Fed Pause Before European Peers to Lift Treasuries, European Stocks

Summary:

Traders see Fed pausing rate hikes before European peers. US Treasuries outperform, set to win from Fed pause, cuts.

As markets bet banking turmoil will prompt the Federal Reserve to pause rate hikes before Europe, U.S. bonds and European equities are tipped to win from the recent ructions.

The Fed delivered a small 25 basis-point (bps) rate hike on Wednesday and hinted rises may end soon, with Chairman Jerome Powell admitting the central bank needs to consider how much the turmoil has tightened financial conditions.

But European peers powered ahead on Thursday. Britain and Norway hiked rates by 25 bps each, the Swiss National Bank jacked up rates by 50 bps. Norway and Switzerland signalled more increases ahead.

The Swiss move in particular highlighted that European central bankers were more sanguine about banking fears than the Fed, coming on the heels of Credit Suisse's rescue by UBS that rocked financial markets.

The SNB pushed on, saying the takeover "put a halt to the crisis". The European Central Bank hiked rates by 50 bps a week ago.

"The Fed's dovishness shows the regional bank issue is still ongoing and will have a far bigger impact on credit conditions there than in the UK or Europe," said Investec's head of UK equity strategy Roger Lee.

Indeed, many investors take the view that Credit Suisse's woes are idiosyncratic and European banks are better regulated. They also expect smaller lenders in the United States, at the heart of the banking turmoil, will have a bigger impact on the U.S. economy, raising recession risks in the world's largest economy.

So, while traders' price in a swift end to Fed hikes, seeing just under a 50% chance of a 25 bps move in May, followed by rate cuts, further tightening is anticipated in Europe.

ECB rates are seen peaking near 3.5% this year, from 3% before the ECB's policy meeting last week.

The Bank of England, battling double digit inflation, is expected to raise rates by another 25 bps by June.

The outlook is highly uncertain. BoE chief Andrew Bailey said he did not know if Thursday's hike was the last one, ECB boss Christine Lagarde has said market turmoil may do some of the ECB's tightening for it if it dampens demand and inflation.

Winners

Bets that U.S. rate cuts will come well before an easing in Europe left investors upbeat on U.S. government bonds.

Two-year Treasury yields have slid 92 bps this month, versus 60 bps in Germany. Yields move inversely with prices.

"The main takeaway is that it's likely the end is near in terms of the Fed hiking, we're seeing more priced in for rate cuts by the end of this year," said Gerard Fitzpatrick, head of fixed income at Russell Investments. "That will be positive for the duration for the (U.S.) bond market"

Fitzpatrick said he was positioned for a steepening of the U.S. yield curve, expecting shorter-dated yields to fall further, while European bonds could come under pressure given sticky inflation.

With banking sector problems expected to be a bigger drag on the U.S. economy, some investors saw U.S. stocks as overvalued.

ClearBridge strategist Jeffrey Schluze said, European banking regulation since the global financial crisis has been more stringent than in the United States, making the outlook for European lenders relatively strong.

Investors are the most overweight European stocks relative to U.S. peers since October 2017, according to a BofA Fund Manager survey that was conducted between the collapse of Silicon Valley Bank and the Credit Suisse turmoil.

While banking stocks have been battered globally, the S&P 500 is up 0.5% this month, while Europe's STOXX 600 index down 3.2%.

"The valuation of the S&P 500 relative to where (Treasury) yields are at the moment is high if there's going to be a recession. Europe is trading about in line with historical averages and the UK looks cheap," Investec's Lee said.

Change In Tone

Before the banking turmoil, markets were driven by one-way moves as high inflation pressured U.S. and European markets.

The U.S. dollar captures the change in tone. Jumping 2.8% against six major peers in February, the dollar index was heading for its longest daily losing streak in 2/12 years on Thursday and has lost 2.7% in March.

Now, currencies of emerging economies where borrowers take out loans in dollars and repay them with domestic currency revenues, are bouncing. The South African rand is up 1.5% against the dollar this week. Mexico's peso has soared 18% after two weeks of heavy losses.

"Before it was about how the U.S. is being more aggressive and the dollar was going up," said Divyang Shah, strategist at Refinitiv's IFR Markets. "What this means for markets is that there will be more cross-market volatility as people play divergence themes again."

