Economy

Federal Reserve Chairman Jerome Powell insisted Wednesday that the central bank is not deliberately trying to cause a recession and that the economy is on solid footing.
“With all due respect to that comment, it’s just not consistent with the data on the ground,” said RBC economist Tom Porcelli.
In the aftermath of Wednesday’s decision to raise benchmark interest rates 75 basis points, Wall Street reaction coalesced around a few common themes.

Federal Reserve Chairman Jerome Powell’s insistence that the central bank is not deliberately trying to cause a recession and that the economy is on solid footing is exactly what someone in his position would be expected to say.
The trouble is, the Fed’s likely to get a recession anyway as data shows the economy is a far cry from stable.

Consequently, markets whipsawed Thursday, going from a positive reaction on Wednesday to Powell’s post-meeting comments to a rout as worries fester over what effect higher interest rates and tighter monetary policy will have on a fragile state of affairs.
“What the market is worried about, even before you get to a recession, is a policy mistake, that the Fed breaks something,” said Quincy Krosby, chief equity strategist at LPL Financial. “The market also is questioning his comment that the economy is strong.”

Federal Reserve Board Chairman Jerome Powell speaks to reporters after the Federal Reserve raised its target interest rate by three-quarters of a percentage point to stem a disruptive surge in inflation, during a news conference following a two-day meeting of the Federal Open Market Committee (FOMC) in Washington, U.S., June 15, 2022.
Elizabeth Frantz | Reuters

More specifically, two comments the Fed chair made stand out from the news conference: First, that the Fed is not trying to “induce a recession now. Let’s be clear about that.” Also: “There’s no sign of a broader slowdown that I can see in the economy.”
In fact, there are myriad signs of a slowdown.
On Thursday alone, real estate data for May showed a 14.4% monthly slowdown in housing starts at a time when there is a chronic shortage of homes. A Fed manufacturing reading showed continued contraction in the Philadelphia region. Weekly jobless claims were higher than expected as well.

That data piles onto other recent points: Inflation at 41-year highs, consumer confidence at historic lows, and retail spending falling amid dramatically higher prices.
“At minimum, growth was going to slow even before the Fed started pressing on the brakes,” said Tom Porcelli, chief U.S. economist at RBC Capital Markets. “The evidence on that is seemingly growing on a pretty consistent basis now … With all due respect to [Powell’s] comment, it’s just not consistent with the data on the ground.”

The problem with the solution

In the aftermath of Wednesday’s decision to raise benchmark interest rates 75 basis points, the biggest move in 28 years, Wall Street reaction to the hike, plus Powell’s comments, coalesced around a few common themes.
First, as Krosby said, “The market believes the Fed is going to expunge inflation pressures.”
However, “That’s the problem now. There’s a sense in the market that he could lead us straight towards the Fed breaking something, which is a policy error,” she added.
Second, there was a general lack of clarity about what happens next. Will the Fed hike 50 basis points or 75 basis points come July? Statements from Powell indicated that both are on the table, but his seemingly glass-half-full comments about the economy left more wiggle room than markets were comfortable with.
Finally, the chair contradicted himself on multiple occasions.
He noted that the Fed has little control of inflation inputs such as energy and food prices, but said the Fed will keep hiking until gas prices fall. He also said inflation expectations are well-anchored while conceding that the policy pivot away from a half percentage point hike to Wednesday’s move was influenced by a rising inflation outlook, as shown in Friday’s University of Michigan survey.
And then there was the economic question, with the chair insisting the economy is well positioned to handle higher rates while an Atlanta Fed gauge is showing flat economic growth in the second quarter after falling 1.5% in the first.

A ‘confused’ Fed chief

Taken together, Powell’s comments “came across as confused, lacking confidence, and raising macroeconomic and financial stability risks,” Bespoke Investment Group said in a client note.
The firm also took Powell to task for emphasizing food and fuel inflation, which are generally considered outside the Fed’s purview.
“Not only is the Fed targeting the wrong variable explicitly and casting aside forward guidance, they also appear to be far too optimistic about near-term growth; Powell’s description of consumer spending as ‘strong’ amidst ‘no sign of a broader slowdown in the economy’ adds to our concern that the Fed is behind the curve and hurtling towards a policy error as a result,” Bespoke said.
Powell affirmed that he and his fellow policymakers won’t be locked into a specific course of action but will be guided by data.
He might not like what he sees for a while, particularly if he focuses on headline inflation influences such as gas and groceries.
RBC’s Porcelli said those numbers likely will point to 9% annual increases for the rest of the summer, putting the Fed in a potential box if it uses those levels as policy triggers.
“They need an off ramp. They need to acknowledge the reality that they can’t control this stuff,” Porcelli said. “They need to have a better narrative. Short of him laying out a more cohesive strategy for how they’re going to deal with this, this lends itself to an idea that maybe they do make a more meaningful policy mistake.”

