Economy

OTTAWA (Reuters) – The Bank of Canada is poised to hike its key overnight interest rate for the first time in three years on Wednesday, kicking off a string of increases geared at curbing hot inflation even as Russia’s invasion of Ukraine adds to global uncertainty.All 25 analysts polled by Reuters expect Canada’s central bank to increase rates to 0.50% from the current record low 0.25% when the decision is released at 10:00 a.m. ET (1500 GMT). It last hiked rates in October 2018, then slashed three times in March 2020 as the COVID-19 pandemic took hold. In January, the Bank surprised markets by holding rates even as it said the economy had broadly recovered, taking the more measured approach of formally casting off its commitment to keep rates low and clearly signaling increases were coming.”The Bank of Canada has been very explicit with what we should expect. They’ve been saying that rates are headed higher,” said Royce Mendes, head of macro strategy at Desjardins Group. He expects back-to-back hikes in March and April.The Ukraine conflict is unlikely to derail that, Mendes said, particularly with Canada’s economic growth clocking in stronger than expected and rising oil prices set to push already hot inflation above forecast in the first quarter.”This is coming at a time when the Bank of Canada is already concerned about inflation expectations being on shaky ground,” said Mendes.Canada’s inflation rate hit 5.1% in January, its highest level since September 1991 and its 10th consecutive month above the Bank of Canada’s 1%-to-3% control range. Deputy Governor Tim Lane said last month the Bank would be “forceful” in its moves.That had some investors betting the central bank would start with an initial 50-basis-point increase. But with Russia’s attack on Ukraine, markets now see 25 bps this month, with up to six hikes in 2022 back to a pre-pandemic 1.75%. [BOCWATCH]Where the Bank of Canada could surprise markets is with its balance sheet. In January, the central bank said it would keep its holdings of Government of Canada bonds stable “at least until” it began to increase interest rates.But some economists think it has already signaled an earlier start. Stephen Brown of Capital Economics pointed to Deputy Governor Lane saying last month that quantitative tightening would begin “as soon as we’re starting to raise rates” and that the bank would have more to say at its March decision.”Maybe it was just a slip of a tongue,” said Brown. “It would just surprise me that he said that, if the bank hadn’t exactly already discussed something along those lines.” More

MOSCOW (Reuters) – Russia’s central bank said on Wednesday it was temporarily suspending transfers by foreign legal entities and individuals from several countries to accounts abroad.The bank said it was also temporarily limiting transfers to some countries at the equivalent of no more than $5,000 a month for non-residents who did not have an account. More

“Ships sailing under an aggressor flag will have no place in the Klaipeda port,” Lithuanian Transport Minister Marius Skuodis told BNS, referring to the country’s main port.The ban would affect ships sailing under Russian flag or with any other connections to Russia, its people or companies, BNS reported. More

MOSCOW (Reuters) – Russia’s Central Bank Governor Elvira Nabiullina said Russia’s economy had come up against an extreme situation, something she said they had all hoped would not happen, in an video address to the bank’s staff aired on Wednesday.Nabiullina said the bank was doing everything possible to help Russia’s financial system and central bank cope with any shocks. More

