Week Ended Sept 30th, 2022
“Rescue financing” in the UK
[SKIP THE COMMENTARY AND GO STRAIGHT TO THE TABLES]
Another ugly week to end another ugly month, bringing us to the end of the third consecutive down quarter for global equities. Everywhere you turn there was red this week. If you’re bothered by declining stock prices, rest assured that bonds offer no less misery. The UST 20+ year total-return bond index was down 8.0% in September and is down 29.8% YtD, exceeding the YtD loss on the S&P 500 which is “only” down 24.8% YtD. Depressed yet? If not, let me add to your misery. This was the eighth consecutive weekly loss for the S&P 500, which has now fallen below its earlier YtD low on June 16th. Since the benchmark US index reached its post-June high of 4,305 on August 16th, it has declined 720 points (–16.7%) to 3,586 in only seven weeks. Global equity markets outside of the US have offered no relief either. Government bond prices have been hammered in the UK and the Eurozone, just as in the US, as inflation remains stubbornly high in those economies. Perhaps more frightening to me is that corporate credit markets have started to notice, with investment grade and high yield spreads and yields widening sharply this past week. I suppose if there was one saving grace it is that the US Dollar finally showed that it might have peaked with the Dollar slightly weaker, although it didn’t help the Yen which has returned now to government-intervention lows. So much for any sort of government or central bank intervention having lasting effects, a thought that should be kept in mind since the Bank of England has turned its sights on shoring up the long-dated UK government bond market (Gilts), which I will discuss further below.
If that commentary didn’t wind you up enough, take a look at the summary table below if you can bear it.
SUMMARY OF KEY DRIVERS FOR THE WEEK Certainly you have heard about the travails of the U.K. this past week, starting with
Ongoing and accelerating declines in Sterling and UK government bonds (Gilts) continuing early into the week,
U.K. pension funds long duration on margin (or equivalent) getting caught out by the sharp increase in Gilt yields, and
The Bank of England ultimately coming to the rescue to sort out a potential mess amongst UK pension funds by agreeing to buy long-dated UK government bonds for at least 13 consecutive business days (through October 14) to settle markets.
The BoE also said that it was focused on getting inflation back to 2% and would defer the start of its quantitative tightening programme for one month, adding that it remains fully committed to QT. You can read the short press release from the BoE from Wednesday here.
Central banks are doing their job when they step-in on the rare occasions when markets become so disorderly that they can lock-up, and this is well understood as one of the key roles of central banks. However, this particular crisis feels self-inflicted to me in that the sell-off in Sterling and Gilts, already underway, was sharply accelerated by an ill-advised and poorly timed announcement of a series of fiscal stimulus measures by Chancellor of the Exchequer Kwasi Kwarteng last Friday. If you are interested, the BBC ran a concise summary of the major provisions of this circa £160 billion plan which you can find here. Naturally, this package of stimulus measures would translate into significantly more borrowing by the UK treasury, with the not-unexpected effect of Gilts selling off sharply (meaning skyrocketing yields) – and Sterling tanking – which continued until the BoE announced its temporary purchase programme focused on long term Gilts on Wednesday. To get a sense of the magnitude of yield increases, the 10-year UK government bond yield fell to an intraday low of 3.19% on September 22 before soaring to an intraday high yield of 4.61% on September 28, a span of only four trading days.
As I said in last week’s update, I find the lack of coordination between the government of new Prime Minister Liz Truss and the Bank of England most bizarre, and I can easily see how this mini-budget unnerved investors. It is ironic that the Bank of England – probably through no choice of its own – has bought the Conservative government undeserved time by stepping in to avoid what could have been a catastrophic meltdown. This looks to be a real mess, and I suspect the BoE rescue will do little to soothe investors once the support falls away in a couple of weeks. Rather, the only long-term cure would involve revising or pulling the so-called mini-budget all together. Failing this, I see Gilts resuming their sell-off and Sterling weakening further, although the BoE actions did stabilise both markets this week.