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Germany’s finance minister has challenged the European Central Bank over the spectre of bond market fragmentation in the eurozone, saying he did not see particular hazards in current market conditions. Christian Lindner told the ECB’s president in a closed-door session that he was not worried by recent moves in spreads between bond yields in the euro area, and that talking about fragmentation in the bloc’s financial markets could damage confidence, according to people familiar with the discussion. His words came after the ECB held an emergency meeting on Wednesday in which its governing council pledged to accelerate plans to create a “new anti-fragmentation instrument” — a reference to the widening gap in the cost of borrowing between more stable sovereigns such as Germany and more vulnerable member states such as Italy.The unscheduled ECB meeting came after bond yields of countries such as Italy and Spain shot up to their highest level for eight years in the wake of a decision by ECB rate-setters last Thursday to stop buying more bonds and start raising interest rates.Euro area finance ministers discussed the situation with Christine Lagarde, the ECB president, in a meeting in Luxembourg on Thursday. Not all politicians appeared convinced that recent movements were untoward, and Lindner suggested that the ECB’s hastily convened meeting risked stoking up market nerves. Speaking ahead of the meetings, Lindner said the euro area was “stable and robust” and he did not share concerns over fragmentation in the region. While spreads were rising among some member states, their current levels indicated “no need for any concern”. “Our task as finance ministers is to show that we are going back to sustainable public finances and leave the expansionary fiscal policy of the [coronavirus] pandemic behind,” he said, stressing the importance of tackling inflation. The German finance ministry did not respond to requests for comment. Sigrid Kaag, the Dutch finance minister, said after the meetings in Luxembourg that it was important to “project confidence and calm” and not to “express ourselves prematurely” when monitoring what was happening in the markets. Lagarde defended the ECB’s handling of the situation in the meeting, telling ministers, “we have to address fragmentation risk to enable the implementation of monetary policy throughout the euro area”, according to people familiar with the discussions. She added: “Fragmentation risk is a serious threat to our price stability mandate. Doubting our commitment would be a serious mistake.”Paschal Donohoe, president of the eurogroup, later said recent movements in financial markets were a response to the “understandable” decision by the ECB to begin the normalisation of monetary policy. Ministers, he added, were “absolutely united” in their view that the euro area would continue to be “very robust, continue to be resilient, even as those market conditions change in the way they are”. Lagarde talked tough on inflation last week by unveiling a plan to end eight years of negative interest rates and bond buying. But days later the ECB called an emergency meeting and said it would speed up work on a new policy tool to tackle turmoil in bond markets. The central bank has given little detail on how the new instrument might work, though most experts expect it to involve targeted purchases of the bonds of eurozone countries suffering from an unwarranted increase in their borrowing costs compared with others. Analysts expect the ECB to unveil the tool at its meeting on July 21.Italian central bank governor Ignazio Visco said on Thursday that its emergency meeting did not signal panic. But he also said that any increase in the Italian spread above 2 percentage points created “very serious problems” for the even transmission of monetary policy.The ECB worries that a bond market panic could push up borrowing costs of weaker countries to a level that drags them into a financial crisis and stops the central bank from bringing inflation down from its record level of 8.1 per cent to its target of 2 per cent.One explanation for what the ECB is trying to achieve came from board member Isabel Schnabel, who said in a speech shortly before Wednesday’s meeting that “there is no reason to assume that sovereign bond yields are identical”. 

“There are times, however, when yields rapidly diverge from economic fundamentals, causing financial instability and hence fragmentation”, which Schnabel defined as “a sudden break in the relationship between sovereign yields and fundamentals, giving rise to non-linear and destabilising dynamics”.Ministers attending the eurogroup meeting in Luxembourg separately agreed that they should work on strengthening the region’s common framework for handling bank crises and national deposit guarantee schemes. They did not, however, endorse a detailed work plan for completing the EU’s banking union project, as had been mooted. They instead agreed to review the project down the road, with a view to identifying “possible further measures” addressing outstanding elements of the plan. More

