Aurelia Butler

This article is an on-site version of our Unhedged newsletter. Sign up here to get the newsletter sent straight to your inbox every weekdayGood morning. This week’s central bank meetings should hopefully give markets something new to chew on. Or not! Maybe it will all go as expected and nothing interesting will happen. Either way, this newsletter will march on. Email us: [email protected] and [email protected] higher rates curb buybacks and send the market lower?Our colleague Nick Megaw had a nice piece over the weekend on falling US share buybacks. The thrust of it was that between regional banks hoarding capital in the wake of the Silicon Valley Bank micro-crisis and higher interest rates, companies are buying back fewer of their shares. His chart: Stock buybacks rise and fall cyclically, which is a persistent market irrationality (you would want companies to buy their shares back when the market is weak, and stocks are cheap; but they do the opposite). What is interesting about Megaw’s piece is that it suggests that if we are in a new, higher-rate regime, buybacks might be lower on a secular basis:“Structural reasons as well as the interest rate environment are both contributors,” said Jill Carey Hall, equity and quant strategist at Bank of America. “We would expect buybacks to not be as big for the foreseeable future . . . When rates were zero it made sense for companies to issue long-dated, low-rate debt and use it to buy back shares. Now not so much.”  This issue is important because, for a long time, corporations have been the only consistent net buyer of US stocks. This Deutsche Bank chart from a few years ago tells the tale well (I will try to find or build an updated one in the coming days):This is not a surprising result. Households (domestic and foreign) buy stocks when they need to invest, and sell them when they need to consume. It makes sense that over time there would be a rough match between their buying and selling (subject to demographic trends). Companies do an initial offering and then, as a general rule, avoid diluting investors with further issuance, while doing buybacks when they can. If the dominant net buyer of stocks is set to back off because of higher debt costs, a negative impact on prices seems to make sense. That is, there might be a direct causal channel linking higher interest rates and lower stock prices. Consider a company with a price/earnings multiple of 20 and a tax rate of 20 per cent, which can borrow medium-term money at 2.5 per cent, as a triple-B-rated company probably could have two years ago. An entirely debt-financed buyback of 5 per cent of this company’s shares outstanding would be over 3 per cent accretive to its earnings per share. At a 6 per cent cost of debt, which a triple-B company might pay today, such a buyback would be dilutive to EPS (EPS accretiveness, I should emphasise, is hardly the final word on whether a buyback is a good idea, but it is a relevant consideration and is satisfyingly quantifiable). But the fact that rates affect the economics of debt-financed buybacks does not, in itself, imply that at dramatically higher rates, dramatically fewer buybacks will be done. The sensitivity of buyback decisions to economic reality, and the proportion of buybacks that are financed with debt, could both have a mitigating influence. On the first point, while it is hard to see why a company would do a buyback that was not accretive to earnings per share at all (except, perhaps, to offset dilution from stock compensation), we know that buybacks are at least somewhat insensitive to economic reality because we know they are procyclical. More buybacks get done when stocks are more expensive. Companies are not perfectly economically rational about buybacks, so the impact of higher debt costs on buybacks might be less than one would expect. On the second point, it is important to note that a lot of buybacks are done by companies that generate so much cash that debt costs are irrelevant. In the last quarter, Microsoft, Apple, Alphabet, Exxon and Chevron — massive cash spinners all — accounted for more than a quarter of all the buybacks in the S&P 500, according to data from S&P Dow Jones Indices.Overall, I think we should temper our fears about higher rates dragging down the market by discouraging buybacks. But to the degree to which you think buybacks support stock prices — and there is a debate to be had about this — it may be that higher rates will further divide the market into haves and have-nots. The cash-rich haves will be able to sustain their buybacks, and potentially their share prices, and while the have-nots who have depended on debt financing will have to give them up.Labour market normalisation If the economy does land softly, will we know it when it happens? Has it happened already? Growth