Economy

Georgieva told Reuters on the sidelines of a G7 finance ministers and central bank governors meeting in Germany that it is getting harder for central banks to bring down inflation without causing recessions, due to mounting pressures on energy and food prices from Russia’s war in Ukraine, China’s zero-COVID policies that have slashed manufacturing with lockdowns, and the need to reorder supply chains to make them more resilient.”I think what we need to start getting more comfortable with is, that may not be the last shock,” she said, noting that she stopped viewing inflation as a “transitory” one time shock when the Omicron COVID-19 outbreak took hold late last year. More

Georgieva said on the sidelines of a G7 finance ministers’ and central bank governors’ meeting that the main issue for the funding would be its timing – avoiding delays that may push the country into monetary financing, where its central bank effectively funds the government. “You know, what happens if a country has to go into monetary financing. A war brings hyperinflation and then terrible, terrible, damage – which we think we can avoid,” Georgieva said. More

With inflation soaring to a record high 7.4%, the ECB confirmed plans at the meeting to end a bond purchase scheme in the third quarter but maintained an otherwise non-committal tone, avoiding any other pledges, including on interest rates, which remain deeply negative.The accounts showed consensus that ultra easy policy must now be reversed but there was divergence on how quickly and how far the bank should go. “Some members viewed it as important to act without undue delay,” the ECB accounts showed. “A risk was also seen that, if the Governing Council did not signal a faster policy normalisation process, inflation expectations would continue to rise.””Net asset purchases should be ended as soon as possible, opening the possibility for a first interest rate hike shortly after,” the ECB added. “The view was expressed that the criteria for interest rate hikes were already clearly met.”Nearly all policymakers who have spoken publicly since the meeting are now backing an interest rate increase in July, the ECB’s first hike in over a decade, and many are pushing to lift its deposit rate into positive territory this year. It is currently at minus 0.5%.Others in the meeting urged the ECB to be cautious in tightening policy and move only gradually. Policymakers have often said that normalisation means raising rates to the “neutral” level, where the ECB is nether stimulating, nor holding back growth.But the neutral rate is undefined and unobservable, policymakers say. The nominal natural rate is likely to be between 1% and 1.5%, suggesting that once adjusted for inflation, it remains negative, analysts estimate.”Estimates suggested that the natural real interest rate was still negative,” the accounts showed. “The expected path of the nominal key ECB interest rates would approach a neutral level only at a very late stage of the policy normalisation process.”In the next move, the ECB will decide at its June 9 meeting to end bond purchases around mid-year and will likely provide unmistakable hints that a rate hike will follow at the July meeting.Markets currently price 107 basis points of rate hikes for the rest of the year, or a little more than a quarter percent increase at each policy meeting from July onwards. More

COLOMBO (Reuters) -Sri Lanka’s central bank has secured foreign exchange to pay for fuel and cooking gas shipments that will ease crippling shortages, its governor said on Thursday, but police fired tear gas and water canon to push back student protesters.Most of Sri Lanka’s petrol stations have run dry as the island nation battles its most devastating economic crisis since independence in 1948. At some pumps in the commercial capital, Colombo, dozens of people stood in lines holding plastic jerry cans, as troops in combat gear and armed with assault rifles patrolled the streets. Traffic was extremely light.Residents said most people were staying at home because of the lack of transport.Hundreds of students carrying black flags marched on Colombo’s central Fort area, chanting slogans against the government. Police fired repeated rounds of tear gas and water canon to push them back, according to a Reuters witness.Central bank Governor P. Nandalal Weerasinghe told a news conference adequate dollars had been released to pay for fuel and cooking gas shipments, utilising in part $130 million received from the World Bank and remittances from Sri Lankans working overseas.He was speaking after the central bank held interest rates steady at a policy meeting, citing a massive 7 percentage point increase in April that it said was working its way through the system.The country was more politically and economically stable, Weerasinghe said, adding that he would stay on in his post. He told reporters on May 11 he would resign in two weeks in the absence of political stability as any steps the bank took to address the economic crisis would not be successful amid turmoil.Opposition parliamentarian Ranil Wickremesinghe was named prime minister last week and he has made four cabinet appointments. However, he has yet to name a finance minister.Inflation could rise further to a staggering 40% in the next couple of months but it was being driven largely by supply-side pressures and measures by the bank and government were already reining in demand-side inflation, the central bank governor added.Inflation hit 29.8% in April with food prices up 46.6% year-on-year.Sri Lanka’s economic crisis has come from the confluence of the COVID-19 pandemic battering the tourism-reliant economy, rising oil prices and populist tax cuts by the government of President Gotabaya Rajapaksa and his brother, Mahinda, who resigned as prime minister last week.Other factors have included heavily subsidised domestic prices of fuel and a decision to ban the import of chemical fertilisers, which devastated the agriculture sector.TEST SUPPORTSri Lanka is also officially now in default on its sovereign debt as a so-called grace period to make some already-overdue bond interest payments expired on Wednesday.Weerasinghe said plans for a debt restructuring were almost finalised and he would be submitting a proposal to the cabinet soon.”We are in pre-emptive default,” he said. “Our position is very clear, until there is a debt restructure, we cannot repay.” The central bank said energy and utility prices needed to be urgently revised, and analysts said the prime minister’s ability to push reforms through parliament and overcome public anger would be crucial.”They need to bring in critical reforms and other measures to parliament to test their support and see if they really have consensus and stability,” said Shehan Cooray, head of research at Acuity Stockbrokers in Colombo.He added, however, that the situation had taken a turn for the better. “Given that there was a point where it was even difficult to find a governor, the fact that he has decided to remain is a good thing,” Cooray said.Wickremesinghe, speaking in parliament, said the government was working to release six fuel shipments that had arrived at Colombo’s port.”There are two petrol shipments among them but this will not end the shortages,” he said, adding that supplies had been locked in only until mid-June. “Our aim now is to reduce the lines and find a way to start a fuel reserve so even if a couple of shipments are missed there is fuel available.”However, there is considerable opposition to him. Protesters agitating for the removal of the Rajapaksa brothers say he is their stooge. More