Moscow is blocking foreign investors, who hold tens of billions of dollars worth of Russian stocks and bonds, from exiting after its invasion of Ukraine triggered a wave of economic sanctions and a haemorrhage of assets.The Bank of Russia said on Wednesday it had banned coupon payments for foreign investors holding rouble-denominated sovereign debt, known as OFZs, and Russian companies were also barred from paying dividends to overseas shareholders. It did not specify how long the curbs, which don’t apply to local investors, would last.”They have no problem with paying OFZs because they can print roubles, but they seem to have decided that foreigners won’t get the money,” said Paul McNamara, investment director at asset manager GAM Investments.”We can argue the toss about whether that is a default or not, but it doesn’t really matter because this stuff is under Russian law so they can pay them if they want to or not pay them if they can’t.”Russia was due to pay a 6.5% coupon on Wednesday on an OFZ due to mature in February 2024 while the next payment on hard currency debt, coupons on two Eurobonds, is due on March 16.Major asset managers such as Vanguard, BlackRock (NYSE:BLK), Ashmore and Fidelity held the February 2024 bond, according to data from the Refinitiv eMaxx database, based on filings for the end of January.Russian banks and companies had $391 billion in outstanding external debt as of Oct 1, according to Dmitry Polevoy, head of investment at Locko-Invest. “Issuers are eligible to take decisions on paying dividends and making payments on other securities,” the central bank said in a statement on Wednesday. “But actual payments … towards foreign clients will not be made. This applies to OFZs as well.”The National Settlement Depositary (NSD), the Russian system for overseeing the sale of securities, said it was limiting payment options on Russian securities for foreign individuals and companies, as well as a right to transfer such assets, in line with a central bank request.The world’s biggest settlement systems, Euroclear and Clearstream, are no longer accepting Russian assets, effectively shutting off an exit route for overseas investors.Belgium-based Euroclear said in a note on Tuesday that the NSD had blocked its accounts as a result of the central bank measures.”To the extent legally permissible, you should wire out any remaining long balances in roubles as soon as possible,” it said.Clearstream also informed its customers on Tuesday evening that the NSD has blocked all securities held on Clearstream Banking’s FNH Account until further notice.Foreigners held around 3 trillion roubles ($28 billion) worth of OFZs out of a total market of 15.5 trillion roubles, according to central bank data, and nearly $20 billion, or 51%, in sovereign Eurobonds. Foreigners held 19.7 trillion roubles in Russian shares as of July, 1, or around a third of the total market capitalisation at that time. Moscow has kept the stock market shut this week to help stem losses.In a matter of weeks, Russia has gone from a lucrative, oil-rich investment destination to a financial pariah. The rouble has plunged to record lows, and in London, depository receipts for Russia’s biggest bank Sberbank and gas giant Gazprom (MCX:GAZP), once Moscow’s top blue chips, have lost over 90% of their value.($1 = 108.6820 roubles) More

UK house prices rose again in February, defying higher mortgage rates and surging inflation to increase the most in cash terms since 1991.The Nationwide House Price Index climbed at an annual rate of 12.6 per cent in February, up from a record January rise of 11.2 per cent. The price of a typical UK home is now £29,162 more than a year ago — the largest year-on-year increase recorded by the lender.Robert Gardner, Nationwide’s chief economist, said a combination of “robust demand and limited stock of homes on the market” had kept upward pressure on prices, despite inflation reaching a 30-year high and pushing borrowing costs upward.“The continued buoyancy of the housing market is a little surprising, given the mounting pressure on household budgets from rising inflation . . . the squeeze on household incomes has led to a significant weakening of consumer confidence,” he said.The month-on-month increase in house prices for February was 1.7 per cent.he average price of a home in the UK is now £260,230 — and has increased more than £44,000 since February 2020, before the start of the pandemic.Gardner said the uncertain economic outlook, particularly with war in Ukraine further denting confidence and inflation expected to rise, would mean house price growth would slow in the year ahead.“Housing affordability has already become more stretched, in part because house price growth has been outstripping earnings growth by a wide margin since the pandemic struck,” he said.“The price of a typical home is now equivalent to 6.7 times average earnings, up from 5.8 in 2019.” More

Australia’s economy is bigger than it was before the pandemic following a strong rebound in the fourth quarter of last year, when consumers emerged from lockdown to spend heavily over Christmas. Gross domestic product grew 3.4 per cent in the final three months of 2021, in stark contrast to a 1.9 per cent contraction in the third quarter, when restrictions introduced to quell an outbreak of the Delta variant threatened to push the country into recession.With an election due to be called after the budget this month, Josh Frydenberg, Australia’s treasurer, attributed the rebound to the government’s financial policies. He said the spread of Omicron and the war in Ukraine would not derail the economic performance.“Australians and Australia are world beaters,” said Frydenberg. “We have one of the highest vaccination rates in the world, one of the lowest mortality rates in the world and now, unquestionably, one of the strongest economic recoveries in the world.” Australia introduced some of the strictest global lockdown rules in 2020, including closing its borders. Restrictions were reimposed in 2021 after the emergence of the Delta variant.Gareth Aird of Commonwealth Bank said that Australia’s economy was now larger than before the pandemic after GDP growth hit its equal strongest quarterly growth rate since March 1976. Consumers, who have accumulated A$250bn (US$181bn) of savings since the start of the pandemic, drove the recovery. Spending on hotels, cafés and restaurants rose 24 per cent in the quarter while expenditure on recreation and culture grew 17 per cent. Clothes and footwear sales were up more than 40 per cent.Josh Williamson, an analyst at Citigroup, said that consumers had offset declining business and public sector investment. “The only reason the economy managed to finish the year so strongly was because household consumption increased by a massive 6.3 per cent,” he said.“Stated differently, households contributed 3.2 percentage points to the 3.4 percentage points of growth in the fourth quarter.” 

