The world is changing, markets are not
“We are in this for as long as it takes to get inflation down.” – Vice Chair of Fed Lael Brainard, speech at the Clearing House and Bank Policy Institute 2022 Annual Conference, New York, New York on Sept 7, 2022 (here)
QUEEN ELIZABETH II
It would be entirely inappropriate for me not to break protocol this once and start with something that has nothing to do with financial markets or the global economy. Genuine sadness was felt around the world on Thursday evening when the death of the UK’s beloved Sovereign, Her Majesty Queen Elizabeth II, was announced. People have different views on the UK monarchy, to which everyone is entitled, but there is little disagreement that the Queen was a very special woman, not only for Brits and members of the Commonwealth Realm, but for nearly everyone she has touched in one way or another during her amazing 70+ year reign. Personally, I was awestruck by her grace, dignity, kindness and service, in spite of overseeing the world transform before her eyes over her long reign, neither in a straight line nor in an always positive direction. However, she never wavered in her warmth or in her conviction to her duties, in spite of these distractions. King Charles III has very big shoes to fill in this respect, far from an easy task when you are taking the crown from a leader as beloved as his dear mother, HM Queen Elizabeth II. May Queen Elizabeth rest in peace, and may King Charles III be as worthy as a Head of State as his mother, Queen Elizabeth, who will be badly missed for all the right reasons.
It felt like an abbreviated and lacklustre week, with markets closed on Monday in the US due to the Labor Day holiday and the week ending on a rather dour tone because of the death of the much-admired Queen Elizabeth. In spite of these anomalies, equities rediscovered their footing and showed solid gains across the board for the first time in four weeks in both the US and Europe. Friday was an especially strong day as the holiday-shortened week ended on a positive tone. Perhaps this sudden turn in sentiment is attributable to growing belief that the worst is behind us and that all bad information is factored into prices. I am sure you’ve heard this argument before, but it’s not something I buy into. More likely, the solid week was just a temporary reprieve because some trades were becoming increasingly crowded, including short equities and long the US Dollar (especially the latter).
Overshadowed by the death of the Queen, I would be remiss not to also remind readers that a new Prime Minister – Liz Truss – took charge in the United Kingdom earlier in the week. I have difficulty looking at the photo of Queen Elizabeth and Liz Truss, as the Queen was inviting Ms Truss to form a government and become the 15th Prime Minister under her reign, just 48 hours or so before her death.
Returning to markets, the gains in risk assets this week occurred even though there were an ongoing series of reminders that the direction of travel of monetary policy is one way without a sliver of hope of a pivot until inflation is tamed. This could take many quarters and will inevitably lead to slower global growth, led by the US, the UK and Europe. In the US, both Fed Vice Chairman Brainard and Fed Chairman Powell reiterated the Fed’s sole focus on taming inflation during separate speaking engagements, whilst the ECB decided on a jumbo 75bps increase in its three overnight bank rates (from 0% to 0.75%) on Thursday. President Lagarde’s press conference following the ECB monetary policy decision was dire, as she acknowledged the challenges facing the Eurozone in the quarters ahead.
As risk came back into the market, investors sold US Treasuries, pushing yields higher across the curve and leading to a (negative / inverted) steepening in the 2y-10y yield difference. Improving risk sentiment also encouraged investors to move back into corporate bonds, with credit spreads reversing direction and tightening for the first week in several. USD and EUR high yield spreads were about 25bps tighter on the week. Naturally, the euphoria spread into the speculative cryptocurrency market, as Bitcoin came off sub $19,000 closes mid-week to end Friday at $21,250, a solid 6.4% gain W-o-W. The price of gold rose slightly, and the price of WTI crude fell slightly, in spite of OPEC+ announcing earlier in the week that it would curtail supply.
At the beginning of the week, the crescendo of discussion in the media around the strong US Dollar was increasing, pushing the USD briefly across the US$1.10/USDX1.00 level, stronger than in decades. Even the jumbo rate rise from the ECB did little to halt the appreciating greenback (against the Euro). The Yen is getting clobbered, the Pound is bouncing around $1.15/£1.00, and the Euro is working hard to hang around parity. The US Dollar is acting largely as a shock absorber for some of the imbalances in the global economy and is the ultimate safe-haven currency. However, at this inflated level, the strong greenback is neither positive for the global economy nor for the US. Nonetheless, long the Dollar has become a crowded trade. As risk sentiment improved during the week, the US Dollar backed off its historic highs and ended slightly lower for the week. As one-sided as sentiment is at the moment regarding the US Dollar, I can’t see this lasting forever.
