Date: October 22, 2018
Are Jumpy U.S. Equities Hiding a Nasty Surprise?
It was quiet out there in the markets—spooky quiet. All five of the calmest quarters for U.S. stocks in the past 20 years have occurred since the start of 2017. Then came Oct. 10-11, when markets were hit by a storm that came out of the clear blue sky. The S&P 500 fell 5.2 percent over two days. That represented the fifth-biggest increase in volatility in the almost 90-year history of the index and its predecessors, according to Rocky Fishman, a Goldman Sachs Group Inc. equity derivatives strategist. Stocks partially rebounded in the following sessions. Even so, there was a sense that something had changed. Several of the previous volatility spikes had clear causes, such as the outbreak of the Korean War in 1950, President Dwight Eisenhower’s heart attack in 1955, and the failure of a United Airlines buyout in 1989. This time around, Democrats quickly blamed the minicrash on President Trump’s trade policies, while other observers cited higher oil prices, the strong dollar, or rising labor costs. The president blamed the Federal Reserve, which he says will damage economic growth by raising interest rates too much. “I think the Fed is making a mistake,” he said on Oct. 10. “They’re so tight. I think the Fed has gone crazy.” Trump isn’t entirely wrong. Many economists and market strategists agree with him that higher interest rates are a big factor in the stock market’s sudden weakness. Where they part company with the man in the White House is over Trump’s conviction that the Fed is making a mistake. Many say a gradual course of rising rates is just what the economy needs now—even if that makes stock investors nervous. “This is not a level of interest rates that should be destabilizing,” says Michelle Meyer, head of U.S. economics for Bank of America Merrill Lynch. It’s the speed of the rise in longer-term rates that seems to have spooked stock investors, she says. The yield on 10-year Treasury notes jumped from 2.4 percent at the start of 2018 to more than 3.2 percent in early October, right before stocks tumbled.
Euro-Area Banks Facing Funding Cliff Consider Reliance on ECB
Euro-area lenders are facing a cliff edge for their funding, and some are hoping the European Central Bank will help them out. Around 722 billion euros ($832 billion) of long-term loans granted to banks by the ECB will start maturing from 2020, and new regulatory standards mean replacement funds could be needed as soon as next year. One concern is that lenders could be forced to refinance just as market rates rise, spurred by tighter U.S. policy and tensions such as Brexit and Italian politics. Some banks have been in contact with the ECB to discuss the risk of letting those four-year loans expire without affordable alternatives being in place, according to people familiar with the conversations. Some discussions took place on the sidelines of the International Monetary Fund meeting in Bali this month, the people said, asking not to be named as the matter is confidential. An ECB spokesman declined to comment. Any squeeze on banks threatens to undermine lending, slowing the euro area’s economic expansion and potentially delaying the ECB’s exit from crisis-era stimulus. The central bank’s negative deposit rate is already depressing lenders’ profitability, as President Mario Draghi acknowledged at a press briefing after the IMF meeting. The ECB’s cheap four-year loans, known as Targeted Longer-Term Refinancing Operations or TLTROs, were doled out from 2014-2017 and were intended to push banks to lend more to companies and households. The repayment deadlines mean the region’s massive excess liquidity will start contracting, putting upward pressure on market rates — unless the ECB starts a new round of funding.
Are Japanese Bonds Coming Back Into Vogue? One Insurer Says Yes
The advance in yields on Japanese government bonds is making them an increasingly attractive proposition amid rising global uncertainties, according to Fukoku Mutual Life Insurance Co. “JGBs can be considered as a place to shift money redeemed from maturing bonds at current levels,” Takehiko Watabe, executive officer at the insurer, said in an interview on Monday. “Choosing by elimination, reallocating money JGBs can be an option rather than taking currency risks.” While Fukoku didn’t announce any fresh allocations for local bonds under its October-March plan released Monday, Watabe’s comments are a clear signal that JGBs are back on the radar for life insurers — which are among Japan’s largest buyers of foreign debt. Depressed yields at home have seen Japanese holdings of overseas bonds propel to $2.4 trillion. The talk of a potential shift in the Asian nation’s money flow has picked up as the Bank of Japan’s tapering of bond purchases and a Treasury-led global rout drove the 30-year yield to as high as 0.95 percent this month. That’s within striking distance of the 1 percent mark touted as a key determinant of how life insurers invest. Watabe said Fukoku can consider “allocating some money to yen bonds” in its plan for the next fiscal year if the 20-year yield exceeds 1 percent. The 30-year is “worth considering as an option” above 0.9 percent, he said. The yield was at 0.905 percent on Monday. “If the 30-year JGB is around 0.9 percent, there won’t be much of a difference between 10-year European debt after hedging, as we only can buy maturities up to 10 years for overseas debt,” he said. “Whether we choose European bonds or JGBs will depend on the relative cheapness at a given time.” Fukoku is one of the smaller life insurers in Japan, with its asset base — equivalent of $60 billion as of June — being about a 10th of the size of Nippon Life Insurance Co. Investors will look for more signals when companies including Nippon and Japan Post Insurance Co. lay out their second-half investment plans later this week. “We are taking a wait-and-see stance for the second half” of the fiscal year, Watabe said, citing uncertainties related to the U.S. mid-term elections, the impact of the U.S.-China trade war on economies and the consequences of Brexit. “If global yields rise, there is hope that JGB yields will also edge higher. We are holding expectations for the yield curve to steepen so that JGBs will be come an investment choice,” he said.