Below trend growth to continue
Fed talk overnight tilted hawkish with the Fed’s Bullard advocating for two hikes in 2022 and also flagging the case for balance sheet unwind after tapering ends.
Global yields continued their ascent overnight with the US 10yr yield up 5.6bps to 1.54% after having reached an intra-day high of 1.5652%. The moves still largely reflect markets coming to terms with the hawkish tilt from the US Fed and BoE last week, and since last Wednesday’s FOMC meeting US 10yr yields have risen by 22bps with 9.7bps of that being reflected in the implied inflation breakeven (now 2.39%) and 12.4bps in the real yield (now -0.85%). Overnight debt ceiling angst was also a contributing factor, while the recent rise in energy prices threatens to make the transitory lift in inflation persist for a little longer as Chair Powell noted in his testimony. Fed rhetoric continues to steer hawkish with the Fed’s Bullard (voter in 2022) pressing his case for two rate hikes in 2022 (note the FOMC was split 9 v. 9 in the dot plot) and also mooted the possibility of allowing the balance sheet to unwind once tapering finishing.
Equities tumbled as the rise in yields start to bite with the S&P500 -2.0%, and while much of the weakness being driven by the tech sector (NASDAQ -2.8%), 10 out of 11 sub-sectors were in the red apart from energy which was up 0.5%. Brent oil blasted up through 80 during Asia trading to a high of USD80.75, before falling back to $78 and showing a fall of -1.7% for the day. Surging natural gas prices across Europe remain a concern, with UK gas futures rising to a fresh high and up over 50% for the month to date. How the rise in energy prices play out in terms of inflation and consumer demand is unclear. It could be that rising energy prices feed into higher transitory inflation that becomes more protracted (here inflation expectations will be key), or that consumer demand starts to falter in the face of higher prices.
Fed talk overnight tilted hawkish with the Fed’s Bullard advocating for two hikes in 2022 and also flagging the case for balance sheet unwind after tapering ends. In a Reuters interview Bullard said on inflation: “ there is now a risk we are going to overachieve and be too high for too long…How much of that do we want?…That is the key question for the (Federal Open Market) Committee over the next year.” The flagging of discussion on unwinding the balance sheet is potentially significant. Bullard said given the sharp rebound in activity “everything can occur much faster than it could have in the previous recovery,” and so “we should start to allow runoff of the balance sheet…We could get going on that process at the end of the taper” next year. (see Reuters: Fed’s Bullard: More aggressive Fed stance best to ensure longer expansion ). Chair Powell although more measured in his testimony overnight, stated some of the supply-side bottlenecks have “gotten worse”. As for Fed reaction to market moves, Bostic said he was expecting higher yields and steeper curves.
While the Fed has clearly tilted hawkish, there is an unusual amount of uncertainty surrounding the institution following the resignation of regional Fed presidents Kaplan and Rosengren, as well as whether Chair Powell will get a second term. Overnight Democratic Senator Warren said she would oppose Powell for a second term (meaning he will also need Republican support to be nominated), with Senator Warren noting that the Feds loosening of the post-2008 financial regulations “makes you a dangerous man to head the Federal Reserve.” Liberal Democrats have sought to make the Fed chair nomination a test of Mr. Biden’s commitment to progressive goals, and instead are supporting Governor Brainard as Fed Chair (see WSJ: Elizabeth Warren Says She Will Vote Against Second Term for Fed’s Jerome Powell).
The test of Biden’s progressive commitments is also intersecting with keeping the US funded past the end of the month. Senate Republicans blocked a bill that would simultaneously suspend the debt ceiling through to December next year and keep the government funded. Republicans won’t accept the lift in the debt ceiling in protest against Biden’s multi-trillion dollar spending plans. Further politicking over this issue and can be expected this week, with market reaction to date limited to the extent that we’ve been down this road many times before with last-minute resolutions ultimately saving the day. Treasury Secretary Janet Yellen said October 18 is the likely deadline by which extraordinary measures will be exhausted, while spending bills must be past to keep the government funded after Sept 30 with the spending bill being held up by progressive Democrats who want to pass the larger social infrastructure package.
After the market’s focus on troubled Chinese property developer Evergrande last week, the attention has remained on China this week after the reporting of widespread power outages. Bloomberg notes that these have captured at least 17 Chinese provinces and regions making up two-thirds of the country’s GDP. The cause is said to be record high coal prices causing power generators to trim output despite soaring demand, while some areas have pro-actively halted electricity flows to meet emissions and energy intensity goals.
Adding to the sombre market backdrop, the Conference Board measure of US consumer confidence unexpectedly fell for the third successive month, down to a 7-month low of 109.3, blamed on the spread of the delta variant. If that is truly the case, then the 30% fall in new case numbers from their peak should see a reversal over coming months. However, we suspect that CPI inflation of over 5% has also been a factor, seeing a fall in spending power, not gone unnoticed by consumers.
The USD’s safe-haven credentials have resulted in broadly based gains, with the BBDXY index up 0.5%. The gain has been held back by the fact that EUR has managed to hold up better than others, only down slightly to 1.1680, with the market ignoring ECB President Lagarde’s particularly dovish tone as she opened the central bank’s annual forum. She said that there are “ no signs that this increase in inflation is becoming broad-based across the economy…the key challenge is to ensure that we do not overreact to transitory supply shocks that have no bearing on the medium term”.
EUR might have been a beneficiary of cross-currency flows out of GBP, which has seen significant selling pressure as the market weighs up whether the BoE might be on the verge of a policy mistake, looking to tighten policy in the face of significant supply-side shocks and higher taxes, which will crimp growth. GBP has fallen 1.2% overnight to 1.3530, doing worse than the commodity currencies during this risk-off episode.
Both the NZD and AUD have fallen about 0.6-0.7% overnight to 0.6950 and 0.7235 respectively, with lower risk appetite the prevailing force and the market ignoring the fact that both countries are enjoying strong terms of trade gains amidst the widespread lift in commodity prices. NZD crosses are all lower, apart from a lift in NZD/GBP to 0.5140.
It is a very quiet day domestically with no data scheduled. Offshore it is also quiet with most focus on the ECB’s Research Conference. Details below:
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