has clearly held up; on inflation, though, it is harder to say. Core inflation measures are lagged. Some already argue that, after accounting for the slow pass-through of market rents to the official indices, inflation is currently verging on 2 per cent and we are in a soft landing. We just can’t see it yet.If inflation is too slow a gauge, the next place to look is the labour market. When labour demand outruns supply, it irritates the Fed, keeping it focused on supposedly labour-sensitive inflation data like non-housing core services, which picked up in August. With monthly payroll growth below 200,000 and unemployment ticking up, everyone agrees the labour market has cooled off. The question is how much.In two recent notes, Goldman Sachs economists argue that we’re basically back to normal. Labour market rebalancing is “now largely complete”, with many measures of tightness back to pre-pandemic levels (the red line below takes the average):  (The “labour market differential” is the number of people telling the Conference Board jobs are plentiful minus those saying they’re hard to get. The “jobs-workers gap” is employment + job openings — labour force, using Goldman’s estimate of job openings.)The lingering worry is wage growth, which is still far from normalising. You can make the case, as Goldman does, that it is just a matter of time before wage growth falls. In theory, a decline in labour market tightness — which is to say worker bargaining power — should happen before wage growth slows. One of the strongest measures of tightness, the quits rate, tends to lead changes in wage growth, as the chart below shows (look, for example, at the mid-2010s):You are seeing a snapshot of an interactive graphic. This is most likely due to being offline or JavaScript being disabled in your browser.All clear, then? In his latest edition of The Overshoot, Matt Klein points out an important subtlety. Much of the wage disinflation we have seen so far is coming from a reversal in the additional gains enjoyed by job switchers — people who have gotten raises by finding new jobs — since the pandemic. Data from the Atlanta Fed’s wage tracker indicates switchers are now getting raises in line with stayers. Stayers’ pay increases, meanwhile, are stubbornly high (pink line below):One observation that might square Klein’s point with Goldman’s is that when we talk about the labour market normalising to 2019 levels, it’s less often noted that the 2019 labour market was very strong. Yes, inflation was at 2 per cent back then, but there could well be a difference in wage-price dynamics once inflation is already high. Returning to 2019 may be necessary, but not sufficient, to bring inflation down. Until wage growth falls, declaring a soft landing strikes us as premature. (Ethan Wu)One good read“Which of you shall we say doth love us most/That we our largest bounty may extend/Where nature doth with merit challenge?”FT Unhedged podcastCan’t get enough of Unhedged? Listen to our new podcast, hosted by Ethan Wu and Katie Martin, for a 15-minute dive into the latest markets news and financial headlines, twice a week. Catch up on past editions of the newsletter here.Recommended newsletters for youSwamp Notes — Expert insight on the intersection of money and power in US politics. Sign up hereThe Lex Newsletter — Lex is the FT’s incisive daily column on investment. Sign up for our newsletter on local and global trends from expert writers in four great financial centres. 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In early February, the St Louis branch of the Federal Reserve published a blog post warning that higher interest rates could “complicate” banks’ finances.The post was as prescient as it was optimistic. The Fed’s supervisors said rising interest rates created both “challenges and opportunities for banks”. They suggested that banks should carefully analyse the situation, but also said there were several steps banks could take to mitigate any issues.Less than a month later, Silicon Valley Bank (SVB) failed, largely due to the effect of sharply higher interest rates, kicking off the worst period of banking turmoil since the Great Financial Crisis. Signature Bank quickly followed into the abyss. Shares of dozens of banks plunged in value, raising questions about their survival, too. In Europe, UBS bought the long-suffering Credit Suisse in a government-backed deal that saved its rival from collapse.Emergency measures from the Federal Reserve, billions of dollars from the federal deposit insurance fund, and tens of billions of loans from the government-backed Federal Home Loan Banks quelled the crisis. Few, if any, banks now seem at risk of failing. However, while the crisis has passed, the challenge from higher interest rates, as the St Louis Fed warned in May, has not.Higher interest