 600 up 0.4% to 433.41
  • MXAP little changed at 163.41
  • MXAPJ up 0.3% to 531.42
  • Nikkei down 0.3% to 26,677.80
  • Topix little changed at 1,876.58
  • Hang Seng Index up 0.3% to 20,171.27
  • Shanghai Composite up 1.2% to 3,107.46
  • Sensex down 0.5% to 53,763.20
  • Australia S&P/ASX 200 up 0.4% to 7,155.24
  • Kospi up 0.4% to 2,617.22
  • German 10Y yield little changed at 0.94%
  • Euro down 0.5% to $1.0677
  • Brent Futures up 1.0% to $114.69/bbl
  • Gold spot down 0.5% to $1,856.22
  • U.S. Dollar Index up 0.30% to 102.16

Top Overnight News from Bloomberg

  • New Zealand dollar and sovereign yields rose after the RBNZ hiked rates by 50 basis points and forecast more aggressive tightening, with the cash rate seen peaking at 3.95% in 2023
  • The euro slipped and Italian bonds extended gains after comments from ECB officials. Executive board member Fabio Panetta said the ECB shouldn’t seek to raise its interest rates too far as long as the euro-area economy displays continuing signs of fragility. Board Member Olli Rehn said the ECB should raise rates to zero in autumn
  • The pound was steady against the dollar and gained versus the euro, paring some of its losses from Tuesday. Focus is on the long-awaited report into lockdown parties at No. 10
  • The BOE needs to tighten policy further to fight rising inflation, but it’s also wary of acting too quickly and risking pushing the UK into recession, according to Chief Economist Huw Pill
  • Sweden’s krona slumped on the back of a stronger dollar and amid data showing that consumer confidence fell to the lowest level since the global financial crisis
  • Yen eased as Treasury yields steadied in Asia from an overnight plunge

A more detailed look at global markets courtesy of Newsquawk

Asia-Pac stocks were mostly positive but with gains capped and price action choppy after a lacklustre lead from global counterparts as poor data from the US and Europe stoked growth concerns, while the region also reflected on the latest provocations by North Korea and the RBNZ’s rate increase. ASX 200 was led higher by commodity-related stocks despite the surprise contraction in Construction Work. Nikkei 225 remained subdued after recent currency inflows and with sentiment clouded by geopolitical tensions. Hang Seng and Shanghai Comp were marginally higher following further support efforts by the PBoC and CBIRC which have explored increasing loans with major institutions and with the central bank to boost credit support, although the upside is contained amid the ongoing COVID concerns and with Beijing said to tighten restrictions among essential workers.

Top Asian News

  • US SEC official said significant issues remain in reaching a deal with China over audit inspections and even if US and China reach a deal on proceeding with inspections, they would still have a long way to go, according to Bloomberg.
  • China will be seeing a Pacific Island Agreement when Senior Diplomat Wang Yi visits the region next week, according to documents cited by Reuters.
  • North Korea Fires Suspected ICBM as Biden Wraps Up Asia Tour
  • Luxury Stocks Slip Again as China Covid-19 Worries Persist
  • Asia Firms Keep SPAC Dream Alive Despite Poor Returns: ECM Watch
  • Powerlong 2022 Dollar Bonds Fall Further, Poised for Worst Week

In Europe the early optimism across the equity complex faded in early trading. Major European indices post mild broad-based gains with no real standouts. Sectors initially opened with an anti-defensive bias but have since reconfigured to a more pro-defensive one. Stateside, US equity futures have trimmed earlier gains, with relatively broad-based gains seen across the contracts; ES (+0.1%).

Top European News

  • Aiming ECB Rate at Neutral Risks Hurting Economy, Panetta Says
  • M&S Says Russia Exit, Inflation to Prevent Profit Growth
  • Prudential Names Citi Veteran Wadhwani as Insurer’s Next CEO
  • EU’s Gentiloni Eyes Deal on Russian Oil Embargo: Davos Update
  • UK’s Poorest to See Inflation Hit Near Double Pace of the Rich

FX

  • Buck builds a base before Fed speak, FOMC minutes and US data - DXY tops 102.250 compared to low of 101.640 on Tuesday.
  • Kiwi holds up well after RBNZ hike, higher OCR outlook and Governor Orr outlining the need to tighten well beyond neutral - Nzd/Usd hovers above 0.6450 and Aud/Nzd around 1.0950.
  • Euro pulls back sharply as ECB’s Panetta counters aggressive rate guidance with gradualism to avoid a normalisation tantrum - Eur/Usd sub-1.0700 and Eur/Gbp under 0.8550.
  • Aussie undermined by flagging risk sentiment and contraction in Q1 construction work completed - Aud/Usd retreats through 0.7100.
  • Loonie and Nokkie glean some underlying traction from oil returning to boiling point - Usd/Cad capped into 1.2850, Eur/Nok pivots 10.2500.
  • Franc, Yen and Sterling all make way for Greenback revival - Usd/Chf bounces through 0.9600, Usd/Jpy over 127.00 and Cable close to 1.2500.

