Week ended June 17, 2022
CASH IS KING, EVERYTHING ELSE SUCKED
SUMMARY OF MARKETS
There’s no other way to describe this past week in markets except “horrific”, and that applied across nearly all asset classes as a “risk-off” sentiment gained momentum throughout the week. Friday was perhaps the best of the worst, but even then the traditional US indices barely kept their heads above water. The Shanghai index is the only index I track that eked out a modest 1% gain on the week, whilst the S&P 500, the FTSE 100, and the STOXX 600 turned in losses of 5.4%, 4.1% and 6.7%, respectively. Cryptos got hammered, credit spreads widened, and UST yields soared. Could you have ever imagined at the beginning of this year that by mid-June the total return on the 20y UST index (-23.8% YtD) would be worse than the return on the S&P 500 (-22.6% YtD)? Any way you slice it, this was another fitting week of a very ugly year so far in financial markets.
Why is this happening? Some investors and pundits might lay the accelerating “risk off” sentiment at the feet of central banks, in some respects quite rightly because all of them have been slow to acknowledge and begin their tightening policies to address inflation. And whilst they were navel-gazing, inflation became increasingly entrenched in spite of most central banks insisting that inflation would subside on its own as the pandemic wound down. Some of my followers might bite my head off for this, but I do have a touch of sympathy for central bankers because a rather material portion of global inflation is supply-driven at the moment, not demand-driven. However, this assertion will fall on deaf ears to most people that are in high inflation zones because the central banks were still slow to act, which has put them all in the hot seat. It is becoming increasingly clear that central banks cannot rein in inflation without adverse effects on the economy. Of course, inflation also splatters political leaders in high inflation countries, none of whom is probably facing more scrutiny at the moment than US President Joe Biden.
Speaking of central banks, all of the major banks raised interest rates this week and tightened monetary policy further except – of course – the Bank of Japan. Even the Swiss National Bank surprised investors by unexpectedly raising its overnight bank rate by 50bps (although it is still at -0.25%). The devil is of course in the detail, and what mattered most is the commentary about the trajectory of future tightening measures, meaning what mechanisms, how soon, and how much? The Federal Reserve revised its economic projections down, but the revisions were so modest given what lies ahead that I think they are in la-la land. The BoE, which had already acknowledged the poor state of the UK economy (e.g. negative economic growth, inflation as high as 11%, etc.), reminded investors that its one and only focus is on bringing down inflation even if it comes at a severe economic cost. The ECB has the additional concern of fragmentation and gave the hollowest statement I could imagine early in the week, void of anything useful as to how the central bank intends to keep peripheral yields from gapping out further. Ladies and gentlemen – that’s the state of play!
Last week, I provided my views on various asset classes given the turmoil going on at the moment. If you want to review these, go back to the update for the week ended June 10, 2022 here. I stand by most of these but want to note one thing. I said the 10y UST yield would not go above 3.25% because tightening by the Fed would put a ceiling on bond yields as the US economy slowed. That took exactly one day to be wrong, with the 10y UST yield soaring above 3.50% by mid-week. Funny enough though, we find the 10y yield back at 3.25% as the week ended, so my assertion that a slowing US economy (or expectations thereof) might cap yields could still be the case, although the 3.25% cap looks a bit unlikely now I admit.
ECONOMIC AND GEOPOLITICAL NEWS THAT MATTERED THIS WEEK
Fed, BoE, ECB in the hotseat
The script as far as major central banks went about as expected this week.
The Federal Reserve raised the Federal Funds rate 75bps and has started its programme of reducing its balance sheet – the FOMC statement is here. The 75bps increase was the largest increment since 1994. More on the Fed below.
The Bank of England raised the Overnight Bank Borrowing rate for the fifth time since December, to 1.25% - see Monetary Policy summary and minutes from the June 15th Monetary Policy Committee meeting here. It’s not pleasant reading.
The ECB provided a cryptic response on fragmentation in the Eurozone, referring to the widening of spreads for peripheral sovereigns. See statement here following the meeting of the Governing Council.
·The Bank of Japan held its Monetary Policy meetings on Thursday and Friday. You might be surprised to learn (sarcasm) that the BoJ is standing firm, one of the few dovish central banks in the world at the moment. You can find the BoJ Statement of Monetary Policy here.
The Federal Reserve as usual also revised its economic projections which you can find here. As much as I want to say the Fed is being upfront with Americans, I believe they have lost their marbles as far as mapping out the gradual decline in inflation at very little economic cost. I think the US economy might not make it to the end of 2022 without contracting. However, for the sake of argument let’s look at 2023 when a recession is much more likely. The Fed’s median forecast for real GDP growth for 2023 is 1.7% and year-end unemployment of 3.9%, meaning that a recession is not projected (and is in fact not even close). If that turns out to be the extent of the cost of taming the highest inflation in 40 years, we should be dancing in the streets. I can’t see that being the case – I expect worse.
US retail sales
Even before central banks sprung into action the US Census Bureau released rather dire US retail sales for May on Wednesday. You can find that report here. US retail sales declined 0.3% in May (vs gain of 0.7% in April), and this shows just the sort of mixed economic data that the Federal Reserve will be forced to contend with as we move forward.
Monday is a holiday in the US so markets will be closed, perhaps a good thing so US investors can lick their wounds from this past week. My view is that risk assets are gapping down so quickly that there are almost certainly technical factors at play around fund flows and perhaps margin calls. It is clear that valuations are a lot more attractive now than they were at the end of last year. As 2Q22 earnings season approaches (mid-July), the focus is likely to be increasingly on earnings, the denominator of the P/E ratio in other words. Many large bellwether companies have come clean mid-quarter as far as acknowledging that they are experiencing cost / margin issues and / or supply chain disruptions, but many others have not said anything at all. Certainly earnings concerns are hanging over equity and credit markets at the moment. As earnings approach, sentiment in this respect might support current valuation levels or could prove to be highly destabilising. I don’t want to think about the latter!!
Some of the relevant economic data to be released this coming week includes: May CPI for both the UK (Weds) and Japan (Fri); UK retail sales figures for May (Fri); consumer confidence / sentiment indicators for the Eurozone (Weds) and US (Fri); and various manufacturing and services data / PMI from the Eurozone and US. In between, you can be assured that various representatives from the Fed, the BoE and the ECB will be babbling on, moving markets on their every word, or interpretation thereof.
Corporate bonds (credit)
Safe haven and other assets
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