TORONTO (Reuters) -Canada’s main stock index slumped on Thursday to its lowest level in 14 months and its currency weakened as investors grew more worried that aggressive central bank interest rate hikes would trigger a recession, weighing on corporate earnings.The Toronto Stock Exchange’s S&P/TSX composite index ended down 3.1% at 19,004.06, its biggest drop since June 2020 and its lowest level since April 2021.The Canadian dollar was trading 0.3% lower at 1.2930 to the greenback, or 77.34 U.S. cents, after touching on Wednesday its weakest intraday level in more than one month at 1.2995.U.S. stock indexes also tumbled on Thursday as the Swiss National Bank and the Bank of England lifted interest rates following the Federal Reserve’s 75-basis-point hike on Wednesday, with central banks aiming to slow domestic activity in the face of soaring price pressures.”It is becoming increasingly necessary to see a decline in growth in order to stave off inflation,” said Joseph Abramson, co-chief investment officer at Northland Wealth Management.”People have been talking about recession but it’s not in market expectation yet if you look at the forward earnings growth. So that’s the next shoe to drop.”Broadbased declines on the TSX included a decline of 5.3% for the energy sector, extending its recent pullback, even as oil prices rose.U.S. crude oil futures settled nearly 2% higher at $117.58 a barrel after the United States announced new sanctions on Iran.Technology, which tends to be particularly sensitive to higher interest rates, fell 3.8% and heavily-weighted financials were 2.9% lower.One major outlier among individual stocks was LifeWorks Inc. Its shares jumped 66.4% after Canadian wireless carrier Telus (NYSE:TU) Corp agreed to buy the human resources services company in a C$2.9 billion ($2.2 billion) deal.Domestic data showed that Canada’s wholesale trade decreased by 0.5% in April from March, weighed by a drop in fertilizer imports from Russia.Canadian government bond yields were mixed across the curve. The 10-year touched its highest since May 2010 at 3.664% before pulling back to 3.409%, down 5.1 basis points on the day. More

The EU launched new legal proceedings against Britain on Wednesday after London published its new legislation, with both moves expected to take over a year to come into force.The EU could eventually review terms of the free trade deal it agreed with Britain. It has already thrown doubt on its role within the $99 billion Horizon Europe research programme.”We have to keep all options on the table,” Sefcovic, the European Commission Vice President who oversees EU relations with Britain, told Sky News.He said the two sides needed to continue talking to hammer out a solution to improve trade friction on goods moving between Britain and Northern Ireland, and that a unilateral approach by London would only sow uncertainty. London has proposed scrapping some checks on goods from the rest of the United Kingdom arriving in the British province and challenged the role of the European Court of Justice to decide on parts of the post-Brexit arrangement agreed by the EU and Britain.Sefcovic has said the move is illegal. The British province is in the EU single market for goods, meaning imports from the rest of the United Kingdom are subject to customs declarations and some checks on their arrival. The arrangement was set to avoid reinstating border controls between Northern Ireland and EU member Ireland, which are seen as contravening the spirit of the 1998 Good Friday peace agreement. More

(Reuters) – Federal Reserve policymakers are less confident than at any time since the height of the pandemic about what will happen with the economy, data published alongside their forecasts and the Fed’s hefty three-quarters-of-a-point rate hike this week show. The last time they were this worried they could be underestimating the coming deterioration in the labor market was in the depths of the Great Recession. But they are even more worried they are overestimating a hoped-for decline in inflation, documents https://www.federalreserve.gov/monetarypolicy/fomcprojtabl20220615.htm charting confidence and risks seen in their forecasts show. The data helps underscore why policymakers are so focused on raising interest rates fast even if doing so causes a bigger dent to growth and unemployment than previously hoped, and why it is clarity on the inflation outlook that will drive policy.”It is clear that path of inflation continues to be the key consideration in how quickly the Fed gets to, and how far it moves past, the range of neutral in order to bring inflation down ‘clearly and convincingly,'” wrote Morgan Stanley (NYSE:MS) economists, referring to the standard Fed Chair Jerome Powell has set for declaring victory on price pressures and slowing up on rate hikes.All 18 Fed policymakers are more-than-usually uncertain about their inflation and economic growth forecasts, and all but one note the same about their unemployment rate projections, the data shows. The same documents also show that no policymaker believes their forecasts are too pessimistic, and most believe they could be underestimating the risks.Graphic: Fed uncertainty on the rise- https://graphics.reuters.com/USA-FED/zdpxoedzjvx/chart.pngThat means that though Fed forecasts embody the “softish” landing to which they aspire – inflation dropping to 2.2% by 2024, with the economy motoring along at 1.9% and unemployment rising just half a point to 4.1% – they are worried things could be worse, particularly for inflation. It also means, as with this week’s last-minute decision to deliver a hefty 75 basis point move after worse-than-expected inflation readings, that what Powell calls this “extraordinarily challenging and uncertain time” is sure to leave investors hanging.RAPID PACE OF RATE INCREASESUnquestionably, interest rates will rise, and rise fast: 17 of the 18 Fed policymakers see the target rate at least at 3.6% by next year, two full percentage points higher than today, and five see it above 4%. But is that where they will end up? Not even Fed Chair Powell knows. “I think we’ll know when we get there,” Powell told reporters Wednesday. “With the FOMC looking to remain nimble amid heightened uncertainty, guidance set out by communications should not be regarded as written in stone,” Barclays (LON:BARC) economists said in a note to clients following the this week’s Federal Open Market Committee meeting.Graphic: Is the Fed too optimistic?- https://graphics.reuters.com/USA-FED/egpbkgydmvq/chart.pngIt’s a warning that investors may need to keep in mind as Powell’s colleagues start Friday to make their first public statements after this week’s policy meeting, and when Powell gives testimony next week before lawmakers on Capitol Hill. More