This bounce in equities and other risk assets at the end of the week was certainly most welcomed as it provided relief to investors after a few difficult weeks. The reality though is that nothing has changed as far as the context, the news, or the challenges ahead. I appreciate the argument that perhaps risk assets now more accurately reflect the reality of central bank tightening, but I am far from convinced that equities and other risk assets (and I am including real estate in this) are accurately reflecting the significant increases in yields that are lie ahead of us. Any way you slice it, higher yields are not good for stocks, and they are not good for corporate credit. We are only weeks away from 3Q2022 earnings, and with (equity) valuation multiples still relatively inflated, I see more potential downside in stocks should investors’ expectations of earnings be misaligned with reality. Disruptions caused by Ukraine-Russia conflict and the slowing Chinese economy will both also continue to dampen global growth and weigh heavy on risk assets. Can someone please show me the upside here?
Below is a summary of markets this week and YtD with the full tables at the end of the weekly (here).
ECONOMIC AND GEOPOLITICAL NEWS THAT MATTERED THIS WEEK
ECB goes big
The ECB raised its overnight bank rates by 75bps on Thursday to combat rising inflation made worse by the escalating prices of natural gas. As I have written on several occasions in the past, the task the ECB has before it makes the Fed’s job look like a walk in the park, because the room for manoeuvrability is scant. You can find the ECB’s monetary policy decision press release here. The prepared remarks from Ms Lagarde, President of the ECB, and Mr Guindos, Vice President of the ECB, are here.
Liz Truss named new Prime Minister of the UK
Liz Truss was named by Conservative Party members as the new Prime Minister of the U.K., replacing Boris Johnson. For those readers not familiar with the mechanics of the British government, you should know that Ms Truss was notelected (to be PM) by the population of the U.K., and she was not even elected by Members of Parliament (MPs) from her Conservative party. Rather, she was elected by registered Conservative party members of the U.K., which number around 172,000, in a country of 67 million people, by a 57.4% majority over former Chancellor of the Exchequer Rishi Sunak. I have doubts about some of the promises Ms Truss made on her way to get elected, but I will stop here because time will tell. For reference, the next general election in the U.K. is scheduled for January, 2025, although as we have seen in the past 10-12 years, snap elections can occur sooner if circumstances dictate. Should you want to get the one minute lowdown on exactly who Ms Truss is, check out “Liz Truss: A Quick Guide to the UK’s New Prime Minister” on the BBC here.
OPEC+ announces supply reductions; Russia halts Nord Stream 1
OPEC+ is cutting supply in an attempt to bolster sagging oil prices, and Russia has cut off natural gas shipments to Europe by shutting the Nord Stream I pipeline indefinitely. Gas prices soared following news of the latter, perhaps not unexpected given what is essentially a proxy war being waged in Ukraine between Russia and much of the west, which is supporting Ukraine. I consider the reduction in supply by OPEC+ of 100m bbl/day a measure that might stabilise prices in the short run, but it is amazing how little OPEC+ has learnt over the years about the more influential demand side of the equation as far as determining oil prices. As the global economy slows, I suspect that oil prices will inevitably remain under severe pressure no matter what OPEC+ does. WTI crude prices were down 0.9% this week in spite of OPEC+ pledging to reduce production. You can find the decision from the OPEC+ meeting from Monday on the OPEC website here.
Vice Chair Brainard and Chair Powell follow the script
In separate addresses in public, MS Brainard and Mr Powell toed the line as far as presenting an unwavering picture of Fed tightening. This also almost certainly ensures that the Fed Funds rate will be increased 75bps at the next FOMC meeting in two weeks. You can find Ms Brainard’s comments to the Clearing House and Bank Policy Institute 2022 Annual Conference in New York on Wednesday here (from Fed website). You can find Mr Powell’s video Q&A session to the Cato Institute’s Monetary Policy forum on Thursday here (CNBC, approximately 50 minutes).
Here are some of the key data and dates on which to focus.
CPI for August will be released on Tuesday for the US and on Wednesday for the UK. US retail sales for August will be released on Thursday, and the Michigan Consumer Sentiment Index on Friday. UK retail sales for August will also be released Friday. There is also some economic data coming from China in the second half of the week.
Queen Elizabeth’s funeral will be at Westminster Abbey on Monday, September 19th, which King Charles has announced will be a Bank Holiday (and markets will be closed in the UK).
Upcoming central bank meetings (current bank rate and expected increase at policy meeting is in brackets):
Federal Reserve – September 20th-21st (2.25%-2.50% now, consensus +0.50% – 0.75%)
Bank of England – September 22nd, deferred for one week due to Queen’s death (1.75% now, consensus +0.50%)
Corporate bonds (credit)
Safe haven and other assets