Aurelia Butler

Wall Street stocks rose on Tuesday and US government bond prices fell, as investors looked ahead to tighter monetary policy from the Federal Reserve. The S&P 500 index rose 1.1 per cent as investors balanced remarks from Fed chair Jay Powell about the need for rapid interest rate rises with his reassurance that tightening would not spark a recession. The tech-heavy Nasdaq Composite added 2 per cent. Meanwhile, the yield on the benchmark 10-year US Treasury note rose 0.09 percentage points to 2.38 per cent — the highest level since May 2019 — as its price fell. Powell said on Monday that the Fed should move “expeditiously” towards tighter monetary policy. He also pushed back on concerns that this would cause a recession, citing episodes in 1965, 1984 and 1994 when the central bank slowed an overheated economy without prompting a sharp contraction.“The bond market is responding to expectations of tighter monetary policy, but equity markets are saying if Powell is confident about the growth outlook then risk assets will do well,” said Seema Shah, global investment strategist at Principal Global Investors. “Equity markets responding in this way is a bit surprising,” she added. “One of these views is going to give at some point.” Not all investors were persuaded that the Fed’s tough talk would translate into policy decisions, which potentially could explain the continued support for equities. “This is a Fed that is talking very hawkish and getting the market to do their dirty work for them,” said Andy Brenner, head of international fixed income at NatAlliance Securities. “I do not think that this is an aggressive Fed.” Tesla rose 7.9 per cent on Tuesday after the electric carmaker opened a plant in Germany, pushing its market capitalisation back above $1tn for the first time since January. Europe’s regional Stoxx 600 share index, which remains about 6 per cent lower for the year, ended the day 0.8 per cent higher, with strong gains for financial stocks. Bundesbank president Joachim Nagel said on Monday that the European Central Bank should raise interest rates this year if the inflation outlook warranted it. Germany’s Xetra Dax closed up 1 per cent and London’s FTSE 100 gained 0.5 per cent. The US Treasury market is experiencing its worst month since 2016 after the Fed raised interest rates last week for the first time since 2018. US consumer price inflation soared to a 40-year high of 7.9 per cent last month.Russia’s invasion of Ukraine has prompted sharp jumps in the prices of commodities from oil to wheat, exacerbating inflationary pressures caused by resurgent demand following coronavirus shutdowns and prompting markets to predict the Fed will raise its key interest rate to more than 2 per cent by December.“Inflation expectations for the next one to two years are now extremely high,” said Brian Nick, chief investment strategist at Nuveen. “But the scenario where the Fed goes ahead and does what it is signalling it will do is probably the best-case scenario,” he added. “Do too little and inflation becomes further entrenched.” The 10-year German Bund yield, a barometer for eurozone borrowing costs, rose 0.04 percentage points to 0.5 per cent, its highest level since October 2018. Brent crude settled 0.1 per cent lower on Tuesday at $115.48 a barrel, with the international oil benchmark still nearly 20 per cent higher since February 23, the day before Russia invaded Ukraine. Hong Kong’s Hang Seng index gained 3 per cent. It began to rally last week when Chinese vice-premier Liu He made a rare intervention to pledge state support for the economy and capital markets. More

(Reuters) – San Francisco Federal Reserve Bank President Mary Daly said Tuesday she believes the “main risk” to the U.S. economy is from too-high inflation that could get worse as Russia’s invasion of Ukraine boosts oil prices and China’s crackdown on COVID-19 further disrupts supply chains.”Even though we have these uncertainties around Ukraine, and we have the uncertainties around the pandemic, it’s still time to tighten policy in the United States,” Daly said at a virtual Brookings Institution event, “marching” rates up to the neutral level and perhaps even higher to a level that would restrict the economy to ensure inflation comes back down. “Inflation has persisted for long enough that people are starting to wonder how long it will persist,” she said. “I’m already focused on let’s make sure this doesn’t get embedded and we see those longer-term inflation expectations drift up.”The Fed last week raised rates for the first time in three years, and signaled ongoing rate hikes ahead. Fed Chair Jerome Powell on Monday said the central bank needs to move rates “expeditiously” higher in remarks widely understood to signal more aggressive tightening at coming meetings. Daly on Tuesday said the labor market is tight enough to be unsustainable, pointing to worker churn including new hires who “ghost” their new employers by not showing up because they have other options. “In addition to pushing up wage inflation, which could ultimately push up price inflation, putting us in sort of a vicious cycle,” she said, “it’s just not a very sustainable way to manage the economy.” She said she sought a “smooth landing” for the labor market as rate hikes help bring down inflation More