rates have ushered in a new normal in the banking industry. A slowing economy and higher scrutiny from regulators following recent bank failures have largely capped the amount of lending that banks are able to do at elevated rates.And banks are seeing the effects of higher rates on borrowers, particularly those in commercial real estate. Defaults on corporate loans, which generally carry interest rates that float — meaning they automatically adjust with market rates, not just when the borrower refinances — are also on the rise.The European Central Bank warned in May that European lenders, such as SVB and other US banks that ran into trouble, would see the value of their assets fall faster, on average, than the value of their debts — a particularly bad scenario for a bank if interest rates continued to rise. For the average bank, the central bank concluded, the drop in book value would be a very manageable 4 per cent. But the ECB also found that, for a quarter of European banks, the hit from rising interest rates would be high enough to force those banks to take steps to mitigate the damage.Already, a number of institutions, including Citigroup and Goldman Sachs, appear to be abandoning the notion that the best model for a global bank is to offer all services to everyone — the supermarket model of banking — something that seemed to be banking gospel just a decade ago.“You have to look at each business from the ground up and not bottom down at this point,” says Greg Hertrich, who is the head of deposit strategy at Nomura. “Twenty-five years ago, everyone wanted to be a one-stop shop, and that has changed.”The biggest effect of rising rates, at least so far, has been on the banks’ bottom lines. For much of the past decade, banks have been one of the biggest beneficiaries of low interest rates, and essentially — at least for them — free money.With interest rates near zero, depositors had nowhere else to go with money that they did not want to risk in the market. As a result, customers had to accept — and eventually got used to — receiving no interest on their accounts. The rise of internet banking, along with ATM and other account fees, made bringing in customers and their deposits all the more lucrative for banks.That started to change in early 2022, when the US Federal Reserve began raising interest rates to slow quickly rising inflation. In the first quarter of last year, the average US bank had an annual-equivalent funding rate — that is how much in interest it paid compared with its total assets — of 0.15 per cent. That funding rate has jumped nearly 12 times to just under 2 per cent in the past 18 months, mostly driven by the rising costs of deposits, with some banks offering interest rates on accounts in the 5 per cent range. Lending income is rising as well, but not nearly that fast.You are seeing a snapshot of an interactive graphic. This is most likely due to being offline or JavaScript being disabled in your browser.In the second quarter of 2023, the average bank saw its interest income rise just 8 per cent from the quarter before. Interest expense, however, jumped 27 per cent.“It is the fact that funding costs have gone up and your assets, your loans and bond investments are worth less,” says Hertrich. “My guess is that they are going to pull every lever that they can.”Some banks are already starting to retreat from, or even exit, consumer banking.Bank of America chief executive Brian Moynihan had long talked about the importance of bank branches. But even BoA is cutting branches at a time when the cost of bringing in new deposits, and holding on to the ones you have, is much greater than it has been for some time. Last year, the number of BofA branches fell to 3,900, down 7 per cent from the year before. It was the first time the bank had fewer than 4,000 branches since shortly after its merger with NationsBank in the late 1990s.Just a year ago, Goldman Sachs was investing heavily in consumer banking in the UK, in an effort to win customers for its fledgling online bank Marcus. These days, it appears to have lost its interest in Marcus and consumer banking in general, both in the UK and at home in the US. Late last year, Goldman stopped making consumer loans through Marcus and scrapped plans for a checking account. It did recently launch a high interest savings account, initially paying close to 4.5 per cent a year, but in a partnership with Apple and under the iPhone maker’s brand, not Marcus.Emmanuel Dooseman, global head of banking at accounting and consulting firm Mazars, says there are only so many options for banks. Many lenders, he points out, committed to long-term loans when interest rates were still low, which will weigh heavily on profits.There could, he says, be a renewed interest in small business lending, as well as mortgage lending, where rates have risen. But that will expose banks to the risk that high-interest loans made now will go unpaid if the economy sours.“There is no short-term answer,” notes Dooseman. The only way for banks to deal with lower lending income is to cut costs until profitability rebounds. Last week, Truist, one of the US’s largest banks, announced a fresh round of cuts that it says will save $750mn dollars in expenses per year.“There are no quick fixes,” says Dooseman. “It’s just time.” More