Fixed Income

  • Choppy trade in bonds amidst fluid risk backdrop and ongoing flood of global Central Bank rhetoric, Bunds and Gilts fade just above 154.00 and 119.00.
  • Eurozone periphery outperforming as ECB's Panetta urges gradualism to avoid a normalisation tantrum and Knot backs President Lagarde on ZIRP by end Q3 rather than going 50 bp in one hit.
  • US Treasuries flat-line before US data, Fed's Brainard, FOMC minutes and 5-year supply - 10 year T-note midway between 120-21/09+ parameters.

Commodities

  • WTI and Brent July futures are firmer intraday with little newsflow throughout the European morning.
  • US Energy Inventory Data (bbls): Crude +0.6mln (exp. -0.7mln), Gasoline -4.2mln (exp. -0.6mln), Distillates -0.9mln (exp. +0.9mln), Cushing -0.7mln.
  • Spot gold is pressured by the recovery in the Dollar but found some support at its 21 DMA.
  • Base metals are pressured by the turn in the risk tone this morning.

US Event Calendar

  • 07:00: May MBA Mortgage Applications -1.2%, prior -11.0%
  • 08:30: April Durable Goods Orders, est. 0.6%, prior 1.1%
    • -Less Transportation, est. 0.5%, prior 1.4%
  • 08:30: April Cap Goods Ship Nondef Ex Air, est. 0.5%, prior 0.4%
  • 08:30: April Cap Goods Orders Nondef Ex Air, est. 0.5%, prior 1.3%

Central Banks

  • 12:15: Fed’s Brainard Delivers Commencement Address
  • 14:00: May FOMC Meeting Minutes

DB's Jim Reid concludes the overnight wrap

This morning we’ve launched our latest monthly survey. In it we try to ask questions that aren’t easy to derive from market pricing. For example we ask whether you think a recession is a price worth paying to tame inflation back to target. We also ask whether you think the Fed will think the same. We ask whether you think bubbles are still in markets and whether the bottom is in for equities. We also ask you the best hedge against inflation from a small list of mainstream assets. Hopefully it will be of use and the more people that fill it in the more useful it might be so all help welcome. The link is here.

Talking of inflation I had a huge shock yesterday. The first quote of three came back from builders for what I hope will be our last ever renovation project as we upgrade a dilapidated old outbuilding. Given the job I do I'd like to think I'm fully aware of commodity price effects and labour shortages pushing up costs but nothing could have prepared me for a quote 250% higher than what I expected. We have two quotes to come but if they don't come in nearer to my expectations then we're either going to shelve/postpone the project after a couple of years of planning or my work output might reduce as I learn how to lay bricks, plumb, tile, make and install windows and plaster amongst other things. Maybe I could sell the rights of my journey from banker to builder to Netflix to make up for lost earnings.

Rather like my building quote expectations, markets came back down to earth yesterday, only avoiding a fresh closing one-year low in the S&P 500 via a late-day rally that sent the market from intra-day lows of -2.48% earlier in the session to -0.81% at the close and giving back just under half the gains from the best Monday since January. Having said that S&P futures are up +0.6% this morning so we've had a big swing from the lows yesterday afternoon.

The blame for the weak market yesterday was put on weak economic data alongside negative corporate news. US tech stocks saw the biggest losses as the NASDAQ (-2.35%) hit its lowest level in over 18 months following Snap’s move to cut its profit forecasts that we mentioned in yesterday’s edition. The stock itself fell -43.08%. Indeed, the NASDAQ just barely avoided closing more than -30% (-29.85%) from its all-time high reached back in November. The S&P 500's closing loss leaves it +1.03% week to date as it tries to avoid an 8th consecutive weekly decline for just the third time since our data starts in 1928. Typical defensive sectors Utilities (+2.01%), staples (+1.66%), and real estate (+1.21%) drove the intraday recovery, so even with the broad index off the day’s lows, the decomposition points to continued growth fears.