Source: Reuters

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FastBull Featured

Daily News

【Quick Facts】

1. BoE raises interest rates for the 11th consecutive time.

2. France broke out a march involving millions of people.

3. The market bets that the Fed has ended the rate hike cycle.

4. The Fed's expansion of the table again shows a different image.

5. Panetta: Continue to assess the combined effect of interest rate hikes and tapering.

【News Details】

1. BoE raises interest rates for the 11th consecutive time.

The BoE voted 7-2 on Thursday to raise interest rates by 25 bps to 4.25%, also the 11th consecutive rate hike, but said an unexpected rebound in inflation could fade quickly, prompting speculation about whether it has ended its rate hike cycle.

The statement showed that the Monetary Policy Committee will continue to closely monitor signs of persistent inflationary pressures, including labor market tightness and wage growth and services inflation. If there is evidence of more persistent pressures, then further tightening of monetary policy will be needed.

Asked about the most recent rate hike, Bank of England Governor Bailey said, "We don't know if this is the peak. What I can tell you is that we've seen signs of inflation really peaking. But of course, it's too high .... We need to see it start to come back down gradually and get back to target."

2. France broke out a march involving millions of people.

French unions plan new protests against pension reforms, calling for new national strikes and protests next week. In total, more than one million people protested across France on Thursday, local time. The march in the French capital Paris, which was held up by violent (law enforcement) actions, was 119,000 strong. Polls show that most French people oppose President Macron's bill to raise the retirement age from 62 to 64, which Macron says is necessary to keep the system running.

3. The market bets that the Fed has ended the rate hike cycle.

Currently, some investors are betting that the Fed's rate hike this week will be its last action to curb inflation, with the bankruptcy of two U.S. regional banks and a bailout agreement for Credit Suisse helping the Fed to complete its mission to tighten the financial environment and put pressure on borrowers. While the market does not rule out the possibility of another 25 bps rate hike in May, for now it seems the most likely scenario for the Fed to leave rates unchanged and then make a series of rate cuts later in the year.

4. The Fed's expansion of the table again shows a different image.

The just-released latest Fed H.4.1 report shows that the Fed's FIMA Repo Facility was used on a $60 billion scale (as of Wednesday's level), with average weekly usage also rising. This is the first time since it was converted to a standing facility used on a large scale.

The FIMA Repo Facility has a per-counterparty limit of $60 billion, and this week's announced usage was exactly $60 billion. It is uncertain whether the $60 billion was borrowed from the Fed by the same central bank.

In addition, the probability of using FIMA is smaller in developed economy countries that have the right to use the Fed's foreign exchange swap, because the interest rate cost paid for the foreign exchange swap is lower.

In short, the $60 billion scale is not a small amount, enough to show that the current dollar liquidity environment is tight, even some monetary authorities / sovereign accounts to the Fed to call the emergency liquidity facilities.

5. Panetta: Continue to assess the combined effect of interest rate hikes and tapering.

ECB Executive Committee member Fabio Panetta said in a speech Wednesday that the global economy has experienced a series of shocks over the past three years - pandemics, supply chain bottlenecks, wars, energy crises, and now banking problems. While the effects of some of these shocks are beginning to recede, it will take time for the volatility of economic activity and prices to level off and form a new equilibrium. In the face of an exceptionally complex economic situation, the combined effects of different policy instruments, the risk of non-linear effects, and the spillover effects of policies in other regions need to be continuously assessed. The combined effect of interest rate hikes and tapering should be continuously assessed.

【Focus of the Day】

UTC+8 15:00 UK Retail Sales (Feb)

UTC+8 17:00 Eurozone Markit Manufacturing PMI Preliminary Value (Mar)

UTC+8 17:15 ECB Governing Council member Nagel to speak

UTC+8 17:30 UK Markit Services PMI Preliminary Value (Mar)

UTC+8 19:00 ECB Governing Council member Centeno to speak

UTC+8 20:30 Canada's Monthly Retail Sales Rate (Jan)

UTC+8 00:00 BoE monetary policy member Mann to speak

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Owen Li

Economic

For the fourth time in a week, U.S. Treasury Secretary Janet Yellen took a microphone on Thursday aiming to reassure Americans that the U.S. banking system is safe, each time with a subtle shift in message.

But bankers and Wall Street never heard what they fervently wanted: That the government would guarantee all $19.2 trillion in U.S. bank deposits until the banking crisis that erupted two weeks ago calms down.