German authorities and power companies are preparing for a potential rationing of energy next winter in the event Vladimir Putin shuts off the pipelines that provide more than half of the natural gas consumed by Europe’s largest economy.Large industrial groups have received letters from network operators asking them to outline their energy needs in anticipation of possible shortages, according to three people who have seen the requests. Two industrial companies with plants in the east and south-east of Germany told the Financial Times they had been warned by their local suppliers that gas deliveries could be curtailed by the end of the year.Meanwhile, the Federal Network Agency, the regulator that oversees Germany’s energy infrastructure, confirmed it was holding talks with businesses to prepare for “unavoidable shutdowns” if energy supply shortages occur.The discussions were “about being prepared for a case that we hope will never happen”, said Klaus Müller, the agency’s president.Under German law, companies deemed essential to the provision of the country’s basic goods and services would be prioritised in an emergency, alongside households. As a result, many of Germany’s largest corporations would be forced to cut their consumption, most likely by idling production.“Although we have a law in place, we have not set out real criteria to decide which non-protected, ie industrial or commercial, customer will get cut off first . . . that makes the industry quite nervous,” said Christian Hampel, a BDO Legal partner advising some of the companies contacted by network operators.The latter were also enquiring over “what would happen to the broader gas supply system if you shut off one particular company”, Hampel added.Business groups including the body representing Germany’s chemical and pharmaceutical industry met with the Federal Network Agency on Friday to discuss such procedures, according to people briefed on the talks.The chemical and pharmaceutical trade body warned policymakers attending the meeting that “almost all sectors — agriculture, food, automotive, cosmetics and hygiene, construction, pharmaceuticals or electronics” would be hit by forced cuts to production in the sector. The chemical and pharmaceutical sector, which includes companies such as BASF and Bayer, uses 27 per cent of Germany’s natural gas supply.The preparations come as Germany’s ruling coalition strives to find alternative gas supplies to those coming from Russia.Speaking after sealing an agreement with Qatar for the supplies of liquefied natural gas, economy minister Robert Habeck said that deal would not solve bottlenecks for next winter. He added the order of priority for the consumption of energy would be decided “politically” in the event of shortages.Some German industrial groups have had to pause production due to soaring energy and raw material costs. The Lech steelworks in Bavaria, which uses the same amount of electricity as a city of 300,000 inhabitants, said this month that it had been forced to axe working shifts. Steelmaker Thyssenkrupp has warned of “economic turmoil” that could disrupt its manufacturing operations.Businesses not seen as a priority for gas supplies have been petitioning the Federal Network Agency in recent days to underline their relevance to the wider German economy, according to three people involved.In a survey of 175 companies released last week, 70 per cent of respondents called for a review of regulations, to take into account the “systemic” relevance of industrial groups that risk suffering shutdowns. More