Investors had already been braced for a more difficult day following the Monday night news from Snap, but further fuel was then added to the fire after US data releases significantly underwhelmed shortly after the open. First, the flash composite PMI for May fell to 53.8 (vs. 55.7 expected), marking a second consecutive decline in that measure. And then the new home sales data for April massively underperformed with the number falling to an annualised 591k (vs. 749k expected), whilst the March reading was also revised down to an annualised 709k (vs. 763k previously). That 591k reading left new home sales at their lowest since April 2020 during the Covid shutdowns, and comes against the backdrop of a sharp rise in mortgage rates as the Fed have tightened policy, with the 30-year fixed rate reported by Freddie Mac rising from 3.11% at the end of 2021 to 5.25% in the latest reading last week.

The strong defensive rotation in the S&P 500 and continued fears of a recession saw investors pour into Treasuries, which have been supported by speculation that the Fed might not be able to get far above neutral if those growth risks do materialise. Yields on 10yr Treasuries ended the day down -10.1bps at 2.75%, and the latest decline in the 10yr inflation breakeven to 2.58% leaves it at its lowest closing level since late-February, just after Russia began its invasion of Ukraine that led to a spike in global commodity prices. And with investors growing more worried about growth and less worried about inflation, Fed funds futures took out -11.5bps of expected tightening by the December meeting, and saw terminal fed funds futures pricing next year close below 3.00% for the first time in two weeks. 10 year US yields are back up a basis point this morning.

Over in Europe there was much the same pattern of equity losses and advances for sovereign bonds. However, the decline in yields was more muted after there was further chatter about a potential 50bp hike from the ECB. Austrian central bank governor Holzmann said that “A bigger step at the start of our rate-hike cycle would make sense”, and Latvian central bank governor Kazaks also said that a 50bp hike was “certainly one thing that we could discuss”. Along with Dutch central bank governor Knot, that’s now 3 members of the Governing Council who’ve openly discussed the potential they could move by 50bps as the Fed has done, and markets seem to be increasingly pricing in a chance of that, with the amount of hikes priced in by the July meeting closing at a fresh high of 32.5bps yesterday.

In spite of the growing talk about a 50bp move at a single meeting, the broader risk-off tone yesterday led to a decline in sovereign bond yields across the continent, with those on 10yr bunds (-4.9bps), OATs (-4.3bps) and BTPs (-5.9bps) all falling back. Equities struggled alongside their US counterparts, and the STOXX 600 (-1.14%) ended the day lower, as did the DAX (-1.80%) and the CAC 40 (-1.66%). The flash PMIs were also somewhat underwhelming at the margins, with the Euro Area composite PMI falling a bit more than expected to 54.9 (vs. 55.1 expected).

Over in the UK there were even larger moves after the country’s flash PMIs significantly underperformed expectations. The composite PMI fell to 51.8 (vs. 56.5 expected), which is the lowest reading since February 2021 when the country was still in lockdown. In turn, that saw sterling weaken against the other major currencies as investors dialled back the amount of expected tightening from the Bank of England, with a fall of -0.44% against the US dollar. That also led to a relative outperformance in gilts, with 10yr yields down -8.3bps. And on top of that, there were signs of further issues on the cost of living down the tracks, with the CEO of the UK’s energy regulator Ofgem saying that the energy price cap was set to increase to a record £2,800 in October, an increase of more than 40% from its current level.

Asian equity markets are mostly trading higher this morning with the Hang Seng (+0.64%), Shanghai Composite (+0.58%), CSI (+0.17%) and Kospi (+0.80%) trading in positive territory with the Nikkei (-0.03%) trading fractionally lower.

Earlier today, the Reserve Bank of New Zealand (RBNZ), in a widely anticipated move, hiked the official cash rate (OCR) by 50bps to 2.0%, its fifth-rate hike in a row in a bid to get on top of inflation which is currently running at a 31-year high. The central bank has significantly increased its forecast of how high the OCR might rise in the coming years with the cash rate jumping to about 3.4% by the end of this year and peaking at 3.95% in the third quarter of 2023. Additionally, it forecasts the OCR to start falling towards the end of 2024. Following the release of the statement, the New Zealand dollar hit a three-week high of 0.65 against the US dollar.

Elsewhere, as we mentioned last week, today marks the expiration of the US Treasury Department’s temporary waiver that allowed Russia to make sovereign debt payments to US creditors. US investors will no longer be able to receive such payments, pushing Russia closer to default on its outstanding sovereign debt.