Yellen is the face of the U.S. government on the issue, and her public comments have sent markets on a roller coaster ride.

Becoming more explicit each time she has spoken, Yellen has repeatedly said the U.S. will safeguard deposits but has stopped short of a blanket guarantee, which would insure account balances of any size, including those above the current limit of $250,000.

Her comments on Thursday more clearly indicated than previously that further guarantees for uninsured deposits would come in the form of rescues for depositors of individual failing banks where problems threaten to spark runs on other banks.

She told U.S. lawmakers that bank regulators and the Treasury were prepared to make comprehensive deposit guarantees at other banks as they did at failed Silicon Valley Bank and Signature Bank.

"These are tools we could use again, for an institution of any size, if we judge that its failure would pose a contagion risk," she told a U.S. House of Representatives Appropriations subcommittee hearing.

The comments helped lift broad stock indexes. But regional bank shares including those of struggling First Republic Bank continued to slide.

Yellen on Wednesday told a Senate subcommittee that she was not considering a move to circumvent Congress and grant "blanket insurance" on all U.S. bank deposits.

Congress' Clout

That's a step that the government and regulators took unilaterally in the 2008 global financial crisis, but the Biden administration would now have to get approval from Congress under 2010 reforms.

Hardline Republicans oppose any increase in the current $250,000 Federal Deposit Insurance Corp limit, making it unlikely that Yellen could hastily arrange such a backstop even if the crisis worsens.

Banks and markets have found Yellen's comments unsettling at times. On March 16, she told a told a Senate hearing that banks had to pose a systemic risk to win a deposit guarantee, a comment interpreted as leaving small community banks to fend for themselves.

But at a bank conference on Tuesday, she said that similar actions to the SVB guarantee "could be warranted if smaller institutions suffer deposit runs," reassuring those institutions.

Yellen's reluctance to endorse a universal backstop has drawn criticism from investors including hedge fund manager Bill Ackman. They argue that a universal guarantee is needed to prevent depositors at small and mid-size banks from fleeing for perceived safety at large banks viewed as "too big to fail."

Source: Yahoo

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Alex

Central Bank

Having raised interest rates at the fastest pace on record to tame inflation, the world's top central banks are openly contemplating an early end to their rate hikes, not least because of financial turmoil in recent weeks.

The U.S. Federal Reserve, the European Central Bank and the Bank of England all raised rates as expected in the last week, but each of them signalled caution about their next move, leaving investors unsure where borrowing costs are going.

The Fed indicated it was on the verge of pausing, the ECB said it would no longer provide guidance and instead decide meeting-by-meeting, while the BoE said it expected the surge in inflation to cool faster than previously predicted.

Central banks have already done much of the legwork in raising rates, and inflation is well off its highs, even if there are lingering questions about just how stubborn price growth will prove to be on the way down.

But until the recent bout of financial sector volatility, the expectation had been that both the Fed and the ECB still had some way to go.

That all changed in a matter of a weeks.

Although bank shares have rebounded since the collapse of Silicon Valley Bank and the UBS-led rescue of Credit Suisse, the stress is far from over.

Central banks are concerned that the market ructions could translate into higher funding costs for lenders, which in turn would slow borrowing, thwart credit growth, weigh on economic growth and ultimately dampen inflation.

"The turmoil might lead to some additional tightening of financing conditions not triggered by monetary policy, in which case maybe we have to do less," Dutch central bank chief Klaas Knot told Reuters.

Fed Chair Jerome Powell had a similar warning on Wednesday, noting that more expensive funding had broader ramifications for growth, borrowing and investments.

"Events in the banking system over the past two weeks are likely to result in tighter credit conditions for households and businesses, which would in turn affect economic outcomes," Powell said.

The Bank of England said on Thursday policymakers would "monitor closely any effect on the credit conditions faced by households and businesses" and what that means for the economy.

Interconnected

The interconnected nature of the financial system means that what happens in the United States - particularly Fed policy - has ramifications for everyone.

It was the Fed's rapid rate hikes that created much of the stress on Silicon Valley Bank's balance sheet, souring sentiment towards regional U.S. banks and providing the impetus for the sell-off in Credit Suisse.

"This is the kind of thing economics students discuss in late-night bars, rather than being relevant for markets, but the speed with which the U.S. regional banking crisis spread to a major Swiss bank, and the speed with which global monetary policy expectations adjusted, highlights how joined-up the global financial cycle is," Societe Generale currency strategist Kit Juckes said.