Vladimir Putin’s assault on Ukraine will remake our world. How it will do so remains uncertain. Both the war’s outcome and, even more, its wider ramifications, including those for the global economy, are largely unknown. But certain points are already all too evident. Coming just two years after the start of the pandemic, this is yet another economic shock, catastrophic for Ukraine, bad for Russia and significant for the rest of Europe and much of the wider world.As usual, the impact of refugees is mostly local. Poland already houses the second-largest refugee population in the world, after Turkey. Refugees are also pouring into other eastern European countries. More will come. Many will also wish to stay near their homeland, hoping for an early return. They need to be fed and housed.Yet the ramifications go far beyond eastern Europe or even Europe as a whole, as an excellent interim economic outlook from the OECD shows. Russia and Ukraine account for only 2 per cent of global output and a similar proportion of world trade. Stocks of foreign direct investment in Russia and by Russia elsewhere are also only 1-1.5 per cent of the global total. These countries’ wider role in global finance is also trivial. Yet they matter to the world economy, all the same, mainly because they are important suppliers of essential commodities, notably cereals, fertilisers, gas, oil and vital metals, whose prices in world markets have all soared.The OECD estimates this shock will lower world output this year by 1.1 percentage points below what it would otherwise have been. The impact on the US will only be 0.9 percentage points, but on the eurozone it will be 1.4 percentage points. The comparable impact on inflation will be plus 2.5 percentage points for the world, plus 2 percentage points for the eurozone and plus 1.4 percentage points for the US. Increased prices of energy and food will reduce the real incomes of consumers by far more than these gross domestic product losses alone. The real incomes of net energy and food importing countries will also be worse affected than their GDP alone. It is also likely that the OECD’s estimates will be too optimistic. That will depend, among other things, on the duration of this evil war and on the possible spread to China of sanctions or to Europe of embargoes on energy imports.These expected direct impacts on output are far smaller than those of Covid: in 2020, world output ended up some 6 percentage points below trend. But a full recovery from Covid had not occurred before the arrival of this new shock, which has damaged international relations, enhanced worries over national security, and undermined the legitimacy of globalisation. This tragedy is likely to cast long shadows.One reason for this is its impact on inflation and inflationary expectations. The US Federal Reserve has become more hawkish. But it still believes in “immaculate disinflation” — the ability to curb inflation without much, if any, rise in unemployment. The European Central Bank also confronts a jump in inflation, to which it will be forced to respond. In practice, the tightening is likely to damage activity and jobs more than now hoped, partly because of financial fragility.More fundamentally, the emergence of geopolitical divisions between the west, on the one hand, and Russia and China, on the other, will put globalisation at risk. The autocracies will try to reduce their dependence on western currencies and financial markets. Both they and the west will try to reduce their reliance on trade with adversaries. Supply chains will shorten and regionalise. Yet note that Europe’s reliance on parts from Ukraine was already regional.Economic policy has only limited relevance in time of war. It cannot save those under assault, though it can seek to punish or deter those responsible. But it can and must respond to the consequences. Monetary policy must continue to be targeted at controlling inflation and inflationary expectations, however unpleasant that may seem. But it is possible and necessary for countries to apply their fiscal resources to looking after refugees and offsetting the impact of higher energy and food prices on the most vulnerable. The latter include many in developing countries, especially in net importers of energy and food. They will require substantial short-term support. The special drawing rights created last year could now be used for such purposes. High-income countries do not need them and should give or at least lend them to those countries in most need.

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The response to this tragedy will need to be far more than short term. Just as Covid forces us to plan how to deal with future pandemics, so this war must force us to think harder about security in a world more hostile than most of us expected or at least hoped. Energy security will be enhanced by an even faster shift towards renewables. This is no longer just about the climate. In the short run, diversification of sources of fossil fuels will also be essential. Again, it is clear that the west and especially Europe will have to make a large and co-ordinated increase in their collective defence capacity. This will cost money. Europeans have the resources to be more strategically independent. They should use them. So long as the isolationist right remains so powerful in the US, that will not only be right, but wise.Last but not least, Russia must remain a pariah so long as this vile regime survives. But we will also have to devise a new relationship with China. We must still co-operate. Yet we can no longer rely upon this rising giant for essential goods. We are in a new world. Economic decoupling will now surely become deep and irreversible. I see no way of avoiding [email protected] Martin Wolf with myFT and on Twitter More