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WASHINGTON (Reuters) -With a possible partial government shutdown looming in two weeks, House of Representatives Speaker Kevin McCarthy on Sunday said he would bring a defense spending bill to a vote “win or lose” this week, despite resistance from hardline fellow Republicans.McCarthy is struggling to bring fiscal 2024 spending legislation to the House floor, with Republicans fractured by conservative demands for spending to be cut to a 2022 level of $1.47 trillion – $120 billion below the spending on which McCarthy agreed with Biden in May.Late on Sunday, members of the hardline House Freedom Caucus and the more moderate Main Street Caucus announced a deal on a short-term stopgap bill to keep the government open until October 31, but with a spending cut of more than 8% on agencies apart from the Departments of Defense and Veterans Affairs.The measure, which is unlikely to become law, also includes conservative restrictions on immigration and the U.S. border with Mexico.Republicans have said that such a deal could allow the House to move forward on the defense spending bill this week. But it was unclear whether the measure had sufficient Republican support to pass the chamber. The spending cuts were also likely to draw opposition from Democrats in the House and Senate, who reject the immigration provisions. Republicans hold a narrow 221-212 majority in the chamber as they bicker over spending and pursue a new impeachment drive against President Joe Biden while the United States faces a possible fourth partial government shutdown in a decade.McCarthy has begun to face calls for floor action seeking his ouster from hardline conservatives and others who have accused him of failing to keep promises he made to become speaker in January after a revolt from some of the most conservative Republicans in the House. The Republican-controlled House and Democratic-led Senate have until Oct. 1 to avoid a partial shutdown by enacting appropriations bills that Biden, a Democrat, can sign into law, or by passing a short-term stopgap spending measure to give lawmakers more time for debate.McCarthy signaled a tougher stand with hardliners, telling the Fox News “Sunday Morning Futures” program that he would bring the stalled defense bill to the floor this week. The House last week postponed a vote on beginning debate on the defense appropriations bill due to opposition from the hardliners.”We’ll bring it to the floor, win or lose, and show the American public who’s for the Department of Defense, who’s for our military,” McCarthy said.McCarthy also said he wants to make sure there is no shutdown on Oct. 1, saying: “A shutdown would only give strength to the Democrats.”McCarthy has held closed-door discussions over the weekend aimed at overcoming a roadblock by the conservative hardliners to spending legislation. They want assurances that legislation will include their deep spending cuts, as well as conservative policy priorities including provisions related to tighter border security that are unlikely to secure Democratic votes.”We made some good progress,” McCarthy said. Representative Elise Stefanik, the No. 4 House Republican, told the “Fox News Sunday” program that she was optimistic about moving forward on appropriations after closed-door discussions. But Republican Representative Nancy Mace told ABC’s “This Week” that she expects a shutdown and did not rule out support for a vote to oust McCarthy’s ouster. Mace complained that the speaker has not made good on promises to her involving action on women’s issues and gun violence. “Everything’s on the table at this point for me,” Mace said.Mace played down the consequences of a shutdown, saying much of the government would remain in operation and that the hiatus would give government workers time off with back pay at a later date.Democratic former House Speaker Nancy Pelosi said a shutdown would risk harming the most vulnerable members of society who depend on government assistance.”We’re talking about diminishing even something as simple and fundamental as feeding the children,” Pelosi told MSNBC. “We have to try to avoid it.” More

