WEEKLY: Fed, BoE raise rates; US equities / bonds take it on the chin
Week ended Nov 4th, 2022
Most investors were focused on the rate increases delivered by the Federal Reserve and Bank of England this week. Both central banks did as expected, serving up 75bps increases in their overnight bank borrowing rates. Both central bank heads – Jerome Powell and Andrew Bailey – followed their bank’s release of policy statements with press conferences to provide more colour about the trajectory of monetary policy in their country. The comments from each central bank head laid bare the divergence in future monetary policy in the U.S. and the U.K.
The Fed is unwavering in its commitment to rein in inflation, and Mr Powell said as much to the press following the release of the FOMC decision, squashing a relief rally right in its tracks and smacking investors squarely in the face. BoE Governor Andrew Baily has less room to manoeuvre as the U.K. economy slows, and was therefore more neutral in his comments, suggesting in fact that investors are pricing in too high of a terminal rate. The BoE is also likely to get help from the U.K. government in its fight again inflation. Just a few weeks ago, former PM Liz Truss’s government was about to open the financial stimulus spigot, but new PM Rishi Sunak is going in the opposite direction as he tries to restore confidence in U.K. financial markets. There is almost certainly a series of fiscal austerity measures coming that will involve tax increases and spending cuts, with the Conservative leadership already floating trail balloons in the press. Any way you slice it, the U.K. is in a heap of trouble economically.
The Fed has more room to carry on with its hawkish approach Stateside, with economic signals indicating little evidence of a slowing economy, even though the Fed has raised the Fed Funds rate 350bps since March and is carrying on with its QT programme. The jobs report on Friday did the Fed no favours, with nonfarm payrolls surging substantially more than expected, illustrating the resiliency of the U.S. economy but also the futile fight so far to tame 8%+ (CPI) inflation. The next fly-in-the-ointment is the mid-term elections in the U.S., but even in this respect, it seems likely (and is probably priced in) that the Democrats will lose the House and possibly the Senate. Should this occur as expected, Mr. Biden’s expansionary (but not unreasonable) series of assistance and related fiscal programmes will come to a screeching halt.
Having the world’s major reserve currency and the largest and most and liquid government bond market (i.e. US Treasuries) certainly has benefits, providing the U.S. with the unique ability to stray where no other country can in terms of its fiscal and monetary policy prudence. Even so, the fight against inflation is proving hard work as it is increasingly clear that the Fed – and most other central banks – started their battles against inflation too late. Inflationary economies will face tremendous challenges and difficult decisions in the coming quarters. They are likely to experience plenty of damage in terms of slower economic growth and rising unemployment, and this in turn will increase volatility of financial assets and further push investors towards a “risk off” attitude.
There are plenty of links in the section “What Mattered this Week” should you like to dig deeper into this week’s news that mattered, including the decisions by the Fed and BoE.
MARKETS THIS WEEK
Global equities did well this week with the exception of the U.S., which was jerked all over the place by volatile earnings reports and the ongoing schizophrenic view of investors about the Fed’s likely glide path. Chinese equities were up 5.3% WoW, the best performer of the week, as rumours circulated that the government might move away from its economically-disastrous “Zero COVID” policy. How quickly things can change, as it was only a couple of weeks ago that Chinese equities tanked as President Xi tightened his grip on power. The FTSE 100 also powered forward, delivering a sold gain on the week (+4.1%). I suspect this is more attributable to the composition of the index – heavy in energy and commodities companies – than the mantra “bad news –> good markets”. Naturally, energy and commodities companies would be beneficiaries of China taking steps to push its economy forward faster.
US equities were poor this week and were also highly variable, swinging intraday between solid gains and sizeable losses. Even so, October was a great month for the DJIA, which rose 14%, its best month apparently in 45 years. It is interesting to contrast the performance of this more concentrated and less-tech reliant index with the NASDAQ, the worst performing US index for October, which was down 1.4% for the month. November has continued this trend – “big is better” and “tech is rubbish” – as the DJI was the best of the worst in the U.S. this week, although it closed down 1.4%. You can find the #Refinitiv earnings summary for the week ended November 4 here.
Away from U.S. equities, US Treasuries also got clobbered (again) as yields headed higher. October was another poor month as far as returns for USTs, adding further misery to the portfolios of bond investors. YtD total returns in the 7-10 year ICE UST bond index and the 20+ year ICE bond index are –17.5% and –35.1%, respectively. Ouch!
UST yields rose across the entire maturity complex, reflecting a combination of ongoing economic strength and concerns about raging inflation. The 2y-10y yield differential in the UST market reached (negative) levels not seen since the early 1980s, suggesting that investor conviction is increasing that the U.S. will eventually fall into a recession.