To the day ahead now, and central bank publications include the FOMC minutes from their May meeting and the ECB’s Financial Stability Review. Separately, we’ll hear from ECB President Lagarde, the ECB’s Rehn, Panetta, Holzmann, de Cos and Lane, BoJ Governor Kuroda, Fed Vice Chair Brainard and the BoE’s Tenreyro. Otherwise, data releases from the US include preliminary April data on durable goods orders and core capital goods orders.

Tyler Durden Wed, 05/25/2022 - 08:00

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Economics

Is The Recent Rise In US Interest Rates Peaking?

After months of higher Treasury yields, the possibility that rates have peaked is a topical discussion, fueled by easing rates in recent days. Although…

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After months of higher Treasury yields, the possibility that rates have peaked is a topical discussion, fueled by easing rates in recent days. Although there are still three trading days to go this week, the widely followed 2- and 10-year Treasury yields look set to post their first run of three-weekly declines this year.

The modest drop in yields may be a temporary lull before the upswing resumes, although analysts are considering factors that may put a ceiling on further increases for the near term.

Perhaps the main catalyst that’s changing sentiment for bonds: an expanding wave of forecasts that US recession risk is rising. “The bond market is clearly putting a greater focus on the risk of a recession and less of a concern on sustained inflation,” says Mark Freeman, chief investment officer at Socorro Asset Management.

Bloomberg notes that US economic data has recently weakened overall, relative to expectations. The change has cut the Bloomberg US Economic Surprise Index to its lowest level since last September.

The Treasury market appears to be entertaining the possibility, iif only on the margins, that growth will stumble. The 10-year Treasury yield fell to 2.76% on Tuesday (May 24), the lowest in over a month. If the benchmark rate holds below last week’s close, it’ll mark the first time since November that the yield has slipped for three straight weeks.

A critical factor, of course, is how long the Federal Reserve raises interest rates. For a clue, let’s start with the policy-sensitive 2-year Treasury yield, which is also showing hints of rolling over (or at least temporarily topping out).

Fed funds futures are still estimating a high probability that the central bank will lift rates again at the June 15 FOMC meeting. The market is currently pricing in a 90%-plus probability for a 50-basis-point hike to a 0.75%-to-1.0% target rate.

But the outlook for additional rate hikes has turned cloudy. Futures are now forecasting a high probability (90%) of no change in rates for the July FOMC meeting.

Inflation’s future path will likely determine what the Fed does beyond the June meeting, which appears to be a done-deal in terms of a 50-basis-point hike. The Treasury market is effectively pricing in next month’s hike, but for now it’s a wait-and-see environment beyond June.

One reason is that there are several hints that the recent surge in US inflation has peaked. Even if true, that doesn’t mean that inflation will return to the low pre-pandemic levels soon. But if inflation data shows more signs of topping out, as it did in April, the Fed may be more inclined to put its rate-hiking plans on hold, at least temporarily. Market sentiment seems to be adjusting to this possibility.

The key debate ultimately centers on US economic strength and on this front there are mixed signals. On the one hand, it appears that output is set to rebound in the second quarter following the contraction in Q1. For example, the Atlanta Fed’s GDPNow model estimates Q2 growth will revive to a moderate 2.4% increase (seasonally adjusted annual rate) from a 1.4% slide previously.

Meanwhile, the New York Fed’s Weekly Economic Index continues to reflect slowing but still moderately positive growth through May 14. The implication: the easing in the US economic trend will take the edge off of inflation in the months ahead.

That’s also the implied message in yesterday’s PMI survey data for this month. “The early survey data for May indicate that the recent economic growth spurt has lost further momentum,” says Chris Williamson, chief business economist at S&P Global Market Intelligence. “Growth has slowed since peaking in March, most notably in the service sector, as pent up demand following the reopening of the economy after the Omicron wave shows signs of waning.”

The critical question is whether the hints of softer growth momentum will continue and translate to a further pullback in inflation from its recent peak – almost surely a necessary event to stay the Fed’s hand in raising rates beyond June.

Key updates to watch start with May inflation numbers, which arrive in a few weeks. The strength (or lack thereof) of the labor market will be closely read too. Next week’s update on nonfarm payrolls is expected to show that hiring slowed in May to a 340,000 monthly increase from 406,000 in April, based on the consensus forecast via TradingEconomics.com. That’s still a relatively solid gain to keep the economy moving forward, but it’s also enough of a slowdown to support the inflation-has-peaked narrative.

For the moment, the bond market’s on board with this view. The question is whether incoming data will give the crowd a reason to abandon this developing narrative?


How is recession risk evolving? Monitor the outlook with a subscription to:
The US Business Cycle Risk Report


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