LUXEMBOURG (Reuters) -The head of the European Central Bank briefed euro zone finance ministers on Thursday on a planned tool to fight high spreads between bond yields of the bloc’s nations, but remained vague about how and when the new scheme may kick in, sources said.The ECB had committed on Wednesday to offering fresh support to the currency bloc’s indebted southern countries, in a bid to temper a market rout that threatened a repeat of the debt crisis that almost brought down the single currency a decade ago.On Thursday, Christine Lagarde explained to ministers in a closed-door meeting the rationale for the new tool, which was still being designed by the bank, sources familiar with the discussions said.She told ministers that the goal of the bank’s new tool against so-called “fragmentation” was not to close the spreads on bond yields but to bring them back to normal levels, two officials said.It was not clear when the new tool would be ready and Lagarde offered no timing to ministers, one of the sources said.Earlier on Thursday, ECB Vice President Luis de Guindos told a conference in Milan the bank would “rapidly” implement the scheme.Lagarde told ministers that the tool, once ready, might kick in when spreads increased beyond certain thresholds, but did not give any precise figure about those thresholds, the two officials said.The tool could also be used when spreads increased too fast within a short period of time, the officials added.At a news conference after the meeting, the chair of the Eurogroup of euro zone finance ministers, Paschal Donohoe, said ministers did not discuss any conditions that should be tied to the launch of the new tool.One of the officials said Lagarde told the meeting that fragmentation was a “serious” risk that would be addressed, and warned that the bank’s commitment should not be put into question.Fragmentation refers to a divergence in the borrowing costs of euro zone members.”We have to address fragmentation risk to enable the implementation of monetary policy throughout the euro area. Fragmentation risk is a serious threat to our price stability mandate,” Lagarde told ministers, according to the source.”Doubting our commitment would be a serious mistake,” Lagarde said, according to the source. More

Russia’s annual investment conference in St Petersburg was created by president Vladimir Putin to showcase the country’s businesses and lure global investors to Russia. But with Russia mired in an economic crisis sparked by western sanctions, this year’s forum looks more like a morale-boosting exercise.“The events that are happening now, the way the state, business and people are reacting to economic events, shows we’ve got through it, we’re a strong country,” Maxim Oreshkin, Putin’s economic adviser, told a panel discussion on Thursday. Others were even more upbeat. “This is the best economic year for Russia since the collapse of the Soviet Union,” Kremlin-linked businessman Konstantin Malofeyev insisted.Despite the bold front, the conference, which runs until Saturday, was noticeably more muted than the previous affairs. Then, oligarchs and state-run companies signed major business deals and held lavish parties for a host of global industry and political leaders. This year, western delegates and their allies have largely stayed away as international tensions escalate amid the Ukraine war.