Russia’s army is attempting to starve the people of Mariupol into submission in an act of barbarity that almost certainly constitutes a war crime. But the knock-on effects of Vladimir Putin’s invasion of Ukraine threaten hunger, even starvation, for millions of people beyond the immediate theatre of war.Russia and Ukraine are major food producers, accounting for roughly 30 per cent of global exports of wheat and barley. Russia alone exports 15 per cent of global fertiliser, while Belarus, also under sanctions, is an important producer of potash, crucial for growing soyabeans that in turn go into animal feed. If farmers around the world use less fertiliser, next year’s harvests in Brazil, Argentina and other agricultural powerhouses could collapse.Ukraine’s wheat exports are being blockaded by Russian ships. Ukrainian farmers don’t have seeds or fuel for their tractors. Grain prices are a third higher than when the war began and two-thirds above where they were a year ago. For people in the rich world, the coming food shock will put further upward pressure on grocery bills already affected by the highest inflation in decades. For poorer countries, engulfed by the economic consequences of Covid, higher food prices may spell catastrophe. Millions of people in countries affected by conflict — including Yemen, Ethiopia and South Sudan — are teetering on the brink of famine. Food importers from India to Indonesia face higher bills. Egypt subsidises bread, a staple, for 70mn people, a huge drain on the exchequer. Leaders of other countries in a similar fix will remember the kind of social unrest, including the Arab uprising, that can follow rising food prices. Given how badly the world has done in distributing vaccines equitably, the omens for how it will deal with a food crisis are not good. The chronically underfunded World Food Programme says rising costs mean it will have to cut rations for millions of people, reallocating food from the merely hungry to the outright starving. The quickest remedy would, of course, be to end the war in Ukraine. In the longer term, the world should reduce its reliance on Russian food and fertiliser. It should invest more in raising agricultural yields in Africa, which still has plenty of underutilised arable land, and cut down on scandalous food waste in the developed world.In the short term, there is a clear case for richer countries to increase funding. Sanctions against Russia are entirely justified but richer countries must cushion the blow for poorer ones caught in the crossfire. One possibility is to look again at the reallocation of Special Drawing Rights, effectively free money, $650bn of which was created within the IMF last year as part of the global pandemic response. Most of it went to rich countries while plans to on-lend a portion to poorer nations have got bogged down.Individual countries remain free to donate allocations. They should consider doing so. Some mechanism could surely be found to use SDRs more generally to help countries with their balance of payments problems. If that proves impossible, the IMF will need to find emergency resources to help the most vulnerable nations meet their rising food bill. In the modern era, famines are almost always man-made. Amartya Sen, the Nobel economist, said they could not happen in a democracy because of the free flow of information and the consequent public outrage. But democracy is ever more under attack. Putin is the latest aggressor. Unless he is stopped, hunger will follow. More