Central banks have also been quick. The Fed raised interest rates by 475 basis points in nine successive meetings, the ECB by 350 basis points over six meetings and the Bank of England by 415 basis points in 11 sessions.

This is lightning-fast by central banking standards and ECB's Knot said policymakers needed to have a deeper look at how it is affecting lenders.

"Interest rate risk in the banking book deserves a more prominent treatment and a more prominent discussion among banking supervisors," Knot argued.

Another issue is inflation. It is now well off its multi-decade highs, and while disinflation is likely to be bumpy, with continued pressure from wages on both sides of the Atlantic, the slope is clearly downwards.

Combined, these factors suggest that big central banks are nearly done, and that upcoming rate moves may be their last.

For the Fed, markets see a 50% probability of just one more hike in May, having priced out an entire increase since the start of the turmoil. At the ECB, investors see only 50 basis points of moves left, less than half of what they predicted just two weeks ago, while just one more 25-basis-point hike by the BoE is priced in for May or June.

"The U.S. economy may see tighter lending standards than what could be explained by macroeconomic fundamentals. If so, our view is that it could indeed substitute for further rate hikes," Michael Gapen at Bank of America said.

Source: Yahoo

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Owen Li

Economic

Asian markets round off the week with Japanese inflation and PMI data likely to be the main local drivers on Friday, offering direction that is unlikely to come from yet another choppy day in U.S. markets on Thursday.

Wall Street rose - although ended up off its highs - but bank stocks slumped to the lowest since 2020; key parts of the U.S. yield curve steepened, but the three month/10-year segment is its flattest and most inverted since 1981; market-based inflation expectations fell, but so did Fed rate expectations.

Japan CPI A Distraction Amid Thickening Global Fog_1

Rates markets are now pricing in around 100 basis points of Fed easing this year, something Fed Chair Jerome Powell said on Wednesday is definitely not the central bank's base case scenario.

The uncertainty is rooted in what impact the banking crisis will have on U.S. credit conditions in the coming months, and by extension on economic activity and inflation. As Powell stated baldly on Wednesday: "We simply don't know."

Treasury Secretary Janet Yellen did know that she had a second chance on Thursday to soothe concerns among investors and the wider public about whether authorities will move towards guaranteeing all bank deposits.

She told a House committee she is prepared to take further actions to ensure bank deposits are safe, a day after telling a Senate committee blanket insurance was not on the agenda. It might not be on a par with Powell's assurances - bank stocks still fell - but perhaps sentiment will improve on Friday.

So Asia opens on Friday to firmer world stocks, lower yields, mix U.S. yield curves, higher global rates after the UK and Swiss hikes - but a growing sense that the world policy peak is in sight - a rising dollar, and a notably stronger yen.

Japan CPI A Distraction Amid Thickening Global Fog_2

Japanese annual core inflation in February is expected to have fallen sharply to 3.1% from a 41-year high of 4.2% the month before, thanks to government subsidies for gas and electricity bills to cushion rising living costs.

But many economists say broader price pressures remain strong throughout the economy, which could force the Bank of Japan to phase out or scrap its yield curve control policy soon.

Here are three key developments that could provide more direction to markets on Friday:

- Japan consumer price inflation (February)

- Japan flash PMIs (March)

- Australia flash PMIs (March)

Source: Reuters

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Justin

Economic

Now that the 20th National Congress of the Chinese Communist Party and Chinese People’s Political Consultative Conference have concluded in Beijing with a lot of fanfare, the necessary decisions to boost the economy have been taken. These include spelling out the government’s economic priorities, plans for reforming the administrative structure and changes to leadership.

This is a welcome confidence boost for China and the world economy. It comes after a dismal economic performance in 2022, zero Covid-19 policy, regulatory crackdown and ideological orientation set during the Congress. It shows that the Chinese leadership has put the welfare of the people above everything else. It was clearly stated that domestic demand, private consumption and employment are top priorities.

While the service sector has picked up since the end of the zero Covid-19 policy, other components are facing headwinds. Private consumption is one such area as households and small- and medium-sized enterprises reduced their savings cushion during zero covid-19. Income and employment have not picked up either.

Private investment remains cautious until stronger measures to support private business become apparent. Confidence plummeted last year following repeated lockdowns and the fallout from unpredictable regulatory crackdowns on sectors such as education, entertainment, internet platforms and real estate. It appears that private investors are sitting on the fence.