“Every year I would sign something with the Italians or the Japanese or whomever. Now there’s nothing to sign and nobody to sign it with,” said an oligarch who is under western sanctions.Instead, organisers have turned to allies such as China’s Xi Jinping and Egypt’s Abdel-Fattah al-Sisi for Friday’s keynote event. But both will send video messages instead of taking the stage alongside Putin. The Russian leader will speak alongside the leaders of the Donetsk and Luhansk People’s Republics, the Moscow-backed Ukrainian separatist enclaves.Other foreign dignitaries attending include the presidents of Kazakhstan and Armenia, the prime minister of the Central African Republic and officials from Cuba, Venezuela and Myanmar, as well as representatives of Afghanistan’s ruling Taliban.Officials at Thursday’s main economics panel did not mention Ukraine or the war, instead outlining ways Russia could muddle through the economic fallout.Western sanctions have cut off capital markets access for most Russian companies, battered import supply chains, prompted an exodus of foreign businesses from the country and forced the government to limit Russians’ access to hard currency. Addressing Thursday’s main economic session, central bank governor Elvira Nabiullina warned that “external conditions have changed for a long time, if not forever”, calling on businesses to abandon their export-focused approach and concentrate on the domestic market.Russia’s central bank chief Elvira Nabiullina urged businesses to abandon their export-focused approach and focus on the domestic market © Olga Maltseva/AFP/Getty ImagesMeanwhile, Russia’s oligarchs are reluctant to criticise Putin’s invasion for fear of domestic reprisals and are keeping a low profile. Some have stayed away entirely, including sanctioned industrial magnate Oleg Deripaska, who last week posted a video online of a cherry orchard and wrote that it was “time to collect the harvest” instead. Others tried to attend the forum incognito and asked organisers not to print their names on their badges. “There aren’t that many people, noticeably fewer this year. Everyone is going up to everyone and asking: ‘How are you doing under sanctions?’” said an executive at a leading Russian industrial firm. “It’s a sad sight.”Western executives who did attend said they were worried the sanctions were hurting the west more than Russia by encouraging countries in the global south to do business with Moscow on improved terms, even as the US and Europe struggled with spiralling inflation as energy prices soared because of the war. “If you’re losing an export market and you’re going to be paying 30 per cent more for energy, and energy’s half the unit manufacturing costs of your product, you know, you’re going to get screwed,” a western businessman attending the forum said. “Your Chinese competitor is getting a 40 per cent discount on energy. That’s a shift in the terms of trade.”Others said they feared leaving money behind amid the corporate stampede to exit Russia in the weeks after the Ukraine invasion. “Why should I hand over a billion-turnover business to Russia as a gift?” Vincenzo Trani, president of the Italian-Russian chamber of commerce, told a panel while discussing UniCredit’s plans to divest its Russian subsidiary. “Is this definitely in Italy’s interests?”Russia has vowed to find new international partners even if more western companies leave.

Sergei Chemezov, a close associate of Putin’s who leads the Rostec state industrial conglomerate, told Russian newspaper RBC: “The west’s treachery isn’t a reason to slam the windows and doors shut. We will go [our] separate ways with the proponents of sanctions, but we have partners in other regions of the world who are behaving in a consistent and principled manner.” Malofeyev said the economic pain to Russia caused by western sanctions was outweighed by their effects on the west.“Western businesses and countries are suffering from rising energy prices,” he said. “And Russian businesses are winning because they’re taking over market niches they never could have dreamed of,” he added. “The only shame is [officials] waited for the west to cut them off instead of doing it themselves first.”However, not all foreign delegates shared Russia’s confidence, with one senior western businessman saying: “How convincing is it when you replaced the biggest global corporates with a delegation from the Taliban?” Additional reporting by Polina Ivanova in London More

A storm is brewing in emerging market debt. The Federal Reserve’s aggressive campaign against inflation has boosted the dollar. Add disruptions to the energy and food markets caused by the war in Ukraine, and you have the biggest set of challenges to developing economies for years. The yield spread between the JPMorgan EMBI Global index — a benchmark index of dollar-denominated EM sovereign bonds — and safe US Treasuries has surged in recent days. Over the past year, the EMBI index has risen from about 300 to more than 400 basis points, according to Bloomberg data.Sri Lanka offers a prime example of how external shocks can cripple a country. Its stock market has plummeted 64 per cent in dollar terms this year. Public anger over rising food and energy prices triggered the collapse of the government last month and pushed the south Asian nation to default on its debt. It is unlikely to be the last. The World Bank reckons almost 60 per cent of the lowest-income countries were in debt distress or at high risk of it before Russia’s invasion of Ukraine this year. EMs face more than $5.5tn of bond and loan redemptions in 2022, according to the Institute of International Finance. The most vulnerable countries have high debt and limited foreign exchange reserves. Egypt, Tunisia and Pakistan are among those in talks with the IMF for rescue packages. In sub-Saharan Africa, Ghana, Kenya, South Africa and Ethiopia stand out as being high risk. In the past, EMs could count on cheap money created by loose monetary policies in the west to paper over problems. No longer. Rising interest rates in the developed world have curbed foreign investors’ risk appetite. At 18 per cent, foreign participation in local bond markets is at its lowest point since 2009, the IIF noted.US retail investors are shunning EM debt. More than $38bn has flowed out of specialist mutual and exchange traded bond funds since the start of the year, according to EPFR data. The exodus will continue. More