Date: August 3, 2018
Fed Describes Economy as ‘Strong’ for the First Time Since 2006
So long, modest, moderate and solid. Strength is making a comeback. The Federal Reserve described economic activity as “strong” in Wednesday’s statement, the first time it’s done so since it called it “quite strong” in May 2006 — in the late stages of the last economic expansion, shortly before the housing market drove the economy into meltdown. Morgan Stanley highlighted the change in a research note. “The Fed upgrading its language supports our late cycle view,” Hans Redeker and Gek Teng Khoo wrote in the bank’s FX Morning note. That will lead to “monetary authorities taking the liquidity punch bowl away, turning excess liquidity into a shortage, eventually driving cost of capital higher.” The central bank left interest rates unchanged Wednesday following the conclusion of a two-day meeting in Washington, though it stuck with a plan to gradually lift borrowing costs as growth looks good and joblessness has stayed low. Market participants and economists fully expect officials to raise rates for a third time this year at their September meeting, with a fourth move in December also on the cards. Policy makers forecast four 2018 rate hikes in projections they updated in June. While the 2007-to-2009 recession grew from housing market and banking excesses, Fed Chair Jerome Powell told Congress in July that “nothing really is flashing red” in financial markets right now. The U.S. economy grew at a 4.1 percent rate in the second quarter, its fastest pace since 2014, though economists polled by Bloomberg expect that to moderate in the second half. Inflation is close to the Fed’s 2 percent goal and unemployment of 4 percent in June is below the 4.5 percent level that officials judge to be its long-run sustainable level.
Corporate Bonds are Finally Waking Up to Britain’s Brexit Risks
The U.K. credit market has begun to take notice of Brexit. Prices of corporate bonds in sterling have fallen behind similar euro and dollar securities as investors begin to price in the possibility of the U.K. crashing out of the European Union. Investment-grade debt in pounds has failed to ride a credit rally in recent weeks, with spreads widening 3.5 basis points while comparable euro and dollar bonds tightened, data compiled by Bloomberg show, signaling investors are seeking a premium to hold sterling debt. Concerns of a disorderly exit are growing after the U.K. government and the European Union brace for talks critical to the next stages of Brexit. The chance of the U.K. dropping out of the European Union without a deal is “uncomfortably high”, Bank of England governor Mark Carney said today, and there are just 11 weeks to go until a self-imposed deadline to get a divorce deal signed. “Volatility in U.K. fixed income markets will soon return as the summer period ends, and the inevitable Brexit related headlines return,” said Mohammed Kazmi, portfolio manager at Union Bancaire Privee, which manages 125 billion Swiss francs ($126 billion) of assets. The credit market is already digesting rising rates in the U.S. and the U.K., as well as the potential impact of imminent withdrawal of support from the European Central Bank. That’s added to a sense of fragility and greater sensitivity to political events. “We believe it is increasingly prudent to follow a wait-and-see approach for sterling credit as the risk premium looks modest,” analysts at CreditSights Inc. wrote in a recent note. “There is a high likelihood of further political uncertainty driving market volatility over the months ahead.”
Italy Yield Tops 3% Before Budget Meeting as Bonds Extend Slump
Italian bonds slumped for the third day ahead of a budget meeting between the country’s populist leaders and the finance minister. Ten-year yields broke above 3 percent for the first time in nearly two months following a report by La Stampa newspaper that the gathering would take place at 11 a.m. Central European Time. Frictions between Finance Minister Giovanni Tria and Deputy Prime Ministers Matteo Salvini and Luigi Di Maio have rattled Italy’s debt market since the formation of the country’s government. Italian bonds have endured a turbulent few months under the country’s new leaders. Italian bonds have been the euro-area’s laggards this year as the country’s new government has spooked investors with its anti-European Union rhetoric and plans for fiscal expansion. The League-Five Star Movement coalition has outlined plans to cut taxes as well as provide a basic income for the poorest. Newspaper Il Sole 24 Ore had earlier reported that the meeting was to have taken place on Thursday. The budget will be presented in September. “The known tensions between Tria and the two deputy PMs mean that the stakes are high for this meeting,” said Antoine Bouvet, an interest-rate strategist at Mizuho International Plc. “This sort of headline risk justifies holding tail-risk trades, such as curve flatteners.” Increased hedging via German swap spreads and selling across Euribor interest-rate futures signaled some investors were bracing for further declines in Italy’s debt. A lack of liquidity in Italian bonds has helped compound the selloff, according to traders in London who asked not to be identified because they is not authorized to speak publicly. Yields on 10-year government debt rose as much as 19 basis points to 3.10 percent, with the spread over those on their German peers rising 20 basis points to 264 basis points. The yield on two-year securities climbed as much as 40 basis points to 1.38 percent. Data published Friday showed that Italy’s manufacturing and services activity declined by more than expected in July, while industrial production expanded for a second month in June.
China Dethroned by Japan as World’s Second-Biggest Stock Market
China just lost its ranking as the world’s number two stock market. After a Thursday slump, Chinese equities were worth $6.09 trillion, according to data compiled by Bloomberg. That compares with $6.17 trillion in Japan. The U.S. has the world’s largest stock market at just over $31 trillion. China’s stock market overtook Japan’s in late 2014, then soared to an all-time high of more than $10 trillion in June 2015. Chinese equities and the nation’s currency have taken a beating this year amid a trade spat with the U.S., a government-led campaign to cut debt and a slowing economy. “Losing the ranking to Japan is the damage caused by the trade war,” said Banny Lam, head of research at CEB International Investment Corp. in Hong Kong. “The Japan equity gauge is relatively more stable around the current level but China’s market cap has slumped from its peak this year.” The Shanghai Composite Index has lost 17 percent in 2018 to be among the world’s worst performers. Industrial and tech stocks have been among China’s worst performers, with those subgauges on the CSI 300 Index of large caps sliding more than 20 percent this year. China’s Politburo, a body comprising the Communist Party’s 25 most senior leaders, signaled on Tuesday that policy makers will focus more on supporting economic growth amid risks from the deleveraging campaign and the trade standoff. Still, the Shanghai Composite Index suffered its worst week since early February. “The market will likely continue to hover at low levels for the next couple of months,” said Linus Yip, Hong Kong-based strategist with First Shanghai Securities Ltd. “But there’s still a chance that China’s stock market will recover with total capitalization ascending to the world’s No. 2 place again. After all, the economic fundamentals are still stable and growth momentum will resume after a short-term downturn.” Losing the number two spot is a reminder that China’s role in global financial markets — while large — still doesn’t match its economic might. Policy makers have pledged to open areas such as investment limits on industries from banking to agriculture, but foreign ownership of equities and bonds remains low. The yuan’s share of global payments fell to 1.81 percent in June from 1.88 percent a month earlier, according to data from the Society for Worldwide Interbank Financial Telecommunication.