SINGAPORE (Reuters) – The U.S. dollar and most major currencies were flatlining in early trades on Monday, barring a blip in sterling, as a Japanese holiday and a bunch of upcoming central bank meetings sucked the air out of markets.The Bank of Japan’s policy meeting on Friday is the highlight of the week in Asia, after Governor Kazuo Ueda stoked speculation of an imminent move away from ultra-loose policy. In a week packed with central bank meetings, decisions are also due from the U.S. Federal Reserve on Wednesday and Bank of England on Thursday.The yen was flat versus the greenback at 147.82 per dollar with markets in Japan closed for a national holiday. In the week since Ueda’s remarks about a early move from negative rates, it has dropped 1.3% and taken losses for 2023 to more than 11%.Carol Kong, economist and currency strategist at Commonwealth Bank of Australia (OTC:CMWAY), said she expects the yen to be volatile leading up to the policy meeting.”In terms of the direction of travel, dollar/yen can definitely track higher,” Kong said. Investors may have potentially misinterpreted Ueda’s comments. And the recent spell of weakness in Japanese wages and possibility prices too could soften and push the BOJ farther from its inflation goal, the case for a BOJ policy tightening is still not very strong, Kong said.”So that means dollar yen can track higher, particularly if Governor Ueda sounds dovish and dashes hopes of policy tightening at the upcoming meeting,” she said.The dollar index was a tad lower at 105.23, with the euro up 0.11% at $1.0667. Sterling was last trading at $1.2397, up 0.06% on the day. Most investors expect divergences in economic growth and in yields will keep the dollar propped up, particularly against the euro. Sterling has slid nearly 6% against the dollar since mid-July, while the euro has dropped more than 5% as the UK labour market and economy and the euro zone economy slowed. The European Central Bank raised interest rates to 4% last week but said this hike could be its last. With Japan shut, cash Treasuries were untraded on Monday.U.S. Treasury yields have been edging higher, with the two-year above the 5% threshold and up 25 bps this month, spurred by rising government spending and the anticipation of the Fed keeping rates high for longer faces to rein in inflation that’s still above target. Last week’s U.S. retail sales data played a part, reducing the odds of recession even further.Futures are pricing in just a 3% chance that the Fed raises interest rates at the end of its two-day meeting next Wednesday. “With growth still strong and still tentative evidence the labor market and inflation are normalizing, officials are unlikely to be willing to send a signal that they are done raising rates,” analysts at Deutsche Bank Research wrote. The Bank of England is likely to hike interest rates once again this week, and markets are already looking for a pause in a massive tightening cycle that has policymakers worried about the cooling economy. UK inflation figures for August are also due on Wednesday, just ahead of the meeting.Meanwhile, oil prices are adding a layer of complication to central banks’ growth-inflation dilemmas. Oil is also on track for its biggest quarterly increase since Russia’s invasion of Ukraine in the first quarter of 2022. Brent crude futures hit a 10-month high above $93 a barrel on Friday and posted a third weekly gain on supply tightness spearheaded by Saudi Arabian production cuts and some optimism around Chinese demand. More

SYDNEY (Reuters) – Asian shares started cautiously on Monday in a week packed with central bank meetings that include the Federal Reserve and the Bank of Japan, which will be closely scrutinised for the global interest rate outlook. Both S&P 500 futures and Nasdaq futures rose 0.2% in early Asia. MSCI’s broadest index of Asia-Pacific shares outside Japan slipped 0.1% after gaining 1.2% last week. Japan’s Nikkei is closed for a holiday.Sentiment in Asia improved recently after news of more policy support from Beijing and better-than-expected Chinese data add to signs the slowdown in world’s second largest economy could have past it worst. However, the stress in the property sector persisted, with the fear that it is spreading to the financial system. Troubled Chinese trust firm Zhongrong International Trust Co said it was unable to make payments on some trust products on time.This week, global central banks will take centre stage, with five of those overseeing the 10 most heavily traded currencies – including the U.S. Federal Reserve – holding rate-setting meetings, plus a swathe of emerging market ones as well.Markets are fully priced for a pause from the Fed on Wednesday, so the focus will be on the updated economic and rates projections, as well as what Chair Jerome Powell says about the future. They see about 80 basis points of cuts next year.”In theory, the FOMC meeting should be a low-volatility affair, but it is a risk that needs to be managed,” said