Government-funded infrastructure investment is likely to slow. Fiscal support will be restrained, with the target for headline deficit based on a narrow definition of government revenue and spending raised only slightly to 3% of gross domestic product. Local governments are likely to scale back major investments, with a smaller quota for special local bonds used mainly to finance infrastructure projects. Many local governments have reached their debt levels after years of overspending as income from real estate allocation shows no sign of revival.

Money supply will not follow the quantitative easing of western central banks, but will be ready to support worthwhile projects. However, the increasing need to expand M2 to achieve envisaged growth targets, which has been observed in recent years, is not sustainable.

Another uncertain growth component is the foreign sector with exports and imports declining at the beginning of 2023. This depends on world demand and geopolitical developments which are beyond the control of China. There are now signs that trade tensions will not disappear any time soon.

Science and technology were second on the list of government priorities, with officials aiming to coordinate business to achieve breakthroughs in core technology to boost self-reliance and self-strengthening. The government has earmarked vast amounts of money to subsidise the purchase of domestically produced chipmaking equipment. This outlay is in response to the US increasingly tightening curbs on the export of chipmaking technology, which might be used for artificial intelligence and military purposes.

The planned reform of the administrative structure includes the establishment of a national data centre as well as an overarching financial supervisory authority, comprising banking and insurance but also non-bank financial business – a source of financial instability. Small- and medium-sized banks in particular have become a source of risk. However, reorganising government structures to eliminate financial risk is futile as risk has to be managed rather than eliminated. Risk management starts with each financial player.

Finally, adding to the uncertainty, there were no insights as to how the government would react to a resurgence of the Covid-19 pandemic or how an escalation of the Ukraine war would affect the economic scenario.

Source:Herbert Poenisch

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Justin

Central Bank

Economic

Bank of England keeps its options open on future hikes

The Bank of England has increased interest rates by 25 basis points, a move that may well be its last. Bank Rate now stands at 4.25%.

We only get a statement this time around (no press conference), and an initial flick-through shows that it reads as fairly balanced. Growth and employment look stronger, it says, but services inflation - which has been volatile so far this year- is seen as in line with expectations, and nominal wage growth weaker.

In short, the Bank is keeping its options open. Like last month, it has indicated it could hike again if inflation is continuing to show signs of “persistence”. Our read of that phrasing is that officials are less beholden to month-to-month swings in the data than perhaps the Federal Reserve/European Central Bank and are trying to take a more top-level look at pricing-setting behaviour. It’s this that will determine whether the Bank hikes again in May - and for now we think it won’t, though another 25bp move is possible if the inflation data turns more hawkish.

If improvements in broad inflation picture continue, expect a May pause

Indeed, recent trends in inflation have looked more encouraging. The Bank’s own survey of businesses suggests price-setting behaviour is becoming less aggressive, while as the BoE acknowledges, wage growth tentatively appears to have peaked on a three-month annualised basis. Services inflation should start to come down in time, with lower gas prices. When asked about recent price hikes by the ONS, service-sector firms more commonly cited energy prices than labour costs as the driver of these changes - and the same should be true in reverse.

Assuming these trends continue then we think a pause in May is likely. That’s also partly dependent on banking sector stability and like its peers overseas, the BoE will keep reiterating that it has separate tools that are better suited to maintaining financial stability.

We’re also likely to see the committee become more divided. There were no massive fireworks in the vote split on this latest decision - seven members voted for the 25bp hike, and as at the past two meetings, Silvana Tenreyro and Swati Dhingra voted for no change. Both have, however, hinted it might not be long before they consider voting for cuts.

Gilts in the long pause

Gilts, like other bond markets, now have to reflect a new phase of this cycle where central banks are at, or near, their policy rate peak. Two conclusions should ensue. Firstly, stability in policy rates means lower volatility in front-end yields, if the BoE can stick to its message of patience.

Progressively, this volatility will be displaced to the longer end, especially if a resilient economy pushes the inflation premium higher.

The second conclusion is that the yield curve now stands a better chance of re-steepening, as the front-end upside is now limited and as the inflation premium is no longer suppressed by a hiking central bank. We continue to think yields are skewed lower with 10Y headed to 3% by year-end. This is unlikely to be in a straight line however, and we have growing confidence in our call for a steeper curve.