LONDON (Reuters) -European stock indexes rose Tuesday and U.S. and European government bond yields extended the previous session’s gains as investors adjusted their expectations for rate hikes following hawkish comments from the U.S. Federal Reserve.Fed Chair Jerome Powell said the central bank could move “more aggressively” to raise rates to fight inflation, possibly by more than 25 basis points at once.Markets were recalibrating the higher possibility of a 50 bps hike. On Tuesday morning, money markets were pricing in a 80% chance of a 50 bps hike in May, although this dipped down to 70% around midday.At 1224 GMT, the U.S. 10-year Treasury yield was at 2.3478%, having hit its highest since 2019.RBC Capital Markets’ chief U.S. economist, Tom Porcelli, wrote in a note to clients that during the speech “it was easy to wonder if a 75bps hike or even going intra-meeting is possible.””Both outcomes seem incredibly extreme but when we hear Powell talk about inflation he comes off as incredibly anxious to us.”Euro zone government bond yields also rose, with Germany’s benchmark 10-year yield hitting a new 2018 high of 0.526%.Although Wall Street had closed lower after Powell’s comments, stock markets in Europe rose. The MSCI world equity index, which tracks shares in 50 countries, was up 0.2% on the day.The STOXX 600 was up 0.4%, having climbed high in recent sessions to reach a one-month high. London’s FTSE 100 was up 0.4%.Wall Street futures edged higher.Matthias Scheiber, global head of portfolio management at Allspring Global Investments, said the pickup in stocks could be a case of investors buying the dip, but that growth stocks would struggle if the U.S. 10-year yield moves closer to 2.5%.”We saw the sharp rise in yields yesterday and we see that continuing today on the long end so that’s likely to put pressure on equities… it will be hard for equities to have a positive performance.”But JPMorgan (NYSE:JPM) said that 80% of its clients plan to increase equity exposure, which is a record high.”With positioning light, sentiment weak and geopolitical risks likely to ease over time, we believe risks are skewed to the upside,” wrote JPMorgan strategists in a note to clients.”We believe investors should add risk in areas that overshot on the downside such as innovation, tech, biotech, EM/China, and small caps. These segments are pricing in a severe global recession, which will not materialize, in our view.”The conflict in Ukraine continued to weigh on sentiment. U.S. President Joe Biden issue one of his strongest warnings yet that Russia is considering using chemical weapons.Oil prices extended their gains following news that some European Union members were considering imposing sanctions on Russian oil – although Germany said that the bloc was too dependent on Russian oil and gas to be able to cut itself off.The U.S. dollar index was steady at 98.44 , while the euro was up 0.2% at $1.10325.The Japanese yen plunged past the 120 level versus the dollar, hurt by the divergent rate-hike expectations for the United States and Japan.”The perception that the JPY may become a funding currency rather than a safe-haven unit after the BoJ made it clear that they do not want to hike rates at present has further helped USD-JPY break above the key 120 threshold,” UniCredit said in a client note.In cryptocurrencies, bitcoin was up 4.4% at around $42,865 . More

Good morning. Warren Buffett bought a big conglomerate in cash on Monday. Berkshire Hathaway’s having a moment, and it seems Buffett is keen on keeping the momentum going. Bond markets have momentum too — in the wrong direction. More on that below. Email us: [email protected] and [email protected] yield curve is scaring everyoneLast week Ethan wrote that the horrific performance of US Treasuries was something of an inevitable return to normal after they were placed into a policy-induced economic coma during Covid: Across the curve, Treasury yields are returning to their pre-pandemic levels — even if in fits and starts. Even the stubborn 30-year yield is back where it was in early 2019 . . . Epic fiscal, monetary and epidemiological interventions transformed the US economy overnight. A bear market in Treasuries mostly represents things returning to normal, though high inflation and Russia’s war have made for a bumpier ride.This remains true, but the ride has only become rockier in the past few days. As the FT markets team reported on Monday, Treasuries have now had their worst month since 2016. Federal Reserve chair Jay Powell exacerbated the sell-off with a hawkish speech, in which he left open the possibility of 50 basis points rate increases in the coming months. All the same: the 10-year yield is only where it was in mid-2019. Welcome back, everyone.The worry is that returning to normal at the same time the Fed digs in for a fight against inflation might trigger a recession. That, at any rate, is the worry being flagged by the yield curve. Powell’s speech triggered a lively, 18-basis point rally in the two-year Treasury; the 10-year moved up by less than half as much; leaving the difference between the two at a measly 19bp. This left everyone staring grimly at a chart like this one:The blue line, the 10-year/2-year curve, is barrelling straight towards zero. In the past 40 years, every time that has happened, a recession has followed (as the shaded bits of the chart show). In fact, it’s worse than that: inverted 10/2 curves have preceded the last eight recessions and 10 out of the last 13 recessions, according to Bank of America. Why? David Kelly, chief strategist at JPMorgan Asset Management, sums it up pithily: An inverted yield curve doesn’t do much to the economy, but it’s a very bad sign. The only reason you’d buy a long-term bond at a lower yield than a short-term one was if you thought yields were going to fall . . . this usually happens when most people think the Fed has gone too far or will go too far.That’s the classic “Fed mistake”. Kelly frames the current case for a Fed mistake in terms of the historically low unemployment rate. The economy has to slow somewhat in the not-too-distant future, because at 3.8 per cent unemployment, “we’re out of workers”. “It’s hard to produce more when there is no one to produce it,” he says. This might happen just as the US central bank pushes rates to their peak, exaggerating the slowdown to the point of recession.So the Fed risks causing a recession and then having to rush to correct its mistake. John Higgins of Capital Economics lays out what the swerving policy pattern looks like: In the past, the 10-year yield itself fell significantly after the 10-year/2-year and 10-year/3-month spreads fell to, or below, zero . . . this coincided with a ‘bull steepening’ of the curve, as the Fed subsequently eased policy to counteract the onset of an economic downturn.But the Fed’s easing comes too late, markets take the first hit, and the economy follows. Here is Bank of America’s technical analyst Stephen Suttmeier on how it plays out:While the lead times vary and can be long, the typical pattern is that the 2s/10s yield curve inverts, the S&P 500 tops sometime after the curve inverts and the US economy goes into recession six to seven months after the S&P 500 peaks . . . post-inversion dips and last gasp rallies for the S&P 500 . . . often occur prior to the deeper recession-linked market corrections.Markets can do quite well in and around curve inversions, as this excellent table of sector performance from Strategas’ Ryan Grabinski highlights:

Tech leads heading into an inversion. Classic defensives such as utilities, healthcare and consumer staples do well afterwards, as investors gird for what is to come. But remember: when the recession does eventually hit, it’s just awful. Suttmeier calculates that during the average recession, the S&P 500 drops by a third over 13 months — enough to make anyone think twice about hanging on for that last bounce after the curve inverts. This is all pretty dreary, and explains why, if the 10/2 does invert, people will freak out a bit. There are, however, a few rays of sunshine visible, if you are willing to squint a bit. This first ray is the 10-year/3-month curve, which interest rate nerds like to point out has been shown to have superior recession-predicting power than the 10/2. Powell referred to this in his speech on Monday. Here he is, as quoted by Bloomberg speaking at the National Association for Business Economics:There’s good research by staff in the Federal Reserve system that really says to look at the short — the first 18 months — of the yield curve. That’s really what has 100 per cent of the explanatory power of the yield curve. It makes sense. Because if it’s inverted, that means the Fed’s going to cut, which means the economy is weak.Looking at the 10/3 month curve in the first chart up above, you will notice it is not nearly inverted (here is some of the research Powell is referring to), a very different message from the 10/2. Capital Economics contrasts the probability of recession predicted by the 10/2 and the 10/3 month, using a model similar to one the Fed itself uses:

So even if the 10/2 inverts, we might be able to dodge the recessionary bullet? Ethan Harris, of the Bank of America economics team, argues that we can. He thinks what the yield curve is telling us has changed over the years. Harris points out that long bond yields are made up of two parts: the sum of projected short-term rates, and then a premium on top of the sum, to compensate investors for locking up their money. But this latter part, the “term premium”, has been squeezed out of the market by central bank quantitative easing: The 10-year term premium has averaged about 1.5 per cent over the postwar period. Hence, in the past it took a very tight Fed and high fears of recession to trigger a yield curve inversion. Specifically, the market had to expect the future funds rate to average 150bp below the current funds rate to invert. The Fed only cuts that much in a recession. No wonder inversion was a good predictor of recessions.Today, the long end of the US yield curve is heavily distorted. The Fed has deliberately driven down the long end of the yield curve with its asset buying programme. At the same time, very low bond yields outside the US exert downward pressure on US yields. The upshot is that the term premium has now dropped into negative territory. The yield curve can now invert even if the market expects no rate cuts from the Fed.Here is Harris’ chart of the term premium. The change has been dramatic:

This makes perfect sense to me. But to say arguments like Powell’s and Harris’ are met with cynicism by crusty old Wall Streeters is an understatement. As our friend Ed Al-Hussainy of Columbia Threadneedle put it: Every time the 10/2 curve inverts, market participants come out with a long list of reasons why the curve’s slope tells us little about the current environment and should have no correlation with a recession. We all know what happens subsequently.For the past half century or so, what happens subsequently is a recession.One good readFintech has been the new hotness for awhile. But rising rates could make boring old banks cool again. More