Exports fell by 1.5 per cent with lower coal, metals and mineral fuels shipments offsetting robust growth in cereals. Paul Bloxham, an economist with HSBC, warned that the impact of the Omicron variant would weigh on first quarter numbers. “Nonetheless, retail sales still rose in January and falling Covid-19 case numbers, as well as rising mobility indicators, suggest first-quarter GDP will slow, not fall,” he added.The GDP data came in below forecasts from the Reserve Bank of Australia, which has yet to raise interest rates despite above-target inflation. The Reserve Bank of New Zealand has raised rates three times in the space of six months to curb inflation. Williamson said that the war in Ukraine would probably make central banks more dovish and did not expect the cash rate to rise in Australia until August. More

Good morning. There was a lot of positive response to Tuesday’s letter. As it turns out, there is a big audience for an FT journalist prepared to admit he’s been an ass. We will bear this in mind in the future. Today the topic is big moves in European sovereign credit and the lack of big moves in corporate credit, particularly in the US. We are curious to hear your thoughts on both topics. Email us: [email protected] and [email protected] have consequencesBond markets are pricing in a recession in Europe. Below are 10- and 2-year sovereign yields for the US, Germany and the UK. The move in the German and UK long bonds just between Monday and Tuesday — 21 and 28 basis points, respectively — is dramatic. The 11 point US move looks like a mere aftershock by comparison.