Turning to corporate credit, yields were higher across the credit spectrum in sympathy with higher UST yields, whilst credit spreads also widened in high yield. Gold had one of its best weeks this year (+2.3% WoW), and oil prices also increased (+5.3% WoW). The US Dollar was flattish on the week but volatile, falling sharply on Friday after strengthening the day before – the greenback reached $113.15/USDX 1.00 (intraday) on Thursday but closed the week at $110.79/USDX.
WHAT MATTERED THIS WEEK
Bank of England raises rates and starts quantitative tightening
Bank of England successfully auctioned £750m of short-dated Gilts on Thursday, beginning its previously-announced quantitative tightening programme on schedule and without event. Unlike the Fed, which is letting maturing bonds (USTs and MBS collectively) roll off at a clip of $95 billion/month, the BoE held an outright auction focused on shorter maturities. For context, the BoE balance sheet appears to be around £1.1 trillion. The yield on the 2y Gilt ended the week at 3.06%, 20 bps tighter than the week before and a whopping 86bps tighter than just one month ago. Needless to say, the beginning of QT looked like it went well.
The Bank of England also jacked up its overnight borrowing rate by 75bps on Thursday to 3.0%, its highest level since November 2008. You can read the Monetary Policy statement from the Bank of England here. As has been customary, the BoE tends to be most forthright on the challenges ahead, which are severe in the U.K. The BoE is projecting inflation to near 11% in 4Q2022 and believes that the U.K. economy will contract 0.75% in 2H2022. Unemployment could increase to 6.4% by 2025 (from 3.5% currently). Unlike Mr Powell, Governor Andrew Bailey provided more hope to investors by suggesting that the market had priced in an overly aggressive terminal rate, sending UK bonds and equities higher. The most important milestone now as far as the U.K. is the autumn budget to be delivered by Chancellor of the Exchequer Jeremy Hunt on November 17th.
Fed raises rates, remains committed to fighting inflation
The FOMC did exactly as expected on Wednesday, increasing the Fed Funds rate by 75bps to 3.75% – 4.00%, and continuing with its current QT programme totalling $95bln/month. Initially, investors read the following comment in the FOMC statement (here) as the Fed would potentially slow down its tightening sooner than expected:
“The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals. The Committee's assessments will take into account a wide range of information, including readings on public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments.”
However, in the press conference following the release of the FOMC statement, Chairman Jerome Powell poured cold water on this assessment, reminding investors that bringing down inflation was the sole objective at the moment, even if it leads to slower economic growth and higher unemployment. Rarely have I seen sentiment change so quickly, as both stocks and bonds reversed course and moved into the red. You can watch Mr Powell’s press conference on YouTube here.
The US employment report was released on Friday morning before the New York open, with significantly more jobs being added than economists has expected. Unemployment edged up to 3.7%. The BLS Employment Situation Summary for October is here. The underlying data was somewhat mixed, but generally was supportive of the Fed’s continuing focus on quelling inflation. US equities first rose strongly on the news, then fell mid-day before clawing back some of the losses and ending up 1.4% on the day. It was another wild ride!
Eurozone 3Q22 growth and October flash CPI
EU/Eurozone GDP was up a scant 0.2% in 3Q2022 QoQ (+2.1% vs 3Q21). The #Eurostat release regarding 3Q22 GDP is here. Eurozone CPI flash estimate for October increased to a record 10.7% in the Eurozone (Eurostat press release here). It feels increasingly to me like we have a case of old-fashioned stagflation brewing in the Eurozone!
Below are some of the key data releases and other financial events that matter for the weeks ahead.
S&P 500 earnings – 423 S&P 500 companies have reported earnings this cycle. Another 31 companies will report earnings this coming week, including LYFT, CG, DIS, ATVI, RIVN, NIO, RL, RBLX and AZN.
Mid-term elections will be this Tuesday, Nov 8th, with 35 Senate seats (of 100), all 435 House of Representatives seats and 36 governorships up for grabs. It appears that Republicans will (re)take control of the House whilst the Senate is a toss-up, according to polling company #FiveThirtyEight.
As far as economic data, the focus this week will be on US CPI for October, which will be released on Thursday, and GDP in the U.K. for September and the 3Q22, which will be released on Friday.
Upcoming central bank meetings:
Federal Reserve – Dec 13th-14th
Bank of England – Dec 15th
ECB – Dec 15th
Bank of Japan – Dec 19th-20th
Corporate bonds (credit)
Safe haven and other assets