The ECB has long battled the industry’s biggest players, who are reluctant to relocate activities after Brexit, despite explicit demands by the ECB, which supervises the bloc’s biggest financial institutions.In a sign that patience is wearing thin, Enria said the ECB will issue “binding decisions” to key investment firms, prescribing action on a case-by-case basis.”We want to ensure that incoming legal entities have onshore governance and risk management arrangements that are commensurate, from a prudential perspective, with the risk they originate,” Enria said in a blog post. “The extent of the actual relocation and specific booking configuration will depend on the current set-up of each bank.”Banks could be required to appoint a head of trading desk within the euro area legal entity or may be asked to ensure the desk has the adequate infrastructure and number and seniority of traders to manage risk locally, the ECB said. They could also be asked to establish a solid governance and internal control framework of remote booking practices and to ensure limited reliance on intragroup hedging.Of the trading desks assessed by the ECB at seven key institutions, around 70% still used a back-to-back booking model, a frowned upon practice in which a firm transfers risks to a third party or to another intragroup entity which then hedges it.It also concluded that 20% of desks were organised as split desks, in which a duplicate version of the primary trading desk located offshore is established within the euro area legal entity to manage the part of the risk originated there.These practices remove risk management expertise from the euro zone entity, leaving the local unit vulnerable in case of market turbulence. “It is our duty to protect the depositors and other creditors of the local legal entity, prevent the disruption of banking services and safeguard broader financial stability in our area of jurisdiction,” Enria said. More

LONDON (Reuters) – As the European Central Bank races towards the stimulus exit to tame record-high inflation, angst about whether it can contain stress in weaker economies is creeping back into corners of bond markets.For sure, indicators of stress are comfortably below peaks seen at the height of the 2020 COVID-19 crisis, and nowhere near levels of the 2011-2012 euro zone debt crisis. Cohesion is stronger after the pandemic and war in Ukraine, while an 800 billion euro recovery fund supports the bloc and France last month re-elected a pro-European president.Yet with inflation at 7.5%, ECB bond-buying stimulus will end soon — challenging weaker southern European states and putting fragmentation risks back in focus as their government borrowing costs versus safer Germany shoot higher.”It is something I worry about,” said DZ Bank rates strategist Christian Lenk. “The million dollar question is where are bond spreads too wide that the ECB intervenes.”Here’s a look at what stress indicators show. 1/ CANARY, COALMINEIf the premium investors demand to hold bonds from lower-rated states rises too far above top-rated Germany, the ECB’s ability to transmit monetary policy effectively is challenged. So-called fragmentation risk could heighten economic instability.At 200 basis points (bps), highly-indebted Italy’s 10-year bond yield gap over Germany is below peaks of more than 300 bps hit in March 2020 and 2018, when a new populist Italian government clashed with the European Union over budget policy. But it is near the widest levels since May 2020 after widening 65 bps this year. Talk of ECB measures to contain spreads has grown; ING says markets could test the ECB’s resolve by pushing Italy’s spread to 250 bps.Graphic:Italy’s 10-year bond yield gap over Germany- https://fingfx.thomsonreuters.com/gfx/mkt/byprjdlrgpe/BTPspread1805.PNGA blowout in this spread prompted the ECB to launch its emergency stimulus scheme in March 2020, as a pandemic-induced financial rout raised fears about the currency bloc’s viability.2/ INSURANCE POLICYThe cost of insuring against a debt default in southern Europe has risen recently to the highest since 2020, although credit default swaps (CDS) sit below previous peaks.Graphic:CDS in southern Europe creeping higher again- https://fingfx.thomsonreuters.com/gfx/mkt/akvezrqmkpr/CDS1805.PNGAnother gauge of fragmentation risk is the spread between CDS contracts issued under trade body International Swaps and Derivatives Association’s (ISDA) 2003 definition and those issued under its 2014 guidelines. The latter includes guidance on redenomination risk and carries a premium. The gap between two such Italian CDS contracts is roughly 64 bps, around the widest since April 2020, Rabobank said.Rabobank’s head of rates strategy Richard McGuire notes the spread was double current levels in 2018. “From an historical perspective this gives investors cause to be alert rather than alarmed,” he added. Graphic:Italy 2003 CDS vs Italy 2014 CDS- https://fingfx.thomsonreuters.com/gfx/mkt/byvrjdlkgve/ITCDSVSCDS.PNG3/ LIFE AFTER 2013 How investors trade bonds issued before and after 2013 is also worth watching.That year, regulators said European government bond contracts should contain collective action clauses (CACs), meaning majority bondholder approval is needed for a restructuring including a change in the currency of payment. UniCredit estimates that roughly 415 billion euros of Italian bonds are not covered by CACs.An Italian bond issued in 2008, before the CAC ruling and maturing next year, has risen 72 bps this year. A one-year Italian bond issued in 2022 and maturing 2023, is up a similar amount. If the 2022 bond outperforms its non-CAC peer, that would suggest fragmentation worries are returning. More