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A number of closely linked factors might explain the moves over the past few weeks. Recession or not, it makes sense that first the threat and then the arrival of war would push investors towards safe, liquid assets. If things might get bad, you want stuff you will be able to sell to raise cash. Then there is anticipation that central banks will abandon plans to tighten policy. That is visible in the even more dramatic moves in 2-year bonds. In case there was any doubt, here are the market-implied eurozone policy rates for 2022, from yesterday and two weeks ago. Over that period, the market has gone from anticipating rates pushing almost to positive territory to predicting that they will not move at all:Flights to safety and spooked central banks are not the whole story here, though. Consider this equally dramatic chart of the stock prices of four large European banks, which I chose on the grounds that they do not have much direct exposure to Russia:Banks are very sensitive to rates, but they are equally sensitive to the economy. The chart above does not tell a happy story about the effect of the war in Ukraine on European and UK growth. We tend to agree, then, with Benjamin Jeffery, rates strategist at BMO Capital Markets, who told our colleague Kate Duguid this about the big move in sovereign yields: The move in longer-dated rates is evidence of both a bet on a slowing economy and safe-haven demand. The initial move was mostly flight-to-quality driven, but at this point it’s going to be hard for Germany to avoid a technical recessionPseudonymous Twitter banking analyst JohannesBorgen has an excellent thread about why European banks are getting whacked. He points out that the decimation of Russian asset values, while it will be painful for some banks, is not enough to explain the broad and deep stock price declines. Nor are rates. It seems the stagflation Unhedged has mentioned as a side-effect of the war is now being priced in. He makes another important point, wars make big, unpredictable things happen: A bank could do an illicit (sanctioned) trade — not even on purpose, just because there are so many new rules happening in so little time, or because of a rogue agent. As BNP remembers, this can be expensive. With all financial plumbing (Swift, correspondent banking, payments from Russia) in a storm, Herstatt [ie settlement] risk is not entirely excluded: a large settlement problem could trigger big losses. And, of course, with all the volatility and inevitable losses, especially for leveraged investors, we could see funds blow up — and some banks taking a hit. This point is probably important to keep in mind as we try to understand not just bank stocks, but all asset prices in the weeks to come. Wartime means pricing in more unknown unknowns. Banks are often the first to be hit by these unidentified risks, but generally not the last.Dispatches from credit landCredit is partying on, but no party lasts for ever. Will partygoers leave in a slow trickle, or in a stampede?The staid credit analysts at S&P suspect the former. Jon Palmer and Nick Kraemer write that leveraged loans — bank loans to indebted firms — will start defaulting more often later this year, but at a historically modest rate. Yet halfway through a largely optimistic note, there is this morsel of worry:Over two-thirds of leveraged loan issuance in 2021 was covenant-lite [ie, having fewer protections for lenders], with total covenant-lite issuance for the year ($563.5bn) shattering the previous annual record. Investors were very comfortable moving down in credit quality, with ‘B-’ or lower debt issuance more than doubling in 2021 from the previous high in 2020. Investor demand continued to drive strong ‘B-’ or lower leveraged loan issuance in January.More than three-fifths of ‘B-’ or lower leveraged loan issuance in 2021 was for mergers and acquisitions . . . The heavy volume of recent M&A activity could spell weakness in the index should the economy sharply decelerate.This is not new. For years, low yields have given borrowers a leg-up on lenders. What’s different now is the pandemic. In a textbook recession, you might expect a wave of defaults to wash out all but the most creditworthy of borrowers. That didn’t happen this time, as Allianz Research explained in October:We estimate ceteris paribus that the global economic shock could have resulted in a 40 per cent surge in worldwide insolvencies in 2020. But since 2020 ended with a 12 per cent decrease in insolvencies, it means that the massive state interventions and further extensions of ‘whatever it takes’ policies prevented more than 35 per cent of insolvencies globally, at least temporarily.Huge fiscal support worldwide and loosened bankruptcy rules in parts of Europe turned imminent doom into a mild boom. Easy money encouraged more lax lending. Record covenant-lite debt issuance followed. And to some investors, governments have only succeeded in putting off the pain. Here’s Dan Zwirn of Arena Investors:What you have is three sailors all drunkenly keeping each other up. One is [private equity], paying tremendous multiples of unlevered free cash flow on enterprises. The second is leveraged loan providers lending far too much, for far too long, at terribly low spreads . . . And then you have a CLO [collateralised loan obligations, ie, bundles of leveraged loans] market that is willing to wave it in because, ultimately, the preponderance of the people in the capital structure don’t view themselves as bearing the risk. So therefore [CLOs] will keep getting printed, and keep hungering for more debt, and keep creating a perception of ready and able refinancing, until they don’t, at which point it will all spiral backward the other way.Zwirn argues metrics like the default rate are susceptible to “mass delusion”, where a cov-lite, low-rate environment lets most borrowers wriggle out of default. He likes measures that are harder to trick, like debt-to-cash flow ratios.Others are sceptical of relying on ratios. Martin Fridson at Lehmann Livian Fridson Advisors, in an analysis of what best predicts credit risk, drew this conclusion:A key implication of our findings is that high-yield investors should be wary of, and perhaps ignore altogether, simplistic claims about relative value that merely invoke one particular financial ratio. This is so even if some otherwise well-informed analysts describe the cited ratio, eg, total debt/ebitda, free cash flow, as the “gold standard” for measuring credit risk.Fridson thinks rating agencies tend to be pretty accurate. I’m not sure who’s right, so I asked someone who looks at much different data — Dan North, a veteran economist at Euler Hermes. The firm is a trade credit insurer, meaning it guards against companies defaulting before they pay for goods. If there are disturbing rumblings on the ground, he might well hear them early. Here’s North’s take:[Worries about credit weakness hiding under the surface] may be right. But from where we sit, we don’t really see that. We have a pretty good pulse on what’s actually happening in terms of payments. One of the reasons why is that in our policy contracts, we require the policyholder to tell us every month who is paying them late, how much in dollar terms and how far past due they are . . . These are payments for trade, not so much payments for credit. And it’s a little bit more discretionary: if you are issuing a bond, you have to make a payment, otherwise you’re in big trouble.The bottom line is that credit demand is strong, and already-slow normalisation could wane further if the war in Ukraine prolongs the global interest rate rising cycle. Credit’s real test will come when rate increases start kicking in. How the party ends depends a lot on the punchbowl masters at the world’s central banks. (Ethan Wu)One good readUkraine is winning the meme war. More