Chris Weston, head of research at Pepperstone. “We should see the median projection for the 2023 fed funds rate remaining at 5.6%, offering the bank the flexibility to hike again in November, should the data warrant it.”Weston added that if the Fed revises up the rate projections for 2024, that would see rate cuts being priced out, resulting in renewed interests in the U.S. dollar and downward pressure on shares. On Thursday, Bank of England is tipped to hike for the 15th time and take benchmark borrowing costs to 5.5%, while Sweden’s Riksbank is seen hiking by 25 basis points to 4%. Bank of Japan is the key risk event on Friday. Markets are looking for any signs that the BOJ could be moving away from its ultra-loose policy faster than previously thought, after recent comments by Governor Kazuo Ueda sent yields much higher. Last Friday, Wall Street ended sharply lower as U.S. industrial labour action weighed on auto shares and chipmakers dropped on concerns about weak consumer demand. Rising Treasury yields also pressured Amazon (NASDAQ:AMZN) and other megacap growth companies.Cash Treasuries were not traded in Asia with Tokyo shut. Treasury yields edged higher on Friday, with the two-year above the 5% threshold, as futures price in higher rates for longer ahead of a the Fed’s policy meeting this week.In the currency markets, the U.S. dollar was still standing strong near its six month top at 105.23 against a basket of major currencies.The euro recovered 0.1% to $1.0068 in early Asia trade, after slumping to a 3-1/2 month low of $1.0629 last week as the European Central Bank signalled its rate hikes could be over. Oil prices were higher on Monday, after hitting 10 month tops last Friday, stoking inflationary pressures. Brent crude futures rose 0.1% at $94.01 per barrel and U.S. West Texas Intermediate crude futures were up 0.2% at $90.97.The gold price was flat at $1,923.33 per ounce. More

LONDON (Reuters) -Chile’s Codelco is ending long-term contracts to sell copper concentrate to Chinese clients from 2025, bidding to broaden its product offering to them after evaluating its production outlook, five sources with direct knowledge of the matter said.The sources said Codelco is aiming to replace exclusively copper concentrate deals with others that include concentrate and value-added intermediate products such as blister and anode which are derived from concentrate and can be turned into copper metal or cathode.Some Chinese customers have protested against the changes, but will have to accept new contract negotiations that include intermediates because they will need Codelco’s concentrates at a time when deficits are expected, the sources said.The Chilean miner wants to restructure its sales strategy and agreements because of uncertainty about whether it can meet its contractual obligations, the sources said.”Some measures adopted are due to the normal management of Codelco’s commercial product portfolio and not to availability adjustments and/or lower production,” Codelco said in response to a request for a comment.”Codelco continually updates its contracts according to the prevailing dynamics in the market.”Operational problems at the state-owned miner saw its production slip last year to about 1.46 million metric tons, the lowest in around a quarter of a century and output has slipped further this year. Codelco is expected to produce between 1.31 million to 1.35 million metric tons of copper a key material for the power and construction industries.Output at the world’s largest copper producer has been dropping despite $15 billion invested in flagship mines including El Teniente and Chuquicamata where costs have overrun significantly, according to an influential industry body.The sources, all of whom have long-term contracts with Codelco, said they had been receiving termination notices from Codelco from July to August and that the company wanted to start new agreements with different terms.Two of the sources said Codelco was ending their evergreen supply contracts from 2025. Evergreen contracts introduced by Codelco in 2018 are two-year and three-year deals which roll over annually, in which customers can be assured of certain amounts a year.Codelco accounts for 29% of Chile’s copper production. Chile’s congressional committee in late August launched an investigation to review Codelco’s corporate structure and project delays.China is the world’s biggest buyer of mined copper with its import volume accounting for over 60% of the world’s total. The world’s largest consumer of industrial metals bought 25.3 million tonnes of copper concentrates last year, according to International Copper Study Group. The global copper concentrate market is expected to see a steep deficit during 2025-2027 as Asian and African smelters ramp up capacity, outpacing mine supply. More