WASHINGTON (Reuters) – Michael Barr, the second person nominated by Democratic President Joe Biden to be the Federal Reserve’s Wall Street cop, will appear before the Senate on Thursday to make the case for why he should take on the central bank’s sweeping regulatory portfolio.Barr, a former Treasury Department senior official under President Barack Obama, looks to be well-positioned to win Senate confirmation after receiving early support from key moderates and progressive Democrats in the evenly divided chamber. He will testify before the Senate Banking Committee at 10 a.m. ET (1400 GMT).In his prepared testimony, Barr said he would work to ensure the financial system is resilient, operates fairly, and allows room for innovation with “clear rules of the road.”He is in a stronger position than Sarah Bloom Raskin, Biden’s first nominee for Fed supervision vice chair, who withdrew her nomination after Democrat Joe Manchin refused to back her.Barr, currently a law professor, has already drawn support from moderate Democrats, including Manchin, and progressives anxious to ramp up scrutiny of Wall Street after what they say was regulatory easing under Republicans. At Treasury, Barr was a central figure in the drafting of the 2010 Dodd-Frank financial reform law, which established a range of safeguards following the 2008 financial crisis.”This is going to be a far easier, simpler and faster hearing than we saw last time,” said Isaac Boltansky, director of policy research for brokerage BTIG, adding that Barr should be confirmed by August.Barr would fill the remaining vacancy on the Fed board and take on a broad agenda that is likely to include revisiting rules that were eased under his predecessor, Randal Quarles, and taking steps to address climate change risk, fintechs and cryptocurrencies.Raskin withdrew her nomination after Manchin, who represents coal-producing West Virginia, opposed her because she had called for financial regulators to more aggressively police climate change risks. The decision effectively ended her nomination. But Manchin announced Tuesday he would back Barr. In the progressive wing, Elizabeth Warren, a prominent big-bank critic, said in April that she supported Barr. Progressives have changed their tune on Barr after opposing him last year for comptroller of the currency, another top regulatory post. They wanted a more liberal pick, saying his work in the private sector, as well as his resistance to some stricter Dodd-Frank proposals, were marks against him.However, after progressives’ preferred candidates, including Raskin and Saule Omarova, a previous Biden pick for comptroller of the currency, flopped amid resistance from moderate Democrats, they are now eager to simply fill key posts.The Fed’s regulatory work, for example, has slowed with no fulltime supervision chief. “The Fed urgently needs a vice chair on board who can guard against risks to financial stability,” said Carter Dougherty, a spokesman for advocacy group Americans for Financial Reform. If confirmed, Barr will also join 18 other Fed policymakers in setting the course of monetary policy as the central bank battles to bring down 40-year-high inflation. Barr’s views on monetary policy are not well known, but so far policymakers have been unanimous in pivoting to a more aggressive stance as price pressures have persisted. Barr noted in his prepared testimony that he would be “strongly committed” to bringing down inflation if confirmed. More