I like and believe in the concept generally of trickle-down economics, perhaps an acquired taste from President Reagan in the 1980s, but I am strongly against the unleashing of a package of broad and likely inflationary fiscal stimulus measures in this context, especially since much of it is not targeted at those most in need. This is simply the wrong place and the wrong time, and the plan cooked up by Mr Kwarteng and his merry men is nothing short of shambolic.
That aside, the settling of the UK financial markets had stabilising effects on global risk markets, at least for one day. The BoE stepping in was a reminder that a central bank put does exist if markets get sufficiently disorderly. Atlanta Fed President Bostic amongst other Fed officials was the first to throw water on this concept though, reminding investors that the Fed remains fully committed towards its objective of tamping down inflation in the States by tightening monetary policy regardless of what is going on in the UK. Nonetheless, global markets seemed buoyed on Wednesday by the BoE action, a reminder that central banks do have the firepower to manipulate markets should intervention be required. This was perhaps enough to create hope and push equities higher mid-week, although a confluence of other US-centric economic news – all suggesting signs of stagflation – removed any feel-good from markets rather abruptly on Thursday, one day later. US data did not help – PCE showed inflation remains stubbornly high, even as economic indicators like existing-home sales show that the US economy is slowing and early signs of upcoming earnings were not good (more below).
Market sentiment can turn on a dime when it wants, and it generally does when least expected. I am not at all convinced we are out of the woods, but the trade favouring lower bond and equity prices is starting to get very crowded as everyone heads in the same direction, and the smallest glimmer of hope might cause markets to reverse-face and rally, even if only temporarily. My fear in the coming weeks though is mainly around 3Q22 earnings, beginning mid-October, as the early signs are far from encouraging. A poor round of earnings could easily drive the S&P 500 down to the 3,200 – 3,400 range before support were to emerge. So much for the pandemic euphoria in risk markets, as the excessive bubbles continue to deflate across many asset classes.
OTHER ECONOMIC AND GEOPOLITICAL NEWS THAT MATTERED THIS WEEK
Eurozone flash inflation comes in hot
Eurozone flash estimated inflation for September was 10.0% YoY, a sharp increase from the 9.1% YoY for August – Eurostat press release here
PCE – the Fed’s favourite inflation target – also comes in hot
Personal Consumption Expenditures (PCE), the most-watched inflation indicator by the Fed, rose 0.3% MoM in August (vs a decline of 0.1% in July MoM). Perhaps more concerning is that core PCE (excluding energy and food) rose 0.6% in August (vs flat in July). The data was released by the Bureau of Economic Analysis on Friday – press release with more detail is here.
US existing home sales head south
The National Associate of Realtors reported that existing home sales fell 0.4% in August versus July and were down 19.9% YoY. This is not surprising given the sharp increase in mortgage rates in the US and the bubble-like price increases experienced in housing during the pandemic. You can find the NAR press release here.
Apple warns, Nike suffers from inventory issues
As a potential harbinger of what may lie ahead as far as earnings, Apple said that it was reducing the production of iPhone 14s because demand did not appear sufficiently strong. Nike also delivered mixed 2Q22 earnings, beating top-line consensus estimates but highlighting some unfavourable trends for the quarters ahead. The company missed bottom-line earnings due to lower gross margins as higher (and perhaps “wrong”) inventory levels forced markdowns AAPL’s shares were down 8.1% WoW, whilst NKE’s shares plummeted 14.3% WoW, most of this coming Friday post-announcement of earnings.
Below are some of the key data releases and other financial events that matter for the weeks ahead.
S&P 500 earnings – most initial focus to be on banks which begin reporting 3Q22 earnings on Friday, Oct 14th(JPM, MS, WFS, CITI) (BoA on Oct 17th and GS on Oct 18th)
Upcoming central bank meetings (and last one of year):
ECB – Oct 27th (next and Dec 15th)
Federal Reserve – Nov 1-2 (next Dec 13-14)
Bank of England – Nov 3rd (next Dec 15th)
Bank of Japan – Oct 27-28 (next Dec 19-20)
Corporate bonds (credit)
Safe haven and other assets
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