An internal staff memo from the desk of Greg Peters, co-chief investment officer of the $890bn asset manager PGIM Fixed Income, reaches our inbox. It makes some timely points so we’re sharing the highlights. Peters has been around the block and knows his stuff. Despite being known internally for somewhat jazzy jackets, he has helped manage some of PGIM’s biggest strategies since joining in 2014 and before that led Morgan Stanley’s fixed income research. It’s fair to say that his mood doesn’t currently match the brightness of his blazers. Here’s the main message of the memo, with our emphasis. I want to take this moment to plainly and clearly reiterate my thoughts on the market and risk opportunities. I continue to assert and thus wish to restate that I believe it is entirely too early to dip your toe into the risk waters. The simple fact is that valuations are decidedly average and the tightening into a recession game hasn’t even yet begun in earnest. The persistent inflation backdrop increases my confidence in a central bank induced recession. Frankly, I don’t see another way out. There’s some rubbernecking around crypto “getting smoked” and how it could escalate into a “full fledged meltdown” for the space, as well as a prediction that sterling is going to nosedive because “the unsteady BOE, fraught politics and Brexit are rearing their individual and collective ugly heads”.But the central message of Peters’ memo is on his view that central banks globally are willing to sacrifice economic growth to combat inflationary pressures. And even setting aside how fiercely (or not) central banks will react to inflation, the economic impact of price rises is starting to become a major worry. Walmart’s woeful results on Tuesday provided one of the strongest hints yet that some companies are struggling to pass cost pressures on to consumers. That raises broader worries about both corporate profit margins and the health of American spenders — two pretty important pillars of financial market returns in recent years.Walmart’s share puke — now down 18 per cent over the past two sessions — has naturally hogged headlines. But on Wednesday, Target also warned that rising costs were eating into profits, hammering home that this is potentially a broader problem. The news sent its shares down nearly 25 per cent, while US consumer staples stocks, supposedly one of the steadiest, most defensive corners of markets, went down a whopping 6.4 per cent. That dragged the S&P 500 down another 4 per cent on Wednesday to take its decline to 17.7 per cent this year. The Nasdaq slumped over 5 per cent to extend its 2022 loss to almost 27 per cent. The breadth of the sell-off reeks of recession fear, triggered by consumer-hurting inflation. This has morphed from a spec-tech wreck, to a broad tech rout, and now to an unnervingly broad market decline. Here’s more from Peters’ memo, with FTAV’s emphasis:In my mind, CBs have worked too hard for too long to gain inflation fighter status that they are not going to casually throw away that hard earned credibility currency. I continue to look at the early 1980s as a guide where the Fed cranked up interest rates by 10% percentage points; killed the economy which prompted inflation to fall, which in turn allowed for a multiple decade backdrop of low inflation and a reasonably prosperous economy. Perhaps, the Fed wont hit it as hard as the early 1980s given the different secular factors that they face in the years and decade ahead — but they are still going to pump the economic brakes enough to turn growth negative. In my simple mind, it is an inevitable outcome and nothing more than the uncomfortable math of monetary policy.  So yes, I have a very high probability of a recession over the next 12-24 months. However, Peters reckons implications for markets is a bit more complex. Stocks have sold off and corporate bond spreads widened significantly, making valuations a bit less wild. But Peters still doesn’t think they are nearly compelling enough yet to start dip-buying, given the risks of recessions. I am very sure that if the economy hits a recession, spreads will widen. Actually, that recession/spread relationship might be the only universal truth that I can accept as true. Consequently, given that we are only at the average in spreads AND I think recession risk is elevated, I don’t see a rational argument to add nonsystematic spread risk to the portfolios. . . . The next months and quarters are highly likely to be volatile with violent moves in spreads both wider and tighter. Unless spreads blow out quickly over the near term, I would look to use the volatility to reduce risk in spread tightening (and thus better liquidity conditions) and not buy the dip. Buy the dip is a failed formula with CBs fighting inflation as a backdrop. Only one thing would make Peters change his mind, and that is a clear sign that inflation has peaked, which would encourage central banks to back off. This would reduce the risk of a policy mistake and/or a CB led recession. I know this sounds overly simplistic, but inflation is what matters most and driving central banks, politics and consumer psyche. All said, I believe that duration and interest rates are going to be a much cleaner play around this central bank inflation fighting into a recession narrative. At some point, although not yet as I still see another 25bp or so in 10yr yields, the rate market is going to be the first to react as I expect to see duration rally (both front-end and the belly) well before spreads. You got a preview sense of that yesterday, and past few days, but I don’t think it will hold with the Fed continuing to move thus continuing to unhinge the belly. That said, FTAV recalls Paul Samuelson’s old 1966 quip that the stock market had predicted nine of the past five recessions. Is this just another classic markets freakout that will pass? More